Steps In An Estate Freeze with Chris Sabat | E070
A step by step dive into estate freezes.
On this episode of Financial Planning For Canadian Business Owners, Jason Pereira talks to Chris Sabat - General Counsel McMillan Estate Planning. Today Chris is going to talk about a deeper dive into statement freezes. We have covered a freeze in the past, but specifically today, we are going to go over a little bit more around the thinking and the mechanics of how you execute an estate freeze and why?
Episode Highlights:
1.16 Chris is a lawyer working with a team of lawyers, accountants, financial planners, and state planners at Macmillan Estate Planning Company in Calgary. Primarily McMillan serves entrepreneurial families throughout Western Canada.
1.58 Chris says it is not a situation where they find themselves going into their account and having a discussion that needs some advice taking that advice and trying to interpret that invoice for their lawyer. That is what kind of unique from my perspective about McMillan is that all those experts bring brought under one roof. So as per Chris, it really helps to facilitate a positive result in relation to something like an estate freeze.
2.44 Jason says we all in our own industries get caught up in jargon and our level of what we consider based on proficiency or base understanding, but that’s not what the average person thinks. Sometimes it is easy for us to get carried away, and sometimes it translates into something that is very simple and powerful.
3.05: According to Chris, Estate freeze is sort of a revenue Canada taxation of your state. What you’re doing is you’re freezing the tax liability. That will be imposed upon your passing and transferring that value deferring that taxation into the hands of your children or successive generations. In a nutshell if we want to stop the increased taxation of your estate while still providing you with access to that value, should you happen to need it.
4.45: Chris says that the revenue Canada recognizes with things like the succession of a business, one of the challenges is the tax building comes about on passing. This can be a way to help transfer between two successful successions within a family.
5.35: In most cases, the conversation on estate freezes typically gets started, probably by the accountant or the advisor, and then the lawyers get roped into it. Jason asks Chris to talk to about the first steps or requirements they brought to the table in this estate freezer.
5.55 Chris explains that the estate freezes can be used in relation to a wide variety of assets. It can even be used for things like publicly traded securities or investment accounts. So, it is not necessarily just restricted to the use of the transfer of shares or the freezing of the value of a corporation or qualified small business.
6.48 Chris says as a first step, we must have a value. Whether it is an investment account that is the subject of the freeze, whether it is a real estate portfolio that contains primarily passive assets, or whether or not it’s an active company qualified small business corporation. We need to have some sort of valuation.
8.35: As per Chris, entrepreneurial families don’t want to give up control. They always want to have some control over the business and its future going forward.
10.23: There are a couple of provisions in the tax code of section 85 which allow us to roll over assets. There are others like 51, which allows us to exchange, but these are all recognizing the tax code is being non-taxable events, they are basically tax-deferred events.
10.56 Jason asks Chris, “You mentioned two options you had, either held by the next generation or held by a family trust. Could you talk about the positives and negatives of both those strategies?”
11.05 Chris highlights the huge negative around the transfer or the direct transfer. It is like having the children as individuals subscribed to the grocers, a huge downside of that is that the children actually own shares. If the children own shares, that means Mom and Dad can’t be in control.
13.14: Another huge advantage with the family trust from my perspective, especially for your qualified small business corporation, is the ability to multiply your lifetime capital gains exemption or the lifetime capital gains exemption that applies for the business, says Chris.
15.29 Jason says, let’s talk about what happens when you establish the estate freeze, and for whatever reason, you wanted to send your kids or whatever it might be, and you want to undo the estate freezes. So, what’s involved with something like that?
16.02 Chris: One reason that the unwinding of the estate freeze comes about is because the vast majority of trusts have a 21-year deemed disposition, so we do the estate freeze. We have given the growth value to the family trust 21 years in the future. Revenue Canada in essence, gives you one of two options. You can pay the taxes on the capital gains; the family trust can pay the taxes or roll their shares out to one or more beneficiaries. So, it is not uncommon in families to see a freeze done maybe at least a couple of times during their lifetime.
