Is the sale of my business to employees taxable, and what do I report to the CRA?

Selling shares to employees, whether to individuals or to an employee ownership trust, is a disposition for tax purposes. The Canada Revenue Agency (CRA) says that to calculate a capital gain or loss you subtract the property’s adjusted cost base, and any outlays and expenses incurred to sell it, from the proceeds of disposition. A sale to an employee ownership trust adds reserve rules and an extra form, covered below.

Where the gain is reported

CRA’s capital gains guide says to use Schedule 3, Capital Gains or Losses, to calculate and report your taxable capital gains or net capital loss. Those CRA pages are written for an individual’s return. If the seller is a corporation, or the business is sold as assets rather than shares, ask your accountant which return and schedules apply.

When part of the price is paid later

To deduct a reserve in any year, CRA says you complete Form T2017, Summary of Reserves on Dispositions of Capital Property. CRA says that, generally, the maximum period over which most reserves can be claimed is four years, so the gain is included in income over five years, and that a nine-year reserve period applies to listed dispositions, including one under a qualifying business transfer. Income Tax Act subsection 40(1.3) reads the reserve with one-tenth and nine in place of one-fifth and four for shares disposed of that way. The detail is on the page about spreading the gain on a sale to an employee ownership trust.

Forms and rules specific to an employee ownership trust

• CRA’s guide describes a qualifying business transfer as a transaction where, if certain conditions are met, a taxpayer disposes of shares of a corporation to a trust that is an employee ownership trust at that time.
• The same guide refers to Form T24EOT, Joint Election for Capital Gains Deduction in respect of a Qualifying Business Transfer. Whether you qualify, and for how much, is for your accountant to confirm against the form.
• Subsection 15(2.51) of the Act says the shareholder-loan rule in subsection 15(2) does not apply to a loan or debt in respect of a qualifying business transfer if, immediately after the transfer, the lender or creditor is a qualifying business and the borrower is the employee ownership trust that controls it; the sole purpose of the loan or debt is to facilitate the transfer; and, when it was made, bona fide arrangements were made to repay it within 15 years of the transfer.

Before you file

The Department of Finance’s explanatory notes say the definition of a qualifying business transfer is intended to ensure that only genuine business transfers to employee ownership trusts on arm’s length terms benefit from the 10-year capital gain reserve and the 15-year exceptions to the shareholder loan rule and the deemed interest benefit rule. Keep the share purchase agreement, the closing statement and records of your cost base on file.