Estate Planning

Strategy Talks

Podcast Series

Estate Freezes to Save Taxes

Dean Mullett
Helen Mallovy Hicks
Kathy Munro
Wesley Mark

Episode 11: Estate Freezes to Save Taxes

Release date: May 15, 2009
Hosts: Dean Mullett and Helen Mallovy Hicks
Guest: Kathy Munro and Wesley Mark
Running time: 18:47 minutes

Kathy Munro, a Tax Services partner of PricewaterhouseCoopers, who works in the High Net Worth Tax Services practice, and Wesley Mark, a partner in the Advisory Services practice of PwC and a member of the Valuation & Strategy Advisory group, give listeners two different viewpoints on how an estate freeze could help your business manage through this troubled economy.

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Episode 11 transcript:

Dean: Welcome to Strategy Talks with Dean and Helen, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, co-head of our Restructuring and Distress Strategy Group, and a member of our Credit Crisis Task Force.

Helen: And I'm Helen Mallovy Hicks, a Partner in the Advisory Practice of PricewaterhouseCoopers in the Dispute Analysis & Valuations group.

Dean: The current state of the economy is understandably of great concern for most Canadian businesses. This series of audio podcast discussions with a variety of subject matter and industry guests are designed to help your business weather the storm by exploring some of today's hottest issues related to the economic crisis.

Dean: In today's episode, we go on the offensive in the downturn. And we look at the estate freeze as a way to save taxes. Today, we are joined by Kathy Munro, the national leader of our high network tax practice, and Wesley Marks, a partner in our valuation and strategy group. They are here to give us different view points on how estate freeze can help your business through this troubled economy. Welcome.

Helen: So Kathy, maybe we can start off, can you explain to us what is an estate freeze and how is it used?

Kathy: So first, I just want to explain what's driving this? It's a couple things really. Two things no one can avoid: death and taxes.

Dean: We try!

Kathy: Because when an individual dies let's say you have a business owner that owns share of a company that is worth $10 million. And let's say that the tax cost of the shares is a nominal amount. When the individual dies, there is a deemed disposition of all of his assets including the shares at fare market value. And the gain, in this case $10 million is subject to tax rate and in Ontario the tax rate is about 23.21 percent right now. So the terminal tax liability for this individual would be about 2.3 million. There are spousal roll over rules, so that if the individual is survived by a spouse and he or she leaves the shares to a surviving spouse, so the tax can be postponed until the death of the last spouse.

But you can't avoid the 2.3 million of tax. So what happens is that if the value of shares increases, from today, from 10 million to 20 million, then the terminal tax liability is going to increase from 2.3 million to 4.6 million. So by implementing an estate freeze today, at today's current value you can prevent the terminal tax liability from increasing over time. And then you can plan for it's funding as well, because I've seen, in my practice in estate planning, because I work on a lot of estates, sometimes families have to sell the shares of the business because they don't have enough cash or liquid assets to fund the tax that's going to be due.

Dean: So in that scenario, the tax bill then is going to be put off to the next generation, that incremental piece.

Kathy: That's right, if it increase in my example from 10 million of value to 20 million of value, then when the business owner, "dad" let's say, passes away, 2.3 million is due in taxes when he dies, the other 2.3 million of value is taxed. Either when the kids later dispose of the business or upon their death.

Dean: And they could do a freeze?

Kathy: Yeah and they could do a freeze, yup.

Helen: So often an issue that business owners have with an estate freeze is passing control. Giving away control, business owners don't like to do that and are concerned about giving away control to the children. How do you deal with that in an estate freeze?

Kathy: Someone who implements an estate freeze does not have to give any voting rights to the children. And in fact in most freezes I do, the children don't own any shares of the company directly. So what often times happen is that a trust is used, a discretionary trust to own the common shares of the business after the freeze. So let's say dad is implementing the freeze of his business that is worth 10 million, dad would exchange his common shares for frozen preference shares that have the value of 10 million and the value stays at 10 million and those preference shares have all the votes. Common shares are issued to a discretionary trust and that is where the growth is going to go to. But by using a trust you basically have almost 21 years to decide who is going to get those common shares in the future.

Dean: What happens if you freeze and then at some later date you change your mind about who the beneficiaries are going to be?

Kathy: Often times, when I implement an estate freeze for my clients, or what I'm seeing is that the freezer, the business owner himself or herself is being included in the class of beneficiaries. So that 20 years after the freeze date if the trustee so decides, maybe the children aren't going to get all of the growth, maybe the freezer or the business owner will get half and the children will get the remaining half — it can be totally discretionary and up to the trustees of the trust to pick and choose who's going to get the growth chairs in the future.