17.48: At the end of the day, what you are doing is you are transferring the shares to one or more of the beneficiaries, and it is a relatively simple exercise, says Chris
19.06 Jason request Chris to explain the concept of a wasting freeze.
20.05: Chris explains no one has a continual ongoing valuation of their business, so once you have got that fixed value, you quite conveniently redeemed and then wither away those capital gains. Typically, what we are doing is we are stopping future capital gains and getting rid of some of the historical capital gains that have been built up in the estate.
21.09: Talking about section 208, Jason inquires how does the misery, that is, the complications of that section of the act, impact? How is it to be approached at this point?
21.27: Chris explains bill C208 is the law. It is not finalized. Revenue Canada has made it clear, or the Department of Finance has made it clear that they are going to propose amendments to Bill C208. What Chris likes about Bill C208 is that, in a sense, there is maybe a recognition that business succession planning is a long-term exercise.
24.40 As per Chris’s observation about an estate freeze, especially when they utilize things like family trusts, is that unfortunately. They are often looked at as an accounting exercise. They looked at it from the perspective of how do we minimize tax? At the end of the day, we have got a business valuation. We have got a share swap. The question is that professionals assisting you understand all of the potential complications that can come about in these types of scenarios.
27.10: Jason says estate freeze is simply an accounting strategy. This is not a taxation exercise at its core this is a financial planning exercise. This is a family dynamics exercise. This is an entrepreneurial succession planning exercise.
3 Key Points:
The one thing unique about McMillan is that all professionals need to be involved in accountants, lawyers, experts, and things like business, succession, etc. So, all of those individuals have been brought under one roof. From Chris’s perspective, the advantage of that is that it is not the sort of situation where maybe a client identifies, and we hear something about the concept of an estate freeze and how that might be advantageous.
The kind of first level of an estate freezes it is about limiting capital gains on passing and then where it really becomes powerful. We can really create value, or at least minimize the taxation that is going to be imposed upon events like the sale of a business.
The problem historically around succession planning was that there was a penalty if you happen to sell your shares to your children. It was treated as a dividend. With Bill C208, ultimately, what we are going to be able to do is facilitate transactions where there is actually an intergenerational transfer of the company shares, and you will be able to utilize that lifetime capital gains exemption. So, it does work in conjunction with an estate freeze.
Tweetable Quotes:
“In a nutshell, the bottom line about Estate Freeze is we are stopping the growth in one person’s name and passing it on to another generation’s name.” - Jason Pereira
“Family trust is often the preferred method.” - Chris
“In cases where the freeze happens, and there’s an amount, especially in excess of the capital gains exemption amount, a lot of clients who speak, they plan on taking a given an income from the company for the rest of their lives.” - Jason Pereira
“We know the Department of Finance is going to come in, and they are going to fiddle with the bill, and of course, their concern is surplus stripping. They don’t want abuses of the Income Tax Act in order to allow people to extract value at a non-dividend tax rate at the capital gains rate.” – Chris
“Bill C 208 once cleaned up it still stays true to the actual spirit of what you trying to do, would actually maybe eliminate for that would allow that deemed dividend on a wasting freeze to become a capital gain.” – Jason
“When it comes to things like business succession when it comes to controlling issues when it ensures that at the end of the day other than just saving tax, the estate freeze meets the goals and objectives of the family.” – Chris
Resources Mentioned
Facebook – Jason Pereira’s Facebook
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LinkedIn – Jason Pereira’s LinkedIn
Transcript:
Producer: Welcome to the Financial Planning for Canadian Business Owners podcast. You will hear about industry insights with award-winning financial planner and entrepreneur Jason Pereira. Through the interviews with different experts with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success, and make the most of your business and life. Now, your host, Jason Pereira.
Jason Pereira: Welcome. Today on the show I have Chris Sabat, General Counsel of MacMillan Estate Planning. I brought Chris on specifically to talk about a deeper dive into estate freezes. We've covered estate freezes in the past, but specifically today we're going to go over a little bit more around the thinking and the mechanics of how you execute an estate freeze and why. With that, here's my interview with Chris. Chris, thanks for taking the time.
Chris Sabat: Thank you for having me on the show.
