The spring economic update, which Finance and National Revenue Minister Francois-Philippe Champagne delivered in the House of Commons on April 28, proposed changes to the rules for employee ownership trusts.Sean Kilpatrick/The Canadian Press
Business owners could unlock significant tax savings if they sell their business to an employee ownership trust (EOT) now that Ottawa is making the regime’s key tax break permanent.
An exemption on the first $10-million of capital gains realized from the sale of a business to employees was set to expire at the end of this year, after a three-year availability, but the federal government proposed extending it indefinitely in the 2026 spring economic statement.
If the proposal is passed, business owners may be incentivized to put planning in place years ahead of an exit to ensure a successful transition, says Hemal Balsara, head of tax, retirement and estate planning services at Manulife Financial Corp.
“You’re not just going to look at [an exit] from a three-year lens, you’re going to look at it from a 10-year lens or a 15-year lens,” Mr. Balsara says. “All of a sudden, you could start grooming people to take over the enterprise.”
A 2023 report from the Canadian Federation of Independent Business found that 76 per cent of owners planned to exit their businesses over the next decade, but only 9 per cent had a succession plan.
Selling to employees could be an attractive option for entrepreneurs at a time “when there’s going to be a large turnover of businesses, and when the possibility exists that some of them might wind up the company rather than try to find a market [for it] or sell it,” says Brian Ernewein, senior advisor, national tax, at KPMG LLP in Ottawa.
Introduced in 2024, an EOT is a form of employee ownership in which a trust holds shares of a qualifying business on behalf of its employees. The trust can finance the acquisition through a loan from the business to be repaid, over 15 years, from the after-tax portion of dividends it receives from the business.
For the transaction to qualify for tax incentives, it must involve the sale of a corporation in which more than 50 per cent of the fair market value of its assets were used principally in an active business in Canada over the 24 month-period before the sale, and 90 per cent or more at the time of the transaction. Professional corporations don’t qualify.
Selling to an EOT provides business owners with an alternative succession option when selling to family or an external party might not make sense, while also offering tax benefits. These include:
EOT tax exemption: The exemption on the first $10-million of capital gains realized on the sale of the business represents a potential tax savings of about $2.5-million (assuming a top tax rate of 50 per cent).
If there are multiple owners of the business, the $10-million tax exemption must be shared between them. However, only owners who were actively engaged in running the business – defined as an average of 20 hours of work a week over a 24-month period – are eligible to claim the exemption.
In addition, the business itself must meet qualifying conditions in the two years preceding the sale – and up to 10 years following – for owners to claim or keep the exemption.
LCGE: Both the lifetime capital gains exemption and the EOT exemption may be claimed on the sale of a business to an EOT.
As some of the eligibility requirements to claim the LCGE are the same as for the EOT exemption, an owner may be able to “stack” the two tax breaks, Mr. Balsara says.
For 2026, the LCGE is $1.275-million, representing potential additional tax savings of up to $318,750 for the seller, assuming a top tax rate.
Each owner may be able to claim their LCGE on the sale of a business, unlike the EOT exemption.
Extended capital gains reserve: When someone receives proceeds of a sale of capital property over time, they don’t have to recognize the gain as taxable income until the year they receive the proceeds. However, a minimum of 20 per cent of the gain must be recognized each year, effectively creating a five-year deferral period.
Under the EOT rules, only 10 per cent of the gain on the sale to an EOT must be recognized each year, extending the deferral period to 10 years. This tax deferral would be beneficial to the owner in cases in which the purchase price for a business is repaid over many years.
No AMT: When calculating income for purposes of the alternative minimum tax, taxpayers must include all their capital gains, as opposed to half under the regular tax system.
Under the EOT rules, capital gains eligible for the $10-million exemption are exempt from AMT.
Still not for everyone
Despite these potential tax incentives, some business owners won’t be comfortable selling to an EOT and receiving payments over time instead of selling to an external buyer who can buy the business in full and up front, Mr. Ernewein says.
Mr. Balsara adds that “some entrepreneurs are just focused on maximizing enterprise value.”
However, when someone is “looking to positively impact the community, looking to possibly benefit from tax incentives along the way, too, [EOTs] are going to be one of those things – along with the grooming and training of employees – that is going to be a game-changer,” he says.