EMPLOYEE OWNERSHIP TRUSTS

Contact Neufeld Legal PC for your incorporation legal work at 403-400-4092 or Chris@NeufeldLegal.com

Employee Ownership Trusts (EOTs) have become a new and attractive option for succession planning available to Canadian business owners. Canadian Employee Ownership Trusts are modelled on their predecessors from the United Kingdom and the United States of America, and offer a unique way to transition a business to employees while preserving its legacy and offering significant tax benefits.

Key Features of Canadian Employee Ownership Trusts

  • New Legislation: The Canadian government introduced specific legislation for EOTs in its 2023 budget, with the rules becoming effective on January 1, 2024. This legislation provides the structure and tax incentives necessary for this business model.

  • Tax-Free Capital Gains: The most significant incentive is a $10 million capital gains exemption for business owners who sell a qualifying business to an EOT. This exemption applies to sales that occur between January 1, 2024, and December 31, 2026. This tax-saving opportunity can be a powerful motivator for a business owner looking to retire or exit their business.

  • Extended Capital Gains Reserve: For sales to an EOT, the standard five-year capital gains reserve is extended to 10 years. This allows the seller to spread out the tax on the sale of shares over a longer period, improving cash flow.

  • Financing Flexibility: A key feature of the Canadian EOT is the relaxation of shareholder loan rules. This allows the business itself to lend money to the EOT to finance the purchase of shares from the owner. The EOT then repays the loan from the company's future profits, and the loan can be outstanding for up to 15 years without adverse tax consequences. This makes it possible for employees to acquire the business without having to use their personal funds.

  • Perpetual Ownership: The 21-year deemed disposition rule for trusts does not apply to EOTs. This means an EOT can hold the business in perpetuity without triggering a taxable event every 21 years, promoting long-term stability and business continuity.

Requirements for a Canadian Employee Ownership Trust

To qualify for the tax benefits and operate as a legal EOT in Canada, a trust must meet several strict conditions:

  • Canadian Resident: The EOT must be a trust resident in Canada.

  • Irrevocable: The trust must be irrevocable, meaning it cannot be undone.

  • Control Requirement: The EOT must acquire and hold a controlling interest (more than 50%) of the company's shares.

  • Beneficiaries: The beneficiaries of the trust must be all current employees of the business (with some exceptions for new employees on probation or those who were significant shareholders). The EOT can also be set up to include former employees.

  • Governance: The board of trustees must have at least one-third of its members as employee beneficiaries. Furthermore, the trustees cannot act in the interest of one beneficiary to the detriment of another.

  • Arm's Length Transaction: The seller must deal at arm's length with the trust and any purchasing entity. The seller cannot retain a controlling interest in either the company or the trust after the sale.

  • Fair Market Value: The sale of shares to the EOT must be at fair market value.

Employee Ownership Trusts vs. Employee Share Ownership Plans in Canada

It is important to differentiate Employee Share Ownership Plans (ESOPs) from the newly introduced EOT structure.

  • EOTs are a specific legal and tax-defined structure designed for succession planning. The trust holds all the shares on behalf of all employees, who are the beneficiaries. The primary benefit for employees is a share of company profits, not direct ownership of individual shares.

  • ESOPs in Canada can take many forms, from simple stock option plans to formal share purchase programs. They are not as strictly regulated as EOTs and don't come with the same specific tax advantages. An ESOP typically involves employees directly acquiring individual shares, often over time.

For business succession planning, including the utilization and deployment of an Employee Ownership Trust, contact our law firm to engage the professional services of an experienced corporate business lawyer. Contact our law firm to schedule a confidential consultation at 403-400-4092 or via email at Chris@NeufeldLegal.com.

* Please note that the flat rates associated with a standard incorporation are strictly limited to a basic incorporation (provincial or federal) and does not involve other matters that might be corrollary to the incorporation process or might be atypical for a standard incorporation, including but not limited to related legal or tax advice, engagement with other governmental bodies or professional bodies, licensing, drafting of pertinent business contracts (i.e., shareholders' agreements), negotiations, disputes, financing, coordination with other companies or other legal structuring.

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