Anonymised, illustrative composite. A machine shop's balance sheet carried four years of accrued management fees owed to its founder, never paid. The buyer's diligence read it as a debt to assume. Part of it was already income the company had not reported.
At a glance
The target machined precision components for the oilfield-services sector, founded and wholly owned by one shareholder who also charged the company an annual management fee for running it. The fee was properly documented and properly deducted each year — the company's tax returns showed it as an expense, reducing taxable income exactly as a real management fee should. What the returns did not show, because nothing on a tax return has to, was that the fee had never actually been paid in cash. Each year's amount sat on the balance sheet as a payable to the shareholder, and by the time the buyer's diligence team pulled the working papers, four years of it had accumulated to $480,000.
The buyer's first read, from a straightforward balance-sheet perspective, was that this was an ordinary related-party liability: a debt the company owed its own shareholder, to be settled, assumed, or forgiven as part of closing, like any other line on the debt schedule.
ITA s.78(1), headed “Unpaid amounts,” does not let a deductible expense owed to a related party sit unpaid indefinitely. Where an amount “owing by a taxpayer to a person with whom the taxpayer was not dealing at arm's length” is still unpaid at the end of the second taxation year after the outlay was incurred, one of two things is required to happen. Either “the amount so unpaid shall be included in computing the taxpayer's income for the third taxation year following the taxation year in which the outlay or expense was incurred”, or the taxpayer and the payee file an agreement in prescribed form, on or before the return-filing deadline for that third year, to treat the amount as paid and re-loaned instead.
Nobody at the company had ever filed that election. On the oldest year's $120,000 fee, the second-year deadline had passed eighteen months before the deal even started, and the mandatory income inclusion had already occurred in the company's tax filings for the year it fell due — whether the company's own return had actually reported it correctly was a separate question the diligence team then had to check. The remaining three years' fees were each on their own clock, the newest with roughly ten months left before its own second-year deadline.
$480,000 total accrued, $120,000 a year across four years. One year's $120,000 was already past its s.78(1) deadline and should already have been added back to income; the diligence team's review of the return for that year found it had not been. That is not a debt the buyer would “assume” at closing — it is a reassessment risk that existed the moment the second-year deadline passed, independent of who owns the company afterward.
Read the unit. A related-party payable that has sat unpaid past the s.78(1) clock is not a liability in the ordinary sense the way a bank loan or a trade payable is. A bank loan is a claim the buyer inherits and can negotiate, refinance, or pay off, and nothing about the passage of time changes what it is. This payable, once the second-year mark passes without an election, stops being merely a debt and becomes a statutory income inclusion the company has already triggered — whether or not it ever gets reported correctly is a compliance question, but the inclusion itself is not optional and does not wait for a buyer to notice it.
The election route in paragraph (b) is the only way to stop the clock, and it has its own mechanics. Filed on time, “the amount so unpaid shall be deemed to have been paid by the taxpayer and received by that person on the first day of that third taxation year”, with the ordinary withholding rules under s.153 (other than the instalment-remittance rule in s.153(3)) applying as if the payment had actually been made. And on the other side of that same deemed payment, “that person shall be deemed to have made a loan to the taxpayer on the first day of that third taxation year”, in the amount unpaid, net of any withholding. The unpaid management fee becomes, on paper, a fee that was paid and then immediately lent back — a real shareholder loan going forward, on the company's books and subject to whatever rules apply to shareholder loans, rather than a silently aging deduction.
The parties reworked the closing mechanics rather than the price. For the year already past its deadline, the seller agreed the company would file an amended return reflecting the required income inclusion before closing, with the seller bearing the resulting tax as a pre-closing liability under the purchase agreement's tax indemnity. For the three years still within their windows, the company and the shareholder filed the s.78(1)(b) election before closing, converting each year's fee into a deemed-paid, deemed-re-loaned shareholder loan — formal debt the buyer could see, price, and require to be repaid or subordinated at closing, instead of an aging liability with its own hidden trigger dates.
Left alone, each year's fee would have kept crossing its own second-year mark on schedule, adding a fresh $120,000 to the company's income roughly once a year for as long as the payable sat unpaid — a recurring income inclusion the new owner would inherit without ever having agreed to it, discovered only when each year's return came due or when CRA eventually reviewed the account. Treating the whole $480,000 as a static number to be negotiated down, rather than as a series of deadlines already partly missed, would have left that exposure sitting on the company after closing with the buyer's name on it.
The tell was in the account name itself: “accrued” management fees, unchanged for four straight years on the trial balance, with no interest charged and no repayment schedule anywhere in the minute book. A payable to a non-arm's-length party that never moves is not ordinary trade credit. Ask how old it is, year by year, before asking how much it is.
Canadian small-business transaction data is not published anywhere, so most valuations in this country quote an American benchmark. The Deavo–Treadstone Acquisition Index is a daily record of Canadian listings built to replace that: asking-price distributions by province and city are published now, and days on market, departure rates and asking-to-sale spreads follow as the series lengthens. Leave an email and we will tell you as each measure lands.
No pitch, no listings. One email when the first report lands.
