Trusts, Succession, and Business Succession Lawyers

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Estate Freeze and Trust

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Many businessowners plan to pass their business to their children or other family members. To facilitate this, retirement planning and tax minimization strategies are crucial. Our team of trust and business succession lawyers, in partnership with tax experts, can develop a comprehensive estate plan. This can involve executing an estate freeze, establishing freeze trusts, or performing any other operation recommended by a tax specialist or a certified accountant in taxation. Theses services ensure a smooth business transfer, allowing you to enjoy a well-earned retirement.

Succession planning is vital for the longevity of your business. It involves identifying key employees or qualified family members who align with your business’ view and needs. We provide various legal solutions for effective succession planning, tailored to factors like the company’s fair market value and potential tax implications.

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Estate Freeze Explained

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Under the Canadian Income Tax Act, it is presumed that a person disposes of all their property at their death. This disposal is considered to occur at the property’s fair market value at the time of death. This is a crucial concept to understand.

An estate free refers to a strategy where the value of a company’s shares is “frozen” at a specific date. The primary goal is to transfer the future appreciation of the business to another taxpayer, often a family member set to take over the business. During an estate freeze, the shareholder convers their common shares into a new class of redeemable shares, valued at the fair market value at the time of the freeze. Consequently, upon the death of the shareholder, the estate is taxed based on the value of the frozen shares, while any increase in value since the freeze benefits the next generation.

There are various methods to execute an estate freeze, but we will focus on the classic approach involving share exchange or capital restructuring. For example, consider Mr. Tremblay, who founded a family business and is its sole shareholder. If Mr. Tremblay wishes to pass the business to his son, Luc, he might implement an estate freeze. This would involve selling his common shares back to the company in exchange for preferred shares, while issuing new common shares to Luc.

Now, we propose to delve into the main advantages resulting from this operation for Mr. Tremblay.

a) Tax Savings and Tax Deferral at Death

Let us examine the financial advantages of an estate freeze using Mr. Tremblay’s situation as an example. Assume that in 2022, the value of Mr. Tremblay’s company shares was $1,000,000. His accountant predicts that the company will have a fair market value (FMV) of $5,000,000 in 10 years. Mr. Tremblay has an unused capital gains exemption (CGE) balance of $100,000.

If Mr. Tremblay were to pass away ten (10) years later in 2032 without having implemented an estate freeze in 2022, the taxable capital gain, after accounting for the GCE, would be significantly higher. Assuming a 50% income tax rate, the tax liability would be considerably larger compared to the scenario with an estate freeze. However, because of the estate freeze executed in 2022, the taxable capital gain at the time of Mr. Tremblay’s death is calculated based on the 2022 FMV of the shares. This results in a much lower tax liability and a substantial tax deferral. The estate freeze effectively locks in the value of the shares at the time of the freeze, significantly reducing the taxable amount upon Mr. Tremblay’s death.

b) Ease of Access to Ownership of the Company

During the estate freeze, Mr. Tremblay convers the value of his 100 common shares into preferred shares. Prior to this operation, each common share was worth $10,000 (totaling $1,000,00). Post-freeze, the common shares’ value becomes zero, making it possible for the company to issue new common shares at a nominal value, for example $100 per share. This demonstrates how an estate freeze can make ownership more accessible without significant investment.

Entrepreneurs like Mr. Tremblay often wishes to maintain control over their company. To achieve this, the preferred shares created can be designated as “super-voting” shares. For instance, if Mr. Tremblay’s 100 preferred shares have 10 votes per share, this voting power can prevent new common shareholders, like his successors, from gaining control of the company. Additionally, strategies such as drafting new internal operating rules or signing a unanimous shareholders’ agreement can further protect the rights of the person initiating the estate freeze.

Given the unique nature of each situation, it is essential to consult with a tax specialist or, at the very least, a Certified Professional Accountant (CPA) for personalized advice. Our lawyers may guide you through these complex processes while working as a team with these professionals.

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Trusts as a Business Succession Tool

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While trusts are less commonly used for business transfers, they are still a valuable tool for business owners. Trusts can be particularly useful in situations where identifying a successor is challenging. For instance, potential successors might be minors, currently studying, or gaining experience within the business. In such cases, a trust becomes an ideal solution. It allows business owners to defer the decision of choosing their successor until a later, more appropriate time.

When a businessowner establishes a trust, they transfer their company shares into a trust. This creates a separate legal entity, known as the trust estate, which is distinct from the personal assets of the entrepreneur and the beneficiaries. Upon creating the trust, the entrepreneur typically assumes the role of trustee, subject to certain legal requirements. As a trustee, they have the responsibility of managing the trust and retain the authority to decide when and to whom the shares will be distributed among the trust beneficiaries.
In addition to the flexibility, it provides to the entrepreneur, the trust offers many other advantages.

a) Asset Protection

Assets transferred into a trust become a distinct entity, separate from the founder’s personal assets. This separation offers protection against potential creditors, especially beneficial for safeguarding family assets.

b) Capital Gains Deduction

Using a family trust to structure shareholdings can enable the multiplication of capital gains deductions when the business is sold. This can lead to significant tax savings.

However, each situation is unique, and it is crucial to get personalized advice. Consulting a tax specialist and a Certified Professional Accountant (CPA) is advisable for an accurate assessment of your specific case.

No matter your specific circumstances, it is crucial to seek guidance from a lawyer who is well-versed in trusts, succession, and business succession to obtain tailored legal advice and guidance through each step of the process.