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Does a Sale to an Employee Ownership Trust Require a Business Valuation?
Article Written November 6, 2026 | Business Valuation
Employee Ownership Trusts, or EOTs, are still relatively new to Canada. Introduced in January 2024 as part of the Canadian government's efforts to encourage employee ownership and facilitate business succession, the EOT rules create another exit alternative for owners of Canadian private businesses.
An EOT is a form of employee ownership under which a trust holds shares of a corporation for the benefit of the corporation's employees. The structure can facilitate an employee acquisition of the business without requiring individual employees to fund the purchase of shares themselves. For an owner considering succession, an EOT therefore provides another alternative to a sale to a third party such as a competitor, private equity fund, public company or family office.
As a valuator, I am conditioned to assume that given the term “fair market value” is woven throughout the Income Tax Act, a valuation (of some sort) is required for any transactions involving tax aspects or potentially non-arms’ length characteristics such as the buyers being employees. And my experience over the years with employee ownership programs well before the EOT legislation was enacted effective January 2024 is that key objectives of prudent company owners who want to transition part or all of their business to employee ownership are to (a) ensure they are getting a fair price for the years of work and the sacrifices made for building a business and to ensure they can fund their retirement, and (b) ensure that the price is fair to the employees. Of course, the natural way to help achieve these objectives is to secure a valuation report prepared by a professional valuator.
So upon close reading of the EOT legislation, I was surprised to note that there is no specific mention of a mandatory valuation for the EOT process. The question for me when structuring an EOT transaction became:
Does the business have to be independently valued?
As mentioned, the EOT rules do not simply say, "obtain an independent valuation report"; but that is not the end of the analysis. The reality is that FMV plays an important role in determining whether several of the requirements of the EOT regime are satisfied. Importantly, the price at which shares are transferred may provide evidence relevant to another important requirement: whether the parties are actually dealing at arm's length.
As a result, the better question is not "Is a valuation report technically required?" but rather:
How can the parties demonstrate that the various FMV and arm's-length requirements associated with an EOT transaction have been satisfied?
First, what qualifies as an EOT?
Under the rules described by the Canada Revenue Agency, an EOT must be an irrevocable trust that, among other requirements:
is resident in Canada, excluding deemed resident trusts;
exists exclusively for qualifying employee beneficiaries;
has trustees who satisfy specified conditions;
determines beneficiaries' income and capital interests according to the prescribed rules;
has all or substantially all, generally 90% or more, of the FMV of its property attributable to shares of one or more qualifying businesses ("QBs") that it controls; and
requires more than 50% of employee beneficiaries to approve certain significant transactions or events before they occur.
That fifth condition introduces a valuation question.
Determining whether 90% or more of the FMV of the trust's property is attributable to shares of qualifying businesses is inherently a value-based test. Someone applying the test must therefore have a reasonable basis for determining both the value of the QB shares and the value of any other property held by the trust.
That does not necessarily mean that a valuation report will be required every time the test is considered. But where values are uncertain or the trust owns material property in addition to QB shares, the reliability of the underlying valuation evidence becomes important.
The second 90% test: Is the transaction a qualifying business transfer?
Valuation becomes relevant again in determining whether the initial sale to an EOT constitutes a qualifying business transfer ("QBT").
The CRA describes a QBT as a disposition by a taxpayer of shares of a corporation to a trust, or to a CCPC controlled and wholly owned by a trust, where prescribed conditions are met.
One of those conditions applies immediately before the disposition. All or substantially all, generally 90% or more, of the FMV of the assets of the subject corporation must be attributable to qualifying assets used principally, generally more than 50%, in an active business carried on by the corporation or an eligible controlled corporation.
Again, this is not simply a book value test.
Consider a business whose balance sheet contains operating equipment, accounts receivable and cash, but which also owns investment assets, excess cash or real estate. Historical book values often bear little relationship to FMV. Applying the 90% test using carrying values from the financial statements could therefore produce a very different result from a test based upon the assets' actual FMVs.
A valuation may consequently serve a purpose beyond simply establishing the purchase price of the company. It can provide support for the underlying qualification tests upon which the EOT structure depends.
