DFK Tax Newsletter

 

Issue 2 - 2024 Edition - September 11, 2024 - Yves Lagasse, Craig Ross LLP, Winnipeg, MB

Employee Ownership Trust Update – Federal Budget 2024


The 2024 federal budget provides additional details on the $10 million exemption from taxation on capital gains realized on the sale of a business to an Employee Ownership Trust (“EOT”) that were not included in the 2023 Fall Economic Statement or Bill C-59.  The 2024 budget also proposes to expand the definition of a “qualifying business transfer”.

Background

The 2023 federal budget introduced rules to facilitate the creation of EOTs and allow a group of employees to purchase a business over time.  This represents an attractive succession opportunity for small business owners who have no suitable family members to sell to, or who fear that a third party may not preserve the business’s legacy.  The new EOT rules will allow employees to borrow from the business to finance a buy-out with an extended repayment period and allow a longer capital gains deferral period for the retiring owners.  This is intended to help employees overcome the challenge of having to finance the acquisition from their personal savings.  The new EOT rules are included in Bill C-59 with one exception.  The bill doesn’t include the proposed tax exemption on up to $10 million in capital gains realized on a sale to an EOT.

2024 Budget Details on the $10 million Exemption

Qualifying conditions

Budget 2024 (and Bill C-69) provides that the $10 million capital gains exemption will be available to a taxpayer (other than a trust) on the sale if several conditions are met:

  • The taxpayer who is at least 18 years old (or a personal trust of which the taxpayer is a beneficiary, or a partnership in which the taxpayer is a member) disposes of shares that are not shares of a professional corporation.
  • The transaction is a qualifying business transfer, in which the trust acquiring the shares is not already an EOT or a similar trust with employee beneficiaries.
  • The qualifying business transfer occurs between January 1, 2024 and December 31, 2026.
  • Throughout the 24 months immediately prior to the qualifying business transfer:
    1. The transferred shares were exclusively owned by the taxpayer claiming the exemption, a related person or a partnership in which the taxpayer is a member; and
    2. Over 50% of the fair market value of the corporation’s assets were used principally in an active business.
  • No individual has previously claimed the deduction in respect of a disposition of shares that derived their value from the same active business.
  • At any time prior to the qualifying business transfer, the taxpayer (or their spouse or common-law partner) was actively engaged in the qualifying business on a “regular and continuous” basis for a period of at least 24 months.
  • Immediately after the qualifying business transfer, at least 75% of the beneficiaries of the EOT reside in Canada.
  • The EOT, any purchaser corporation owned by the EOT, and the individual jointly elect for the deduction to apply and file the election on or before the EOT’s filing due date for the taxation year that includes the qualifying business transfer.
  • The legislation also prohibits an individual who claimed a deduction in respect of a qualifying business transfer to the EOT (and any related individuals) from being a beneficiary of the EOT.

Also, if multiple individuals have capital gains from a sale of shares to an EOT and the above conditions are met, they may each claim the exemption, but the total exemption in respect of the qualifying business transfer can’t exceed $10 million. The budget said: “The individuals would be required to agree on how to allocate the exemption.” The agreed allocation would be part of the required joint election.

Disqualifying Event

A disqualifying event would occur if an EOT loses its EOT status, or if less than 50% of the fair market value of the qualifying business’s shares is attributable to assets used principally in an active business at the beginning of two consecutive taxation years of the qualifying business.

The consequences of a disqualifying event depend on whether it occurs within or after 24 months of the qualifying business transfer:

  • If the disqualifying event occurs within 24 months of the qualifying business transfer, the capital gains deduction is not available and would be retroactively denied if an individual has already claimed it. The EOT, the purchaser corporation (if applicable), and the taxpayer are jointly and severally, or solidarily, liable for the tax payable by the individual as a result of the deduction being denied due to a disqualifying event occurring within the first 24 months after a qualifying business transfer.
  • If the disqualifying event occurs more than 24 months after the qualifying business transfer, the EOT is deemed to realize a capital gain (equal to the total elected amount of exempt capital gains) in the year the disqualifying event occurs. Consequently, the EOT would be solely liable for tax realized on the deemed capital gain that arises on a disqualifying event occurring more than 24 months after a qualifying business transfer.

Expanded definition of a “Qualifying Business Transfer”

The 2024 budget proposes to expand the definition of Qualifying Business Transfer for EOT purposes  to include the sale of shares to a worker cooperative corporation meeting the definition in the Canada Cooperatives Act.