Employee ownership trusts are becoming more attractive for business succession

Selling a business is one of the most critical decisions a Canadian business owner will make—and finding the right succession path is not always straightforward.

While options such as a third-party sale or an intergenerational business transfer exist, some business leaders may prefer to keep ownership within the organization.

An employee ownership trust (EOT) allows a company’s stewardship to transition to employees through a trust structure rather than through employee direct share ownership.

While uptake was limited historically due to the structure and complexity of EOT rules, recent legislative changes increased certainty around the associated tax incentives.

These developments could make EOTs much more appealing for business owners, especially those who are seeking out alternate succession strategies. Consulting with the appropriate advisors can help leaders effectively determine whether an EOT is a viable succession pathway for their business.

What is an EOT?

An EOT is a Canadian-resident trust that holds shares of a qualifying business for the benefit of its employees. Employees do not acquire shares directly; the trust holds the shares collectively and employees participate as beneficiaries.

Canada’s EOT framework was introduced in the 2023 federal budget to expand the range of succession planning options available to business owners—particularly those who are not considering a traditional sale or family-based transition.

Rather than requiring employees to fund an acquisition personally, the EOT structure allows ownership to transition through the trust using a combination of financing and future business earnings.

What do the new changes mean?

One of the key tax incentives for EOT transactions is a capital gains exemption available to individual business owners on a qualifying sale.

Under this framework, up to $10 million of capital gains realized on the sale of a business to an EOT may be exempt from tax—subject to certain conditions.

This exemption was initially temporary and applied only to qualifying dispositions for the 2024–2026 taxation years. Bill C-30 removed this limitation, making the exemption permanent.

This change provides greater certainty and allows EOTs to be a more appealing strategy as part of longer-term succession planning.

How does an EOT work?

An EOT transaction involves a business owner selling shares of a qualifying business to either the EOT or a corporation controlled and wholly owned by the EOT.

Following the transaction, the EOT becomes the controlling shareholder, employees become beneficiaries of the trust and the business continues operating as usual.

The purchase price is typically funded using vendor financing, third-party debt and future business cash flows.

Since employees generally do not have the capital to acquire the business directly, the transaction is structured to be funded over time. This often means the vendor does not receive full proceeds on closing and repayment depends on the future performance of the business.

Benefits of EOTs

A qualifying EOT transaction may provide access to several tax incentives, including the federal $10 million capital gains exemption. EOTs could also offer access to an extended capital gains reserve of 10 years, instead of the usual five years, which could allow owners to recognize a portion of the income from the sale gradually. This may be helpful when financing the purchase over time.

From a succession perspective, EOTs may provide a pathway where no suitable third-party buyer exists or where family succession is not viable.

Unlike intergenerational transfers—which focus on maintaining ownership within a family—EOTs allow ownership to transition to employees while preserving continuity of operations. By keeping ownership within the organization, EOTs may also help preserve company culture, retain key employees and reduce some of the disruption that can accompany an external sale.

EOTs could also provide financing flexibility in structuring the transaction as ownership may be transferred over time rather than through a full cash sale at closing. However, this flexibility often comes with additional considerations for the vendor—particularly where proceeds are contingent on future business performance.

Key considerations for owners

While EOTs offer enticing potential benefits, these highly technical arrangements require careful evaluation.

Eligibility

For a sale to qualify as an EOT transaction and for the vendor to claim the related capital gains deduction, a number of specific conditions must be met.

These include—but are not limited to—the following:

• Qualifying business transfer: The sale must be a share sale to an EOT, or a corporation controlled by the EOT, and the EOT must acquire control of the business. Immediately before the sale, all or substantially all of the corporation’s value must come from assets used principally in an active business.
• Qualifying business: The business must generally be carried on through a Canadian-controlled private corporation (CCPC).
• Vendor requirements: The vendor must be an individual who is at least 18 years old, and they (or their spouse/common-law partner) must have been actively involved in the business for at least 24 months prior to the sale.
• Historical ownership: Generally, the shares must have been owned by the vendor or related persons for at least 24 months—and the active-business asset test must also be met over that period.
• Transfer of control: The vendor must give up control; they must deal at arm’s length following the sale and cannot retain rights that would allow continued control.
• Employee/beneficiary requirements: Beneficiaries must generally be employees (with limited scope for former employees), cannot have significant equity ownership outside the trust and at least 75 per cent of beneficiaries must be resident in Canada to access the deduction.
• Trust requirements: The trust must be an irrevocable Canadian-resident trust that exists exclusively for the benefit of qualifying employees and must meet detailed governance rules.

EOT tax incentives are aimed at business owners pursuing a true exit strategy, rather than a gradual or partial retention of control following the transaction.

To claim the $10 million capital gains exemption, the vendor and purchaser must make a joint election through a prescribed form.

Ongoing compliance

The eligibility conditions are strict and must generally be satisfied both at the time of the transaction and on an ongoing basis.

Certain disqualifying events may result in reversal or loss of tax benefits, which may remain applicable for up to 10 years following a qualifying business transfer.

The structure must be sustainable over the long term—not just at the time of the initial transaction. Meeting these ongoing requirements in practice may limit suitability for some transactions, so consulting tax advisors can help participants satisfy the applicable requirements after closing.

Economic exposure and governance considerations

EOT transactions often rely on deferred purchase price arrangements, vendor financing and repayment through business cash flows. This means vendors may receive proceeds over time and repayment may depend on future business performance.

As a result, vendors could be exposed to continued financial risk even after control is given up, which represents a notable trade-off of pursuing an EOT.

In addition to financial considerations, owners must consider the revised governance structure of the business following the transition and how structural changes will affect employees.

When an EOT may make sense

EOTs may not be suitable for all cases. They may be more successful where the business has stable and predictable cash flows, the ability to support deferred payments or acquisition financing and a capable management team.

From the owner’s perspective, an EOT may be appropriate when a gradual exit is acceptable, immediate and full liquidity is not required, there is no suitable family successor (or ownership is not intended to remain within a family group) or when the owner intends to give up full control after the sale.