How long can I spread the gain on a sale to an employee ownership trust?

A seller who has not been fully paid can report part of a capital gain later, through a reserve. For a sale of shares to an employee ownership trust, the Income Tax Act stretches that period. Selling to employees is one of the routes owners weigh, alongside a family member or an outside buyer, according to the Business Development Bank of Canada. Whether your sale qualifies depends on conditions in the Act.

How the reserve normally works

The Canada Revenue Agency explains that a reserve lets you report a share of the gain in the year you receive proceeds, based on the portion you have not yet received. Generally the longest period over which most reserves run is four years, so the gain is included in income over five years. The reserve is claimed with the CRA’s summary form for reserves on dispositions of capital property.

The longer period for an employee ownership trust

For shares disposed of under a qualifying business transfer, the Act reads the reserve formula as if one-fifth and four were one-tenth and nine. In plain terms, the gain can be included in income over ten years instead of five. Because a reserve follows unpaid proceeds, the longer spread only helps if the price is in fact paid over that time.

What counts as a qualifying business transfer

• You sell shares of a corporation to the trust, or to a Canadian-controlled private corporation that the trust wholly owns.
• All or substantially all of the corporation’s asset value comes from assets used principally in an active business.
• You deal at arm’s length with the trust and keep no right or influence that could let you control the company or the trust.
• The trust is an employee ownership trust: irrevocable, resident in Canada, and for the benefit of employees of the business.

The Act sets further rules on how beneficiaries’ interests are allocated and who may serve as trustee, and a separate capital gains deduction for these transfers carries its own conditions. Each is a question for a tax adviser. For the structure itself, see can I sell my business to my employees.