Interest in employee ownership trusts expected to rise

Despite a lukewarm reaction from business owners, experts say that if Ottawa goes ahead with its plan to make the employee ownership trust (EOT) exemption permanent, interest will improve over time.

Ottawa announced its intention in the spring economic update last week.

The federal government first introduced the measure, which allows employees to buy a business over time, in the 2023 fall economic statement for the 2024–26 tax years. EOTs exempt the first $10 million of a seller’s capital gain from tax, and allow the remaining capital gain to be spread over 10 years.

In 2023, the government expected the measure to provide $25 million in tax breaks by the 2025–26 fiscal year. That was revised down to $10 million in this year’s spring economic update, with the annual cost rising to $80 million by 2030–31 as awareness grows.

“There are companies that’ve said, ‘We’d love to do this, but there’s no way we can get it done by [2026].’ They can now go back and talk about it,” said Jon Shell, chair at Social Capital Partners in Toronto.

It took time for the rules to be announced and the novelty of the move led to lower-than-expected uptake, said Brian Ernewein, senior advisor at KPMG Canada’s national tax centre in Ottawa. “The uncertainty and temporariness of it combined to make it of fairly limited application [so far].”

Under the old three-year deadline, business owners had to move quickly to set up an EOT. The legal process takes three to six months, but it can take longer to get a company to the point where it’s ready, said Wesley Novotny, partner and corporate tax lawyer at Bennett Jones LLP in Calgary.

For example, companies need to meet a high threshold in terms of the percentage of assets used in active business. Over the two years leading up to the EOT, that’s 50%, rising to 90% at the time of sale to employees, Novotny explained. Businesses that keep lots of cash on hand to pay suppliers or park money in real estate would need to do more work to meet that requirement.

Some companies also need time to prepare senior employees for leadership. “It takes years to get everybody aligned,” said Novotny, who has helped Canadian companies set up EOTs. “There’s no question that [permanence] is going to help with uptake. This will help long-term succession planning and keep EOTs on the table.”

Ottawa expects the measure’s permanent iteration to cost $205 million between the 2026–31 financial years.

Not every business that takes advantage of the EOT exemption will use the full $10 million (which translates to $2.5 million in tax savings), Shell said. He projects that each case will lead to about $600,000–$700,000 of foregone revenue on average, or about 125 cases a year by 2030–31 based on estimated annual costs of $80 million.

“In the U.K., it took about five years for [EOTs] to start to hit a plateau. … It takes time for accountants and lawyers to understand it and get it on a business owner’s plate,” Shell added. “Within about five or six years we’re going to get a hundred or more a year, based on what we’ve seen in the U.K. that has similar rules.”