Kalex Partners Inc. welcomes the opportunity to answer your questions and provide support on business valuation matters, including those related to topics covered in this article.
FMV also appears elsewhere in the EOT rules
The significance of FMV is broader still. For example, a qualifying business must be a CCPC controlled by the trust and satisfy additional requirements concerning directors and persons who held significant interests before the EOT acquisition. Those tests themselves include thresholds determined by reference to the FMV of shares and indebtedness.
Similarly, the eligibility rules for beneficiaries contain 10% and 50% tests based on the FMV of shares or, in some circumstances, shares and indebtedness.
The point is not that every reference to FMV necessitates a formal valuation engagement. Rather, it demonstrates something important about the architecture of the legislation: Value is not incidental to the EOT regime. It is part of determining whether the regime applies.
The more interesting issue for EOTs: arm's length
For a transfer to constitute a QBT, at the time of the disposition the seller must deal at arm's length with the EOT and any purchaser corporation. Following the disposition, the seller must also deal at arm's length with the subject corporation, the trust and any purchaser corporation and cannot retain rights or influence that could permit the seller, alone or together with related or affiliated persons, to control those entities.
Arm's length is an important concept throughout Canada's tax legislation, but it is not synonymous with FMV. In fact, it is one of the basic tenets of FMV, the definition being:
“…the highest price available in an open and unrestricted market between informed, prudent parties acting at arm's length and under no compulsion to act, expressed in terms of money or money’s worth, represented by Canadian dollars.”
The CRA's Income Tax Folio S1-F5-C1, “Related Persons and Dealing at Arm's Length”, identifies three criteria that courts have generally considered when determining whether parties to a transaction are not dealing at arm's length:
whether there is a common mind directing the bargaining for both parties;
whether the parties act in concert without separate interests; and
whether one party exercises de facto control.
That distinction becomes especially interesting in an EOT transaction.
Unlike a conventional third-party sale, where an independent purchaser typically negotiates price and terms against the vendor, an EOT transaction may be established specifically to acquire the owner's business. Depending upon the circumstances, this may create a greater need to demonstrate that the transaction represents genuine commercial dealing between parties with separate economic interests.
Does FMV prove that the parties are dealing at arm's length?
The answer is no (based on S1-F5-C1 criteria discussed above), but it can be relevant evidence. Concluding on fair market value means that the valuator is also concluding that the value determined is reflective of the price at which arms’ length parties would transact, but the valuator does not specifically conclude on the three criteria listed above. The question in a valuation report is not whether the parties are at arms’ length, but at what price they would agree on if they were acting at arms’ length. This is a distinction worth emphasizing.
The CRA expressly acknowledges that a failure to transact at FMV may indicate a non-arm's-length transaction, but it is not conclusive. Conversely, a transaction between unrelated parties at FMV does not necessarily establish that the parties were dealing at arm's length. The critical issue is whether there are separate economic interests reflecting ordinary commercial dealing between parties acting in their own interests.
This makes valuation relevant without making it determinative.
Suppose, for example, that an owner has determined that the company is worth $20 million and transfers the shares to a newly established EOT for exactly $20 million. The fact that the purchase price happens to equal FMV does not, on its own, demonstrate that the parties dealt at arm's length.
But now assume that the trustees obtain an independent valuation as part of addressing their fiduciary responsibilities, consider the valuation assumptions, obtain their own professional advice and negotiate the transaction on behalf of the employee beneficiaries.
The valuation is no longer simply a number. It becomes part of the evidentiary record showing how the transaction was evaluated and negotiated. That distinction can matter.
Why EOT valuations present some unique issues
An EOT valuation also raises a practical question that may not arise in quite the same way in a conventional third-party transaction:
Whose interests are being considered when the price is established?
The vendor of a business understandably wants to realize value for the business developed over many years. The EOT trustees, however, have responsibilities associated with the trust and its employee beneficiaries. The CRA's EOT guidance specifically provides that trustees must not act in the interest of one beneficiary or group of beneficiaries to the prejudice of another.
