Here in Canada, a significant amount of private corporations are family operated, and eventually handed down to the next generation of family members. One way of achieving this transfer would be to sell all the shares to the children. However the reality is that many are not in great financial position to make an outright purchase, especially if the value of the company is quite significant.
One of the ways to overcome this obstacle is to implement an estate freeze. In general, the current owner manager exchanges his/her common shares of the corporation for redeemable, retractable preferred shares. The idea is that the preferred shares will have a redemption amount equal to the fair market value of the company at the time of transfer, and what we’ve done is freeze the value of the company in those preferred shares.
Next the children subscribe in new common shares of the corporation for a nominal amount. From the children’s perspective, there is no immediate cash requirement for the new common shares when an estate freeze is initiated . Over time, as the value of the company appreciates in value, so will their respective holdings in the common shares, thus enabling each to participate in the future growth of the company.
In some situations, the parent may choose not to relinquish control over their company until their demise. A concern may include doubts as to their children’s ability to effectively manage the company’s affairs. One way to counter this is to have the parent subscribe in new common shares for a nominal amount and this effectively enables the parent to still retain some control over the affairs of the company.
At the same time, there might be children who are not actively involved in the family business. In this type of situation, it would be recommended that those individuals are issued a different class of shares that perhaps entitle them to dividends but no voting privileges.
The estate freeze could be structured so that the owner-manager aligns his/her retirement objective based on the value of the company. In general what that means is that the owner manager will redeem a portion of the preferred shares over a number of years to meet his/her retirement needs. With proper tax planning, it may be possible eliminate or reduce the amount of tax paid by the owner manager on the redemption of the preferred shares each year. This of course will be dependent on whether there are any other sources of income.
An estate freeze can provide a host of succession and estate planning opportunities, including opportunities not mentioned above. Your Kelowna accountant (a tax professional) should be consulted to determine the best opportunities available to you.
This blog posted on Dome Duong Chartered Accountant provides information of a general nature and should not be considered specific advice, as each reader’s personal financial situation is unique and fact specific. There are many pitfalls to the strategies discussed above and professional tax advice with your Kelowna accountant is essential.