The novel Coronavirus (“Covid-19”) has brought unprecedented changes to the business and economic landscape in Canada. From the decline of the stock market, to businesses shutting down, there is no doubt that the Canadian economic climate has seen a dramatic shift in just a few months.
Despite the tension that this places on small businesses, it may provide an opportunity to implement an estate freeze.
What is an estate freeze?
An estate freeze is a tax-planning tool that results in the transfer of the future growth in the value of a business or its assets to future generations by “freezing” an individual’s interest in his/her business to its current value. A freeze is commonly achieved by having the owner exchange his/her shares of the corporation (“Opco”) on a tax-deferred basis for fixed value preference shares (“freeze shares”), whose aggregate value is equal to the value of Opco at the time of the freeze. The growth shares, which are subsequently issued, receive the future growth of Opco and can be issued for a nominal amount without any tax repercussions. Often these new growth shares (which are generally common shares) are issued to a family trust, with the freezor’s children and more remote issue as beneficiaries. The future growth in value of the company, therefore, is directed future generations.
Why implement an estate freeze now?
On death, a taxpayer is generally deemed to have disposed of all their investments and corporate interests at fair market value (unless transferred to a surviving spouse or qualifying spouse trust). A key benefit of an estate freeze is that it caps the value of corporate interests at the value on the day of the freeze, and thus limits the taxes payable by the taxpayer upon their death. Any taxes owing on the growth from the time of the freeze are deferred to the next generation.
If the value of a business (either operating or investment) has declined in the current economic climate, it may be a good time to implement an estate freeze: the lower the value of the business the time of a freeze, the more limited the exposure to tax at death. This is especially true if the value of a business begins to increase as the world opens back up.