Canadian Budget Creates Structure for Employee Ownership Trusts

The Canadian government’s proposed 2023 budget creates a framework for employee ownership through employee ownership trusts. The budget states:

Employee Ownership Trusts enable employees to share in the success of their work. They support participation in business decisions and allow workers to receive their share of profits. With more than 75 per cent of small business owners planning to retire in the next decade, Employee Ownership Trusts can also give business owners an alternative succession option… Budget 2023 proposes to introduce tax changes to facilitate the creation of Employee Ownership Trusts. Selling the business to employees would become a more attractive proposition for owners looking to exit, and employee-owned businesses would be able to re-invest more of their profits in growth. The government welcomes stakeholder feedback on how best to enhance employee rights and participation in the governance of Employee Ownership Trusts. These changes would take effect for the 2024 tax year, and would reduce federal revenues by $20 million over five years, starting in 2023–24.

The proposal creates a framework for the trust, but no significant tax incentives. Employee ownership trusts (EOTs) must be domiciled in Canada and have only two purposes: holding shares for employees and making distributions from the EOT to qualifying employees based on the employees’ length of service, pay, and/or hours worked. Distributions would normally be in the form of a dividend. The trust must be for the benefit of employees only, and sellers to the trust are excluded. Companies can set minimum service rules to be eligible. The proposal would require employees to elect a trustee or trustees at least every five years and would prohibit sellers and their families from having more than 40% of the trustee seats or board seats. The proposal does not provide a mechanism for employees actually to own shares or get the value of equity in the company—their benefit comes purely in the form of dividends.

The tax provisions for the plans remove any potentially punitive treatment, but add no significant incentives. Under Canadian law, if you sell an asset and get all the money up front, you must pay capital gains that year. But if you get paid over time, you can pay ratably over up to five years. For EOTs this is extended to 10 years. Canadian law also limits trusts from owning shares for more than 21 years; EOTs will be exempted. The proposal also makes it possible for shareholder loans to the trust to be repaid over up to 15 years.

Although the measure is a step forward, Jon Shell of Social Capital Partners, which was very involved in the coalition trying to create an employee ownership structure in Canada, said that “If this policy stands as described today, there's no good reason to expect any business owner to sell to an EOT in this country, and therefore there's no good reason to expect more employee ownership.”

In Canada, as in most parliamentary systems, the budget is proposed by the ruling party, meaning its chances of leading to legislation are promising. Details on the proposal are available on pp. 7–9 in the "Tax Measures: Supplementary Information" document on the budget page.