Dean: So the freezer will could then basically have all the value transferred back to them or the shares transferred back to them.

Kathy: If the trustees so agree.

Dean: Right, because they have to vote on that I guess.

Kathy: And the business owner who is implementing the freeze can be one of the trustees of the trust, he or she shouldn't be the only trustee but it could be the business owner, his or her spouse, a friend, they are the ones that make the decisions as to who is going to get the growth shares in the future.

Helen: So then Kathy, then how can business owners now reap some benefit and actually save taxes by using a freeze. What do they do?

Kathy: Basically, they have to value the shares of their business. Because you need to know what the value is, so that the business owner can exchange his or her common shares, which are the growth shares of the company, for preference that aren't going to go up in value but he will have all the votes. Either the children, if they're old enough, can come in and subscribe for the common shares directly or in some of our situations the business owners know that their kids are going to be involved in the business and are quite comfortable having the children subscribe for the new growth shares directly, but more often a family trust is used is discretionary that gives the business owner 20 years who's going to get the increase in value. And again, whatever growth there is after the freeze, as long as those shares aren't distributed out to the business owner the taxes will be reduced on death because that value won't be in the business owner's hands.

Helen: So the key is to cease on the currently depressed values freeze now, before value returns.

Kathy: That's right, because once the value goes up, in the example I was using in the beginning, once the value goes up to 20 million, well that's the value that you're going to have to freeze at if you wait until the future. When you implement a freeze the CRA says you have to have a reasonable attempt to establish value and when we freeze, or when the business owner exchanges his common shares for preference shares we always have price adjustment clauses included in the legal documents. But the CRA, Canada revenue agency says that the price adjustment clause only operates if there is a reasonable attempt to establish value. But there can be tax issues that can arise if they don't get the value right.

Helen: So Wes, maybe you can talk about that as our subject matter expert on valuations, what kind of valuations are we providing for companies, for freezing or refreezing?

Wes: Yes, probably the most important element of a valuation is that its objective is defendable and supportable. Consistent to what Kathy just said about in terms about what Canada revenue agency is looking at. In terms, of a reasonable effort and in terms of determining value and in that regard is it's probably very important to engage a qualified, professional, experienced business valuator because valuation is not just part science but it's also part art and it involves a lot of professional judgment.

So having someone closely working with you in that regard will go a long ways to making sure you get the value correct or appropriate. Now in terms of the valuation that can be issued here in Canada, there are generally three levels of valuation assurance. Being a calculation level, this is the lowest level, the estimate level which is the medium level and the comprehensive valuation which is the highest level of valuations that can be provided. What we've commonly seen is that for taxes planning purposes the medium, the estimate level, is often used.

Helen: Is that generally accepted by the CRA?

Wes: Generally yes, with that because with that an estimate level of valuation, CRA can see that there is a certain amount of rigor and inquiry and research that has been put into the valuation effort with an estimate level. With the lower level, calculation, there is less rigor and diligence and there is a heavier reliance on management representation and that regard. Where as with an estimate there is more, what you call sort of a third party due diligence perspective coming into play.

Dean: So if someone was contemplating on doing an estate freeze, one of the first things you should do is consider getting a valuation party assisting them. Some people will try to get take a crack at it themselves which is seems crazy.

Kathy: Some people do, especially people who are in the real estate area. They figure they know the real estate better than valuator could know. So they sometimes put together their own working papers and then they give it to a valuation outfit just to come up with tax discounting that and review the information that they've assembled.

Helen: So tell us Kathy, a little about refreezing. Because I know some companies have already done freezes and maybe they've frozen numbers that are much higher than the current market conditions. Can a company refreeze and if so what do they do? How do they do that?

Kathy: Yes, and I have actually been involved in a number of refreeze transactions because as you say Helen, people have implemented an estate freeze of their business at a time when the values were much higher than they are today. So the steps that are taken and this is where a trust was used in the original freeze, is that the shares are distributed to the business owner.

Because often times when I complete a freeze, as I said before the business owner is included in the class of discretionary beneficiaries of the trust and that gives them the most flexibility and comfort in completing the freeze in the first case. So then once the business owner the preference shares, which again, they have a redemption price that is too high as compared to today's value, and the common shares back into their hands, then the freeze is completed again.

Dean: How about an organization, or an individual rather who holds the assets themselves personally? Is there any way, any mechanism that can they can take advantage of this type of opportunity?

Kathy: Yes, but the individual would have to transfer the assets to a corporation. Which that can be done, on a tax free basis by filing a tax selection form with the Canada revenue agency and then undertaking the estate freeze transaction of the corporation. So then, the individual would own the preference shares of the company that have the voting control and value that is fixed at today's value and then the beneficiaries either directly or using a trust again, would purchase the common shares of the company. So that any future growth in the individuals assets which are now held in the corporation would accrue, not to the individual directly, but to the children or to a family trust, depending on the vehicle you use.

