Anonymised, illustrative composite. Ordinary security for a vendor-financed sale, a right to reacquire shares on default, and a deemed-control rule that reached back into a deal everyone believed was closed.
At a glance
A retiring machine-shop owner sold his company to its general manager of eleven years, who could not fund the full purchase price through bank financing alone. The parties agreed on a $1.1 million vendor take-back note, secured by giving the seller a contractual right to reacquire the shares at a formula price if the buyer defaulted on scheduled payments — standard security for a deal structured this way, meant to protect the seller's position rather than to give him any ongoing role in the business.
ITA s.251(5)(b) provides that where a person has a right under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, “to, or to acquire, shares of the capital stock of a corporation…the person shall…be deemed to have the same position in relation to the control of the corporation as if the person owned the shares at that time”. The right the seller took as security fell within that language directly: a contingent contractual right to acquire the very shares he had just sold.
The subsection does carry an exception, but a narrow one: it does not deem control where “the right is not exercisable at that time because the exercise thereof is contingent on the death, bankruptcy or permanent disability of an individual.” A right that becomes exercisable on a missed loan payment is none of those three things, so the carve-out did not apply, and the deemed-control rule reached the buyback right in full.
The seller owned an unrelated small consulting company generating about $180,000 a year in active business income, taxed at the small business rate on the first $500,000 of the combined associated group's income. Once the buyback right deemed him to control the machine shop as well, the two corporations were associated, and the $500,000 small business limit had to be shared between them. With the machine shop's own income now competing for the same limit, the successor's company lost access to roughly $210,000 of small business rate room it had budgeted on, costing an incremental $27,000 to $30,000 a year in higher corporate tax until the note was fully repaid and the right expired.
The right did not need to be exercised to trigger the deemed-control rule — only to exist, contingently, in the seller's favour. The provision is built to catch exactly this kind of security arrangement, because a right to reacquire shares on a payment default gives the seller genuine ongoing leverage over the company even while he holds no shares at all, and the tax rules treat that leverage as equivalent to ownership for control-testing purposes. The carve-out exists precisely to distinguish this commercial security scenario from the narrower cases — death, bankruptcy, permanent disability — where Parliament decided a contingent right should not be treated as present control.
Once flagged, the parties amended the security documents to replace the buyback right with a share pledge and a general security agreement instead — giving the seller equivalent practical protection on default (the ability to enforce against the shares as collateral through a realization process) without a standing contractual right to acquire the shares that s.251(5)(b) would catch. The amendment was not retroactive, so the successor's company remained associated with the seller's consulting company for the tax years the original buyback right was in place before the fix.
Structuring the security as a pledge from the outset, rather than a right to reacquire the shares, would have avoided the deemed-control problem entirely at no cost to the seller's actual protection on default — the two structures give a secured vendor roughly the same practical remedy, but only one of them falls inside s.251(5)(b)'s language. The years of lost small business deduction before the fix were not recoverable.
Any vendor-financing security that gives the seller a right to acquire or reacquire shares, rather than a right to enforce against them as pledged collateral, is worth testing against s.251(5)(b) before it is signed. The carve-out is narrow and specific — death, bankruptcy, permanent disability — and a routine payment-default trigger does not fit inside it, however commercially ordinary the security arrangement seems.
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