What laws and rules apply when I sell my business to employees?

No single statute governs a sale to employees. If shares go to an employee ownership trust, the Income Tax Act sets the conditions the trust and the sale must meet. If new shares are issued to staff, securities law may apply. Employment standards are not covered here, so check the rules that apply where your employees work.

What makes a trust an employee ownership trust

Subsection 248(1) defines an employee ownership trust as an irrevocable trust that, at all relevant times, meets listed conditions. They include residence in Canada, a trust exclusively for the benefit of qualifying employees, a bar on trustees acting in one beneficiary’s interest to another’s prejudice, qualifications for trustees, a required share of trustees who are employee-beneficiaries, and rules for how beneficiaries’ interests are set. The same subsection defines a qualifying business transfer as a disposition of shares to a trust, or to a corporation the trust controls and wholly owns, if all or substantially all of the subject corporation’s asset value comes from assets used principally in an active business; at the time of the disposition the seller deals at arm’s length with the trust and any purchaser corporation, the trust acquires control and is an employee ownership trust whose beneficiaries are employed in the business; and at all times afterwards the seller deals at arm’s length with them and keeps no right or influence that would let the seller control them.

Tax rules that attach to it

The Department of Finance’s explanatory notes say the qualifying business transfer definition 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 and deemed interest benefit rules. Subsection 40(1.3) lengthens the reserve, and subsection 15(2.51) lifts the shareholder-loan rule for a loan that meets its conditions. The page on selling a business to your employees compares the routes.

Securities law

Section 2.24 of National Instrument 45-106 says, subject to section 2.25, that the prospectus requirement does not apply to a distribution by an issuer of its own securities, or by a control person of the issuer’s securities or options, with an employee, executive officer, director or consultant of the issuer or a related entity, or a permitted assign of one, if participation in the distribution is voluntary. Whether a particular sale or issue is a distribution, and whether it qualifies, is a question for a securities lawyer. A sale of existing shares between private parties may raise different questions from a new issue.