A company can outlive its owner. Hence, every small business owner running a successful business should give thought to their exit from the business. You have multiple options: transfer the business to family, sell it to a third party, or dissolve it. From 2024 onwards, you can also sell your business to the employees who have worked hard to bring the business to the scales. The Canadian government introduced Employee Ownership Trusts (EOTs) in Budget 2023 and brought it into effect from January 1, 2024. EOT helps businesses keep the culture intact and enhance long-term sustainability as employees now have a share in the company’s success and profits. The Canada Revenue Agency (CRA) has laid down requirements for establishing and working EOT and is offering tax benefits to make this option of succession planning attractive.

In this article, we will understand EOT’s structure and workings and how to start establishing one.

The Structure of an Employee Ownership Trust

The structure of the EOT is that of a trust that holds a controlling interest in a Canadian-controlled private corporation (CCPC) (51% stake). The beneficiaries of the trust are the company’s employees. As a controlling shareholder, EOT will have a significant say in business operations and other critical business decisions. This way, EOT can align the employees’ interests with the company’s long-term success. While EOT has the structure of a trust, it has special considerations. For instance, the 21-year deemed disposition rule that applies to certain trusts does not apply to EOT.

To establish an EOT, the company must demonstrate to the CRA through positive cash flow and a strong business plan with a clear growth strategy to sustain employee ownership. Like every trust, the EOT is operated by an independent trustee, whom the company’s management or shareholders do not influence. The trustee can be an employee, independent professional, or a combination of both and works towards the benefit of the employees. The trust has to file annual returns and maintain detailed records of all activities, including acquiring and distributing shares.  

What’s in it for the business owners? They need not look for a buyer for their business. They can sell the shares gradually over a period of time, which could reduce the capital gain tax liability. This will remove the anxiety around job security and the work process when a third party acquires your business.

Now that you have a broader picture of the EOT, here’s a quick guide on how to get started. Note that these are just basic steps, and each step will need a detailed discussion with a professional to navigate through the tax laws and work out the finances.

How Does Employee Ownership Trust Works?

Trust Deed: The EOT begins with creating a trust deed that states the terms and conditions of operating the trust. The deed specifies the criteria for employee participation, how shares will be acquired and managed, how profit will be distributed, how trustees will be appointed, and their roles and responsibilities.

Trustees: The next step is to appoint trustees in accordance with the trust deed. The trustee will manage the trust’s assets on behalf of the employees with complete transparency, maintaining records of all trust activities and financial transactions. They also ensure the trust files its tax returns and votes on the company’s board on behalf of employees. 

Transfer Shares to the Trust: As a business owner, you will sell at least 51% of the company’s shares to the EOT, thereby handing over the company’s control to the trust. The EOT has to secure finance to buy the company’s shares. It can consider options such as:

  • Future Earnings of the Company: The EOT can gradually buy the company’s shares using the company’s future earnings.
  • External financing: The EOT can take a loan to buy shares directly from the business owner in one go and use the company’s earnings to repay the loan.
  • Contributions from the company: Business owners fund transfer the shares directly to EOT in return for a promissory note that the trust will repay the amount over time from the company’s earnings. While the transfer happens in one go, the payments are made over time.
  • Contributions from the employees: Employees can voluntarily contribute some amount to the trust through payroll deductions or bonuses to acquire additional shares. This option alone may not fund the 51% stake sale but can be used as a source of funding.

Daily working of the Trust: Once the Trust is established, the trustee manages the rights that come with the shares, such as the right to receive dividends and vote on major decisions such as board member appointment.

In case of any conflict between employees, trustees, and the company management, the EOT can appoint an independent mediator or establish a conflict resolution committee.

Tax Benefits of Employee Ownership Trust

The income earned by the EOT is distributed to beneficiaries and is taxed at the beneficiary level as per their marginal tax rate. If the income distributed is dividends, it will be eligible for the dividend tax credit. However, if the trust retains any income, it will pay tax at the top personal marginal tax rate.

Even business owners have tax benefits. The government has introduced a temporary capital gains exemption for the 2024, 2025, and 2026 taxation years. If companies make a qualified sale of shares to the EOT in these three years, the first $10 million of gains realized will be exempt from capital gains tax, subject to certain conditions. The $10 million exemption is shared by all the owners who transfer their shares to the EOT.

Contact Black and Gill LLP in Toronto to Help You Establish and Manage an Employee Ownership Trust

The tax benefits are complicated and need to meet many requirements. A professional tax expert and estate planner can help you navigate the financial and tax complexities of establishing and maintaining an EOT. At Black and Gill LLP, our accountants and tax experts can provide services such as filing taxes, preparing accounts, and financial consultation. To learn more about how Black and Gill LLP can provide you with the best accounting and tax expertise, contact us online or call us at 416-477-7681 to learn more about how we can help you and your business.