Estate Planning and Trusts 4 2017...Estate Planning and Trusts To Freeze or not to Freeze Name:...

Estate Planning and Trusts

To Freeze or not to Freeze

Name: Francine Nelson Wiseman, BCL, LLB

Company: GWBR

Tuesday, April 4, 2017

Name: Steven Moses, CPA, CA, TEP

Company: PSB Boisjoli LLP

Tuesday, April 4, 2017

2


Estate Freeze:

• Review a typical estate freeze including where one or

more children reside in the United States

Post Mortem Tax Planning:

• Review some of the Canadian and US tax

consequences that may arise in the context of the

current tax rate landscape where the parent owns

shares of a Canadian company.

3


Reasons to “Freeze”

There are many reasons why a freeze could be contemplated, some of which

include the following:

• Minimize capital gains tax payable as a consequence of death

• Allow future growth to accrue to the next generation

• Allow next generation to partake in shareholders’ meetings and decisions

• Opportunity to reduce taxes to an Estate by redeeming preferred shares owned

by the parent during his/her lifetime

• Provide income splitting opportunities

4


“Basic Freeze”

• Parent would incorporate a new company (“Holdco”) presumably under the same jurisdiction

as Operating Company (“Opco”);

Note – This could also be completed at the level of Opco, but we often find both tax

and commercial advantages for establishing a Holdco

• A discretionary family trust (“Trust”) is created with the following attributes:

- The Settlor is a family friend or a non beneficiary/Trustee relative;

- The trustees would include Parent and at least one other person who is neither a

beneficiary nor a settlor;

- The beneficiaries include Parent, spouse, children, grandchildren and other corporate

beneficiaries;

- The Trust is fully discretionary during the lifetime of Parent.

5


“Basic Freeze”

• Parent transfers his/her shares of Opco to Holdco on a tax deferred

basis pursuant to section 85 of the Income Tax Act (“ITA”) and the

Quebec equivalent. In exchange, Parent receives voting preferred

shares having a fair market value equal to that of the shares

transferred;

Note – Consider issuing a separate class of “skinny” voting preferred shares if

parents’ desire is to separate vote from value

• Trust borrows $100 from an arm’s length person and subscribes for

100 non-voting common shares of Holdco (this loan must be repaid by

the Trust, with interest typically from the receipt by the Trust of a

dividend from Holdco)

6


Trust

Holdco

Opco

Parent

Non-voting

common shares

100% of all shares

Voting preferred shares

(control)

Non-voting preferred shares

(freeze shares)

7


Why Use a Discretionary Family Trust

• Minor children might not have the legal capacity to subscribe for the non-voting common

shares;

• Protects the shares from future creditors;

• Perhaps protects the shares in case a child suffers a marital breakdown in the future;

• Reduces the risk of the acceleration of gains upon the premature death of someone in the

next generation;

• Multiplies access to the capital gains exemption if freezing at the Opco or Holdco, level

provided shares qualify for this exemption;

• Creates the opportunity to income split without beneficiaries having legal ownership of

shares;

• Flexibility to pay tax free dividends to corporate beneficiaries of the Trust

• Provides discretion to Trustees and thus provides a “crystal ball” for 21 years

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• Over the years, the difference between capital gains

rates and dividend rates has changed.

• Tax practitioners would readily recommend an estate

freeze for all the previously mentioned reasons.

• As of today, the gap between capital gains rates and

dividend rates has increased, especially in the

situation of non-eligible dividends

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Quebec Ontario Alberta

Dividends Dividends Dividends

Other

incomeEligible

Non-

Eligible

Capital

GainsOrdinary Eligible

Non-

Eligible

Capital

GainsOrdinary Eligible

Non-

Eligible

Capital

Gains

2016 0.5331 0.3983 0.4384 0.2665 0.5353 0.3934 0.453 0.2676 0.48 0.3171 0.4025 0.24

2011 0.4822 0.3185 0.3635 0.2411 0.4641 0.2819 0.3257 0.232 0.39 0.1772 0.2771 0.195

