Employee Ownership Trusts: A new succession planning option for Canadian business owners

For many Canadian business owners, succession is one of the most consequential decisions they will face.

According to the Canadian Federation of Independent Business, three out of four small business owners in Canada expect to exit their businesses within the next ten years. Finding the right buyer — someone who will preserve the business, its employees and its culture — is not always straightforward. Family succession is not always possible or desired, and a third-party sale does not always reflect the owner's values or goals for the enterprise they have spent a lifetime building.

Since 2024, Canadian tax law has offered a third path: the employee ownership trust (EOT). Introduced through Budget 2023 and effective for transactions occurring after December 31, 2023, the EOT regime creates a structured, tax-advantaged mechanism for selling a business to its employees.

The 2026 Spring Economic Statement, tabled April 28, 2026, proposed to make this regime permanent. This article explains what an EOT is, how it works, the tax advantages it offers, and what business owners and their advisors need to consider.

What Is an Employee Ownership Trust?

An EOT is a Canadian-resident trust that holds shares of a qualifying business for the benefit of that business's employees. The EOT acquires control of the business, and employees become beneficiaries of the trust, receiving income and capital distributions over time based on their employment contributions to the business. Critically, employees do not need to pay directly for their ownership interest. The acquisition is financed through the business itself, with the trust borrowing from the qualifying business and repaying that loan over an extended period out of the business's earnings.

For a retiring owner, the EOT provides a structured exit with tax incentives. For employees, it provides a path to economic participation in the business without requiring them to invest personal savings. The model is well established in the United Kingdom and the United States, where employee ownership trusts have a long track record. Canada's EOT regime draws on those models and adapts them to the Canadian context.

Does My Business Qualify?

The EOT regime applies to qualifying businesses. A qualifying business is a Canadian-controlled private corporation (CCPC) that, at the time the EOT acquires control, meets the following conditions:

• no more than 40% of its directors owned 50% or more of the CCPC's shares or debt (directly or indirectly, or together with related or affiliated persons) immediately before the EOT acquired control; and
• the CCPC deals at arm's length with, and is not affiliated with, any person or partnership that held 50% or more of the CCPC's shares or debt immediately before the EOT took control.

In addition, for the transaction to constitute a qualifying business transfer — the trigger for most of the tax incentives — all or substantially all of the fair market value of the assets of the corporation must be attributable to assets used principally in an active business carried on by the corporation or a wholly-owned subsidiary. This is the standard "all or substantially all" threshold, generally interpreted as 90% or more.

The arm's length requirement is important: the sale must be a genuine transaction between the owner and a trust that is not affiliated with the owner. The owner cannot retain control or influence over the business following the sale, and must deal at arm's length with the trust and the qualifying business at all times after the disposition.

In practical terms, many owner-managed operating CCPCs will satisfy these conditions. Holding companies and investment corporations will generally not qualify unless they meet the active business asset test. Owners with complex corporate structures should review those structures carefully with their advisors before proceeding with a plan to implement an EOT.

How Does the Structure Work?

The EOT is an irrevocable trust resident in Canada. It acquires a controlling interest in the qualifying business — either directly or through a wholly-owned CCPC — and holds that interest for the benefit of the employees. All or substantially all of the fair market value of the trust's property must be attributable to shares of one or more qualifying businesses that the trust controls.

Trustee composition is a defining feature of the EOT structure. The trustees must:

• each has equal votes;
• be either Canadian resident individuals or Canadian corporations licensed to act as trustees;
• ensure that at least one-third of the trustees are current employee beneficiaries of the qualifying business (excluding employees still within a probationary period of up to 12 months); and
• where trustees are appointed other than through an election by current employee beneficiaries held within the past five years, ensure that at least 60% of all trustees deal at arm's length with every person who sold shares of the qualifying business to the trust.

The trustee structure is designed to ensure that employees have a meaningful role in the management of the trust, while also protecting against arrangements where the former owner retains de facto control through friendly trustees. Trustees are obligated to act in the interest of all beneficiaries and cannot favour one group of beneficiaries to the prejudice of another.

