Canada’s Employee Ownership Trust (EOT) framework is now in place with the recent enactment of Bill C-59 and Bill C-69. This is exciting news for Canadian business owners, providing a new exit strategy that will likely change the landscape of corporate succession planning.
What is an EOT?
The Canadian EOT framework is based on similar models successfully implemented in the U.S. and the U.K. Designed to facilitate business succession, EOTs allow the ownership of a Canadian-Controlled Private Corporation (CCPC) to be transferred to its employees. The process involves the sale of a majority of shares to the EOT, which holds them in trust on behalf of all employees. The EOT becomes the legal owner of the shares, but the employees become the beneficial owners.
Tax Benefits of EOTs
Capital Gains Exemption – Bill C-69 introduces a temporary exemption from taxation for the first $10 million in capital gains realized on the sale of a business to an EOT. This substantial tax incentive applies to qualifying share dispositions occurring between Jan 1, 2024, and December 31, 2026.
10-year Capital Gains Reserve – For qualifying transfers, the capital gains deferral period will be extended from five years to ten years. This means that only 10% of the gain on deferred proceeds must be brought into income annually, instead of the usual 20% under the five-year reserve period.
Shareholder Loan Exclusion – In normal circumstances, shareholder loans must be repaid within one year to avoid paying taxes on the loaned amount. Under the new EOT framework, the repayment deadline is extended to 15 years, allowing businesses to lend funds to an EOT to finance the purchase of shares and repay that loan over 15 years without adverse tax consequences.
Exception to the 21-Year Rule – As EOTs are intended to hold shares indefinitely, they will not be subject to the 21-year deemed disposition rule that applies to most trusts. This means that, unlike other trusts, EOTs won’t have to pay tax on any unrealized gains every 21 years.
EOT Requirements
- An EOT must be an irrevocable trust, resident in Canada, and exclusively for the benefit of employees
- EOTs should hold a controlling interest in one or more qualifying businesses, with shares accounting for 90% or more of the fair market value (FMV) of the trust’s property
- Certain transactions, such as changes to the EOT’s property must be approved by more than 50% of current beneficiaries
- EOTs must comply with specific trustee conditions regarding factors such as current and previous controlling interest in the company
- The income and capital interests of the beneficiaries can only be determined based on any combination of their tenure at the company, hours worked and remuneration received
Final Thoughts
With 3 out of 4 business owners expected to exit their companies over the next decade, the establishment of EOTs in Canada presents a welcome new avenue for succession planning. The temporary capital gains exemption and other tax incentives included in the framework make EOTs a financially attractive exit strategy. In countries where they have already been successfully implemented, EOTs have been shown to improve business performance by creating a resilient and employee-centric business model. They offer a pathway to ensure the continuity of a business’s legacy while fostering a collaborative and invested workforce.
To learn more about the new EOT framework, visit the CRA’s dedicated EOT page, or reach out to our expert team.
This article was written by the NVS Professional Corporation team, your knowledgeable Barrie and Markham accountants. The content is intended as a general guide for informational purposes only. For specialist advice tailored to your specific situation, please reach out to our expert team.
