The Estate Freeze – Hull on Estate and Succession Planning #153
Listen to The Estate Freeze
This week on Hull and Estate and Succession Planning, Ian and Suzana discuss the estate freeze, what it is and why people would do typically do that in their estates.
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The Estate Freeze – Hull on Estate and Succession Planning #153
Posted on February 24th, 2009 by Hull & Hull LLP
Welcome to Hull on Estates and Succession Planning, a series of podcasts hosted by Ian Hull and Suzana Popovic-Montag. The podcast you’re listening to will provide information and insights into estate planning in Canada. From the offices of Hull & Hull in Toronto, here are Ian and Suzana.
Suzana Popovic-Montag: Hi and welcome to Hull on Estate and Succession Planning. You’re listening to episode 153 of our podcast on Tuesday, February 24, 2009.
Ian Hull: Hi Suzana.
Suzana Popovic-Montag: Hi there Ian. How are you today?
Ian Hull: I’m great, thank you.
Suzana Popovic-Montag: That’s good.
Ian Hull: So why don’t we turn to a new aspect of our estate planning considerations. We focused last time on the shareholder’s agreement. And now what we’ll do is develop a little bit of another corporate aspect of estate planning that’s used in a lot of situations and that is, the estate freeze. It seems appropriate today as we’re here in Toronto at about -20 with the wind-chill. So we’re freezing and so let’s freeze our estates.
Suzana Popovic-Montag: That was good, Ian. And you know its interesting that you raise this topic too, because I find that just over the years, that more and more of the estates that we actually deal with will have some element or another of an estate freeze and so in terms of just the basics, maybe we could just start by describing what exactly an estate freeze is and why people would do that in their estates typically.
Ian Hull: Alright, well over to you. Just kidding. Why don’t we start with really the idea of an estate freeze at its most basic level is where someone has an asset that they think is going to significantly grow but you need two components. One is an asset that you think is going to grow, but two, an asset that has grown. Because essentially the estate freeze allows for the head or the heads of the family who own the asset, say a corporation, say they build I don’t know, video cameras, for podcasting purposes. And they have developed this great video camera that is easy to use and can be downloaded very simply. So they’ve built this whole business up, the family, and they’ve created value in the company that they can live on. It is enough that they are going to have enough money to live on the rest of their lives. So they get to a point where they think well enough growth in my hands – let’s pass it on to the children. And let’s do it in a tax efficient way.
Suzana Popovic-Montag: And that really is the key, isn’t it? Like most of the estate planning that we do for clients, its all motivated either by avoiding taxes or limiting taxes that are payable on death. And I guess that’s exactly what you’re suggesting with an estate freeze. You’ve got an asset that’s increased in value. There’s a point in time where you want to make sure that at the end of the day, when you’re no longer there, that the tax liability associated with that asset can be funded by your estate so that you’re not left with a company that may in fact be crippled because of the tax liability that its facing on the date of your death, so that it can no longer continue on for the benefit of the family.
Ian Hull: So it really is much like setting up a trust during your lifetime and taking the growth of the company and plopping it right in the trust. So the settlor or the person who has created the wealth, begins the process by assessing and valuing what their company is worth on the date of freezing and then they go through lots of machinations and legal documents and so forth to create this new company. And they put this new company on the box. So we’ve got the old company and we’ve created a new company. And in the new company, you have two sets of shares. One, you have the pref shares that are going to stay in the hands of the creator of the company and the other, you have the common shares which allow for the growth. So that typically gets passed on to the children. And in a lot of situations, because the children may not be able to be at a stage where they can control or handle that kind of wealth, even the growth from that wealth, they’ll put that in a family trust. So the classic scenario is settlor creates the new family trust to hold the common shares to allow for the growth.
Suzana Popovic-Montag: Now Ian, who would the trustees typically be of that family trust that’s set up to protect the interests of the children or the ultimate people who will inherit those shares at the end of the day?
Ian Hull: Well that’s a good question. And sometimes quite often it’s the creator of the company plus someone else, because you want to allow for transition and so forth. But at minimum, the settlor is often the trustee of the new trust being created.
Suzana Popovic-Montag: And that, I guess, indirectly also allows a little bit more control to be left with the settlor than if you were to do a set up where you wouldn’t have that trust, so that they would have to dispose those assets and divest themselves of any control in that situation.
Ian Hull: Absolutely.
So like anything when we do estate planning, we don’t want to be overwhelmed by the tax driven aspect of it and we need, it seems to me, we tell our clients that the estate freeze, while it gives you some great tax advantages, essentially helps defer the tax on the growth shares because it’s going into the next generation, and it pinpoints and fixed the creator’s tax liability. But with the good can come the more the bad, the more awkward management issues. And the fundamental issue, the one that needs some considerable dialogue with your family when you do these is, and if they’re at the right stage in life, is to talk about the shift of control, because the family paradigm and the family unit was at one point, the creator of the company was the controlling mind of the company, never really got told what to do. And what often happens with these estate freezes is that the new common shareholders get rights which we’re going to talk about their rights by operation of law, and then the dynamic changes. Because essentially this creator of the company who has been told, well there’s terrific tax reasons for all of this, hasn’t also necessarily been told well guess what, there’s some significant deluding of your control of this company, your baby, the thing that you built your life around. And those kinds of issues need to be talked about.
So we need to talk a little bit about what those new rights of the shareholders are but to step back and make sure that if we’re going to create this new environment, that it’s the right thing for this particular family.
Suzana Popovic-Montag: Now Ian, that control of the transfer and the rights that get vested in the new shareholders, does that get affected by the fact that some of the new shareholders may actually be employed in the company themselves, or does that not have any affect at all?
Ian Hull: No for sure, and I think these transitions can often, the facts can be that one of the children is already in the business. And so this transfer of ownership can create its own new problems because that one child who was in the business will have a special interest in the control or lack of control because essentially they also will be going into business with their siblings. And that may not be something that they were used to either. Its kind of nice having the head or the heads of the families owning it, controlling it and dictating where things are going to go from day-to-day, when you work for the company too because you don’t have to be in business with your siblings. So that comes back to what we talked about in our last series of podcasts and of course with an estate freeze often comes the creation of a comprehensive shareholders’ agreement so that we can accommodate the interests of the head or the heads of the families and maybe potentially employees of the family who are family members.
Alright, so now that we’ve created this new paradigm, what we have to sort of sit back and look at are what kinds of specific train wrecks are going to come. And we’ve already identified the easy one and that is the scenario where, of course, you’ve got an employee who is in the company who’s a child as well. But with these new rights, we have to explore some of the exposure to this person who has run the company on his own or her own. So in our next podcast, we’re going to really flush out some of those specific rights because there are, and just to sort of prelude it, there are of course statutory rights and there are wind-up rights, there are oppression remedies and those kinds of issues, and we’re going to talk a little bit about that. So that the person who is freezing in the outside with these pref shares knows what’s coming.
Suzana Popovic-Montag: Well thank you very much Ian, and I look forward to our next podcast.
Ian Hull: Thanks very much Suzana.
You have been listening to Hull on Estates and Succession Planning by Ian Hull and Suzana Popovic-Montag. The podcast that you have been listening to has been provided as an information service. It is a summary of current issues in estates and estate planning. It is not legal advice and you are reminded to always speak with a legal professional regarding your specific circumstance. To listen to other Hull & Hull podcasts or leave any questions or comments, please visit our website at hullestatemediation