Employee Ownership Trusts in Canada
January 29, 2024 · 3 mins
The evolving landscape of Employee Ownership Trusts (EOTs) and the accompanying tax incentives could paint an intriguing picture for qualifying businesses poised to change hands from 2024 to 2026. To encourage business owners to sell their companies to EOTs, the federal government has announced that the first $10 million in capital gains realized on the sale of a business to an EOT will be tax exempt.
Over the next 10 years, a significant number of Canadian businesses are expected to undergo transitions in ownership as entrepreneurs approach retirement. The anticipation of this sizable shift emphasizes the need for innovative strategies, such as the introduction of EOTs, to ensure seamless succession while preserving the businesses’ core values.
Changes Unveiled: 2024-2026
The timeframe between 2024 to 2026 marks a critical juncture for businesses considering EOTs. This period introduces pivotal changes and improved tax incentives aimed at facilitating a smoother transition.
How do EOTs Work?
An EOT would generally be set up as follows:
- EOT is formed with the employees of the business being named the beneficiaries of the trust;
- The trust then negotiates terms and conditions for the purchase of the business’s shares. Debt financing is arranged to allow the EOT to purchase the shares, which the business itself might provide; and
- EOT provides debt repayments over time using the earnings distributed from the business.
Qualifying for an EOT
To qualify for an EOT, businesses must meet specific criteria, including being a Canadian-controlled private corporation (CCPC) which would require it to meet certain governance and board representation requirements. This strategic alignment ensures that EOTs are established with a genuine commitment to employee ownership, fostering collaboration and shared success.
EOT Advantages
The benefits associated with EOTs are multifaceted. Business owners gain a tax-efficient exit strategy (see below) while maintaining a lasting legacy within the company. Employees, in turn, acquire a direct stake in the business, leading to increased morale, productivity, and loyalty. The synergy created by EOTs aligns the interests of both owners and employees, laying the foundation for sustainable business growth.
Tax Benefits of EOTs in Canada
- The first $10 million in capital gains realized on the sale of a qualifying business would be tax exempt;
- No 21-year deemed disposition rule, where typically a trust is deemed to dispose of its capital property every 21-years;
- Shareholder loan repayment period extended from 1-year to 15-years for any amounts loaned to an EOT from a business to purchase shares of that business; and
- Extending capital gains reserve from 5-years to 10-years, such that the vendor can defer recognizing part of the capital gain for up to 10-years.
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For business owners in Canada considering an exit between 2024 to 2026, EOTs will be a structure that they may want to consider when evaluating options for a transition of their business. Companies with stable cash flow and profits are likely the businesses that will be considering EOTs. The tax exemption on the first $10 million in capital gains, coupled with the other unique advantages of EOTs, have potential for this structure to be an active succession planning option through to 2026.
Peter MacSwain
peter.macswain@confederationgroup.ca
