Transfer appreciating assets (eg, to children) on a tax-deferred basis without losing control

The goal of an estate freeze is to transfer future increases in the value of an OpCo to the common shares of a Holdco.

• typically limits the value of the parents’ shares to the value at the time of the freeze
• parents retain the current value, but in a different form (e.g., common shares —> preferred shares)
• tranferring assets directly could result in a deemed disposition

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Uses

There are five main uses for an estate freeze

1. Income Splitting
2. Creditor Protection
3. Marital Considerations
4. Probate Planning
5. Incorporation Tax Benefits

Income Splitting

• income and capital gains may be taxed in the hands of family members in a lower tax bracket
• may give access to multiple lifetime capital gain exemptions

Note: watch out for the attribution rules and "kiddie tax"

Creditor Protection

• freezor’s shares may be subject to claims due to personal guarantees or judgments favouring creditors

Marital Considerations

• limits marital claims on the growth assets

Probate Planning

• probate fees apply to the value of an estate
• limits future growth of assets —> limits value of freezor’s estate —> reduces probate fees

Incorporation Tax Benefits

• eg, could create another business to be frozen which is not related to the existing Opco

How It Works

Characteristics of the freeze shares

• voting rights —> effective control
• redeemable by issuer: Holdco can redeem them at any time
• retractable by holder: shareholder can demand that they be redeemed
• preference on liquidation
• price adjustable if CRA challenges share value
• dividend-paying (e.g., noncumulative)
• non-impairable (e.g., dividends payable to other classes only if still able to retract)

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In the diagram above

• freeze shares
  • little or no participation in future growth (eg, preferred shares)
  • often the pre-existing shares
• growth shares
  • equity shares with rights to future appreciation (eg, common shares)
  • initially have nominal value
• family trust
  • often used to manage and administer property for the beneficiaries
    • gives some control
    • protects against employee mismanagement
    • trustees may be allowed to determine the beneficiaries
  • promissaory note
    • protects against the attribution rules

Techniques

There are two ways to implement an estate freeze

• Section 85 Rollover: a tax-deferred tansaction
• Section 86 Reorganization: simpler and more popular

Section 85 Rollover

This is a tax-deferred transaction.

• exchange Opco common shares for Holdco preferred shares with voting rights
  • same value
  • no capital gain (ACB_preferred = ACB_common)
    • could increase ACB, which would trigger a current year taxable gain
• preferred shares have a fixed value (eg, $600,000)

Section 86 Reorganization

This is simpler and more popular.

• the steps
  1. exchange Opco common shares for preferred shares
  2. issue common shares of Opco (eg to children)
• no Holdco is required
• automatic tax rollover
• no capital gain (ACB_preferred = ACB_common)
  • can use Section 85 election form to cause a disposition of common share for amounts above the ACB

Articles

• Estate freeze cushions effect of death and taxes (Globe and Mail, Mar 2010)