Page 10 - Newcom

YOUR GUIDE TO SALES AND FINANCIAL PLANNING
BUILDING YOUR BUSINESS
PAGES 10-11 l INVESTMENT EXECUTIVE l DECEMBER 2020
As a business’s value drops, opportunity arises
l BY MICHELLE SCHRIVER
your client’s business may have
dropped in value over the course of the pandemic, making now a good time to consider an estate freeze or refreeze. Such a move can be part of effective tax and succession planning.
Consider a family business in which the owners are near retirement and their children are active in the business. To do a freeze, the owners exchange their common shares for redeemable pre- ferred shares with a fixed value (in other words, they “freeze” the value), and issue new common shares to the children. The freeze reduces the owners’ tax liability upon death and defers taxes by shifting the business’s future growth to the com- mon shares owned by the children.
(The new shares could be held in a dis- cretionary family trust instead, allowing the parents to retain control over the common shares and enhancing access to the lifetime capital gains exemption, if applicable.)
If a client has already done an estate freeze and their business’s valuation drops materially lower — as may have happened during the pandemic — they can do a refreeze: exchange their preferred shares for new ones at the current fair market value, and issue new common shares to the children, the existing discretionary family trust or a new trust. The refreeze at the new valuation level further reduces the owners’ tax liability upon death.
“A lot of people are looking into [freezes] now because of the state of the economy,” says Jingchan Hu, senior manager, tax, with Crowe Soberman LLP in Toronto.
The new freeze value should be high enough after tax to provide the client with enough liquidity to fund their lifestyle
Freezes and corporate attribution
Freezes often are done according to Sec. 86 or 51 of the Income Tax Act, which allows for a tax- deferred share-for-share exchange without having to apply the corporate attribution rules.
However, the corporate attribution rules (Sec. 74.4) would apply “when you’re trying to effectively shift value or provide benefit to someone who’s a designated person,” says Jingchan Hu, senior manager, tax, with Crowe Soberman LLP in Toronto.
According to the rules, when your business-owner client transfers property to the corporation, they may be subject to an annual deemed interest benefit on the property at the Canada Revenue Agency’s prescribed rate.
The benefit applies if the transfer was done to reduce the business owner’s income and to benefit a spouse/common-law partner, or non- arm’s length person or niece or nephew under age 18.
Sec. 74.4(4) provides one excep- tion: when the designated person’s only interest in the corporation is as a beneficiary of a trust from which they don’t receive income or capital. A small
business corporation is also excepted. When a business owner doesn’t qualify for an exception, the company
can eliminate corporate attribution by, for example, paying dividends on the frozen preferred shares. In general, “you’d rather pay taxes on real income than on phantom income,” says Garnet Matsuba, tax counsel with MLT Aikins LLP in Edmonton.
With the prescribed rate at 1%, “it won’t take much in dividends to offset the corporate attribution” relative to when the rate was higher, Matsuba says. The freeze may be “still good in the long term because you can reduce the transferor’s tax liability at death.”
With a refreeze in such a case, the deemed interest benefit would be based on the redemption amount of the original preferred shares, not of the refrozen preferred shares, accord- ing to the CRA. The client’s account- ant would have to calculate whether the refreeze is advantageous.
Matsuba says clients should weigh the benefit of the lower tax liability that would be applied upon death against the cost of paying sufficient dividends to eliminate the attribution.
Your role on the freeze team
During freezes, you work with your business-owner client’s team of accountants and law- yers, and the client’s financial plan is the basis for decision-making.
Crunching the numbers
from the plan helps the client make decisions about preferred shares, including doing a refreeze, says Tannis Dawson, vice-president, high- net-worth planning, with TD Wealth Advisory Services in Winnipeg. For example, a client who doesn’t need their preferred shares from a freeze may want to do a refreeze to de- crease the value of their estate when the opportunity arises, she says.
In another scenario, redeeming the preferred shares over time in what’s called a “wasting freeze” may make sense to ensure no shares remain upon death and tax liability is spread over several years. Further- more, accessing capital gains by selling shares instead of redeeming them may provide greater tax effi- ciency, Dawson says.
during retirement, says Garnet Matsuba, tax counsel with MLT Aikins LLP in Edmonton. “That is a potential pitfall if they underestimate the amount they’ll need,” he says.
Another pitfall: a lower business valua- tion must be supported by evidence.
“There has to be a bona fide operational decline,” says Tannis Dawson, vice-presi- dent, high-net-worth planning, with TD
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