The Canadian government, in its 2023 federal budget, released draft legislation that provides additional details regarding Employee Ownership Trusts, which can assist in employee compensation planning.
The intent to establish EOTs, which were Initially introduced in the 2022 budget, and are similar to those used in other countries, indicates a willingness by the Canadian tax authorities to enable Canadian companies to allow their employees to have ownership of operating companies; however, as currently drafted, the uptake may be somewhat limited.
Employee Ownership Trusts
An EOT is a trust that holds shares of a corporation for the benefit of the corporation’s employees. An EOT can be used to facilitate a purchase of a corporation by its employees, as an additional option for business owners when planning for succession. It also provides beneficial tax treatment to the trust and employee participants.
To facilitate the use of EOTs, proposed legislation has been introduced to provide more beneficial treatment than that afforded by the normal trust taxation regime, including:
- Doubling the period over which a capital gains reserve can be claimed by an individual in respect of qualifying business transfers to an EOT from 5 years to 10 years; and
- Exempting EOTs from a requirement that generally applies to certain trusts that the trust must dispose of its capital property after 21 years.
However, there are certain limitations to the legislation that are likely to restrict its use, including:
- The trust must be resident in Canada.
- The trust must be exclusively for the benefit of employees of one or more “qualifying businesses” controlled by the trust.
- The interest of each beneficiary of the trust must be determined in the same manner, based solely on length of service, total remuneration and/or hours worked.
- To be a qualifying business, the business must be a Canadian-controlled private corporation and all or substantially all of the fair market value of its assets must consist of assets used in an active business in Canada.
As a result, these rules do not apply to employee ownership-type trusts established in other countries that may have Canadian resident participants. These arrangements should continue to be reviewed to determine if they fall under the deemed resident trust rules for Canadian tax purposes.
In addition, the wording of the asset value test appears to prevent EOT-owned businesses from expanding outside of Canada, which is likely to limit the number of companies that may qualify under the legislation as currently proposed.
The focus on EOTs is a welcome addition to employee compensation planning in Canada, and any changes to the proposed legislation should be reviewed to determine their impact on Canadian companies and members of international corporate groups.
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