Jason Pereira: Thank you also, Chris. Originally I had had you booked to talk about Bill C-208. I had accidentally double booked that topic, so I appreciate your adaptability and the ability to turn on a dime and cover another topic I've been needing to cover. Thank you so much for that.
Chris Sabat: I'm happy to help.
Jason Pereira: Chris, tell us a little bit about yourself and what it is you do.
Chris Sabat: Sure. Well, as my title suggests, I'm a lawyer. I work with a team of lawyers and accountants, financial planners and estate planners at MacMillan Estate Planning Company here in Calgary. Primarily MacMillan serves entrepreneurial families throughout Western Canada. What's unique about MacMillan from my perspective is that all of the various professionals ... and when we talk about something like an estate freeze, various professionals need to be involved, accountants, lawyers, experts in things like business succession and so on ... all of those individuals have been brought under one roof.
Chris Sabat: The advantage of that from my perspective is it's not the sort of situation where maybe a client identifies or maybe hears something about the concept of an estate freeze and how that might be advantageous. It's not a situation when they find themselves going to their accountant and having a discussion, getting some advice, taking that advice and trying to interpret that advice for their lawyer.
Chris Sabat: Unfortunately what sometimes happens in this context with things like estate freezes is that clients find themselves going from professional to professional, and trying to interpret or translate that advice for themselves. That's what's kind of unique from my perspective about MacMillan, is that all of those experts have been brought under one roof, and I think it really helps to facilitate a positive result in relation to something like an estate freeze.
Jason Pereira: That's funny. I always say that part of my value proposition to business owners is just I'll translate lawyer to English for you, and more often than not, at least a bit of a chuckle, but yes, that exact experience. We all, in our own industries, get caught up in jargon and our level of what we consider base proficiency or base understanding, but that's not what the average person thinks sometimes. It's easy for us to get carried away, and sometimes just having that translated into something very simple is very powerful. With that, let's start off with a very simple translation. What is an estate freeze, and why should anyone consider doing them?
Chris Sabat: An estate freeze, simply put, from the perspective of the Revenue Canada taxation of your estate, what you're doing is you are freezing the tax liability that will be imposed upon you upon your passing and transferring that value, deferring that taxation, into the hands of your children or successive generations. The idea is that, in a nutshell, we want to stop the increased taxation of your estate while still providing you with access to that value, should you happen to need it.
Chris Sabat: As a general rule of thumb, once the value of a business or once a family's assets maybe reach that $3 million to $4 million mark, you start to get to a place where things like estate freezes work for the family. If you've built an estate, let's just assume it's a business. It's valued at $4 million. Ultimately when both spouses pass away, you can expect a tax bill somewhere around the million-dollar mark, that 24% of that value of the business. The question is, as that business grows from say 4 million to 10 million, do you want to continue to increase the capital gains that will be paid by your estate? Generally speaking, the answer is no.
Chris Sabat: What we can facilitate is that business can grow from say $4 million to $10 million, and the tax liability on passing doesn't change. It's still that million dollars. That's the whole point behind an estate freeze. Often the question that's asked of me is, "Well, why does Revenue Canada permit that?" This isn't something that's particularly aggressive or anything like that from a tax planning perspective. The thought is that Revenue Canada recognizes that with things like the succession of a business, one of the challenges is the tax bill that comes about on passing. This can be a way to help transfer or to ensure a successful succession of a business within a family.
Jason Pereira: Absolutely. In a nutshell, bottom line is we are stopping the growth in one person's name and passing it on to another generation's name, but that said, you don't have to wait until the point where you do have a tax bill. This can be done in advance of one. It can be done when the capital gains exemption right now in small business is, correct me if I'm wrong, somewhere around 860 roughly, 860,000, increasing to one million slowly over time. If you're in a situation whereby the sale of your business and your business that can continue to grow is already worth more than that, at least the gain on it is worth more than that, then it could be worth considering. Of course, the bigger numbers, the more worthwhile it is, right?
Jason Pereira: Okay. Basically I'm guessing in most cases, the conversation on estate freezes typically gets started probably by the accountant or the advisor, and of course, then the lawyers get roped into it. Talk to me about what the first steps or requirements that would be brought to the table in an estate freeze are.
