Don’t be left out in the cold.
Now may be the time to consider a corporate reorganization by way of an estate freeze or refreeze.
We understand that finding positive light in any economic downturn can be difficult. We are here to help.
One possible silver lining is the ability of business owners of privately held corporations to implement strategic corporate reorganizations such as estate freezes or refreezes (if an estate freeze was previously implemented) to capitalize on certain corporate and tax benefits.
Estate Freeze Basics
An estate freeze generally refers to the reorganization of a privately held corporation where the business owner “freezes” the value of the shares of the corporation to the then current fair market value by exchanging common shares for fixed-value preference shares (in an amount equal to the fair market value). At the same time, new common shares are issued to new and/or existing shareholders for nominal value. The current value of the corporation is “frozen” in the fixed value preference shares, allowing for the future growth of the corporation to be attributed to the newly issued common shares.
Benefits of an Estate Freeze
Some benefits of an estate freeze include but are not limited to:
- deferral of capital gains tax;
- enabling family members or close friends to become shareholders as part of a business owner’s succession plan passing the business from generation to generation;
- multiplying the use of the lifetime capital gains exemption; and
- providing access to or crystalizing an individual’s lifetime capital gains exemption.
Before implementing an estate freeze, you should consider many factors in consultation with your professional advisors. These factors include but are not limited to:
- the likelihood of the corporation growing in value in subsequent years;
- any required amendments to the corporation’s Articles of Incorporation to allow for the issuance of fixed value preference shares;
- who will have control of the corporation and the ability to make decisions impacting the corporation after the freeze;
- the share attributes of the fixed value preference shares (e.g. redeemable/retractable); and
- the financial outlook of the corporation and its ability to meet its financial obligations after the freeze.
If you already implemented a corporate reorganization by way of an estate freeze, but the value of the corporation has decreased since the initial freeze, it may be beneficial to implement a refreeze. This will lock in the current market value at the lower valuation to capitalize on the additional deferral of capital gains tax, among other things.
As we continue to navigate the economic impact of COVID-19, smart business owners are looking at ways to limit any detrimental impact and find solutions that will position themselves and their businesses for future success as the economy recovers. Whether you are amid succession planning for your business or wish to reap the benefit of capital gains tax deferral or any other benefit of an estate freeze, now may be the time. The value of your corporation may be materially lower than its pre-pandemic valuation.
This lower valuation can be beneficial as long as there is a realistic expectation of future growth and increased value. A legitimate lower valuation today will help maximize the deferral of capital gains tax and/or multiplication of the lifetime capital gains exemption.
Proceed with Caution
Although a lower valuation during COVID-19 may be justifiable, it is important to speak with your financial and tax advisor on any potential pitfall of basing value too heavily on COVID-19 reduced revenues. This may or may not be accepted by the Canada Revenue Agency as a proper valuation which would typically reflect an earnings history over a period of years. In light of this, the valuation should consider whether the COVID-19 effect should be weighted or disregarded as a temporary blip in the earnings history.
We strongly recommend you consult with a professional tax advisor to discuss all tax implications related to estate freezes. We work closely with many tax advisors to implement estate freezes and can refer you to a tax advisor if necessary.