2006 0.4822 0.3635 0.2411 0.4641 0.3134 0.232 0.39 0.2458 0.195

2001 0.4872 0.3344 0.2436 0.4641 0.3134 0.232 0.39 0.2408 0.195

1996 0.5294 0.3872 0.397 0.5292 0.3574 0.3969 0.4607 0.314 0.3455

Table on Tax Rates

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Post-Mortem Tax Planning

• Typical tax planning includes the following:

i. Loss carryback strategy (Subsection 164(6) ITA)

ii. Pipeline strategy

iii. Hybrid approach

• Given the change in tax rates between capital gains and dividends,

different family needs, etc., the chosen approach has evolved over time

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Post-Mortem Tax Planning

Other factors that must be considered in deciding on the approach include the

following:

• The existence of “grandfathered shares” which would not result in the

application of Subsection 112(3.2) ITA

• Balance in the refundable dividend tax on hand account

• Any balance in the capital dividend account

• Were the shares owned on V-day or acquired in a non-arm’s length transaction

where capital gains exemption was claimed

• Whether or not there are unrealized capital gains within the corporation

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Example 1:

Consider the simplest of examples where Shareholder X

owns all of the shares of a company (“Holdco”) that has

$10,000,000 of value, all in liquid assets

Shareholder X

Cash

Note – Technical matters to be discussed in the following examples

Holdco

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Comparison of Capital Gains Tax and Dividend Tax $ Rounded

FMV at time of death 10,000,000

Adjusted cost base/Paid up capital 0

2016 2011 2006 2001 1996

Quebec

Tax on capital gain 2,665,000 2,411,000 2,411,000 2,436,000 3,970,000

Tax on deemed dividend on share redemption 4,384,000 3,635,000 3,635,000 3,344,000 3,872,000

Advantage of capital gains rate 1,719,000 1,224,000 1,224,000 908,000 -98,000

Ontario

Tax on capital gain 2,676,000 2,320,000 2,320,000 2,320,000 3,969,000

Tax on deemed dividend on share redemption 4,530,000 3,257,000 3,134,000 3,134,000 3,574,000

Advantage of capital gains rate 1,854,000 937,000 814,000 814,000 -395,000

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As illustrated, the tax advantage of using a pipeline (capital gain) strategy as opposed to the loss

carryback (deemed dividend) strategy has increased over the years as follows (all rounded)

Other non-tax factors that must be considered include the following:

• Different beneficiary needs and objectives

• Timing of cash requirements of the beneficiaries

• Costs, complexities and compliance of the approach

• Staying current with CRA pronouncements on technical matters

Quebec Ontario

2016 1,719,000 1,854,000

2011 1,224,000 937,000

2006 1,224,000 814,000

2001 908,000 814,000

1996 (98,000) (395,000)

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Example 2:

Consider the following set of facts:

• Mr. X is 60 years old and divorced;

• Mr. X has 3 major children ranging from ages 18 to

22 who live in Canada. No one in the family is a U.S.

citizen or green card holder;

• Mr. X owns shares of a holding company (“Holdco”)

having a current fair market value of $10,000,000

which he believes will grow in value over time.

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Assume the following facts upon the death of Mr. X:

• Value of Holdco has grown to $20,000,000. Mr. X

still owns his preferred shares worth $10,000,000;

• CDA = $1,000,000 (the shares are not

grandfathered);

• RDTOH = $300,000.

17


Mr. X. had previously completed an Estate Freeze in favor of a

discretionary family trust, such that the structure is as follows:

Mr. X

Holdco

Discretionary

Family Trust

Control and preferred shares

worth $10,000,000 with a

nominal ACB

Non-voting common

FMV shares

$10,000,000

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Tax Consequences Upon Death:

1.Subsection 70(5) ITA• On death, the shares of Holdco owned by Mr. X are deemed to be disposed

of for proceeds of disposition equal to $10,000,000.

2.Subsection 164(6) ITA• Permits a capital loss generated upon a redemption of Mr. X’s preferred

shares in Holdco during the first year of the estate to be carried back and

applied against the capital gain resulting from the deemed disposition upon

Mr. X’s death.

3.Pipeline• Permits the Estate to receive the liquid assets from Holdco without

additional taxes.

