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Some of the benefits of doing an estate freeze include:

• Estate planning.  As noted above, planning for tax minimization for an estate is a major benefit of an estate freeze. Please keep in mind that an estate freeze strategy would mean that the shares 'frozen' at the fixed value would not grow. During times of inflation, this would mean a reduced purchasing power over time. If an estate freeze is being used as part of a broader retirement strategy and future income is going to be needed from share redemptions, then inflation cannot be ignored. Some people use a hybrid strategy, where the existing shareholders receive a mix of fixed-value shares but also some new growth shares, so they can participate in the upside of company growth and also to mitigate the impact of inflation. This should be discussed with your professional advisors and considered as part of an overall strategy.
  
• Setting up a family trust.  As part of a larger corporate reorganization, an estate freeze (section 86 of the Income Tax Act) can be used to freeze share value and concurrently set up a family trust, for estate planning purposes. The concept is that the family trust would own the shares. The trust would have a trustee (or trustees) who are the decision-makers of the trust and the beneficiaries are the people or entities that would receive the benefits, sometimes at the sole discretion of the trustees. Setting up a family trust can be a good way to estate plan, manage future taxes, divide the benefits of share ownership, and smoothly transition a company to the next generation. A family trust strategy can be complex so we encourage you to consult with your professional advisors for setting one up.
  
• Income splitting.  You may be able to structure an estate freeze so that the new shareholders would be taxed at their possibly lower tax bracket. Please keep in mind that there are rules in the Income Tax Act which limit many forms of income splitting so please discuss this with your tax advisor.
  
• Maximizing the lifetime capital gain exemption. If you expect that your company will grow such that it will exceed your lifetime capital gains exemption limit in the future, an estate freeze may be structured to have the future growth in value apply across multiple new shareholders. Again there are complicated tax rules that apply so we advise you to speak with your tax professionals.
• Maintain control.  An estate freeze can be structured such that the voting control of the company can reside in the fixed-value preferred shares and then, as they are redeemed, the new common shares (the growth shares) can have a higher proportion of voting control of the company. The benefit of this is to gradually cede control of a company to the next generation over time, while they gain more experience in running the business.

Business Valuation in Support of an Estate Freeze
The Canada Revenue Agency has rules around establishing the value used in an estate freeze. It requires a reasonable and bona fide attempt at a valuation. Most estate freezes contain a price adjustment clause which typically allows for a retroactive adjustment to the fair market value used for the freeze should CRA not agree with the value used. A price adjustment clause is very useful to avoid disputes with the CRA. It is important to note that the CRA may not allow the price adjustment clause if it is found that a reasonable attempt at valuation was not undertaken. An independent valuation report from a Chartered Business Valuator is, therefore, often used as the basis of value for an estate freeze in order to preserve the benefit of the price adjustment clause and to reduce the associated risk from the CRA. The consequences of having the CRA not agree with the value used in the estate freeze and disallowing the price adjustment clause can include potential taxes, interest & penalties, and legal action.

An estate freeze is a useful and common tax planning tool but it can be quite complex. It is important to use a tax accountant, tax lawyer and an independent Chartered Business Valuator to execute the strategy successfully.

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Please contact Steve Skrlac, MBA, CFA, CBV if you need a business valuation for an estate freeze or corporate re-organization.

Our office is located in Burlington and we serve clients in Toronto (GTA), Oakville, Burlington, Hamilton, SW Ontario, Kitchener-Waterloo and Niagara.

Other resources:

Price adjustment clauses - Canada Revenue Agency resource

Estate freeze pitfalls to consider - Canadian Lawyer Magazine

Estate freezes in Canada - law firm article

Business Valuation for an Estate Freeze

An estate freeze is a type of corporate reorganization where the value of appreciating company shares are frozen and are then exchanged for fixed value shares of the same value amount. New growth shares are then issued and these shares would have any future growth in corporate value attributed to them.

Example:  John Doe would like to retire and pass on the future value of his company to his son, James. John owns 1,000 common shares of his company and wishes to freeze the value of his shares and then issue new growth shares, valued at nil, to James. Assume the 1,000 common shares owned by John were valued at $1,200,000 by a Chartered Business Valuator (CBV). John's common shares would be frozen at $1.2 million and would be exchanged for fixed-value preferred shares that could be redeemed for $1.2 million. James is then issued brand new common shares valued at zero dollars. In this simple example, James would benefit from enjoying all of the future corporate value growth (and future tax liabilities associated with this growth) in his new common shares and John would have his unrealized gain valued at $1.2 million in fixed value preferred shares. When John passes away in the future, there is a deemed disposition and his estate would be responsible for the taxes related to his $1.2 million preferred share value. For any growth in company value, which is reflected in James' new common shares, taxes would be deferred.

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Chartered Business Valuators serving the GTA including Toronto, Mississauga, Oakville, Burlington, Hamilton & southern Ontario.