Chris Sabat: Sure. Just before we jump into that, one thing that's probably worth mentioning is that an estate freeze can be used in relation to really a wide variety of assets. It can even be used for things like publicly traded securities or investment accounts. It's not necessarily just restricted to the use of the transfer of shares or the freezing of the value of a corporation or qualified small business. It can be used in many different contexts.
Chris Sabat: Generally speaking, that first level of an estate freeze, it's about limiting capital gains on passing, and then where it really becomes powerful in particular is when you have something like shares of a qualified small business corporation. There, we can utilize things like family trusts, multiply lifetime capital gains exemptions. We can really create value, or at least minimize the taxation that's going to be imposed upon events like the sale of a business, for example.
Chris Sabat: When we get to what are the steps, the first step is we have to have a value, right? Whether it's an investment account that's the subject of the freeze, whether it's a real estate portfolio that contains primarily passive assets, or whether or not it's an active company, a qualified small business corporation, we need to have some sort of valuation. Sometimes it's a case that we go and we look at the real estate, we do a valuation of that real estate. Let's assume that the value of the real estate is $4.5 million. Well, that becomes your freeze point.
Chris Sabat: What happens is we take the common shares that are maybe in Mom and Dad's hands, and we swap those for preferred shares. Mom and Dad give up their common shares that typically increase in value as the value of the company grows, and they take back preferred shares that have that fixed value of $4.5 million. The net effect of that is that we've now frozen the capital gains in Mom and Dad's hands.
Chris Sabat: Now the question is, well, where do those common shares go? Typically what we see is the common shares are given to the children or the children subscribe to those common shares, or a family trust may subscribe to those common shares. That's where the growth in value of the corporation happens. As the real estate portfolio or as the company grows in value, it's those common shares that increase in value going forward. It's outside of Mom and Dad's personal estate.
Jason Pereira: A couple of things to unpack there, but before we get there, just one thing I want to clarify for anyone listening is that the freezing of this and passing out of common shares, that's a passing on of value. That's not necessarily a passing on of control. That's a point that often scares some people. It's like, "Wait a minute, are my kids suddenly in charge of the company?"
Chris Sabat: You're absolutely right. That's an interesting issue. A common concern for most families is this like, "Look, I built this. It's mine. I want to have access to the value, and I want to be in control." I find, generally speaking, entrepreneurial families don't want to give up control. They always want to have some control over the business and its future going forward. Absolutely this whole exercise can be performed with Mom and Dad having control over the organization or the corporation. Mom and Dad can be in control of the family trust, if that's the entity that subscribes to the gross shares, to the future value.
Chris Sabat: Mom and Dad can actually have access to some of that value as well. Maybe initially, Mom and Dad are thinking, "Hey, look, this $4.5 million of preferred shares that I now hold plus my other personal assets, that's more than enough for us going forward in the future," and then suddenly there's a change in circumstances. Well, they can actually access some of that value, some of that growth going forward in the corporation, so it's quite appealing from that perspective.
Jason Pereira: Let's talk about the mechanism for how those get frozen. You said exchange of common shares for preferred shares that are fixed value. What part of the tax code is being used there, and why is this permissible?
Chris Sabat: That is a great question. At the end of the day, what we have is just a share exchange provision. It depends on the nature of the assets, as far as the particular provisions of the Income Tax Act. Sometimes what we're doing is we're actually rolling assets into a corporation, doing the freeze at that point, and then taking back the preferred shares. At other times, what we have is we may have a corporation that may just have common shares. We're reissuing new classes of shares, and then exchange happens at that point.
Chris Sabat: It varies a little bit depending on the nature of the assets, the structure of the corporation, and we might happen to be dealing with that sort of thing, but at the end of the day, the results are all the same. Mom and Dad ended up with preferred shares in their hands. The value of those shares equates to the value of the company at the moment of the freeze.
Jason Pereira: Yeah. There's a couple of provisions in the Tax Code, Section 85, which allow us to roll over assets. There's others like Section 51(1), which allows us to exchange, but these are all recognized in the Tax Code as being non-taxable events. They're basically tax-deferred events. The gain is still there, but at no point is it triggered as part of this as long as the proper filings are done, so lawyers on the lawyers on the accounts to make sure that happens.