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Analysis of subsection 164(6) ITA

The benefit of this approach is twofold:

i.Entitles the corporation to an RDTOH refund

ii.The use of the CDA to pay a tax free dividend to the Estate

resulting in a reduction of the taxes paid on Mr. X’s death.

Note: Need to consider whether it is worthwhile triggering gains in Holdco

to increase the CDA and RDTOH

20


Technical Problem

Subparagraph 112(3.2)(a)(iii) will cause a reduction dollar for dollar

in the resulting capital loss to the extent that the capital dividends

paid exceed 50% of the lesser of:

a)the capital loss due to the 164(6) ITA election, or

b)the deemed capital gain resulting from the death of Mr. X.

21


Proposed solution

• To overcome the stop loss rules, Estate will need to convert

shares into classes of shares having a value equal to $2,000,000

(“Class R Shares”) and $8,000,000, respectively.

Technical matter:

• Holdco will increase the paid up capital on the Class R Shares

by $1,000,000 and elect that the resulting dividend be deemed to

be a capital dividend (this will increase the adjusted cost base of

the Class R shares pursuant to ss 53(1)(b) of the ITA).

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Technical matter

• Pursuant to Subsection 83(2) ITA, the corporation must elect on

the full amount of the dividend;

• CRA document 2009-031060117 confirms that a two step share

redemption, one elected pursuant to subsection 83(2) ITA and

one a taxable dividend are viewed as separate transactions for

the purpose of applying the stop-loss rule in subsection 112(3.2)

ITA;

• Redeem the Class R shares worth $2,000,000 thus resulting in

an RDTOH refund to Holdco and a taxable dividend of

$1,000,000.

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Technical matter:

Make sure there are no capital gains in the estate in its first

taxation year or the benefits of the loss carryback will be

eliminated – CRA documents 2012-0449801C6 and 2012-

1457541C6

Note: Subsection 112(7) ITA must be considered since if its shares

are exchanged post demise pursuant to section 85 of

the ITA, the stop loss rules could apply to reduce the

capital loss otherwise realized. Therefore, the mechanism

of the share exchange must be such as permitted pursuant

to that subsection.

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Example 2 $ Rounded

Quebec Ontario

Capital gain upon death 10,000,000 10,000,000

Tax on capital gain 2,665,000 2,676,000

Use of loss carryback

Conversion of shares (ss 51) 2,000,000 2,000,000

Increase in paid up capital 1,000,000 1,000,000

Revised adjusted cost base 3,000,000 3,000,000

Redemption of shares : CDA 1,000,000 1,000,000

Taxable dividend 1,000,000 1,000,000

Capital loss 3,000,000 3,000,000

Less : ss 112(3.2) loss restriction 1,000,000 1,000,000

Capital loss 2,000,000 2,000,000

Tax savings from capital loss carryback 533,000 535,200

less Income tax on taxable dividend 438,400 453,000

Tax savings to estate 94,600 82,200

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Analysis - Pipeline

After this planning, the Estate owns shares in Holdco worth

$8,000,000 with an adjusted cost base of $8,000,000. To complete

the pipeline, the following steps are required.

• Incorporate a holding company (“Newco”).

• Transfer the remaining shares to Newco with a FMV of

$8,000,000 for a promissory note worth $8,000,000 or preferred

shares with a PUC, ACB and FMV equal to $8,000,000 and

eventually draw out the remaining funds tax free by redeeming

the shares over an extended period, pursuant to CRA’s

published rulings.

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Estate

Newco

Trust

Holdco

Shares - FMV $8,000,000

ACB $8,000,000

PUC $8,000,000

Common shares

FMV - $10,000,000

(low ACB)

27


Cash Flow Summary $ Rounded

Quebec Ontario

Estate- Fair market value of shares 10,000,000 10,000,000

Less capital gains tax 2,665,000 2,676,000

add tax savings from loss carryback 94,600 82,200

Net cash flow to Estate 7,429,600 7,406,200

Trust - Fair market value before death 10,000,000 10,000,000

Add dividend refund 300,000 300,000

Fair market value after planning 10,300,000 10,300,000

Total fair market value with planning 17,729,600 17,706,200

Total fair market value without planning 17,335,000 17,324,000

Net tax cash flow benefit 394,600 382,200

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What does the CRA currently say about Pipelines?

i.Subsection 84(2) – will have a deemed dividend where:

“funds or property of a corporation resident in Canada have …

been distributed or otherwise appropriated in any manner

whatever to or for the benefit of the shareholders of any class

of shares … on the winding-up, discontinuance or

reorganization of its business ….”

