Estate Freezes for BC Business Owners: What They Are and the Paperwork Involved

If your company has grown and your children are now adults, your accountant may have raised an estate freeze. The phrase sounds technical, but the idea is simple: lock in what your shares are worth today, and let future growth belong to someone else.

A freeze is part tax planning and part corporate law. The accountant models the tax; the lawyer changes the share structure, prepares the resolutions and records, and checks that the result fits your will, your shareholders' agreement and your family's situation.

What an estate freeze does

In a typical freeze, the owner exchanges their common shares, which carry the growth in the company's value, for fixed-value preferred shares worth the same as the common shares today. New common shares are then issued, often at a nominal price, to the next generation directly, to a family trust, or to a holding company. From then on, increases in the company's value accrue to the new common shares.

The owner keeps the frozen value. Freeze shares are commonly redeemable at that fixed amount, may carry a dividend entitlement, and can carry votes so the owner keeps control of the company while the growth moves on.

Why owners consider a freeze

Under the Income Tax Act, a person is generally deemed to dispose of their capital property, including shares, at fair market value immediately before death (s 70(5)), subject to exceptions. If the company keeps growing, so does the tax that may be payable on that deemed disposition. A freeze is designed to cap the owner's share of the gain at today's value, so later growth belongs to the new shareholders and is taxed according to their own circumstances.

There are non-tax reasons too: bringing children into ownership gradually, rewarding those who work in the business, and setting a clear value for estate planning. A freeze is not right for everyone. An owner who may need the future growth to fund retirement, or whose children are not ready to be owners, may prefer to wait or to freeze only part of their holdings.

The tax provisions involved, at a high level

Two provisions of the Income Tax Act are commonly used. Your accountant will advise on which fits, and on the numbers.

• Section 86: reorganization of capital. Where, in the course of a reorganization of a corporation's capital, a shareholder disposes of all their shares of a class and receives new shares of the same corporation, the Act sets the cost of the new shares and the proceeds for the old ones so that, in general, no gain is triggered at that point (s 86(1)).
• Section 85: transfer to a corporation. Where a taxpayer transfers eligible property to a taxable Canadian corporation for consideration that includes shares, the taxpayer and the corporation can jointly elect an amount, in prescribed form, that is treated as the proceeds and cost (s 85(1)). This is often the route where the freeze is done through a new holding company.

Valuation matters. Section 86(2) contains a rule for cases where the old shares were worth more than the new shares and other consideration received, and it is reasonable to regard the excess as a benefit the shareholder wanted to confer on a related person. Freezes are therefore usually built on a professional valuation, and the share terms commonly include a mechanism to adjust the redemption amount if the value is later challenged.

The corporate paperwork under the Business Corporations Act

In a BC company, the share structure lives in the notice of articles and the articles. A freeze usually changes both.

• Creating a new class of shares. A company may create one or more classes of shares (s 54(1)(a)). If the change makes the notice of articles or articles incorrect or incomplete, it is made by altering them; the change is authorized by the type of resolution the articles specify or, if they are silent, a special resolution (s 54(3)).
• Attaching special rights or restrictions. Redemption and retraction rights, a fixed dividend, voting rights and a price adjustment term are attached by shareholders' resolution, and do not take effect until the articles are altered to reflect them (s 58(2) and (3)).
• Protecting existing classes. Rights attached to issued shares cannot be prejudiced or interfered with unless the holders of that class consent by a special separate resolution (s 61). Where there are other shareholders, their consent may be needed.
• Exchanging and issuing shares. The exchange of the owner's common shares for freeze shares and the issue of new common shares are documented in directors' and shareholders' resolutions, subscription and exchange agreements, updated share records, and new share certificates where certificates are used.
• Redemption later. When freeze shares are redeemed, the company must not pay to redeem shares if there are reasonable grounds to believe it is insolvent or would become insolvent (s 79).

Family trusts, wills and agreements

When the new common shares go to a family trust, the trust deed, the choice of trustees and the class of beneficiaries become part of the plan, and the tax rules for trusts add their own considerations for your accountant. The freeze also needs to line up with the rest of your planning:

• Your will and powers of attorney. The frozen shares remain part of your estate. Our article on estate planning for BC business owners covers wills, powers of attorney and shareholder terms.
• Your shareholders' agreement. Transfer restrictions, buy-sell terms and voting arrangements may need amending to deal with the new class. See our guide to shareholders' agreements in BC.
• Your structure. If you do not yet have a holding company, our article on when owners set up a holdco explains what one does.
• Lenders and family law. Loan agreements may require lender consent to a share reorganization, and shares issued to children or a trust may raise family law questions if a relationship later ends.

Thinking about a freeze? Bring your lawyer in alongside your accountant

Our business lawyers can review your articles and agreements, prepare the share structure changes, resolutions and records for a freeze, and coordinate with your accountant and our wills and estates team so the plan fits together.

Call 604-259-2844 or send us a message to arrange a consultation at our Vancouver office.