Majority employee beneficiary approval is required for certain transactions. More than 50% of current employee beneficiaries must vote to approve any transaction that would cause at least 25% of them to lose their beneficiary status (other than terminations for cause), and any winding-up, amalgamation, or merger of the qualifying business. Owners establishing an EOT should understand that employees will have a voice in major decisions affecting the business going forward.

Who Are the Beneficiaries?

The beneficiaries of the EOT must be exclusively current employees, and can also include former employees (including their estates) who were employed by the qualifying business while the trust held control. Employees who have not yet completed a probationary period of up to 12 months may be excluded.

There are concentration limits on individual ownership through the trust. A beneficiary cannot individually hold an interest representing 10% or more of the fair market value of any class of shares of the qualifying business. Together with affiliated persons, a beneficiary cannot hold 50% or more of any class.

• Distribution formulas. The capital and income interests of beneficiaries must be determined using a reasonable and equitable method based solely on any combination of three permitted criteria: total hours of employment service, total salary and wages (subject to a cap equal to twice the dollar value of the highest personal income tax bracket for the relevant year), and total period of employment service. No other criteria can be used.
• Different formulas can be applied to income versus capital distributions, and to current versus former employees, allowing for up to four distinct distribution formulas within a single EOT. This flexibility allows the trust to be designed in a way that reflects the workforce's structure and values. For example, weighting longer-tenure employees more heavily for capital distributions while distributing income more evenly based on current hours.
• The salary cap on the remuneration criterion is worth noting. It prevents high-earning employees from capturing a disproportionate share of distributions simply by virtue of their compensation, which promotes the broad-based employee ownership model the regime is intended to encourage.

The Tax Advantages

The EOT regime delivers its most compelling value through a package of interlocking tax incentives that address the key financial challenges of an employee buyout: the seller's tax on the sale proceeds, the cost of financing the acquisition, and the ongoing tax efficiency of the trust structure.

• $10 million capital gains exemption. This is the centrepiece of the regime. The first $10 million in capital gains realized on the sale of a qualifying business to an EOT is exempt from tax, subject to certain conditions. Where multiple owners sell shares to an EOT as part of the same qualifying business transfer, the $10 million must be shared among them in an agreed-upon manner.
• The exemption was initially available for the 2024, 2025, and 2026 tax years only. However, the Spring Economic Statement 2026, tabled on April 28, 2026, proposed to make the $10 million capital gains exemption permanent. If enacted as proposed, the exemption would remain available for qualifying business transfers to EOTs on an ongoing basis. This is a significant development that strengthens the case for the EOT as a long-term succession planning tool.
• The exemption is subject to conditions, including that the qualifying business transfer must satisfy the relevant conditions during the two years leading up to the sale and at the time of the sale, and that there must be no disqualifying event within 10 years of the sale. Technical amendments enacted on March 26, 2026 as part of Bill C-15 clarified the calculation of and eligibility for the exemption, and confirmed that the disqualifying event period runs for 10 years post-sale.
• Extended capital gains reserve. Where the purchase price is received over time rather than in a lump sum, tax law permits the seller to defer recognition of the related capital gain through a reserve. Ordinarily, the seller must bring a minimum of 20% of the gain into income each year, creating a maximum five-year deferral. For a qualifying business transfer to an EOT, this minimum is reduced to 10% per year, extending the maximum deferral period to ten years. Where the business will be financing the acquisition out of its own earnings over time, this extended reserve is a material benefit.
• Extended shareholder loan repayment period. One of the core practical challenges with any employee buyout is financing. Most employees cannot fund an acquisition from personal savings, and third-party financing for a trust purchase of shares can be difficult to arrange. The EOT regime addresses this by allowing the qualifying business to lend money to the trust to finance the share purchase, with a repayment period of up to 15 years. Without this rule, shareholder loan amounts not repaid within one year would be included in the trust's income, making the structure unworkable. The extended 15-year repayment window allows the acquisition to be financed entirely from the business's future earnings.
• Deemed interest benefit exemption. Ordinarily, where a corporation extends a low-interest or non-interest-bearing loan to a shareholder, the shareholder is deemed to have received a taxable benefit equal to the notional interest at the prescribed rate. The EOT rules exempt the trust from this deemed benefit where it borrows from the qualifying business to finance the share purchase, provided the loan is repaid within 15 years. This allows the EOT to borrow at low or no interest without an annual tax cost, making the economics of the employee buyout significantly more viable.
• Exemption from the 21-year deemed disposition rule. Certain trusts are ordinarily deemed to dispose of their capital property every 21 years to prevent the indefinite deferral of tax on accrued capital gains. EOTs are exempt from this rule, meaning the trust can hold shares of the qualifying business indefinitely without triggering a deemed disposition and its associated tax cost. If the trust later ceases to qualify as an EOT, the 21-year rule is reinstated from the date the qualifying conditions are no longer met, and applies until the trust qualifies again.

