Overview of the Employee Ownership Trust
Employee ownership is used to describe any arrangement in which a company’s employees may own shares in the company or the right to the value of shares in the company. An Employee Ownership Trust (“EOT”) is a trust fund that holds the shares for the benefit of employees to facilitate succession and promote employee ownership of businesses. The trust may include other purposes as well, such as preserving a company’s legacy, community benefit, or its mission. EOTs also present a great succession planning opportunity. In events where finding a buyer is an uninviting option, selling to employees can be used as an alternative to a third-party buyer.
Drawing inspiration from the United States and the United Kingdom, the 2023 federal budget proposed amendments surrounding EOTs to enable employee participation in decision-making and a share in the success of their work. These proposed amendments include specific criteria for businesses that can qualify as well as the requirements that make a trust an EOT. Although these amendments will be effective January 1 st , 2024, it is important to note that these rules may be adjusted by the government prior to its enactment based on the feedback they receive form stakeholders.
Benefits of EOTs (Employee Ownership Trust)
Businesses choose EOT to maintain the character of their business. EOTs, in Canada, are generally taxed like other personal trusts in which the undistributed income is taxed at the highest marginal tax rate, however, there are other benefits:
- It offers a doubled deferral period for capital gains. An EOT allows for capital gains to be claimed over ten years, instead of the five, pursuant to a qualifying business transfer. A qualifying business transfer occurs when a taxpayer disposes of shares to an EOT for an amount equal to or less than the Fair Market Value;
- Currently, the borrower must include any shareholder loans in their income if it is not repaid by the end of the calendar year. However, EOTs have the option of borrowing
funds from the qualifying business with a repayment period of up to 15 years; and
- Unlike other trust assets with a “deemed disposition” rule of 21 years, EOTs are exempt.
However, if, whenever, the EOT requirements are not met, the deemed disposition rules will apply until it requalifies as an EOT.
In conclusion, despite the proposed restrictive qualification criteria, EOTs are a refreshing addition in the Canadian tax and business succession realm. With ongoing amendments, these new provisions can prove to be a tax-effective way to structure a sale of a business. If your business is contemplating a sale, or if you require any other tax assistance, please contact us!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.