Two separate, asymmetric consequences — a possible bad-debt election for the seller, and a mandatory reduction of the buyer's own tax attributes that the buyer cannot avoid or redirect.
Short answer
A vendor take-back note that carries interest is a “commercial debt obligation” under the Income Tax Act the moment it is signed, regardless of how informally a later reduction is documented: s.80(1) defines it as “a debt obligation issued by the debtor (a) where interest was paid or payable by the debtor in respect of it pursuant to a legal obligation.”
On the seller’s side, s.50(1) lets a creditor holding a debt “established by the taxpayer to have become a bad debt in the year” elect to be “deemed to have disposed of the debt…at the end of the year for proceeds equal to nil and to have reacquired it immediately after the end of the year at a cost equal to nil”, crystallizing a loss — but only where the debt is genuinely bad, not merely reduced as a commercial accommodation between two people who get along. On the buyer’s side there is no election and no choice: s.80(3) provides that where the obligation “is settled at any time, the forgiven amount at that time in respect of the obligation shall be applied to reduce at that time, in the following order, (a) the debtor’s non-capital loss for each taxation year that ended before that time…”, before moving on to other tax attributes such as undepreciated capital cost. The buyer does not get to decide where the forgiven amount lands, and no filing or third-party notice is required for the grind to apply — it is discovered only when the buyer tries to use a loss pool that is no longer there.
VTB written off by the seller and forgiven in the buyer’s hands traces the full arithmetic: a $310,000 write-down that read as a straightforward kindness to a struggling buyer extinguished the buyer’s entire non-capital loss pool under s.80(3) before touching anything else.
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