Jason Pereira: We've established that we've frozen the share value. We've got an evaluator in. We've done whatever section rollover is necessary in order to get this done. Now we're on to, okay, the new shares. You mentioned two options. You had either held by the next generation or held by a family trust. Care to talk about the positive and negatives of both those strategies?
Chris Sabat: Yeah, absolutely. A huge negative around the transfer or the direct transfer. I guess if I were to describe it correctly, having the children as individuals subscribed to the growth shares. A huge downside of that is that then the children actually own the shares. If the children own the shares, that means Mom and Dad can't be in control, right? They no longer own or have control over those shares in any way. I certainly have come across instances where other firms have done this sort of a transaction for families, and there's been a bit of a falling out between Mom and Dad and the children. They then find themselves in a situation where it's like, "How do we get control back over this situation, where the children now hold the growth shares in the company?" There really aren't many options.
Chris Sabat: From that perspective, I'm not a big fan of transfer of the shares to the children, or a subscription by the children to the shares themselves. My preference is what you look at is utilize something like a family trust. The family trust then owns all of the common shares, the growth shares, going forward in the future. What we can do is we can pick the trustees that will manage those shares, and that gives Mom and Dad a lot of control because what Mom and Dad can do is they can say, "Well, look, we're going to be the trustees, and so we will decide how the rights associated with those shares are exercised."
Chris Sabat: It also allows Mom and Dad to think about things like, "Okay, well, our daughter or son, they're not particularly good with managing money. I don't particularly like their spouse and I'm worried about their influence on our children, and by extension, on the corporation or on the shares. We can pick, then, or set in place, a process by which succession over the management of the trust is managed." That's the mechanism by which we keep Mom and Dad in control.
Chris Sabat: With a trust with a lot of discretion, Mom and Dad can decide if, when and who out of the family receive value, and in what amount, and so that leaves Mom and Dad in control. If they want to push the value back to themselves, they can do that. If they want to distribute or treat the children or different generations of the family differently, they have that flexibility as well. From that perspective, it works great.
Chris Sabat: Another huge advantage with the family trust, from my perspective, especially for your qualified small business corporation, is the ability to multiply your lifetime capital gains exemption or the lifetime capital gains exemption that applies for the business. In the event of a sale, let's assume Mom and Dad initially are the shareholders of the company. Well, we've got two lifetime capital gains exemptions. I think it's about $892,000 right now, is the value. Really the first $892,000 of sales proceeds is tax-free to each of the mom and dad. Let's call it roughly $2 million can come out of the company tax-free.
Jason Pereira: Well, if we have a family trust, and particularly with a larger family, if we have as beneficiaries of that family trust the children ... let's say there's three children, let's say there's three grandchildren ... we now have six more, or I guess we have individuals, each of which all have a lifetime capital gains exemption. If the value of that business grows from $4 million to $10 million, it's possible that the vast majority of that value on the sale could actually flow to the family tax-free, because each of those individuals' lifetime capital gains exemptions can be utilized. Now, of course you have to count to those individuals. Generally speaking, if you ask the question, would you prefer to send the money to the CRA or give it to your grandchild, the answer's pretty obvious.
Jason Pereira: Depends on the family sometimes.
Chris Sabat: I suppose that's true. That's another case where it's quite advantageous to use the family trust. Whereas if you were giving shares to the individuals in that moment when you don't know what the growth will be for the company, how do you divide those up? How many shares do you give to your son, who may be active in the business to some extent or at least has expressed an interest in being active in the business? How many shares do you give to your daughter? How many should you give to the grandchildren that are minors, that you really haven't had an opportunity to see will they be able to manage money, those sorts of things? The family trust, I think, is often the preferred method.
Jason Pereira: I would agree. I mean, just the inherent flexibility is just far superior to just saying here it is outright. I mean, there is an increased reporting and accounting burden that comes with it, a minor one at that, but yeah. I mean, it's better. Having optionality is valuable. Let's talk about what happens when say you've established the estate freeze, and for whatever reason you wanted to disown your kids or whatever it might be, and you want to undo the estate freeze. What's involved with something like that?
