In our last post, we discussed the various types of shares and their ownership as part of our series on the mechanics of an Estate Freeze. You got the Opco Preferred shares at a frozen and fixed value of $10M and the Opco Voting shares for control. But, we stopped short on discussing who gets the Opco Equity shares. Remember, the Opco Equity shares are designed to benefit from any increase in Opco’s fair market value over and above the $10M freeze value.
In this third post of our series on estate freezes, we will discuss who should own the Opco Equity shares and how they should be held, directly or one step removed.
Who gets the growth
If you desire a full freeze to your family, your children should receive all of the Opco Equity shares. On the other hand, if you wish to retain a portion of Opco’s future value, you can partially freeze Opco. As an example, if you want to retain 25% of Opco’s future growth, the family will receive 75% of the Opco Equity shares and you will receive 25%. In this example, you would have all of the Voting shares, the $10M in Preferred shares and 25% in Equity shares. In deciding the split, you need to determine if you are “rich enough”.
Shareholders have rights
You have decided that you are rich enough and that the family should receive all Opco’s future growth and own all the Opco Equity shares. The question then becomes, does the family own their shares: directly or through a trust? One just needs to have a quick conversation with a corporate lawyer to understand the rights that direct shareholders have; this normally results in a quick conclusion that a Family Trust is the preferred vehicle to hold the Opco Equity shares.
So what does a Family Trust look like?
Today’s Family Trusts have:
- A Protector who has the power to appoint and remove trustees(s).
- Trustees(s) who will oversee the Family Trust’s property – the Opco Equity shares.
- Income and capital beneficiaries who are entitled to receive the Family Trust’s income (dividends from the Opco Equity shares) and capital (the Opco Equity shares in the event of the Family Trust’s dissolution).
- Full discretion over the payment of income and capital to the trust’s beneficiaries at all times.
- The ability to add beneficiaries, which could include a corporation.
Estate lawyers are great at designing protection and flexibility into trust deeds – they are trained to anticipate where things can go wrong.
So, who is a beneficiary?
As a minimum, the children should be discretionary income and capital beneficiaries of the Family Trust. This allows for the payment of dividends from Opco to the Family Trust and then to adult children (as income beneficiaries) to fund their education, lifestyle, etc. In addition, as capital beneficiaries, they could also receive the Opco Equity shares on the dissolution of the Family Trust.
As a protective measure, you and/or your spouse could also be income and capital beneficiaries. As the Family Trust is fully discretionary, the Opco Equity shares could be distributed to back in the event things didn’t work out as planned.
Your estate advisor will bring up a number of issues, such as:
- All of this works fine until someone in the picture moves out of Canada.
- Dividends can be a problem if Opco becomes an investment company.
- What can happen when a child gets divorced.
- The Family Trust is taxable every 21 years on its increase in value unless the Opco Equity shares are distributed to beneficiaries – they will then be direct shareholders.
They will also mention the good stuff:
- The opportunity to multiply the $800k+ capital gains exemption – one exemption for each beneficiary – works extremely well in the event of an Opco sale.
- Possible creditor proofing. This is a legal question that requires advice and possibly an additional company.
- Can now pay dividends to adult family members with corporate funds.
We often tell clients that the potential tax savings pays for the fees to set up and maintain the structure.
Now that we have Opco frozen and a Family Trust is in place, what are the soft family issues you should be concerned about? In the last instalment of our Estate Freeze series, we will delve into those soft issues to provide some insight and guidance.
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.