Taxation of the EOT and Its Beneficiaries

The EOT is a taxable trust and is generally subject to the same rules as other personal trusts. Undistributed income retained in the trust is taxed at the top personal marginal tax rate. Income distributed to employee beneficiaries is not taxed at the trust level but rather at the beneficiary level, and it retains its character in the hands of the beneficiary. If the trust distributes dividends received from the qualifying business, those dividends arrive in the hands of the beneficiary as dividends and are eligible for the dividend tax credit.

This pass-through character is important for planning. A distribution of eligible dividends from the qualifying business through the EOT to employee beneficiaries will generally be taxed more favourably than employment income, depending on the beneficiary's marginal rate and other income. At the same time, owners and advisors should model the full tax picture carefully, since the trust's top-rate exposure on retained income makes it important to distribute income regularly rather than let it accumulate.

EOTs are subject to the same annual trust filing obligations as other trusts and must file a T3 return. The enhanced trust reporting requirements introduced for tax years ending after December 30, 2023, also apply.

Worker Cooperative Corporations

The technical amendments enacted as part of Bill C-15 on March 26, 2026, expanded the EOT regime to cover qualifying business transfers to worker cooperative corporations. These entities are now eligible for the same benefits available to EOTs, including the $10 million capital gains exemption and the ten-year capital gains reserve. This extension broadens the range of employee-ownership vehicles available to business owners and their advisors.

Is an EOT Right for Your Business?

An EOT may be well-suited to certain succession scenarios, but it is not appropriate for every situation. It tends to be most attractive where:

• the owner wishes to exit but has no suitable family successor and prefers not to sell to an external third party;
• the business has a capable and stable employee base that is genuinely invested in the company's future;
• the owner is comfortable with employees gaining governance rights over the trust and, through it, over major decisions affecting the business; and
• the business generates sufficient cash flow to service the acquisition financing over an extended period without impairing operations.

The $10 million capital gains exemption will often be a significant factor in the analysis, but the economics of the EOT depend on more than the tax result on closing. The owner must be prepared to accept a purchase price financed largely through future earnings of the business rather than a cash payment on closing, and must be prepared to genuinely relinquish control. These are constraints that distinguish an EOT from a conventional sale.

The structure also involves ongoing compliance requirements. The EOT must continuously satisfy the qualifying conditions - in respect of the trust's property, its beneficiaries, and its trustees - to maintain the available tax treatment, including the exemption from the 21-year rule. Annual trust filings, adherence to the distribution formula requirements, and the employee vote requirements are continuing obligations that the trustees must manage carefully.

Finally, it is worth noting the interaction with other succession planning tools. The EOT exemption and the lifetime capital gains exemption (LCGE) are separate incentives that may both be available in a given transaction, depending on the owner's circumstances. The interplay between them, and with the intergenerational business transfer rules, should be reviewed with qualified tax counsel before proceeding.

Fillmore Riley LLP's Taxation Practice

Employee ownership trusts represent a meaningful and now permanent addition to the Canadian succession planning toolkit. If you are considering your options for transitioning your business, Fillmore Riley's Taxation practice can help you evaluate whether an EOT is appropriate for your circumstances and assist with all aspects of the transaction, including structuring the qualifying business transfer, negotiating and drafting the trust and financing documents, and advising on the ongoing compliance obligations of the EOT. For more information or if you have any questions, please contact a member of the Fillmore Riley Taxation practice.