Canadian Government Proposes Significant Tax Incentives for Employee Ownership Trusts

In its 2023 Fall Economic Statement released on November 21, the Canadian government (the ruling party in Parliament)  “introduce[d] a series of new measures to advance the government's economic plan by continuing to build a stronger economy, and provide[d] important updates on key pillars of the government's plan to fight climate change and create great careers for Canadians from coast to coast to coast.” The new measures include a tax exclusion on up to the first $10 million in capital gains from the sale of a business to a qualifying employee ownership trust (EOT) (p. 62 of the PDF version of the Fall Economic Statement). A similar law in the UK has spurred rapid development of EOTs, which are growing at a rate three times that of ESOPs in the U.S., even though the UK is much smaller.

Additionally, the supplementary information for the Fall Economic Statement's tax measures states, "The 2023 Fall Economic Statement confirms the government's intention to proceed with the following previously announced tax and related measures, as modified to take into account consultations and deliberations since their release....Legislative proposals released on August 4, 2023," which include EOTs. We discussed the 2023 EOT proposals in March when they were included in the proposed 2023 budget. The August 4 proposals make various (mostly minor) changes to the March 2023 language. The EOT provisions, if enacted, will come into force on January 1, 2024. While Parliament will have to approve the proposal, its prospects are very good.

Jon Shell of Social Capital Partners in Toronto, who was very involved in the efforts to create an employee ownership law, tells us that the Canadian EOT is not the same as the UK EOT. The UK’s version is primarily a profit-sharing vehicle, while the proposed Canadian EOT allows for internal capital accounts and the direct distribution of shares, meaning that it could be a profit-sharing approach, a capital approach, or any combination of the two. In addition, the proposed Canadian approach allows for different formulas for profit sharing and capital gains, provided they meet the standards in the legislation for equitable treatment of participants. If a Canadian EOT is sold, workers would have a claim on the proceeds using a formula. Shell believes the proposed Canadian approach brings flexibility that will allow for new and creative approaches to employee ownership.

The trust must be domiciled in Canada and have only two purposes: holding shares for employees and making distributions from the EOT to qualifying employees based solely on the employees’ length of service, pay, and/or hours worked. If any trustees are appointed rather than being elected by beneficiaries during the last five years, at least 60% of all trustees must be unassociated with former ownership

Shell states, “The initial proposal in Budget 2023 was criticized for being impractical and for not providing any incentives to sell to an EOT. The August update addressed some of the issues with practicality, and the new provisions in the 2023 Fall Economic Statement address the incentive issue. We’re very grateful for the work the government has put into getting this right."