Head to Head: Should the U.S. ESOP structure be brought to Canada?

Canada should maintain the current paths by which companies are creating employee ownership, but it should also create a new vehicle that draws on the U.S. (where I’m based) model, which is a proven way to create more employee ownership.

This recommendation rests on the assumption that employee ownership is a good public policy. The U.S. has had ESOP legislation since 1974. Almost 50 years of data shows employee-owned companies are more competitive and create more jobs and that employee owners have higher economic security. Data analyzed by the NCEO in a 2017 study on employee ownership and economic well-being found employee owners have 92 per cent greater net household wealth than non-employee owners and this advantage extends to workers of all demographic groups and education levels, as well as across industries.

Read: HOOPP, Social Capital Partners financing Taylor Guitars’ move to 100% employee-ownership

Under federal retirement law, U.S. ESOPs are required to be broad-based and have mandated safeguards to ensure they’re managed in the exclusive interest of employees. In return, the model has a variety of tax incentives. U.S. ESOPs are very different from stock options, which tend to have a medium-term time horizon and generate income, rather than retirement wealth.

As well, employees don’t pay anything for shares in the ESOP — the shares are an employer-provided employment benefit. ESOPs can borrow money to purchase shares from the owner, allowing them to purchase substantial blocks of shares in a single transaction.

Almost 6,000 privately held U.S. companies have ESOPs and more than two million people benefit from those plans, according to 2019 data from the NCEO. ESOPs in the U.S. have proven to have many benefits and it’s a direction more organizations in Canada should consider heading in as well.

David Rotfleisch, Founding partner and tax lawyer at Rotfleisch & Samulovitch Professional Corp. (pictured right)

Compared to the U.S., Canada is more suspicious of corporations. Specifically, Canada is very tax-stingy when it comes to incentives to allow employees to become shareholders.

Canada provides share incentives to employees through stock option rules. These rules permit employers to give employees a stock option to acquire shares, including at below market value, and not to pay tax on that benefit until the option is either exercised or sold, depending on the type of corporation.

Read: Toronto’s Juno College planning to move to 100% employee-ownership model

For shares of a Canadian-controlled private corporation, the benefit isn’t taxable until the shares acquired under the option are sold. For options in other corporations, including publicly traded corporations, tax is payable when the option is exercised. The profit is taxed at the equivalent of capital gains rates: 50 per cent.

The tax treatment of stock options is generous, but now has a cap on the benefit amount available with respect to publicly traded corporations. However, stock options are typically only granted to vice-presidents and other executives, not average employees.

In contrast, in the U.S., an ESOP allows employees to buy shares on the stock market at a discount from fair market value without any taxes owed on the discount at the time of purchase. An employee stock purchase plan allows employees to use after-tax payroll deductions to acquire their company’s stock, usually at a discount of up to 15 per cent.

Read: The pros and cons of employee share purchase plans

The key distinction between the U.S. and Canada model is that the U.S. plan is broadly based and available. Any employee can acquire shares in their employer through automatic payroll deductions. In addition to providing a tax break, it allows employees to share in the financial success of their publicly traded employer.

Why should such a plan not be available to Canadian employees?