A freeze is a common tool used in an estate plan. A freeze entails a tax-deferred exchange of participating shares of a corporation for non-participating shares (the “Freeze Shares”). Family members will subsequently subscribe for new participating shares (the “Growth Shares”), with the intended result that all future growth in the value of the corporation accrue to the Growth Shares held by the family members.
For a freeze to work properly, it is imperative that the value of the Freeze Shares be fixed at the freeze value. If the value of the Freeze Shares are not fixed, and future growth in the value of the corporation accrues to the Freeze Shares, then the effectiveness of the freeze is reduced or eliminated.
Share rights affect the value of shares. Hence, in a freeze, it is imperative to choose share rights that preserve and maintain the value of the Freeze Shares at the freeze value. One right that is a significant factor in determining share value is voting rights, specifically when there is voting control.
Often times, skinny voting shares, which are normally controlling non-participating shares, are issued for a nominal amount, and the value of these shares are intended to be fixed at this nominal amount due to a set redemption price. Hence, in a freeze where such shares are issued, it is intended that no future growth in the corporation accrue to these skinny voting shares. However, the CRA has stated a number of years back that these skinny voting shares may hold a voting control premium and hence may be worth more than the nominal amount. This obviously is a concern for tax practitioners as it creates uncertainty and may reduce the effectiveness of a freeze.
In response to concerns expressed by tax practitioners, the CRA has stated at a tax conference in 2009 that where a freezor, as part of an estate freeze, keeps controlling non-participating preference shares in order to protect his economic interest in the corporation, they generally will not take into account any premium that could be attributable to such shares for the purposes of s.70(5) of the Tax Act.
In the TI2013-0487431C6 (2010/11/28 – 2010 CTF Conference – Nov. 28, 2010 – Question 17), the taxpayer is asking the CRA to confirm whether this policy can be extended for the purposes of s.104(4)(a) and in particular with respect to the deemed disposition arising on the death of:
- the spouse or common-law partner who is the beneficiary of a spousal trust or common-law partner trust;
- the settlor of an alter ego trust; and
- the surviving spouse or common-law partner who was a beneficiary of a joint spousal or common-law partner trust.
In response, the CRA advises that it is not their intention to write a policy or state a formal position regarding this issue.
Tags: Article; Individual Tax Planning; Tax; William (Bill) H. Cooper; Wills, Trusts & Estates