Optimizing an Estate Freeze with a Holding Company
Contact Neufeld Legal for your corporate legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Utiliizing a holding company as part of the structural dynamic of an estate freeze, which is a sophisticated tax planning strategy used to lock in the current value of a business or investment portfolio, can better facilitate the transfer of future capital appreciation to the next generation. By introducing a holding company into this structure, business owners can facilitate this transfer more effectively while simultaneously protecting assets and deferring significant tax liabilities. The process generally involves an individual exchanging their appreciating "growth" shares in an operating company for fixed-value shares in a new holding company. This "freezes" the individual's current tax liability at today's value, ensuring that any future increase in the company’s worth accrues to new shareholders (typically the business owner's children or a family trust) rather than swelling the owner's estate.
The mechanics of this transaction rely heavily on Section 85 of the Income Tax Act (Canada), which allows the business owner to transfer their shares of the operating company to the new holding company on a tax-deferred basis. In exchange for their original common shares, the owner receives "preferred" shares in the holding company that have a fixed redemption value equal to the fair market value of the company at the time of the freeze. Because these preferred shares do not grow in value, the owner’s capital gains tax exposure is effectively capped at this fixed amount. This rollover provision is crucial because it allows the reorganization to happen without triggering an immediate tax bill, deferring the capital gains tax until the preferred shares are redeemed or the owner passes away.
Once the freeze is in place and the owner holds the fixed-value preferred shares, the holding company issues new common shares to the intended beneficiaries, such as adult children or a family trust established for their benefit. These new common shares often have a nominal initial value but carry the rights to all future growth of the corporate group. As the underlying operating business continues to expand and become more profitable, that additional value flows directly to the new common shareholders. This structure effectively separates the current value of the business (retained by the parent) from its future growth (passed to the heirs), ensuring the parent maintains economic security via the preferred shares while the next generation reaps the rewards of future success.
The primary tax minimization benefit of this strategy is the mitigation of the "deemed disposition" rule that applies upon death in Canada. Without an estate freeze, a business owner is deemed to have sold all their capital assets at fair market value immediately before death, often resulting in a massive tax liability that can force an estate to liquidate assets just to pay the Canada Revenue Agency (CRA). By freezing the value of the shares today, the owner caps the capital gains tax payable at death to the amount calculated at the time of the freeze. The tax on the future growth is deferred until the heirs eventually sell their shares, potentially decades later, allowing the family to keep more capital working within the business for longer.
Finally, a holding company structure can offer additional tax efficiencies beyond the freeze itself, such as potential income splitting and probate fee reduction. Through the holding company, dividends can theoretically be paid to adult shareholders who may be in lower tax brackets than the original owner, subject to the strict "Tax on Split Income" (TOSI) rules. Furthermore, in provinces with high probate fees, the freeze can be structured to reduce the value of the estate passing through the owner's primary will. By isolating the growth in a separate entity and capping the owner's personal estate value, the family can significantly reduce the administrative costs and taxes associated with transferring wealth, preserving the family legacy for the long term.
So when the corporation's business is advancing such that it requires the incorporation of a holding company, and are looking to undertake the associated structuring and transactional legal work to realize its commercial objectives, contact our law firm at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.
