Freezing Value Inside of a Corporation

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1 CLAUDIUS DU PLOOY DU PLOOY LAW Freezing Value Inside of a Corporation BY CLAUDIUS DU PLOOY As a Canadian business owner, an estate-freeze strategy may be considered to benefit you in achieving your estate-planing goals. THROUGH AN ESTATE FREEZE, FUTURE GROWTH IN VALUE OF A CORPORATION ACCRUES IN NEWLY ISSUED COMMON SHARES TYPICALLY HELD BY OTHERS EITHER DIRECTLY OR THROUGH A TRUST If you are a Canadian business owner, you may want to consider employing the strategy of an estate freeze to achieve your estate planning objectives. An estate freeze typically involves a reorganization of ownership in a privately-held corporation where the value of a corporation is frozen in preferred shares that have a fixed value. Once this is done, new common shares can be issued to various shareholders. Future growth in value of the corporation then accrues in the newly issued common shares that are typically held by others, such as family members, either directly or through a trust. MCLEAN & PARTNERS WEALTH MANAGEMENT 1

2 Before a freeze, a business owner typically holds common shares in the corporation. Common shares provide the owner stake in the corporation s profits as the value of common shares fluctuates with the value of the corporation. For example, ABC Ltd. is a corporation with a value of $1,000,000. John is currently the sole shareholder and holds 100 voting common shares. Preferred shares have a fixed value that is set out in the corporation s articles, which provide an explanation of the share classes. In ABC Ltd., preferred shares are valued at $1.00 each and will never increase, even if the corporation s common shares increase in value. John is going to exchange his 100 common shares for 1,000,000 preferred shares valued at $1.00 each through an estate freeze. These newly issued preferred shares will hold the entire $1,000,000 value of the corporation. After the freeze, new common shares can be issued at a nominal value because the value of the corporation has been frozen in John s preferred shares. This will grant John the ability to do some tax planning, primarily in the ability to declare dividends to different shareholders (on different classes) at different times to minimize the tax burden on John. John will also have the ability to redeem his preferred shares over time. In this example, common voting shares are issued to John so that he maintains control of the corporation while non-voting common shares are issued to his two children, Peter and Michael, and wife, Jane. The Class A, Class B, Class C, and Class D shares will all be issued at $0.01 each because the value of the corporation remains frozen in the 1,000,000 preferred shares. MCLEAN & PARTNERS WEALTH MANAGEMENT 2

3 Family Trusts Setting up a family trust to hold shares in a privately held family business is also an effective way to pass the corporation onto the next generation through succession planning. The future growth of the corporation can be passed onto future generations while control remains with the initial shareholder. A family trust may also be desirable if decisions regarding who will have control or what proportions should be allocated to each child should be delayed. Taking advantage of a family member s lowest marginal tax bracket may reduce overall income taxes paid by the family unit. Family trusts may also facilitate income splitting, which is a common motivation for this type of structuring. Transfer of real property to a corporation Real property held by an individual can also be transferred to a corporation in exchange for share consideration. Similar to common share value being exchanged for fixed-value preferred shares, property can be transferred to a corporation in exchange for preferred shares. This means that the future value of the property will accrue under the newly issued common shares of the corporation. The value of the property at the time of the transfer remains fixed in the preferred shares that were issued in consideration for it. Benefits of an estate freeze IF A LOWER INCOME TAX-RATE IS ANTICIPATED IN THE FUTURE, DEFERRING TAXES PAYABLE COULD BE VERY ADVANTAGEOUS There are a number of benefits that may exist as a result of an estate freeze. If a lower income tax-rate is anticipated in the future, deferring taxes payable could be very advantageous. Income and probate taxes upon death may be reduced by an estate freeze. A purchase price for the business also becomes locked in if the value of the corporation is frozen in preferred shares. The owner of the frozen share value could also sell those shares over time to a future owner and provide a retirement income of desired tranche amounts and frequency. As a holder of preferred shares in a corporation, the shareholder can also MCLEAN & PARTNERS WEALTH MANAGEMENT 3

4 redeem the fixed-value shares over time, and trickle the value out of the corporation. Factors to consider Several factors should be taken into consideration when contemplating a transaction such as an estate freeze. Factors such as determining whether one has accumulated enough wealth to date that freezing it would not negatively affect one s chosen lifestyle, attribution rules in relation to income splitting, and the possibility of freezing property on a tax-deferred bases must be carefully reviewed. For these reasons, estate freezes and similar transactions should be completed with the assistance of financial planning professionals, accountants, and lawyers to ensure that legal and tax implications are considered and properly dealt with. MCLEAN & PARTNERS WEALTH MANAGEMENT 4

5 Du Plooy Law Du Plooy Law is a boutique corporate commercial firm whose primary client base is small and mid-sized enterprises. We focus on providing value to the entrepreneur. Our practice areas include contracts, corporate structuring, acquisitions and divestitures, as well as succession planning for the business owner in conjunction with wills and estate law. The firm prides itself on giving practical experience business law advice and providing value-added legal services to our clients. Tel: (403) claudius@claudiusduplooy.com McLean & Partners Wealth Management McLean & Partners Wealth Management Ltd. provides investment advisory services to high net worth individuals, trusts, and not-for-profit organizations. The firm manages portfolios through both segregated accounts and pooled investment vehicles. Tel: (403) solutions@mcleanpartners.com CWB Wealth Management McLean & Partners is an affiliate of CWB Wealth Management, and a subsidiary of Canadian Western Bank Group of Companies. CWB Wealth Management delivers a unified approach of providing sound advice, solutions and support to help you achieve your vision for the future. As a division of CWB Group, CWB Wealth Management draws on the Group s banking and trust companies to complement its planning, advisory and investment management services. CWB Group is a diversified financial services organization, including Canadian Western Bank (TSX: CWB), the largest Schedule I bank headquartered in Western Canada, and its operating companies and divisions. McLean & Partners provides independent research and advice to its clients on a fee for service basis. The Company is not engaged in any investment banking, underwriting, consulting or financial services activities on behalf of any companies. McLean & Partners research reports are for the sole purpose of managing client portfolios on a managed and non-managed basis. The Company may engage in proprietary trading to invest surplus corporate cash balances. The opinions expressed herein are those of the author and do not necessarily represent those of McLean & Partners Wealth Management Ltd. The information contained in this report has been obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. McLean & Partners Wealth Management Ltd. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. MCLEAN & PARTNERS WEALTH MANAGEMENT 5