Estate Freezes, Capital Gains and Business Shares
When first creating a corporation, it is common place to implement a simple share structure with only one class of shares called “common shares”. The value of the common shares will grow as the company grows in value – this is an important aspect to remember to properly time an estate freeze. When certain conditions are met, a shareholder who sells his shares in a private corporation can receive the first $750,000.00 of sale proceeds tax free (referred to as a personal capital gains exemption), while paying tax on sale proceeds received in excess of $750,000.00. In order to avoid paying such taxes on the excess proceeds, a shareholder can “freeze” the value of his shares (typically as the value approaches $750,000.00) by exchanging them for shares with a fixed value that are equal in value to the common shares being exchanged. The corporation is then free to issue new common shares at a nominal value.
Common shares will then be issued to family members, a family trust or to a holding corporation owned by a family trust (although this would require a sale of the holding company or an amalgamation prior to the sale). Any future growth in the value of the business will be attributed to those new common shares. In the event of the sale of the shares in the corporation, some of the sale proceeds can be attributed to the various beneficiaries of the family trust and each of them can benefit from their $750,000.00 capital gains exemption.
A practical example would be as follows: Jim owns common shares in a corporation that are worth $700,000.00. Jim exchanges his common shares (he gives them back to the corporation) and in exchange the corporation gives Jim shares with a fixed value (typically referred to as preferred or special shares) totalling $700,000.00 in value – the value of the fixed value shares will not grow. New common shares are then issued to the family trust for nominal value, but the value of these shares will increase as the company value continues to increase. The shares in the company are eventually sold and have a total value of $2.25M. Jim will receive $700,000.00 for his “fixed value” shares tax free. The remaining $1.55 million is attributed to various beneficiaries of the trust, with no more than $750,000.00 being attributed to each, allowing them to also benefit from their personal capital gains exemption, and therefore the entire sale proceeds are received tax free. Numerous considerations must be made before proceeding with this type of restructuring and the advice of a chartered accountant will be required. Implemented properly, estate freezes are a powerful tool to reduce the tax burden on the sale of shares in a business.