04/23/2024 | News release | Distributed by Public on 04/23/2024 13:00
With three out of four small business owners in Canada expecting to exit their business within the next ten years, the federal government's proposals to introduce employee ownership trusts (EOTs) presents a new succession planning opportunity. An EOT is a Canadian-resident trust that holds shares of qualifying businesses for the benefit of employees to facilitate succession and promote employee ownership of small and medium-sized businesses.
The proposed EOT rules will allow employees to borrow from the business to finance a buy-out with an extended repayment period and a longer capital gains deferral period for the retiring owners. This is intended to help employees overcome the challenge of having to finance the acquisition from their personal savings. Canada's proposal draws inspiration from successful models implemented in the US and UK.
The proposed EOT rules are included in Bill C-59 with one notable exception. The bill doesn't include the proposed temporary tax exemption on up to $10 million in capital gains realized on a sale to an EOT for the 2024 to 2026 tax years, if certain conditions are met. Budget 2024 clarified that the exemption must be shared in an agreed-upon manner where multiple owners disposing of their shares to an EOT as part of a qualifying business transfer meet the exemption conditions. This exemption was first announced in the 2023 Fall Economic Statement. If enacted, the EOT regime will come into effect retroactively on January 1, 2024.
A qualifying business is a Canadian-controlled private corporation (CCPC) controlled by a trust, where:
Note that certain individuals, corporations, partnerships, and trusts may generally be considered "related" or "affiliated" with each other for tax purposes when there's a controlling interest between them.
A trust is generally considered an EOT if it's an irrevocable trust resident in Canada and meets the following requirements:
Trust Property: The trust must hold a controlling interest in the shares of one or more qualifying businesses and the shares must account for 90% or more of the FMV of the property of the trust. Note that more than 50% of current employee beneficiaries must approve certain fundamental changes to the trust property, such as ceasing control of a qualifying business.
Beneficiaries: The trust must be set up exclusively for beneficiaries that are either current or certain former employees of the qualifying businesses, who don't own:
In addition, the capital and income interests of all beneficiaries must be calculated using a reasonable and equitable method based solely on any combination of their length of service, remuneration, and hours worked. An EOT can provide different distribution formulas for current versus former employees, for each of their income and capital interests in the trust.
Trustees: Each trustee must be a Canadian resident individual, or a Canadian corporation licensed or authorized to serve as a trustee and must all have equal voting rights related to the trust. At least one-third of the trustees must be beneficiaries who are current employees of the qualifying business. Generally, all trustees must be elected within the past five years by certain current employees of the qualifying business; otherwise, at least 60% of all trustees must be at arm's length with anyone who sold shares of the qualifying business to the EOT. Furthermore, the group of trustees must also not be comprised of individuals or corporate directors that held 50% or more of the FMV of the debt or shares of the qualifying businesses (alone or together with any related or affiliated persons or partnerships) before the time the qualifying businesses became controlled by the trust.
The proposed EOT rules offer tax advantages to both the former owners and purchasing employees of a qualifying business. Even though EOTs are generally taxed like other personal trusts whose undistributed income is taxed at the top personal marginal tax rate, they would offer the following benefits:
While the government has proposed tighter intergenerational business transfer rules, the EOT rules present another succession planning opportunity. Selling to employees can be a great option-and could include significant tax savings-if the owner is unable to find or doesn't wish to sell to a third-party buyer, and when family members are uninterested in taking over the business.
If you're planning to exit your business in the near future, we can help with your succession planning. For more information on whether you and your business can benefit from employee ownership trusts, contact your local advisor or reach out to us here.
Disclaimer
The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.
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