Last month we posted our first instalment on the pros and cons of an estate freeze. In particular, we discussed:
- The purpose and outcome of a freeze;
- How rich do you need to be to consider a freeze; and
- When you should freeze.
In this post, we will drill down into some of the mechanics of a freeze of your Opco shares, while at the same time trying to keep the lingo as simple as possible. Before you delve into this post, make sure you read part one.
First of all, you need a bunch of new shares
Tax planners focus on the bottom right hand corner of a balance sheet – share capital. This is where all share changes happen. To make the freeze work, at a minimum, Opco will need to create 3 new classes of shares:
- Voting shares – can vote, but don’t receive dividends nor grow in value as Opco grows in value
- Equity shares – do not vote, but can receive dividends and grow in value as Opco grows in value
- Preferred shares – do not vote, but have a right to a set amount of value and may receive dividends
These shares will accommodate the freeze and will plan for the family’s Legacy.
So what do we do with these new shares?
In our last post we said that your Opco shares have a fair market value of $10M. So the idea of the freeze is to limit your interest in Opco to $10M with all of the future value being for the benefit of your family and to minimize tax. This is where the Preferred shares come in.
With the new classes of shares in place, you can simply exchange your $10M in Opco shares for $10M in new Opco Preferred shares. The freeze is now done. You no longer have your old Opco shares but have $10M in new Opco Preferred shares. All of Opco’s value will be locked in the new Preferred shares.
Your new Opco Preferred shares are fixed in value, meaning that your interest in Opco will never exceed $10M. On a future event (sale or demise) when Opco is worth $15M, only $10M will be yours and the rest is for your family. Your tax is also only based on $10M, which in estate planning terms, is a good thing.
Who owns the other new Opco shares?
This is where it can get complicated, so let’s deal with the easy part first. We mentioned above that immediately after the freeze, all of Opco’s share value will be in the new Opco Preferred shares. Practically, that means the family can buy new Voting and Equity shares for a nominal amount as that’s all they are worth. Throughout my career, there has been an on-going debate between the CRA and tax planners as to what these new shares are worth. For our purposes, lets go with nominal value as almost all freeze’s are based on that premise.
As you will likely want to control Opco, the simple solution is for you to buy, say 100 new Opco Voting shares for some small amount, say $10. You now have all of Opco’s current fair market value in the new Preferred shares plus you control Opco with the new Voting shares.
What about the Opco Equity shares?
You have the Opco Preferred shares at a fixed value of $10M and the Voting shares. But what about the new Opco Equity shares? Who will benefit from any increase in Opco’s fair market value over and above the $10M, and how will those shares be held?
Well, that question will have to wait until our next post. In the meantime, think about how your family should own the new Opco Equity shares: directly, or better yet, one step removed.
Our estate planning posts consider estate planning issues at a high level. Before you commence any form of estate planning, please consult with tax and legal advisors.