On this episode of Financial Planning For Canadian Business Owners, Jason Pereira talks to Chris Sabat - General Counsel McMillan Estate Planning. Today Chris is going to talk about a deeper dive into statement freezes. We have covered a freeze in the past, but specifically today, we are going to go over a little bit more around the thinking and the mechanics of how you execute an estate freeze and why?
Episode Highlights:
- 1.16 Chris is a lawyer working with a team of lawyers, accountants, financial planners, and state planners at Macmillan Estate Planning Company in Calgary. Primarily McMillan serves entrepreneurial families throughout Western Canada.
- 1.58 Chris says it is not a situation where they find themselves going into their account and having a discussion that needs some advice taking that advice and trying to interpret that invoice for their lawyer. That is what kind of unique from my perspective about McMillan is that all those experts bring brought under one roof. So as per Chris, it really helps to facilitate a positive result in relation to something like an estate freeze.
- 2.44 Jason says we all in our own industries get caught up in jargon and our level of what we consider based on proficiency or base understanding, but that’s not what the average person thinks. Sometimes it is easy for us to get carried away, and sometimes it translates into something that is very simple and powerful.
- 3.05: According to Chris, Estate freeze is sort of a revenue Canada taxation of your state. What you’re doing is you’re freezing the tax liability. That will be imposed upon your passing and transferring that value deferring that taxation into the hands of your children or successive generations. In a nutshell if we want to stop the increased taxation of your estate while still providing you with access to that value, should you happen to need it.
- 4.45: Chris says that the revenue Canada recognizes with things like the succession of a business, one of the challenges is the tax building comes about on passing. This can be a way to help transfer between two successful successions within a family.
- 5.35: In most cases, the conversation on estate freezes typically gets started, probably by the accountant or the advisor, and then the lawyers get roped into it. Jason asks Chris to talk to about the first steps or requirements they brought to the table in this estate freezer.
- 5.55 Chris explains that the estate freezes can be used in relation to a wide variety of assets. It can even be used for things like publicly traded securities or investment accounts. So, it is not necessarily just restricted to the use of the transfer of shares or the freezing of the value of a corporation or qualified small business.
- 6.48 Chris says as a first step, we must have a value. Whether it is an investment account that is the subject of the freeze, whether it is a real estate portfolio that contains primarily passive assets, or whether or not it’s an active company qualified small business corporation. We need to have some sort of valuation.
- 8.35: As per Chris, entrepreneurial families don’t want to give up control. They always want to have some control over the business and its future going forward.
- 10.23: There are a couple of provisions in the tax code of section 85 which allow us to roll over assets. There are others like 51, which allows us to exchange, but these are all recognizing the tax code is being non-taxable events, they are basically tax-deferred events.
- 10.56 Jason asks Chris, “You mentioned two options you had, either held by the next generation or held by a family trust. Could you talk about the positives and negatives of both those strategies?”
- 11.05 Chris highlights the huge negative around the transfer or the direct transfer. It is like having the children as individuals subscribed to the grocers, a huge downside of that is that the children actually own shares. If the children own shares, that means Mom and Dad can’t be in control.
- 13.14: Another huge advantage with the family trust from my perspective, especially for your qualified small business corporation, is the ability to multiply your lifetime capital gains exemption or the lifetime capital gains exemption that applies for the business, says Chris.
- 15.29 Jason says, let’s talk about what happens when you establish the estate freeze, and for whatever reason, you wanted to send your kids or whatever it might be, and you want to undo the estate freezes. So, what’s involved with something like that?
- 16.02 Chris: One reason that the unwinding of the estate freeze comes about is because the vast majority of trusts have a 21-year deemed disposition, so we do the estate freeze. We have given the growth value to the family trust 21 years in the future. Revenue Canada in essence, gives you one of two options. You can pay the taxes on the capital gains; the family trust can pay the taxes or roll their shares out to one or more beneficiaries. So, it is not uncommon in families to see a freeze done maybe at least a couple of times during their lifetime.
- 17.48: At the end of the day, what you are doing is you are transferring the shares to one or more of the beneficiaries, and it is a relatively simple exercise, says Chris
- 19.06 Jason request Chris to explain the concept of a wasting freeze.
- 20.05: Chris explains no one has a continual ongoing valuation of their business, so once you have got that fixed value, you quite conveniently redeemed and then wither away those capital gains. Typically, what we are doing is we are stopping future capital gains and getting rid of some of the historical capital gains that have been built up in the estate.
- 21.09: Talking about section 208, Jason inquires how does the misery, that is, the complications of that section of the act, impact? How is it to be approached at this point?
- 21.27: Chris explains bill C208 is the law. It is not finalized. Revenue Canada has made it clear, or the Department of Finance has made it clear that they are going to propose amendments to Bill C208. What Chris likes about Bill C208 is that, in a sense, there is maybe a recognition that business succession planning is a long-term exercise.
- 24.40 As per Chris’s observation about an estate freeze, especially when they utilize things like family trusts, is that unfortunately. They are often looked at as an accounting exercise. They looked at it from the perspective of how do we minimize tax? At the end of the day, we have got a business valuation. We have got a share swap. The question is that professionals assisting you understand all of the potential complications that can come about in these types of scenarios.
- 27.10: Jason says estate freeze is simply an accounting strategy. This is not a taxation exercise at its core this is a financial planning exercise. This is a family dynamics exercise. This is an entrepreneurial succession planning exercise.
3 Key Points:
- The one thing unique about McMillan is that all professionals need to be involved in accountants, lawyers, experts, and things like business, succession, etc. So, all of those individuals have been brought under one roof. From Chris’s perspective, the advantage of that is that it is not the sort of situation where maybe a client identifies, and we hear something about the concept of an estate freeze and how that might be advantageous.
- The kind of first level of an estate freezes it is about limiting capital gains on passing and then where it really becomes powerful. We can really create value, or at least minimize the taxation that is going to be imposed upon events like the sale of a business.
- The problem historically around succession planning was that there was a penalty if you happen to sell your shares to your children. It was treated as a dividend. With Bill C208, ultimately, what we are going to be able to do is facilitate transactions where there is actually an intergenerational transfer of the company shares, and you will be able to utilize that lifetime capital gains exemption. So, it does work in conjunction with an estate freeze.
Tweetable Quotes:
- “In a nutshell, the bottom line about Estate Freeze is we are stopping the growth in one person’s name and passing it on to another generation’s name.” - Jason Pereira
- “Family trust is often the preferred method.” - Chris
- “In cases where the freeze happens, and there’s an amount, especially in excess of the capital gains exemption amount, a lot of clients who speak, they plan on taking a given an income from the company for the rest of their lives.” - Jason Pereira
- “We know the Department of Finance is going to come in, and they are going to fiddle with the bill, and of course, their concern is surplus stripping. They don’t want abuses of the Income Tax Act in order to allow people to extract value at a non-dividend tax rate at the capital gains rate.” – Chris
- “Bill C 208 once cleaned up it still stays true to the actual spirit of what you trying to do, would actually maybe eliminate for that would allow that deemed dividend on a wasting freeze to become a capital gain.” – Jason
- “When it comes to things like business succession when it comes to controlling issues when it ensures that at the end of the day other than just saving tax, the estate freeze meets the goals and objectives of the family.” – Chris
Resources Mentioned
Transcript
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