Chris Sabat: First of all, it's quite common, and it's actually relatively easy. Now, when you receive your accountant's bill or your lawyer's bill, you maybe won't think it was all that easy, but practically speaking, it is quite simple. One reason that the unwinding of the estate freeze comes about is because, as I'm sure you're aware, all trusts, or at least the vast majority of trusts, have a 21-year deemed disposition. We do the estate freeze. We've given the growth value to the family trust. Twenty-one years in the future, Revenue Canada in essence gives you one of two options. You can pay the taxes on the capital gains ... the family trust can pay the taxes ... or it can roll the shares out to one of the beneficiaries, one or more the beneficiaries.
Chris Sabat: It's not uncommon in families to see a freeze done maybe at least a couple of times during their lifetime. What often will happen is Mom and Dad will hit that 21-year mark. They'll be looking around and they'll be saying, "Look, I'm not quite ready to give up all the control or to transfer all of the shares into the hands of the children just yet. Let's redo this transaction. Let's redo the freeze and carry forward in that way." What ends up happening is there's a bump-up in the cost of the shares. Often the shares are rolled up to Mom and Dad. They redo the freeze, and the process starts itself again. That's one way, in a sense, where the freeze is undone.
Chris Sabat: In other cases, for whatever reason, there may just be a decision that we want to undo this freeze. Sometimes it's actually dropping the value of the business. As an example, if you did the freeze and the value of the business for $6 million, COVID hits, there's a massive downturn and you could fairly revalue the business at say $3 million, what you can do is you can basically undo that freeze, set a new lower benchmark of $3 million for the freeze. When the value of the business recovers back to the $6 million, you've actually eliminated capital gains on $3 million. You've increased the value to the family by $750,000.
Chris Sabat: That's another instance where you're undoing a freeze, or some people call it a refreeze. At the end of the day, really what you're doing, you're transferring the shares to one or more of the beneficiaries. It's a relatively simple exercise. There's a fair number of tax filings associated with all of this, but it's very common. That's one of the things that's nice about this.
Chris Sabat: When you're thinking about an estate freeze, I always encourage families to think about it this way. Are you willing to bet that the value of your business is going to grow? Of course, nobody runs a business from the perspective of ... with the notion that there's just not going to be a return on that hard work and that effort. Most families say, "Yeah, I believe this business is going to grow. I believe that our family's net worth is going to grow." What they're doing is they're betting that this will work out, the business will work out, and they've found a way to minimize their taxes on their passing. If it turns out that they're wrong, they just unwind the freeze, give the common shares back to themselves and go on with things as they may happen to be, so relatively straightforward.
Jason Pereira: Yeah, that's a key consideration. I mean, if the parents themselves are beneficiaries on the trust, it's a very easy back door to say, "Well, I'm taking this back. I've had enough of this." That's pretty straightforward. Now, on death, of course, then the normal estate planning process happens, right? Basically, you would have the portion of the shares that are tax-free under the capital gains exemption and potentially a taxable portion, but there's other ways we can deal with a taxable portion throughout life. Can you explain the concept of a wasting freeze to us?
Chris Sabat: Yeah, yeah. No, absolutely. It's actually very simple. At a high level, let's assume that the parents have $4 million of preferred shares. That was the value of the business on the freeze. What happens over time is that, rather than taking dividends, just taking a straight dividend from the company, which is really the only way to take value from the company, what they're doing is they're selling their shares back to the company, and they're not allowed to do that at a capital gains rate. The Income Tax Act basically says, "Look, if you're redeeming shares, selling shares back to the company, that's taxed as a dividend."
Chris Sabat: What happens over time is, of course, let's assume that Mom and Dad sell $2 million of shares back to the company. When they pass, they no longer have that $2 million of shares in their hands. What they've done is they've reduced the capital gains, at today's rates, by $480,000. It works quite well, because it's not something that you can practically do with common shares, because the question is always, well, what's the value of those shares? No one has a continual ongoing valuation of their business. Once you've got that fixed value, you can quite conveniently redeem and wither away those capital gains. Typically what we're doing is we're stopping future capital gains and getting rid of some of the historical capital gains that have been built up in the estate. You're winning on both ends, if that makes sense.
