Employee trusts: a powerful tool for retention and motivation

This article is part of a series on profit-sharing plans, an interesting alternative for companies wishing to improve employee retention within their ranks.
Over the past few months, our team of Canadian tax consultants has assisted a number of companies in the development and implementation of certain profit-sharing plans, and has decided to write articles on the subject in order to inform even more entrepreneurs keen to offer their employees the best possible working environment.

In the previous articles, you were able to understand how the bonusplan works, the freeze and new share issue strategies, thestock option and finally, the phantom stock plan. The following article deals with another plan, the employee trust.

Overview: How does an employee trust work in Quebec?

The establishment of an employee trust generally makes it possible to create a plan that straddles the gap between a stock option plan and a phantom stock plan. The main difference with these plans is the creation of a trust within the company’s shareholder base, in which the beneficiaries of the trust are the company’s key employees.

The broad outlines applicable to the operation of this type of plan

The employee trust acts as a shareholder of the company like any other shareholder. This gives it no special status compared with other shareholders. However, it is important to note that it is the trust that holds the shares, not the employees directly.

At the trust level, it is the trustees who act as “managers” of the assets held by the trust. The “founding” shareholder is normally one of these trustees, so that he or she continues to have some control over the trust’s decisions. This limits the sharing of financial information, and greatly facilitates shareholder accountability and decision-making. In addition, the trust deed may provide for the trustees’ discretion in sharing amounts among the beneficiaries (employees), or provide for a fixed participation for each employee. As a shareholder of the company, the trust may receive dividends. When applicable, the trust then distributes the dividends among the employee beneficiaries. When employees receive dividend income from the trust, they are personally taxed on the income allocated to them by the trust. In the event of a sale of the business, the proceeds from the sale of the shares held by the trust will be allocated in favour of the employees, who will be taxed on the amount received as employment income. Under this type of plan, employees cannot benefit from capital gains treatment on the shares held by the trust. What’s more, since this type of plan involves a trust, the latter will also be required to file an annual income tax return, which entails a certain amount of compliance work.

Case study and analysis of its integration into a profit-sharing scheme

A young human resources consulting firm recently decided to set up a profit-sharing plan for its key employees. Since its inception, the company has shown rapid expansion in several territories. It currently has a place of business in most of Canada’s major cities, and plans to open more in the near future.

Considering that one of the company’s great strengths lies in its talent, management wishes to set up a recognition plan for its employees that is both flexible and predictable. The CEO does not wish to sell shares in the company directly to employees, nor to use a freeze to integrate key employees, due to the large number of key employees who would be eligible for the program, and the inherent complexity of setting up this kind of structure given the number of different territories.

However, management likes the idea of being able to pay dividends to its employees based on the company’s profits, as well as the possibility of key employees sharing in the company’s value in the event of a future sale. These elements are important to the company’s management, as they are aligned with the internal policy that every employee contributes to the company’s success.

In addition, some key employees already have annual bonus clauses as part of their employment contracts. Setting up an employee benefit trust was therefore the best choice for the company. Following a freeze on the company’s shares, the newly created trust subscribed to 15% of the company’s common shares.

In addition, the trust deed allows the trust to increase the participation of certain key employees based on the number of years they have been with the company (for example, when they celebrate 5, 10, 15 and 20 years of seniority).

Although complex, the advantages of this plan are that it allows for flexibility in adding or removing beneficiaries to the trust, based on the deed’s definition of “eligible employees”. In addition, employees are not shareholders of the company, but rather beneficiaries of the trust. Employees therefore have no shareholder rights or privileges, which simplifies the process.

Indeed, management can retain “control” over this aspect by acting as trustees of the trust. This process allows flexibility in the distribution of income and capital to employees, if desired. Nevertheless, this type of plan is complex, administratively cumbersome and costly to set up.

However, for the company’s management, the benefits of this plan far outweighed the potential irritants, and proved to be the perfect compromise for improving retention of key employees and redistributing some of the value back to employees.

The employee trust offers an intermediate solution between stock option plans and phantom stock plans, making it possible to meet both the company’s need for flexibility and the expectations of key employees. Although this plan presents administrative and compliance challenges, the benefits in terms of talent retention and participation in company growth make it an attractive option for growing companies.

For companies seeking to align the interests of their employees with those of the organization while maintaining a degree of control, an employee trust may represent the ideal middle ground.