Employee Ownership Trusts

The recent introduction of Employee Ownership Trusts (EOTs) offers a promising new avenue for business owners to ensure a smooth and tax-efficient transition of business ownership to their employees.

 

Understanding Employee Ownership Trusts

An Employee Ownership Trust (EOT) is a specialized trust designed to hold shares of a corporation for the benefit of its employees. This structure allows employees to acquire ownership of the business without the need for direct financial investment. EOTs are particularly beneficial for facilitating the purchase of a business by its employees and provide a viable option for business owners looking for succession planning strategies.

 

Recent Legislative Updates

The 2024 Federal Budget introduced significant changes to support the establishment and utilization of EOTs. These updates, effective from January 1, 2024, aim to eliminate barriers in tax legislation, provide new tax incentives, and define qualifying conditions for EOTs.

 

Key Features of EOTs

1. Funding the EOT: Typically, the business being sold provides the necessary funding to the EOT for the purchase on behalf of the employees. This loan is then repaid over time from the future profits of the business.
2. Qualifying Conditions: An EOT must be a Canadian resident trust holding shares of a qualifying business for the benefit of its employees. It must maintain a controlling interest in the shares of the business, with all or substantially all of its assets being shares of qualifying businesses.
3. Employee Beneficiaries: Qualifying employees include all individuals employed by the business, excluding those with significant economic interests or those who haven't completed a reasonable probationary period. Former employees are also eligible if they were employed while the business was controlled by the EOT.
4. Governance: At least one-third of the trustees must be current employees, and at least 60% of trustees must be independent of the former owners. Employee beneficiaries must approve significant changes impacting their employment or beneficial interest in the business.

 

Tax Treatment and Incentives

The new legislation introduces several tax incentives to facilitate the creation and operation of EOTs:

• Capital Gains Exemption: The first $10 million in capital gains realized on the transfer of shares to an EOT is exempt from tax for the 2024, 2025, and 2026 taxation years​
• Ten-Year Capital Gains Reserve: Extends the capital gains reserve period to ten years for sales to an EOT, allowing deferred consideration over an extended period.
• Shareholder Loan Exceptions: Extends the repayment period for shareholder loans from one to fifteen years and provides exceptions for deemed interest benefits on low-interest loans.
• 21-Year Rule Exception: Qualifying EOTs are exempt from the 21-year deemed disposition rule, allowing shares to be held indefinitely for the benefit of employees.

 

Benefits and Considerations

EOTs offer numerous benefits, including:

• Tax Efficiency: Providing a tax-efficient exit strategy for business owners.
• Employee Engagement: Ensuring the business remains under employee control, fostering a sense of ownership and continuity.
• Enhanced Retention: Enhancing employee engagement and retention by aligning their interests with the business's success.

 

However, these rules require the owner to divest a controlling interest in the business and may necessitate ongoing involvement to ensure its success. The recent $10 million capital gains exemption is expected to make EOTs an increasingly attractive option for business transitions​

 

Conclusion

Employee Ownership Trusts represent a significant advancement in succession planning, offering business owners a viable option to transition ownership to their employees while benefiting from favorable tax treatments.