Jason Pereira: Well, yeah. I think in cases where the freeze happens and there's an amount especially in excess of the capital gains exemption amount, a lot of clients I speak to, they plan on taking a dividend income from the company for the rest of their lives, right? I've had clients say, "Look, I'll give the company to my kids, but I'm going to take a dividend. I'm going to get a paycheck for the rest of my life." My response is, "No, you're not getting a paycheck. We're going to freeze your shares. We're going to help you maintain control. What we're going to do is we're going to redeem those shares every year, because you're going to take a dividend." It ends up being the same tax consequence. We've got to take the money anyway. Now we've eliminated the capital gain. It can be a big win if it's planned for accordingly.
Jason Pereira: That's the here and now, or kind of. Now I'm going to bring you back to the topic that I was originally going to bring you on the show for, which was Section 208. How does the misery that is the complications of that section of the Act impact how an estate freeze would be approached at this point?
Chris Sabat: That's a great question. I have a bit of hesitancy in answering it because, well, Bill C-208 is law. It's not finalized. Revenue Canada's made it clear, or the Department of Finance has made it clear, that they're going to propose amendments to Bill C-208. There's still a lot of uncertainty about it. What I like about Bill C-208 is that in a sense, there's maybe a recognition that business succession planning is a long-term exercise. You don't just wake up on a Monday morning and say, "You know what, I'm going to give the company to my son." Typically the family members have been involved in the business for a number of years. Often they're not receiving any compensation for their participation in the business. Mom and Dad often want to ensure and ... sorry. I mean, you've touched on it. They want to be in control, but they also want to be confident that when they do surrender control, that the children are ready to actually run the business and to run it well.
Chris Sabat: The problem historically around succession planning was that there was a penalty if you happened to sell your shares to your children, right? It was treated as a dividend. It was a higher tax rate. Whereas if you disposed of the company and sold the shares to myself or to you, Jason, you'd pay at the capital gains rate. You'd have the ability to use that lifetime capital gains exemption.
Chris Sabat: What I see here is that with Bill C-208, ultimately what we're going to be able to do is facilitate transactions where there is actually an intergenerational transfer of the company shares, and you will be able to utilize that lifetime capital gains exemption. It does work in conjunction with an estate freeze. I just think in the moment, there's a lot of uncertainty around exactly how it will work, because we know that the Department of Finance is going to come in. They're going to fiddle with the bill. Of course, their concern is surplus stripping. They don't want abuses of the Income Tax Act in order to allow people to extract value at a non-dividend tax rate, at a capital gains rate.
Jason Pereira: Yeah. I covered this topic ad nauseam with Kim Moody previously, for anyone that wants to check that out. Bottom line, we covered all the surplus stripping reasons and whatnot. What Bill C-208 at its core is trying to correct for is an injustice, what many of us perceive to be an injustice, which is that it is actually cheaper for a third party, technically, to buy your business than it is for your own family member. Because again, they can use after-tax corporate dollars with no penalty, whereas if a family member tries to use the money within the corp to buy back your shares, it's a deemed dividend, just like in the wasting freeze scenario we just gave you. Bill C-208, once cleaned up, if it still stays true to the actual spirit of what it's trying to do, would actually maybe eliminate for that, would allow that deemed dividend on a wasting freeze to actually become a capital gain. There's a big benefit there.
Jason Pereira: I guess the word of caution on this is if you're doing an estate freeze in the next little while, if you were planning on doing it in the last half of this year, maybe wait until they actually finish cleaning up this bill so that you know what the actual rules of the game are, and you'll end up saving some legal dollars. In the meantime, there's still plenty of estate freezes that will go forward without having to wait, because C-208 doesn't really impact it. Yeah. It's interesting times we live in.
Chris Sabat: It absolutely is.
Jason Pereira: Chris, I thank you for this. Anything else anyone should be considering before they enter into an estate freeze, or an important step we maybe overshot or didn't take much time on?
