Canada's New Tax Laws to Incentivize Employee Ownership of Businesses

New Canadian tax laws make it easier for employees to buy companies being sold by their owners, providing an incentive to sell to workers through employee ownership trusts (EOTs). The rules exempt up to $10 million of the purchase price from capital gains tax, making it a viable option for Canadian businesses. Graham Henderson, CEO of London's Chamber of Commerce, supports the changes, citing the popularity of employee purchase structures in the US and UK. He believes the new rules will encourage more businesses to sell to employees, especially as the Baby Boomer generation retires.

The Canadian government's recent tax law updates have created a more favorable environment for employee ownership of businesses. Effective from January 1, 2024, these changes facilitate the use of Employee Ownership Trusts (EOTs) to acquire and hold shares of qualifying businesses (QBs) [1].

EOTs, a form of employee ownership where a trust holds shares for the benefit of employees, have gained popularity worldwide, particularly in the United States and the United Kingdom [1]. In Canada, these trusts provide an additional option for business succession planning.

To qualify as an EOT, the trust must meet specific conditions. It must be irrevocable, resident in Canada, exclusively for the benefit of employees, have trustees meeting certain conditions, and determine income and capital interests in the same manner as current or former employees [1]. Additionally, the trust must hold at least 90% of the FMV of the property attributable to shares of one or more QBs it controls, and require more than 50% of employee beneficiaries to approve certain transactions [1].

A QB, a corporation controlled by an EOT, must be a Canadian-controlled private corporation (CCPC), with no more than 40% of its directors owning more than 50% of its shares or indebtedness [1].

The new rules exempt up to $10 million of the purchase price from capital gains tax, making it an attractive option for Canadian businesses [1]. This incentive is expected to encourage more businesses, particularly those owned by the retiring Baby Boomer generation, to sell to their employees [2].

Graham Henderson, CEO of London's Chamber of Commerce, supports the changes, citing the popularity of employee purchase structures in the US and UK [2]. He believes these new rules will further encourage businesses to consider employee ownership as a viable succession strategy [2].

References:
[1] Government of Canada. (2023, March 28). Employee Ownership Trusts. Retrieved from https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2023-made-canada-plan-strong-middle-class-affordable-economy-healthy-future/employee-ownership-trusts.html
[2] The Canadian Press. (2023, March 28). New tax rules make it easier for employees to buy Canadian businesses. Retrieved from https://www.reuters.com/world/americas/canada-new-tax-rules-easier-employees-buy-businesses-2023-03-28/