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What does the CRA currently say about Pipelines?

ii. CRA will give a ruling if:

a) The corporation in question remains a distinct entity for a

year or longer, and

b) The corporation continues to carry on its “business”

during that year and thereafter the repayment of the

promissory note or the share redemption occurs over

time.

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Example 3 - Facts:

− Mr. X is 70 years old and his holding company is worth $5,000,000;

− Mr. X has 3 major children who live in Canada and are not U.S. citizens

or green card holders;

− The expectation is that the company will only grow by $5,000,000 upon

Mr. X’s death;

− Mr. X extracts dividends on an annual basis such that there is not a

material increase in RDTOH;

− Assume that a freeze was done and upon death, the holding company

has a CDA balance of $1,000,000 and RDTOH of $300,000.

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To Freeze or not to FreezeExample 3 - with estate freeze $ Rounded

Quebec Ontario









Capital loss 3,000,000 3,000,000


Capital loss 2,000,000 2,000,000

Tax savings from capital loss carryback 533,000 535,200



Cash to children 3,762,100 3,744,200

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Example 3 - with estate freeze $ Rounded

Quebec Ontario

If the children require (or want) the cash, the following would result

Fair market value of shareholdings before planning 5,000,000 5,000,000

add dividend refund 300,000 300,000

Fair market value available for distribution 5,300,000 5,300,000

less : tax on distribution 2,323,520 2,400,900

Net cash to children 2,976,480 2,899,100

Total net cash 6,738,580 6,643,300

Amount per child 2,246,193 2,214,433

33


If there was no freeze:

• $10,000,000 gain on death

• CDA $1,000,000

• RDTOH $300,000

34


Example 3 - no freeze $ Rounded

Quebec Ontario









Capital loss 3,000,000 3,000,000


Capital loss 2,000,000 2,000,000

Tax savings form capital loss carryback 533,000 535,200



35

To Freeze or not to FreezeExample 3 - no freeze $ Rounded

Quebec Ontario

Taxable dividend on liquidation

Fair market value of shares 10,000,000 10,000,000

Add : dividend refund 300,000 300,000

Less : redemption 2,000,000 2,000,000

Less: pipeline 8,000,000 8,000,000

Taxable dividend 300,000 300,000

Income tax 131,520 135,900

Cash flow summary

Estate - Fair market value of shares 10,000,000 10,000,000

Add dividend refund 300,000 300,000

Total fair market value 10,300,000 10,300,000

Less tax upon death 2,665,000 2,676,000

loss carryback savings 94,600 82,200

tax on liquidation 131,520 135,900

Net cash to children 7,598,080 7,570,300

Amount per child 2,532,693 2,523,433

Tax savings per child 286,500 309,000

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Example 4 - Child living in the U.S. - Facts:

(a) Mr. X. is 60 years old and divorced;

(b) Mr. X has 2 major children who live in Canada and

are not U.S. citizens or green card holders but 1

major child who lives in the U.S.;

(c) Mr. X owns a holding company (“Holdco”) that is

worth $10,000,000 which he believes will grow in

value over time.

37


Planning changes:

Why?

• Passive Foreign Investment Company (“PFIC”) Test

• At least 75% of its gross income for the year is

passive income, or

• On average for the year, at least 50% of the fair

market value of its total assets are passive assets.

38


Planning changes:

Issue:

No issue until you have “Excess Distributions” – a

distribution in excess of 125% of the distributions over

the last three years.

39


Planning changes:

Issue - Excess distribution:

• Is taxed at the highest marginal rate plus interest, i.e. the test

looks at when you acquired the shares, divides the income over

that period and then taxes the amount as income plus interest.

• Any gain on the shares is treated as an excess distribution and

that distribution is taxed as income instead of a capital gain.

