An employee ownership trust lets an owner sell a business to its own employees through a trust, and on a qualifying transfer before 2027 it comes with the largest capital gains exemption in the Income Tax Act — but the trust that receives the shares has to satisfy a governance test most informal succession plans never anticipate.
Key takeaways
Section 110.61(1) of the Income Tax Act applies to a disposition of shares of a corporation to a trust, or to a purchaser corporation wholly owned by that trust, (ITA s. 110.61(1)), and the deduction is capped by the joint election at an amount “not exceeding $10,000,000” (s. 110.61(1)(e)(ii)(A)). That cap is not per person and not per year — it is shared across every individual who claims on the one transfer, with the election assigning each of them a percentage, and the total across all of them cannot exceed 100%.
The eligibility conditions sit in the same subsection. Throughout the 24 months before the disposition the shares have to have been owned only by the individual or related persons, and more than 50% of their fair market value has to have derived from assets used principally in an active business. The individual has to be at least 18, and either they or their spouse or common-law partner has to have been actively engaged in the business on a regular, continuous and substantial basis throughout any 24-month period before the sale. At least 75% of the trust’s beneficiaries have to be resident in Canada. And neither the corporation nor an affiliate it holds shares in can be a professional corporation (ITA s. 110.61(1)).
None of this happens by default. The trust, any purchaser corporation, and every individual claiming the deduction have to jointly elect in prescribed form, stating the elected amount and each individual’s share of it, filed on or before the trust’s filing-due date for the year of the disposition (s. 110.61(1)(e)).
“Employee ownership trust” is defined in ITA s. 248(1), and the definition does most of the real work in this whole regime. The trust has to be irrevocable and resident in Canada. It has to exist exclusively for the benefit of all the employees of the qualifying businesses it controls — a probationary period before an employee becomes a beneficiary is allowed, but it cannot exceed 12 months (ITA s. 248(1)).
Governance is where an informally structured succession plan tends to fail the test. Trustees must have an equal vote each. At least one-third of the trustees must be employee beneficiaries. Where a trustee is appointed other than by a beneficiary election held within the last five years, at least 60% of all trustees have to deal at arm’s length with every person who sold shares of the business to the trust. Trustees cannot exercise discretion to favour one beneficiary over another, and each trustee has to be a licensed Canadian trust corporation or an individual — not another trust (ITA s. 248(1)).
Beneficiaries are capped too. No employee beneficiary can own 10% or more of the fair market value of a class of shares of a controlled qualifying business other than through the trust, and none can hold, with related or affiliated persons, 50% or more of a class. Capital and income interests among employee beneficiaries have to be allocated the same way for everyone, based only on some combination of hours of service, remuneration — capped at twice the first dollar amount referenced in s. 117(2)(e) — and length of service (ITA s. 248(1)). And a major decision, like winding up a qualifying business or a transaction that would cost 25% or more of beneficiaries their status, needs advance approval from more than 50% of employee beneficiaries.
The disposition itself has to be a “qualifying business transfer,” also defined in s. 248(1): immediately before the sale, all or substantially all of the fair market value of the corporation’s assets has to derive from assets used principally in an active business; the taxpayer has to deal at arm’s length with the trust and any purchaser corporation at the time of the disposition; the trust has to acquire control and has to be an employee ownership trust whose beneficiaries are employed in the business; and at all times afterward, the taxpayer cannot retain any right or influence that, if exercised, would let them control the trust, the purchaser corporation, or the qualifying business, directly or indirectly (ITA s. 248(1)).
That last condition is the one that trips up a seller who wants to keep advising informally. A qualifying business transfer requires the vendor to actually let go — retained influence, even without a formal role, can put the exemption at risk before it is even claimed.
The exemption is not final the day the election is filed. ITA s. 110.61(3)–(4) sets out what happens on a “disqualifying event” — broadly, the trust ceasing to be an employee ownership trust, or the start of a year in which less than 50% of the fair market value of the qualifying business’s shares no longer derives from assets used principally in an active business it controls. A disqualifying event within 24 months of the original disposition means the deduction “is deemed to have never applied” — the exemption unwinds entirely. One occurring later, within eight years of the day that is 24 months after the disposition, instead gives the trust itself a deemed capital gain equal to the elected amount, for the year the disqualifying event occurs (ITA s. 110.61(3)–(4)).
There is also a broad anti-avoidance rule aimed at using the trust to accommodate an indirect acquisition by someone other than the employees, or at structuring around the rule to claim the deduction more than once on the same business (s. 110.61(5)).
A near-identical mechanism exists for worker co-operative conversions under ITA s. 110.62(1): a disposition of shares to a purchaser corporation that occurred after 2023 and before 2027 under a “qualifying cooperative conversion,” with the same 24-month ownership test, the same active-business threshold, and the same professional-corporation exclusion as the trust route. The definitions mirror the trust regime too — a qualifying cooperative business has to be a CCPC with not more than 40% of directors drawn from the group that owned 50% or more of it before the conversion, and a qualifying cooperative worker holds a membership share, is an employee, and does not represent more than 50% of the co-operative’s members together with related persons (ITA s. 110.62(1)). It is the same shape as the trust rule with a different beneficiary structure, and it is genuinely under-used in Canadian succession planning.
To illustrate the arithmetic only — the figures below are a scenario, not a benchmark — suppose a founder holds all the shares of a corporation that, on a fetched-verified test, derives more than 50%% of its value from an active business the founder has run for over 24 months. The founder sells the shares to a newly formed employee ownership trust whose thirty employees are the sole beneficiaries, and the disposition produces a $6,000,000 capital gain. If the s. 110.61 conditions are met and the joint election states the full elected amount, up to $6,000,000 of that gain — the whole gain in this scenario, since it is under the $10,000,000 cap — can be claimed under the deduction, subject to every condition in ss. 110.61(1)–(2) being satisfied and the election being filed on time.
Now suppose that fourteen months after closing, the trust’s governance breaks down and it stops meeting the equal-vote or beneficiary-approval requirements in s. 248(1), so it ceases to be an employee ownership trust. Because that disqualifying event falls inside the 24-month window, s. 110.61(3) applies: the deduction is deemed to have never applied, and the founder’s original tax position is unwound as though the exemption had never been claimed — not merely reduced.
Related: funding a buyout the managers cannot finance alone, a gradual sale to a key employee over several years, the lifetime capital gains exemption glossary entry.
The Act treats them as separate provisions with separate conditions — s. 110.61(1)(a) specifically bars an individual from claiming under s. 110.61 or s. 110.62 twice for shares deriving value from the same active business, but it does not merge the two exemptions into one number. Confirm the interaction for a specific transfer with an accountant before relying on both.
The qualifying business transfer conditions require that after the disposition the taxpayer not retain any right or influence that would let them control the trust, the purchaser corporation, or the qualifying business — a paid, non-controlling role is a separate question from retained control, and the line between the two is exactly what the anti-avoidance rule in s. 110.61(5) is aimed at.
It is excluded outright — s. 110.61(1)(c) requires that neither the subject corporation nor an affiliate it holds shares in be a professional corporation, and that the trust not control a corporation whose employees are its beneficiaries in that form.
A short call is enough to test the 24-month and active-business conditions against your actual structure.
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