Dean: So in the downturn, it almost makes sense to at least have this on their playbook of things that they should be considering doing.

Kathy: Yup, if they think that the value of their assets is going to increase substantially in the future before their death.

Helen: Wes, maybe you can help us out with what are some of the things you're looking at in valuing businesses today? What would be indicators of a decline in value? Because I can imagine from a refreeze situation in particular you need to really carefully document a revision in value. So what are some of the things that people should be looking at in terms of supporting the decline in value? Or what are you looking at?

Wes: In terms of declines in value, particularly given if there is an original freeze that was done; I mean there are some obviously some clear signs if you have declining profitability or cash flows since the original freeze which may have resulted perhaps in increased debt or leverage on your books. But also what one needs to be taking a close look at are the key value drivers for the business. For example, customers, have you lost of a certain number of key customers since the original freeze date? Is there more perhaps costumer concentration now?

Are some of your current customers in trouble? Another area that also needs to be looked at from a value driver perspective are your input costs of say your manufacturer. Have your raw material costs gone up quite a bit since your original freeze date? Such that your margins are now lower than before. A current experience, relates to some companies actually that operate internationally and with foreign exchange rates changing quite a bit over the last couple of years, particularly for example if in the past you were an exporter and the Canadian dollar is weaker, you were a lot more profitable. But these days, with the Canadian dollar generally have appreciated in value, we see some businesses that now that pretty much are in loss making situations. So now might be a good time particularly in time of uncertainty going forward to what exchange rates might be like perhaps you may want to consider refreezing in that regard.

One other thing sort of broad area that one needs to consider is particularly the industry that you operate in, so the growth expectations lower than before? Also in terms of perhaps, transactions involved in businesses in your industry that you currently operate in, are they basically being sold at lower multiples than in the past? Certainly when you look at multiples one clear parameter that you should consider are previous transactions in your industry. As well as comparable companies that are traded in terms of their multiples, are they down since the original freeze date was implemented?

Dean: So in these times they are definitely something to review because you know things aren't static and in each business will impact in different ways, is really the message you're sending?

Wes: Yes, generally you have to look at the broad sort of the market trends, but you also have to look at your business very closely.

Dean: I think we're almost out of time here. And I guess as we do with all of our guests here on PwC downturn podcasts, we give you an opportunity to leave one key message to our listenership. And Kathy, perhaps we can start with you.

Kathy: Everyone should understand what is going to happen on their death and they should understand what taxes are going to be payable and how they're going to fund them. Because I've seen a lot of families having to scramble after their, you know their father, mothers pass away, trying to come up with the money to pay the taxes that are owing. The biggest thing is make sure you do your estate planning and you have an up to date will. And that includes an estate freeze, where it makes sense.

Dean: It's just something that people don't like to think about. But it can just compound the challenges you face if you don't deal with it head on.

Kathy: And a lot of times what I find as soon as people understand what is going to happen on their death, they really want to get their estate plan and their will into place.

Helen: Wes how about you?

Wes: Well, basically from a valuation perspective, my view is basically dangerous if you don't get your value correct in terms of the estate plan because that can result in real tax dollar cost for you. But the other thing that I think is also very important is to start early in the process in terms of getting some advice professionally credited valuator who has certainly been around the block for a while that can understand your industry and also can work with your tax advisor to perhaps come up with some preliminary values so it would help with the actual broader tax planning exercise. You don't want to wait right until the end and find out that the value that the valuator doesn't work with a tax planning perspective.

Helen: Great, well for more information you can access our publication Wealth and Tax Matters for Individuals and Private Companies, the Winter 2009 edition from the PwC website. That edition also has a couple of articles of estate freezes and valuations. And for further information, download Freezing your Estate from our managing in a downturn webpage at

Dean: This concludes this episode of Strategy Talks, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, thank you for listening.

Helen: And I'm Helen Mallovy Hicks. We hope you'll join us again soon for another episode. To download or to subscribe to this podcast series or to find more information on this topic, please visit our Managing in a Downturn website at

The information in this podcast is provided with the understanding that the authors and publishes are not herein engaged in rendering legal accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2009, PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or as the context requires, the PricewaterhouseCoopers global network or other member firms of the network. Each of which is a separate and independent legal entity.

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Hosted by Helen Mallovy Hicks, a Partner and National Leader of the Dispute Analysis & Valuations Group, Strategy Talks is a series of audio podcasts that explore key issues affecting businesses in Canada, and share strategies that companies can use to help address them.