• Generally no tax free reorganization of one’s shares.

• Shares of a PFIC acquired by inheritance from a U.S. decedent

do not get a step up in U.S. tax basis.

40


Common planning for this situation was as follows:

− Only freeze in favor of the 2 Canadian children

Note: Before effecting the freeze, be sure that Mr. X has

other assets to allow for a future equalization or

U.S. child may receive less than his Canadian siblings.

− This will avoid PFIC issues until Mr. X’s death.

− On Mr. X’s death, he owns shares worth $10,000,000 and

his 2 Canadian children own shares worth $10,000,000.

− To simplify, assume that there is no CDA or RDTOH upon

Mr. X’s death.

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To Freeze or not to FreezeExample 4 - Freeze with U.S. child $ Rounded

Quebec Ontario



Net before planning 7,335,000 7,324,000


Redemption of shares equal to 1/3 of all shares 6,666,667 6,666,667

Withholding tax 1,000,000 1,000,000

Tax savings from loss carryback 1,776,667 1,784,000

Net tax to Estate on remaining shares 888,333 892,000

Value of U.S. beneficiary 5,666,667 5,666,667

Value of Estate available for Canadians

Fair market value of shares before redemption 10,000,000 10,000,000

Less : redemption 6,666,667 6,666,667

Less : tax on deemed disposition 888,333 892,000

Net Estate value for Canadians 2,445,000 2,441,333

Total after tax Estate value 8,111,667 8,108,000

Increase in after tax Estate value 776,667 784,000

42


Example 4 - Freeze with U.S. child $ Rounded

Quebec Ontario

Total value attributable to Canadians

Net Estate value for Canadians 2,445,000 2,441,333

Add : value of shareholdings 10,000,000 10,000,000

Total pre distribution value 12,445,000 12,441,333

Value per child 6,222,500 6,220,667

Excess of Canadian beneficiary value over U.S. beneficiary value 555,833 554,000

What if Canadians want cash

Value of shareholdings - per individual 5,000,000 5,000,000

Less : dividend tax on distribution 2,192,000 2,265,000

Net after tax share value 2,808,000 2,735,000

Add net Estate value 1,222,500 1,220,667

Total Canadian after tax value - freeze 4,030,500 3,955,667

43

To Freeze or not to FreezeExample 4 - no freeze with U.S. child $ Rounded

Quebec Ontario



Net before planning 14,670,000 14,648,000


Redemption of 1/3 shares 6,666,667 6,666,667

Withholding tax 1,000,000 1,000,000

Tax savings from loss carryback 1,776,667 1,784,000

Net retention by U.S. Child

Cash from share redemption 6,666,667 6,666,667

Less : withholding tax 1,000,000 1,000,000

Net retention 5,666,667 5,666,667

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To Freeze or not to FreezeExample 4 - no freeze with U.S. child $ Rounded

Net retention by Canadian Children Quebec Ontario

Pipeline of remaining shares 13,333,333 13,333,333

Less taxes from death 3,553,333 3,568,000

Net to Canadian children 9,780,000 9,765,333

Net per child 4,890,000 4,882,667

Total net 15,446,667 15,432,000

Tax reduction 776,667 784,000

Comparison of freeze and no freeze

Total Canadian after tax value - no freeze 4,890,000 4,882,667

Total Canadian after tax value - freeze 4,030,500 3,955,667

Increase in after tax value for Canadians 859,500 927,000

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Query:

• Should the savings in Canada be shared?

• Should the Canadian siblings be fully compensated for the

future tax?

• If there are other assets in the estate, consider giving the

U.S. resident child even more shares and equalize with

other assets for his or her Canadian siblings.

• What does the CRA say about this type of planning?

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CONCLUSION

Factors that may mitigate against a “freeze”:

• Low value of company currently or only a moderate growth in projected

value;

• What is the asset mix and what type of income does the company

generate?

• What are the financial needs of the children?

• Will it be easy to liquidate the company in the future?

• Where do the children live and where will they likely live in the future?

• Are there any children who are U.S. citizens?

Estate Planning and Trusts 4 2017...Estate Planning and Trusts To Freeze or not to Freeze Name:...

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