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Business succession — tax rules to consider for family business transfers

Budget 2023 announced two sets of tax rules to consider where owners transfer their businesses to family members and employees. Find out how these measures might apply to business succession in 2024 and later years.

NOTE: This tax blog was first published on May 16, 2023, based on proposals affecting intergenerational business transfers and employee ownership trusts in the 2023 federal budget documents. On August 4, 2023, revised legislation was released impacting both sets of proposals. In our September 2023 blog, we have updated our summary to reflect the latest legislation. The May blog has been retained for your reference.

For many years, Canada’s tax treatment of business sales and succession has been a hot topic. Business owners wanting to pass on their businesses to future generations faced tax problems that did not arise on commercial sales to non-family members. Further, unlike many other countries, Canada had no tax framework in place to help owners wishing to pass the business to their employees.

Budget 2023 affects both issues. For interfamily transfers, the budget announced proposals that would add new conditions and correct flaws in legislation stemming from a private member’s bill that had attempted to resolve the inequity between family and non-family business transfers. For transfers to employees, the budget introduces specific tax rules to govern the use of employee ownership trusts with the aim of increasing employee buyouts. Both sets of rules are scheduled to come into effect on January 1, 2024.

In this blog, we summarize the main features of these rules and some issues with the proposals as they are currently drafted.


Background: Bill C-208

Bill C-208, An act to amend the Income Tax Act (transfer of small business or family farm or fishing corporation) is a private member’s bill, enacted on June 29, 2021, targeting the tax inequity for non-arm’s length intergenerational transfers of a business.

When selling a corporation to another arm’s-length corporation, as long as the shares qualify, the sale generally triggers a capital gain eligible for the capital gains exemption. The buyer is permitted to make the purchase using a corporation they own, so they can use the after-tax corporate income to help finance the purchase. If an individual buys the shares directly, they must use after-tax personal cash.

However, under the rules in place before Bill C-208’s enactment, if the same shares were sold to a non-arm’s length corporation for non-share consideration under similar conditions, the gain would generally be a deemed dividend under Section 84.1 of the Income Tax Act. If another family member bought the shares personally, then a capital gain would arise that would be eligible for the capital gains exemption (if the usual conditions were met). However, the need to use after-tax cash at the personal level created a significant inequity for business transfers within a family and a tax bias favouring arm’s-length sales.

To eliminate this inequity, Bill C-208 altered the rules that apply to non-arm’s-length sales so that deemed dividend treatment would not apply in certain conditions. As Parliament debated the bill in 2021, the Department of Finance Canada (“Finance”) raised concerns that the bill’s changes could open opportunities for inappropriate surplus stripping. Finance committed to amend the rules to facilitate genuine intergenerational share transfers while preventing tax avoidance and improving tax fairness.

What is a “genuine” intergenerational business transfer?

Almost two years later, these amendments were announced in Budget 2023, which states that the tax treatment introduced in Bill C-208 would “apply only where a genuine intergenerational business transfer takes place.” 

The budget then sets several conditions that must be met. These include general conditions that would apply to all transfers and specific conditions that would apply in two scenarios:
  • “immediate transfers” made within 36 months
  • “gradual transfers” made over 5 to 10 years
Where the conditions are met and an election is made, the business transfer would be excluded from Section 84.1’s deemed dividend rules.
For more information on these conditions and the rules for immediate and gradual transfers, see our detailed checklist.
Also in the budget are announcements that would:
  • eliminate the requirement to provide the Canada Revenue Agency with an independent assessment of the fair market value of the shares sold and an affidavit signed by the vendor and a third party attesting to the share sale;
  • eliminate the grind on capital gains exemption claims where the corporation sold (or associated group) has taxable capital employed in Canada exceeding $10 million; 
  • enhance the capital gain reserve rules by allowing a reserve over 10 years for sales that qualify as immediate or gradual transfers; 
  • increase the normal reassessment period by 3 years for immediate transfers and 10 years for gradual transfers; and
  • add joint and several liability for payment of tax under certain conditions.
Note that Budget 2023 does not affect Bill C-208’s amendments to Section 55.
If enacted, the budget proposals would apply to dispositions on or after January 1, 2024.


Canada’s existing rules have several barriers to the creation of Employee Ownership Trusts (EOTs) and have been the topic of consultations for several years. If enacted, the EOT rules could offer another succession planning option for Canadian business owners.  

With an EOT, a business can be sold to employees through a trust that holds that corporation’s shares for their employees’ benefit without requiring employees to pay for shares directly. When many employees are participating in a buyout, using a trust can make it easier to deal with the legal and administrative details than if each employee owned their shares directly. 

The United States, United Kingdom and other countries that have introduced EOTs have reported benefits for their workers and their economies.1 Many leaders in Canada’s business, academic and non-profit sectors have been calling for the creation of a framework that would allow for of EOTs in Canada.2

How do Employee Ownership Trusts work?

An EOT generally would be set up as follows:

  1. The EOT is formed, and the employees of the target business are made beneficiaries of the trust.
  2. The trustees of the trust negotiate terms and conditions for the purchase of the target business’s shares. Debt financing is arranged to allow the EOT to purchase the shares, which the business itself might provide.
  3. The EOT repays the debt over time using the earnings distributed to it from the business.

