A share freeze (sometimes referred to as an estate freeze) provides an opportunity for the transfer of the future growth in the value of the shares of a corporation to subsequent generations or key employees. The current shareholders effectively divest of this future growth. A share freeze typically limits the value of the current shareholder’s estate to the value at the date the freeze is implemented. The current shareholder typically retains the current value of the shares in the form of fixed value preferred shares.
One of the most common motivators for a share freeze is the desire to pass future value growth of a corporation onto the next generation of a family, thereby minimizing the income tax which will arise on the deemed fair market value disposition which will occur on the death of the parents. Capital gains and other tax exposure on the future growth that could otherwise arise when the assets pass from parents to the next generation are avoided. (Note that in some cases farm corporations can pass tax free to the next generation without a freeze however certain criteria must be met to allow that.)
In a family business, a process that permits the tax-effective transfer of growth to the next generation should also have the effect of creating a greater incentive for the new generation to remain loyal to and promote the success of the family corporation.
A basic share freeze could be implemented by having the parent exchange his or her common growth shares of the family corporation for preferred shares having a fixed (or “frozen”) value equal to the fair market value of the common shares exchanged. The child will then subscribe for new common shares for a nominal value. If properly structured, the parent will not have made a taxable disposition and no taxable benefit will have been conferred on the child, since the full present value of the corporation is represented in the preferred shares issued to the parent in the exchange. (US citizens should be aware that there may be US tax implications involved with a freeze).
In addition to estate planning motivations, a share value freeze can help achieve other business, succession and tax planning goals. Commonly encountered motivators (in family and non-family businesses alike) is the desire to allow for ease entry of key employees into partial ownership of a business, to promote loyalty and dedication, and provide for possible succession to more full ownership in future. This need often arises in mature corporations with accrued value.
In some cases, the owner may want to recognize the value of an employee, or an employee’s past contributions, through advantageous entry terms, but this can create challenges, including exposure of the employee to reassessment under the employee benefit provisions of the Income Tax Act (the Act). While some of these challenges may be mitigated using the employee stock option provisions in the Act, the use of a share value freeze can give flexibility in extending ownership to a key employee without a substantial financial burden being imposed on the employee with deferral of tax on a disposition for the original owner.
A share value freeze may also be needed for the shareholders of an established corporation to convert, on a tax efficient basis, to an ownership structure which will permit income splitting with respect to dividends or future capital gains on sale of the shares of the corporation. In some cases, this type of reorganization will be needed to transfer ownership of future growth with a view to accessing other family members’ $824,176 lifetime capital gains deduction eligibility. The goal in such a case is to shelter future gains on the sale of qualified small business corporation shares or a qualified farm corporation, a goal that can be achieved, without giving up control of the corporation, through the issuance of non-voting growth shares to the beneficiary of the freeze or by holding the new growth shares in a family trust.
A share freeze may be full or partial. A full estate freeze results in the present owners fully divesting themselves of any participating (growth) shares going forward, whereas a partial freeze will see the present owners re-subscribing for a portion of the new growth shares, with the remainder being taken by one or more new owners.