Employee Ownership Trusts Announced In Canada

EOTs: A New Way To Sell A Business In Canada

Canadian business owners have a new option to consider when contemplating their exit strategy: Employee Ownership Trusts (EOTs). 

Announced yesterday in the 2023 Canada budget is draft legislation to facilitate the use of EOTs. 

EOTs allows employees to acquire ownership in their workplace, creating a more engaged and committed workforce. In addition, EOTs can provide tax advantages for both the business owner and the employees, depending on the specific structure of the trust.

EOTs have seen success in countries such as the United Kingdom, where they have grown in popularity over the years.

Stikeman Elliot lawyer, Aaron Sigal, highlights the potential advantages of implementing an EOT in Canadian Lawyer Magazine. Business owners who sell their company to an EOT can retain a degree of control, ensuring a smoother transition and continuity of business operations. Furthermore, this structure can provide a more flexible exit strategy for owners who wish to gradually step away from the business rather than sell it outright.

Employee ownership has been shown to improve employee satisfaction, productivity, and financial performance, with workers enjoying greater autonomy and a more significant stake in the success of the company. These benefits can translate to a more robust and sustainable business model that is resilient in the face of economic challenges.

Sigal also emphasizes that EOTs are not a one-size-fits-all solution. It is crucial for business owners to seek professional advice and carefully consider the specific needs of their company before deciding to pursue an EOT. This includes assessing the feasibility, financial implications, and potential impact on the company culture.

Summary of Budget 2023 Press Release Announcing the EOT

Here is a summary of the Canadian federal 2023 budget paving the way for EOTs in Canada.

Budget 2023 proposes to introduce tax changes to facilitate the creation of Employee Ownership Trusts. Selling the business to employees would become a more attractive proposition for owners looking to exit, and employee-owned businesses would be able to re-invest more of their profits in growth.

Creating a framework for Employee Ownership Trusts (EOT) will assist workers in small- and medium-sized enterprises in becoming employee-owners. Data from the United Kingdom suggests that EOTs may be more likely to form in sectors with above-average compensation, such as the professional, scientific and technical services, construction, and manufacturing sectors.

https://www.budget.canada.ca/2023/report-rapport/gdql-egdqv-02-en.html#m32

Proposed Rules for Employee Ownership Trusts

The Canadian government’s 2023 Budget proposes changes to tax rules and the definition of EOTs, extending the capital gains reserve to ten years for qualifying sales, creating an exception to the current shareholder loan rule, and exempting EOTs from the 21-year deemed disposition rule that applies to certain trusts.

Qualifying Conditions and Definitions for Employee Ownership Trusts

To be considered an EOT, a trust must meet specific criteria, such as being a Canadian resident trust, holding shares of qualifying businesses for the benefit of employee beneficiaries, and making distributions to these beneficiaries under a specific formula. The EOT must hold a controlling interest in the shares of one or more qualifying businesses, with the majority of the trust’s assets being shares of qualifying businesses.

Governance and Trust Beneficiaries

Trustees, including corporations serving as trustees, must be Canadian residents. Trust beneficiaries, aged 18 and older, must elect trustees at least once every five years. The beneficiaries of the trust must consist exclusively of qualifying employees, excluding significant economic interest holders and those who have not completed a reasonable probationary period of up to 12 months.

Tax Treatment for Employee Ownership Trusts

EOTs will be subject to the same tax rules as other personal trusts. Undistributed trust income will be taxed at the top personal marginal tax rate, while trust income distributed to beneficiaries will not be subject to tax at the trust level but at the beneficiary level. Dividends distributed from qualifying businesses to EOT beneficiaries will be eligible for the dividend tax credit.

Facilitating the Establishment of EOTs

To accommodate the establishment and use of EOTs, certain existing tax rules will be modified. The five-year capital gains reserve will be extended to ten years for qualifying business transfers to EOTs. An exception will be introduced to extend the repayment period from one to 15 years for amounts loaned to the EOT from a qualifying business to purchase shares in a qualifying business transfer. EOTs will also be exempted from the 21-year rule, which prevents indefinite tax deferral on accrued capital gains.

Coming into Force

These amendments will apply as of January 1, 2024, providing Canadian business owners a new and innovative exit strategy that benefits both them and their employees.