Price therefore matters on both sides of the transaction. If the purchase price is too low, questions may arise as to whether the vendor has received FMV. If it is too high, the EOT and, ultimately, the business may be burdened with consideration that exceeds the economic value of what was acquired. This can become particularly relevant where the acquisition consideration is payable over time out of the future cash flows of the business.
The valuation conclusion regarding the equity of the subject business is generally the ultimate objective. However, the components of the value conclusion, such as the following, can be helpful in relation to assessing structuring issues (e.g., balance sheet clean up prior to closing and the extent and nature of financing the transaction):
normalized earnings/EBITDA/cash flows;
working capital requirements;
capital expenditure requirements;
non-operating/redundant assets;
servicing requirements for debt and other existing financial obligations;
capitalization rates/multiples;
the terms of any vendor financing; and
the company's ability to fund the transaction while continuing to operate successfully.
Those are valuation considerations rather than statutory EOT requirements in themselves, but they can be important in assessing whether the economics of the proposed transaction make sense.
So, is a valuation report required?
The statutory framework does not appear simply to prescribe that every EOT transaction must be supported by a formal independent business valuation report. However, a more nuanced analysis is required to avoid missing the bigger issue.
The EOT rules contain several tests that depend explicitly upon FMV. These include:
1. The EOT property test
Generally, 90% or more of the FMV of the EOT's property must be attributable to shares of qualifying businesses controlled by the trust.
2. The QBT active-business asset test
Immediately before the transfer, generally 90% or more of the FMV of the corporation's assets must be attributable to the prescribed active-business assets.
3. Certain qualifying-business tests
Some of the restrictions concerning directors and former owners are themselves measured by reference to FMV.
4. Certain beneficiary eligibility tests
The rules employ 10% and 50% FMV thresholds in determining whether particular employees meet the beneficiary requirements.
5. The arm's-length requirement
A QBT requires the seller to deal at arm's length with specified parties. FMV does not establish arm's-length dealing, but the CRA acknowledges that a departure from FMV can be an indicator that parties are not dealing at arm's length. In other words, FMV and arm's-length dealing are separate concepts, but they intersect.
Valuation as evidence, not simply compliance
The most useful way to think about valuation in an EOT transaction is that a valuation should not necessarily be viewed merely as another compliance document. It may form part of the evidence supporting the economic substance of the transaction.
A professionally prepared independent valuation can potentially assist the parties and their tax and legal advisers by providing an objective basis from which to:
establish or assess the proposed purchase price;
evaluate FMV-dependent qualification tests;
identify investment or non-operating assets that could affect a 90% test;
document the financial information, assumptions and valuation methodology underlying the price; and
demonstrate that the trustees had independent financial information when considering the transaction.
None of those factors, individually, proves that a QBT meets every requirement of the Income Tax Act. Nor does an independent valuation transform a non-arm's-length transaction into an arm's-length one.
Rather, the valuation report provides contemporaneous evidence that can be considered alongside the trust documentation, governance arrangements, negotiations, legal agreements and other facts surrounding the transaction.
The practical takeaway
Canadian EOTs create an attractive new succession alternative, particularly for owners who want to transition ownership while preserving the business and providing employees with an economic interest in its future.
But an EOT transaction is not simply a matter of transferring shares into a trust.
The tax regime relies repeatedly upon FMV, including in determining whether the EOT and the underlying business meet relevant qualification tests. At the same time, a QBT depends upon the parties satisfying important arm's-length requirements.
That makes the distinction between "required" and "advisable" particularly important. A formal valuation report may not be expressly required in every EOT transaction. But where millions of dollars of business value are changing hands, qualification depends in part upon FMV tests, and the arm's-length nature of the transaction matters, having an independent and well-documented conclusion of value may be difficult to dismiss as merely optional paperwork.
Sometimes the better question isn't: "Does the legislation say I have to get a valuation?"
It is: "If the value is subsequently questioned, what evidence will we have to support it?"
At Kalex Partners, we provide independent business valuation and forensic accounting services in shareholder disputes, oppression claims, and family business conflicts. Working closely with lawyers and their clients across Canada, we help quantify damages, assess fair value, investigate financial issues, and support negotiated settlements and court proceedings.
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