Succession Planning & Estate Freeze Lawyers Ontario

Succession Planning

The most common form of succession planning involves utilizing section 86 of the Income Tax Act to effectively “freeze” the value of an individual’s estate for estate tax purposes while facilitating the transfer of future growth to the next generation or other beneficiaries using shares of a corporation. This is typically achieved by exchanging the individual’s common shares or other assets, which have appreciated in value over time, for preferred shares or other fixed-value assets which no longer appreciate.

By exchanging common shares for preferred shares, the individual effectively transfers any future growth or appreciation in the value of the business or assets to the next generation or other beneficiaries. The preferred shares held by the individual have a fixed value, shielding them from future increases in the value of the underlying assets.

A Section 86 estate freeze provides several succession planning benefits, including:

Preservation of Wealth: By freezing the value of the estate, the individual has drawn a line in the sand for the appreciating asset (which is typically the shares of a corporation) and can now preserve the value of their assets for future generations by minimizing the impact of estate taxes. As a result of the freeze, the individual can properly plan and insure over the capital gains tax which will inevitably arise on one’s death. If no freeze had occurred, the appreciating asset would continue to accrue value until the date of death of the taxpayer and may amount to an enormous amount of capital gains tax.
Succession Planning: The estate freeze facilitates the orderly transfer of ownership and control of the business or assets to the next generation, ensuring continuity and stability in family businesses or other enterprises. Without a freeze, a new generation would have to buy-in at fair market value which would require them to come up with the funds to purchase. An estate freeze allows the present generation to freeze the current value of an operating company which value will always accrue to that generation, and then allow a new generation to come in and acquire shares at no cost which will then accrue value and create wealth over the new generations’ lifetime. A corollary benefit here is that the retiring generation does not continue to pay tax on any increase in value of the company that will accrue to its successors.

Succession planning is a critical process for businesses to ensure continuity and long-term success. Succession planning goes beyond simply filling vacant positions; it entails strategically grooming and preparing individuals to take on leadership roles, ensuring a smooth transition and minimizing disruptions to business operations as well as minimizing tax implications. Speak with one of our business lawyers as to whether your family business is in need of succession and estate planning.

FAQs:

What is the difference between common and preferred shares in an estate freeze?

On a freeze, the founder's existing common shares, which carry the right to all future appreciation, are exchanged for fixed-value preferred shares whose redemption amount is set at the corporation's fair market value on the date of the freeze. The preferred shares hold their value, generally carry a controlled dividend right, and may carry voting rights where the founder wishes to retain control during the transition. New common shares, which carry the right to all post-freeze appreciation, are issued to the next generation or to a family trust.

How does a Section 86 estate freeze reduce tax?

It does not reduce tax in absolute terms; it fixes the capital gain. The deemed disposition of the founder's shares on death is, after the freeze, calculated against a redemption amount that does not grow rather than against an open-ended fair market value that continues to enlarge over the founder's remaining lifetime. The future growth, the part of the corporation's value that would otherwise have generated additional tax on the founder's death, accrues instead to the next generation's common shares.

Can an estate freeze be used by a non-family business?

Yes. Estate freezes are equally available where the next-generation owner is a co-founder, a long-tenured key employee, an incoming partner, or a holding company controlled by any of the above. The mechanics are identical to a family freeze; the difference is in the choice of who receives the post-freeze common shares and on what terms.

When should I start succession planning?

Materially earlier than most owners begin. The right time to freeze is before the next material increase in business value, which generally means many years before retirement rather than shortly before it. A freeze done at the right time fixes a smaller capital gains liability and gives the next generation a longer runway to accumulate value in their own hands.

Do I lose control of the business after a freeze?

Not necessarily. The freeze separates ownership of future growth from voting control. The founder's preferred shares can be drafted to carry the votes, keeping operational control with the founder for as long as needed, while the post-freeze common shares carry the economic upside but limited or no voting rights until the founder elects to surrender control.

What happens to my corporation if I die without a succession plan?

Without a plan, your shares form part of your estate and are taxed under the deemed-disposition rule, which can trigger a substantial capital gains liability on the final return. The estate then has to sell shares or distribute them according to the will, often forcing a sale of the business or creating disputes among heirs.

What is the deemed disposition on death, and how does it affect business owners?

On death, Canadian tax law treats a person as having disposed of all their capital property at fair market value immediately before death. For a business owner with appreciated shares, this can trigger a large capital gains tax on the final return. An estate freeze caps that exposure by fixing the value of the founder's shares in advance.

What is the difference between a Section 85 rollover and a Section 86 estate freeze?

A Section 85 rollover transfers property, typically assets or shares, into a corporation on a tax-deferred basis, often used to incorporate an existing business or move assets between related corporations. A section 86 estate freeze is a share exchange within the same corporation that locks in current value with the founder and shifts future growth to new shareholders. The two are often used together.

Can I keep control of the business after an estate freeze?

Yes. The founder typically retains voting control by holding voting preferred shares after the freeze, even though future growth accrues to the next generation through new common shares. Control and ownership are decoupled: you decide when and how much voting power to keep and when to transition it, separately from the question of where future appreciation goes.

What is the role of a family trust in succession planning?

A family trust can hold the new common shares issued after an estate freeze, allowing future growth in the business to accumulate for the benefit of children, grandchildren, or other beneficiaries without those individuals owning the shares directly. It also creates flexibility to multiply the lifetime capital gains exemption across family members and manage distributions over time.

How do I pass my business to my children?

The most common route is a section 86 estate freeze, often combined with a family trust holding the new common shares. The founder retains preferred shares of fixed value, the children participate in future growth through common shares or the trust, and ownership transitions over time without triggering an immediate sale or large tax bill.