There are many ways to structure the ownership of a business in Canada, from sole proprietorships to limited liability partnerships to large-scale corporations. Each ownership structure has benefits and drawbacks, including tax implications and personal liability for the owners and directors. However, Canada may see an influx of a relatively new structure in the coming years as the federal government has pledged to remove taxation roadblocks to creating a model called the Employee Ownership Trust.
Employee ownership is not a new concept in Canada. Many companies allow employees to share profits through stock options or purchase plans, for example, but an Employee Ownership Trust (EOT) is different. In an EOT, the majority of the company’s shares are sold to a trust for the benefit of every employee of the business. Employees are not required to invest their own funds in the purchase; they are automatically included in the program by virtue of being an employee. According to some experts, this model has the potential to benefit both workers and businesses once the new tax rules are implemented.
What is an Employee Ownership Trust?
An Employee Ownership Trust is a business structure in which all the employees of a company are given an ownership stake in the business without having to expend their own resources. Participation level may increase according to seniority or level of employment, but every employee must be granted access to the program. Rather than providing an option for employees to buy shares through a share purchase program, the shares are sold to a trust that holds the shares and acts as a fiduciary on behalf of the employee shareholders.
The first step is to establish a trust which will hold the shares on behalf of the company’s employees. From there, the trust will purchase a certain number of shares at fair market value from the owners, usually financed by either a bank loan or a loan directly from the owners. In either case, the loan will be repaid using profits from the shares held by the trust.
Depending on the structure, the employees will either receive annual bonus payments tied to the profits of the business or a payout when they sell their shares back to the company (usually when they leave for another employer or retire)
EOT Precedents: The United States and United Kingdom
The two jurisdictions where Employee Ownership Trusts are most common at the present moment are the US and the UK. The program works similarly in both countries, although some key distinctions exist. Those differences, as pointed out in a report prepared by Canadian non-profit Social Capital Partners, relate to:
- Minimum allocation of shares: In the US, where the structure is referred to as an Employee Stock Ownership Program, there is no minimum concerning the percentage of overall shares the trust must own at any given point. This allows a company to gradually transition to becoming employee-owned and can help reduce the amount of capital needed at the outset. In the UK, an EOT must own at least 51% of the total shares of the business from the outset.
- Payout method: In the US, the shares are held in the trust, and the accumulated value is paid out to the employee when the employee leaves or retires and sells their shares back. In the UK, employees receive annual bonuses corresponding to the value of their shares in addition to their standard compensation.
Advantages of Employee Ownership Trusts
One of the key advantages of the Employee Ownership Trust is succession planning for owners. For owners who have built a company from the ground up, transitioning to an EOT allows them to ensure the company will keep its integrity rather than being sold to a third party, which grants the seller little to no assurance concerning the company’s future. As pointed out in an article published by the CBC this spring, EOTs allow business owners to pass their business on to their valued employees rather than selling to a competitor or another third party.
Employees also stand to benefit significantly from working at a business with an Employee Ownership Trust model. In a 2017 report prepared by the National Center for Employee Ownership in the US, 92% of employee-owners aged 28 to 34 had higher household median incomes than other workers in the same age group. Further, more than half of the same group had longer work tenure, and approximately a third had higher income from their wages.
The Social Capital report referenced above also claimed that the benefits enjoyed by workers are even more pronounced among women and visible minorities, helping to reduce economic inequality across various social groups. These benefits, in turn, also generate stronger employee loyalty and engagement, benefiting both workers and companies in the long run.
Drawbacks of Employee Ownership Trusts
One of the critical drawbacks is the initial funding necessary to establish an Employee Ownership Trust. This is especially the case if Canada adopts the UK model, which mandates that the trust owns most of the total shares.
In Canada, the lack of specific tax incentives for EOTs is a significant factor in why the model is so rare in this country. However, the federal government recently announced it would be taking steps to address this.
Canadian Government Announces Tax Incentives to Encourage EOTs
In 2021, the federal government sought feedback from businesses across the country to determine the key roadblocks in Canada that have prevented more companies from adopting the Employee Ownership Trust model. The principal reason cited among the responses was a lack of tax incentives. In the US and the UK, business owners and employee owners enjoy tax incentives tied to the sale and purchase of shares under an EOT model. In the US, companies that use the EOT model also benefit from corporate tax incentives.
In section 2.4 of the 2022 Federal Budget, the government announced plans to officially establish the Employee Ownership Trust under Canada’s Income Tax Act. This step will provide tax incentives that will encourage more businesses in Canada to adopt this model of ownership.
It remains to be seen how EOTs will operate when the new tax incentives are implemented in the legislation. Experts have pointed out that Canada has the benefit of examining the US and UK models and taking the best of each structure when setting out the regulations and processes here. The EOT model may also change the way shareholder disputes are managed. With a trust holding a large number (and potentially the majority of shares) on behalf of the employees of the business, it seems likely that employees will have a more significant say in how major decisions are made.
For Exceptional Guidance on Shareholder Disputes, Contact Campbells LLP
The talented corporate and commercial lawyers at Campbells LLP have been helping businesses and business owners with shareholder matters, including agreements and disputes, since 1999. We take the time to understand the intricacies of your business before deciding on a course of action, keep you well-informed throughout the process, and help you make the best strategic decisions at every stage of your file. To speak with one of our exceptional Oakville lawyers, contact us online or by phone at 905-828-2247.