Jan. 1 tax change may see business owners rethinking succession
‘If, as an owner, now I have the ability to shelter $10 million in capital gains from tax, of course I'm looking at this’
Article content
New tax rules coming into effect Jan. 1 could see family enterprises rethinking their succession plans and considering an employee ownership trust (EOT), new legislation that allows a family business owner to sell the business to its employees in the form of a trust where the employees themselves are the beneficiaries.
In its most recent economic update, the Canadian government announced plans to introduce a temporary tax exemption, for the 2024 to 2026 tax years, that would apply on the first $10 million in capital gains realized on the sale of a business to an EOT under certain conditions.
This should have business owners taking notice, especially those who already have future succession plans, explains Calgary-based Chris Gandhu, partner and family office leader at KPMG in Canada.
Why are family businesses speeding up succession planning
“Succession plans are being accelerated for both internal business reasons, family reasons, and … what’s happening externally,” says Gandhu. “Tax policy is part of those external forces that are impacting how business owners think about succession.”
A recent survey from KPMG of 235 family business leaders, found that almost 80 per cent of them were accelerating their succession or leadership transition plans.
While there have been a number of factors brewing in the past few years that have led to this high number – including the pandemic, current economic environment and retiring baby boomer generation – what is noteworthy is how the tax changes open up EOTs as a viable succession option for business owners.
“If you’re a business owner, absolutely you want to look at all your options since the EOT proposed tax break actually is time-limited,” explains Gandhu. “And if you have three years to make a decision that’s going to save you a significant amount in tax, I bet that is going to be a motivator.”
Capital gains exemption advantage of employee ownership trusts
In fact, according to the KPMG survey, 72 per cent of family business leaders said they felt EOTs with a capital-gains exemption for owners could have a positive impact on the Canadian economy, fuelling innovation and growth.
Typically, trusts in Canada have what is referred to as the “21-year rule,” which deems certain types of trusts to dispose of their property and recognize the accrued capital gains every 21 years. However, the newly proposed EOT will not be subject to this rule.
That, coupled with the fact that the first $10 million in capital gains could be exempted, “I think that’s going to be key,” says Gandhu. “EOT trusts are interesting, but if, as an owner, now I have the ability to shelter $10 million in capital gains from tax, of course I’m looking at this.”
Britain and the United States have also experienced their own success with similar employee trusts, which acted as the models for Canada’s proposed EOTs.
Reasons to sell the business to employees
While this incoming tax rule may pique some family business leaders’ interest, it might not be the sole motivator for a sale, says Michael Louie, principal at D and H Group, an accounting and tax advisory firm in Vancouver.
“Oftentimes, the decision to sell the business to employees, from my experience, comes about not from the tax savings of the capital gains exemption, and more often occurs where the children do not wish to take over ownership of the business,” says Louie. “The capital gains exemption is a result and not the catalyst for this decision.”
For him, there are many more motivating factors that push family business leaders into succession planning, but he agrees that an EOT does open up possibilities for certain family business leaders, especially those who are not planning to pass on the family business to the next generation.
“Selling to employees is definitely a possibility, but ultimately you have to have trusted employees that are not going to end-run you because they have both rights as shareholders and rights as employees,” adds Louie.
A solution for when children don’t want to take over the business
Indeed, the KPMG survey found that 79 per cent of those considering succession plans were hoping to pass the family business down within the family. But this isn’t always a possibility, as many members of the next generation are not interested in taking over, leaving many in a tough situation.
However, Gandhu says that this new EOT option may give family business leaders a way to keep their legacy going without having to sell to a third party, while also compensating employees.
“It’s a way for the employees of the business to participate in the success,” he explains, adding that this might be especially true for those who are entrenched in their communities and want to see the company stay, and provide employment in that community.
“I think this is a great way for continuity, to continue something that you’ve created,” says Gandhu. “Certainly, it’s not going to be a solution for everyone out there, but it’s worth exploring.”
Please visit here to see information about our standards of journalistic excellence.