Written By Wesley Novotny, Marshall Haughey and Wade Ritchie
The Canadian Department of Finance introduced draft legislation in the 2023 Canadian Federal Budget (Budget 2023) to create employee ownership trusts (EOTs) to facilitate the transfer of a business to the employees of the business. We provided an overview of the rules initially proposed in Budget 2023 in Employee Ownership Trusts—A Useful Tool for Employee Business Ownership?, and recommended various revisions to the proposed rules to improve the tax incentives and ease some of the conditions required to qualify for EOT treatment. The Department of Finance released revised EOT legislation on August 4, 2023, addressing some of our concerns but not the big one—the revised EOT legislation still contained minimal tax incentives.
The 2023 Fall Economic Statement released on November 21, 2023, addresses this concern, making EOTs a viable and attractive structure for vendors of small and medium sized businesses. Specifically, the Department of Finance announced an enhanced $10 million exemption for capital gains realized on the sale of a business to an EOT:
Building on this effort, and to encourage more business owners to sell to an Employee Ownership Trust, the 2023 Fall Economic Statement proposes to exempt the first $10 million in capital gains realized on the sale of a business to an Employee Ownership Trust from taxation, subject to certain conditions.
Few details were provided, although the 2023 Fall Economic Statement states that this incentive would be in effect for the 2024, 2025, and 2026 tax years—suggesting that this incentive could be temporary. More details are expected in the coming months. Regardless, the ability of a vendor to shelter $10 million of capital gains is a significant tax savings and should attract the attention of individuals looking to sell their business. This should also facilitate the succession of small and medium sized businesses to employees.
The proposed EOT rules now contain the following material positive tax features:
- $10 Million Capital Gains Exemption: The first $10 million in capital gains realized by a vendor on the sale of a qualifying business to an EOT may be exempt from taxation in Canada (at least for the 2024, 2025, and 2026 tax years).
- Shareholder Loan Funding: If structured properly, cash from the qualifying business can be used to fund an EOT's acquisition of the business, allowing employees to acquire an indirect ownership interest in the business without any need to directly pay for that interest.
- Extended Capital Gains Reserve: An extended 10-year capital gains reserve for dispositions of a qualifying business to an EOT, which allows a vendor to defer the recognition of a capital gain realized on the sale of a qualifying business to an EOT where all or part of the proceeds from the disposition are receivable after the end of the taxation year.
The proposed EOT rules are set to come into force on January 1, 2024. The newly announced $10 million exemption for capital gains realized on the sale of a business to an EOT has the potential to greatly increase the viability and uptake of EOT structures. Stay tuned for additional Bennett Jones Insights as the EOT rules continue to evolve.
If you have any questions about the proposed EOT rules, or other tax measures in the 2023 Fall Economic Statement, contact any of the authors of this blog.
Please note that this publication presents an overview of notable legal trends and related updates. It is intended for informational purposes and not as a replacement for detailed legal advice. If you need guidance tailored to your specific circumstances, please contact one of the authors to explore how we can help you navigate your legal needs.
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