The existing ITA rules have several barriers to the creation of EOTs. After several years of consultation and examining these barriers, Budget 2023 introduced new rules that, if enacted, would allow for the creation of EOTs and introduce an additional succession planning option for Canadian business owners. Unlike some other countries, however, the proposed rules seem to focus on removing tax barriers as opposed to creating additional tax benefits to promote employee ownership and the use of EOTs, as we discuss later in this blog.

Canada’s new EOT rules

An EOT is generally a Canadian resident trust that has two purposes:

  • to hold shares of a qualifying business for the benefit of trust’s employee beneficiaries; and
  • to make distributions to employee beneficiaries under a distribution formula that can only consider any combination of an employee’s length of service, remuneration and hours worked (and otherwise treats all its beneficiaries similarly). 
The EOT’s share acquisition must be a qualifying business transfer, which would occur when a taxpayer disposes of shares of a qualifying business to an EOT (or a corporation wholly owned by the EOT) and both these conditions are met: 
  • the proceeds received by the vendor do not exceed fair market value; and 
  • the trust qualifies as an EOT immediately after the sale, and the EOT has a controlling interest in the qualifying business immediately after the transfer.
Additional conditions for qualifying as an EOT include: 
  • The trust holds a controlling interest in the shares of one or more qualifying businesses. A qualifying business is a Canadian-controlled private corporation where all or substantially all of the fair market value of its assets are attributable to assets (other than an interest in a partnership) used in an active business carried on in Canada. All or substantially all of the EOT’s assets must be shares of qualifying businesses.
  • The EOT’s beneficiaries are comprised of qualifying employees only. Qualifying employees generally include all individuals employed by qualifying businesses controlled by the trust (other than new employees on probation and certain employees who own a significant investment in the qualifying business’s shares). 
  • Distributions of trust property are restricted. EOTs cannot distribute shares of qualifying businesses to individual beneficiaries.
  • Specific rules apply for appointing trustees. All trustees of the EOT generally must be Canadian residents. Trust beneficiaries elect the trustees at least once every five years. Individuals and their related persons who held a significant economic interest in the business before a sale to the EOT cannot comprise more than 40 percent of the EOT’s trustees, directors of a corporate trustee’s board, or directors of any qualifying business of the EOT. 
An EOT is a taxable trust, so it is generally subject to the same tax rules as other personal trusts. Undistributed trust income is taxable at the highest personal marginal rate, and trust income that is distributed to beneficiaries is taxed at the level of the beneficiary and not the EOT.

Tax benefits of EOTs

In addition to providing a new business succession alternative, the proposed EOT rules carry the following tax benefits:

  • No 21-year deemed disposition ruleAs EOTs are intended to exist indefinitely for the benefit of employees, EOTs would not be subject to the 21-year deemed disposition rule (which deems a trust to dispose of its capital property every 21 years).
  • Extended shareholder loan repayment period The repayment period to avoid an income inclusion under the shareholder loan rules would be extended to 15 years (from one year) for amounts loaned to an EOT from a qualifying business to purchase shares in a qualifying business. The shareholder loan rules would otherwise present a significant tax barrier.
  • Extension of capital gains reserve On a sale of qualifying corporation to an EOT, the existing capital gains reserve would be extended to up to 10 years (from 5 years) so that a vendor could defer recognizing part of the capital gain for up to 10 years, based on the amount of unpaid proceeds at the end of a tax year. Under these rules, the vendor would have to bring at least 10 percent of the gain into income each year for 10 years. This makes the treatment of share transfers to an EOT consistent with other transfers. 

EOT frameworks in other countries — how does Canada’s compare?

One of the biggest reasons why EOTs have become popular in the U.S., U.K. and some other countries is the tax incentives they provide to vendors and employees. Not only do these regimes foster the creation of EOTs, but their tax incentives also encourage sellers to choose to sell to an EOT instead of conventional buyers.  

In the U.K., for example, no capital gains or income tax applies on the selling shareholders when they sell their businesses to properly structured EOTs.3 In addition, companies controlled by EOTs can pay out tax-free cash bonuses to employees of up to £3,600 per employee each year. 

The U.S. tax regime for employee stock ownership plans provides several tax advantages to the selling shareholders (e.g., certain vendors can defer their gains) and to the company/trust (in some cases, tax exemptions, deductions or waivers of restrictive tax rules). Preferential tax treatments may be available to the employees also. 

As currently proposed, Canada’s EOT regime provides the framework for creating EOTs and removes some barriers, but offers no additional incentives beyond the tax benefits noted above to encourage business owners to favour a sale to an EOT. It will be interesting to see how widely used EOTs become in Canada.


If enacted, the EOT rules would apply as of January 1, 2024. Budget 2023 invites stakeholder feedback on how best to enhance the rights of employees and their participation in the governance of EOTs. 
We will continue to follow the progress of the proposals for business transfers to family members and employees as they make their way to law, and we will update you as more information is made available or if either set of proposals is changed significantly. 
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1 See this page

See for example, The Canadian Employee Ownership Coalition

Note that in the U.K., individuals pay capital gains tax on gains above a tax-free allowance (i.e., annual exempt amount) of £6,000 for 2023 and 2024 taxation years. No capital gains exemption is allowed on the disposition of privately held business shares, similar to Canada’s lifetime capital gains exemption.


The views and opinions expressed in this article are those of the author and do not necessarily reflect those of CPA Canada.