The concept of employee ownership trusts is gaining traction in Canada as business owners seek more sustainable ways to transition their companies. Following the federal government’s introduction of tax incentives in 2023, some entrepreneurs are finding innovative solutions to succession planning, allowing employees to take the reins while preserving company culture and values.
Employee Ownership: A New Pathway
Peter Deitz, co-founder of Grantbook, a Toronto-based firm that assists non-profits in grant management, spent eight years contemplating the future of his business. His apprehension about selling to an external buyer—who might compromise the company’s ethos—led him to explore alternative options. Deitz ultimately discovered employee ownership trusts, which enable employees to acquire shares without an upfront payment, while the owner receives compensation over time, typically funded by the company’s profits.
The Canadian government first proposed tax reforms to support these trusts in its 2023 budget. A significant feature of this initiative is a capital gains tax exemption of up to £10 million for owners who sell their firms to employees through this structure. However, this exemption is set to expire at the end of 2026 unless the government decides to extend it.
Advocates Call for Permanent Solutions
Supporters of employee ownership trusts argue that allowing the tax exemption to lapse would undermine the model’s potential before it has fully developed. Justine Janssen, executive director of Employee Ownership Canada, noted that this structure benefits both employee engagement and founders worried about their legacy. She reported a surge of interest from business owners contemplating this transition, with four trusts already established and another 20 to 30 potentially in the pipeline this year.
However, the Canada Revenue Agency (CRA) has not been able to provide specific data on the number of these trusts or the number of founders claiming the tax exemption, citing confidentiality constraints.
Challenges and Considerations
Despite the enthusiasm surrounding employee ownership trusts, experts caution that this model may not suit every business. Pamela Cross, a tax partner at Borden Ladner Gervais LLP, pointed out the complexities involved in financing such transitions. While the capital gains exemption can mitigate some financial risks, challenges remain, particularly for companies without stable revenue streams.
Once a trust is established, former owners relinquish control over business operations, which can complicate the payout process. Furthermore, any “disqualifying event” post-sale could jeopardise the capital gains tax exemption, creating uncertainty for sellers.
The Need for Stability
The window for leveraging the capital gains tax exemption is narrowing, which could deter many business owners from pursuing this model seriously. Janssen expressed the need for the government to either make the exemption permanent or extend it, offering clarity for those considering employee ownership trusts. Many business owners have indicated that the tax exemption significantly influences their decision to adopt this model, viewing it as a fair compensation for their patience during the transition.
While there is no clear indication from the government on the potential for extending the tax exemption, recent budget proposals suggest a focus on worker co-operatives, rather than a broader application for employee ownership trusts.
International Comparisons
Employee ownership trusts have been successful in other countries, such as the UK and the US, where the frameworks are often more advantageous for business founders. In the UK, for instance, the exemption applies to all capital gains from the sale of a business, fostering a more supportive environment for transitioning ownership.
Deitz, who successfully transitioned his company ahead of schedule, believes that the capital gains exemption should be expanded, emphasising the need for inclusive policies that benefit small and medium-sized enterprises of all ownership types. He argues that promoting employee ownership could be a crucial strategy for the Canadian government in safeguarding local businesses and their intellectual assets.
Why it Matters
The rise of employee ownership trusts represents not just a shift in succession planning but a potential transformation of the Canadian business landscape. By empowering employees and retaining decision-making within Canada, this model could strengthen economic sovereignty and build resilient companies. The outcome of ongoing discussions about tax incentives will be pivotal in determining whether this innovative approach becomes a cornerstone of Canadian entrepreneurship.
