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An estate freeze is a common estate and tax planning tool to minimize the future tax liability of an individual who owns assets that are appreciating in value. How does it work? You basically exchange the appreciating assets for assets that are fixed in value.
In the most common example, a business owner transfers the common shares of his or her operating company (or an investment portfolio that is expected to increase in value) to a holding company. In return, the owner will receive fixed value special/preferred shares (freeze shares). Often the owner will simply exchange the common (growth) shares of his company for freeze shares of the same company (an internal freeze). The exchange is done on a tax elective “rollover” basis so that no current tax is triggered on the transaction.
Trusts or other family members subscribe for new growth shares of the operating or holding company at nominal values. The future growth in value is effectively passed on to the beneficiaries of the freeze. The future tax liability of the owner is “frozen” at what it would be if he sold his shares now.
An individual might change his mind about the freeze. This could happen when the owner finds he needs more than the value of the freeze shares for retirement or to fund other personal needs such as health care. Changing family or marital circumstances might require a realignment of the values accruing to the various beneficiaries.
This could require a “thaw” so that the owner reacquires all or an increased portion of the future growth. The values of the existing beneficiaries are frozen in a manner similar to the original freeze. If the original freeze is structured properly, it may also be possible to pass the growth in value since the original freeze back to the owner, effectively undoing the freeze completely. A discretionary trust with a corporate beneficiary (or the power to add a corporate beneficiary) is often used in structuring a freeze for added flexibility.
Sometimes, particularly in recent years, rather than the expected growth in value of the frozen assets, there is a significant decline in values. The value of the company may have declined so that it is below the value of the preferred shares issued on the original freeze. In this situation, it may be appropriate to refreeze at the lower current value.
When refreezing, care needs to be taken to determine the cause of the decline in value. If the value has dropped because corporate assets have been stripped, the tax authorities will likely take the position that the common shareholders have received a benefit on the refreeze transaction.
The Canada Revenue Agency has stated that such asset stripping could occur where dividends have been paid to the common shareholders that have impaired the value of the original freeze shares. Another example is where the amount of salaries or bonuses paid to the beneficiaries of the original freeze is in excess of the value of the services performed and responsibilities assumed by them.
Estate freezing, thawing or refreezing are complex transactions which could attract the attribution rules, various tax benefit and other anti-avoidance rules. In addition, the values used should be supportable using accepted valuation techniques. Professional advice is a must when considering these strategies.
To determine if an estate freeze, a thaw, or a refreeze would be appropriate for you; or to assist you in valuing your company, please contact me or your local MNP tax advisor to review your estate plans.
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