As the Canadian government develops its legislation to permit employee ownership trusts, the fact that the proposed model doesn’t include incentives is a big blow to companies considering the option, according to one expert.
“I would have had a different answer for you prior to the  budget,” says Jon Shell, managing partner at Toronto-based Social Capital Partners. “Now that we’ve seen their proposed approach, I probably wouldn’t recommend that an owner spend much time thinking about it.”
Graeme Nuttall, a partner in London-based law firm FieldFisher LLP’s tax practice and the U.K. government’s independent advisory on employee ownership between 2012 and 2015, agrees the lack of incentives is a concern, but he also congratulates the Canadian government for its progress to date.
“Firstly, [for] joining an elite group of countries that recognize employee ownership as a good business succession solution. Also, in proposing the removal of obstacles in the budget announcements and, thirdly, in encouraging other countries . . . to look at introducing the equivalent of the EOT. There are a lot of positives in terms of the Canadian government choosing to support employee ownership.”
The federal government kicked off its commitment to EOTs in its 2021 budget, then included a proposal in its 2022 budget to actually create the EOT — a new, dedicated type of trust under the Income Tax Act to support employee ownership. Though there wasn’t much progress over the next year, last month’s 2023 budget promised to introduce tax changes to facilitate the creation of these trusts. The government intends to introduce the legislation later in 2023, to take effect on Jan. 1, 2024.
The impetus for the government’s attention to EOTs is the success of the U.S. and U.K. models, says Shell, noting both countries use different types of incentives to encourage owners to choose this path as an alternative to other forms of sale. “But the Canadian government has chosen not to provide any incentives for uptake, so our expectation is that very few owners will consider these trusts unless that changes.”
In 2021 alone, 210 U.K. business owners sold to EOTs, creating around 20,000 new employee owners, according to a 2022 report by Social Capital Partners, which noted EOTs are associated with better company performance, stronger local economies, long-term investment and higher wealth and income for workers. In the U.S., policies to support employee ownership trusts have led to 14 million American workers at 6,400 companies sharing in US$1.4 trillion in wealth.
The Canadian model is set to be similar to the U.K.’s EOT, which is a profit-sharing arrangement, compared to the U.S. employee share ownership plan, in which workers gain in the equity growth of a company. While Shell notes the U.S. model is more complicated, he adds there’s no particular reason why the EOT would be better for Canada than the ESOP. “[The government] had a choice between those two things [and] chose one. They haven’t provided any rationale for that choice.”
Under a profit-sharing model, a company distributes whatever it can to the EOT on an annual basis, then the trust distributes that money among employees who’ve been with the company for more than a year, he says. The distribution can be a combination of three factors: earnings, tenure and hours worked.
On the other hand, while the ESOP is a much more complicated structure, Shells says it has greater benefits for workers because they gain in the equity growth of the company. “In the U.S., we know there’s a lot of alignment between the employees and the long-term growth of the company because they benefit from that growth. So there’s also a lot of alignment between employees and the preserving of jobs and local community. In recessions, these companies tend to lay off fewer people, they perform better coming out of recession.”
While the ESOP is a common model in the U.S., there are also EOTs south of the border, says Nuttall, noting the existing trust and corporate law framework allows them to operate. “Generally speaking, EOTs can work without legislation to support them, whereas an ESOP will always require legislative support.”
Both Nuttall and Shell point to three general concerns about the government’s proposed model: the requirement to be a substantially Canadian business; the requirement for every trustee to be elected; and the lack of a favourable capital gains tax regime.
“We want to see more international employee-owned companies operating and expanding internationally,” says Nuttall, adding the requirements around trustee elections isn’t in U.K. best practice for EOTs.
In addition, he says getting advisors to mention EOTs as a business succession solution is an uphill battle, which the U.K. won by introducing a favourable capital gains tax regime, “because this would give a powerful nudge to advisors to mention employee ownership alongside a trade sale and other established forms of exit. That has worked in the UK — since that measure was introduced, we have seen accelerated annual growth of EOT contracts.”
However, while Nuttall is concerned about the restrictive nature of these elements, he’s confident they’ll be ironed out in the consultation process, where those who are enthusiastic about employee ownership can convince the government these restrictions aren’t necessary. “I hope the model that emerges from the consultation process is one that works [and] that’s practical.”