Canada: Should You Be Considering An Estate Freeze?

Do you own assets that are growing in value, such as shares in a privately held company, a portfolio of investments or land? If so, you may be able to arrange your affairs so as to minimize income tax on any future gain in the value of those assets, save provincial probate fees on your death, and plan for the orderly succession of your wealth into the hands of the next generation.

These are some of the objectives that lead people to consider an estate freeze.

What is an estate freeze?

Simply put, an estate freeze is a transaction which limits, in whole or in part, the growth in the value of assets ("original assets") by replacing them with assets that have a fixed value ("frozen assets"). Future growth in the value of the original assets then generally accrues to the benefit of other persons, often children and grandchildren of the individual carrying out the estate freeze (the "freezor"). The transaction is also often implemented in a way that will permit the freezor to continue to control all of the assets and the revenue that flows from them.

Implementing a freeze

The most common method involves the use of a private holding company. Typically, the freezor transfers his or her original assets to a holding company in exchange for voting preference shares of that company. The value of the preference shares received will be equal to the value of the original assets at the time of the transfer and the preference shares will not increase in value in the future. In this way, a the original assets owned by the freezor is achieved.

The holding company then issues common, non-voting shares to new shareholders designated by the freezor, often his or her children or grandchildren or the trustee(s) of a family trust established for their benefit. Any growth in the value of the original assets after the freeze will accrue to these new common shares. The freezor can continue to control the holding company through the ownership of the preference shares.

Many variations of this structure are possible. The final plan should be designed to achieve the specific objectives of the freezor and should reflect his or her personal and financial circumstances and those of family members or others who are intended to benefit from the freeze.

Potential advantages associated with an estate freeze

01|Income tax advantages

Because the preference shares that the freezor receives will not increase in value, the capital gain on those shares, when they are eventually disposed of, will not increase. This means that some certainty is achieved in terms of the tax payable in respect of the preference shares on the death of the freezor.

If the estate freeze is structured so that any increase in the value of the common shares accrues to the freezor's children, assuming that the children outlive the freezor, this will result in a deferral of the tax liability owed in relation to that increase in value until the children either dispose of the common shares or die, whichever first occurs. Even if the tax deferral is only for a few years, depending upon the amount involved, this can result in a substantial benefit to the children.

The tax payable on the disposition of shares of the holding company by the freezor and the children can be further reduced by having each of them use his or her small business capital gains exemption of C$750,000, if it is available.

There is also the possibility of "income splitting" with the children and grandchildren of the freezor. As recipients of dividends on the shares that they hold, they will often be in a lower tax bracket and therefore be taxed at a lower rate than the freezor; however, certain "attribution" rules in the Income Tax Act (Canada) can negate any income splitting benefits. The greatest flexibility to income split will generally only exist if the children or grandchildren are 18 years of age or older.

02|Reduction in probate fees

Through careful planning, provincial probate fees payable by the estate of the freezor can also be reduced and, in some instances, eliminated. This can amount to a saving of 1.4 per cent of the value of the shares in the holding company. This may be achieved through the redemption of the preference shares while the freezer is alive (called a "wasting freeze"), by the use of a multiple will strategy, or by transferring the shares to an alter e tner trust, the latter option being advisable if the freezer is 65 years of age or older.

03 | Family legacy assets

An estate freeze can also be an effective component of a plan designed to pass ownership and control of a family legacy asset, such as a family business, into the hands of the next generation. The use of a trust as part of the plan can ensure that the structure is flexible, giving the freezor time to consider, for example, which of his or her children or grandchildren are best suited to take over the control of the business when the freezor is ready to relinquish that control.

04 | Asset protection

The interposition of a holding company and a trust may provide asset protection in some circumstances for family members who might be faced in the future with a claim by a disgruntled spouse under family law legislation or by a creditor. However, the extent of this protection will depend on a number of factors and legal advice should be sought if this is a consideration.

Timing of an estate freeze

The timing of an estate freeze depends upon many factors, including, for example, the personal and financial circumstances of the freezor and those of his family members, as well as the nature of the family business, if one is involved. One of the biggest mistakes sometimes made is putting in place a structure that does not have sufficient flexibility to accommodate future changes in circumstances and needs. If proper care is not taken, a freezor can be left with inadequate assets to sustain his or her lifestyle and support future business plans. A proper estate plan should ensure that this does not happen.

Conclusion

Even where it is appropriate to implement an estate freeze, it will likely be only one component of a well-designed plan intended to achieve a client's objectives. The lawyers in our Wealth preservation group would be pleased to work with you to design a plan that works for you.


About Norton Rose Fulbright Canada LLP

Norton Rose Fulbright is a global law firm. We provide the world's preeminent corporations and financial institutions with a full business law service. We have 3800 lawyers and other legal staff based in more than 50 cities across Europe, the United States, Canada, Latin America, Asia, Australia, Africa, the Middle East and Central Asia.

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Wherever we are, we operate in accordance with our global business principles of quality, unity and integrity. We aim to provide the highest possible standard of legal service in each of our offices and to maintain that level of quality at every point of contact.

For more information about Norton Rose Fulbright, see nortonrosefulbright.com/legal-notices.

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