Chris Sabat: My one observation about estate freezes, especially when they're utilizing things like family trusts, is that unfortunately I think they're often looked at as an accounting exercise. They're looked at from the perspective of how do we minimize tax. I was actually speaking with a family the other day about this precise issue. At the end of the day, my advice to them was, "Lookit, when it comes to an estate freeze, I can give you a list a mile long of accountants and lawyers that can actually facilitate an estate freeze for you." It's actually not all that complex, right? I mean, at the end of the day, we've got a business valuation, we've got a share swap. The question is, professionals that are assisting you, do they understand all of the potential complications that can come about in these types of scenarios?
Chris Sabat: When it comes to things like business succession, when it comes to control issues, when it ensures that at the end of the day, other than just saving tax, the estate freeze meets the goals and objectives of the family, that's where the art comes into this. I suppose you've touched on it, really, at the outset. Are you working with somebody that can translate this from legalese, which is always problematic, to something that's really plain and simple? Do you understand the end result and how all of this is going to work? Because it's not uncommon to see issues like a child's spouse being included as a beneficiary. They're thinking about it from the perspective of, "Well, there's one more lifetime capital gains exemption." Well, what happens when the divorce happens?
Jason Pereira: I'd say it's the current spouse of said person, not name them, because there's tricks around that, absolutely.
Chris Sabat: Yeah. Yeah, there absolutely is. I'm sure you've seen this in your career. How many times do you come across these sorts of plans that really weren't well thought out? What about the need to make amendments in the future? How do we avoid specific demands for value from family trusted at various points in time? What happens when Mom and Dad whither away their preferred shares? Are there some skinny voting shares that really have no value but ensure that Mom and Dad are actually in control of the company, so they can decide who the directors and officers will be? It's great if Mom and Dad are in control of the trust, but are they still in control of the company?
Chris Sabat: I think there's a bit of an art to these things. Absolutely, the vast majority of accountants and lawyers can get it done for you, but it's those broader what I would consider estate planning, business succession planning issues that are worth watching out for, because this is a significant transaction, at the end of the day.
Jason Pereira: Absolutely. I would also say, to go back to your point, an estate freeze is simply an accounting strategy. To go back to what you said previously about this is looked at primarily through the lens of taxation, and of course that is one of the big upsides of this, but this is not a taxation exercise at its core. This is a financial planning exercise. This is a family dynamics exercise. This is an entrepreneurial succession planning exercise.
Jason Pereira: It's like anything else. I think too often we confuse the thing that we deliver with the actual process, and the process should be far more encompassing to make sure that, hey, this is a thing we did that is going to be successful because of all these other considerations we took. Not this is a thing we did because, hey, my accountant said I need to do that, so I did it, so let's move on, right? It's those kinds of let's not take the time and consideration executions that lead to the real big problems.
Chris Sabat: Yeah, absolutely. The other piece too is often ... and here I'm thinking about things from the perspective of a lawyer. What I find is that often the professionals that we engage, they think about things with their particular lens. As an example, if you go to your accountant and say, "Look, I want to do an estate freeze," they're going to say, "Great idea. Absolutely. Let's lock the government out of future growth. Let's do the withering. Let's eliminate capital gains in the future." If the client were to say, "Well, look, my lawyer is also talking about something like a joint spousal trust," the accountant's typically going to look at it and say, "Well, look, you're not going to save any taxes, so why would you do that?" Whereas the lawyer's thinking about things from the perspective of protecting assets.
Chris Sabat: It's whether you're working with a firm like MacMillan that has got all these people in house or you're working with your own trusted advisors, and generally speaking, I wouldn't encourage that, right? You want your accountant that you've worked with historically and that you plan to work with in the future to be involved in the process, because they need to understand what's happening and why. They're going to have to look after your filings. They're going to have to keep the plan on track. You need to identify other professionals that have a complementary skill set, so that you understand all of the options. Things like maybe moving your preferred shares into a joint spousal trust to help protect that value from other risks, those sorts of things. There is a team that needs to be brought to bear here.
Jason Pereira: Excellent. Chris, thank you very much for taking the time to go through all this. Where can people find you?
Chris Sabat: Well, obviously they can find us on the web, macmillanestateplanning.com, and our main office is here in Calgary, but we do operate throughout Canada. Any questions, we're always happy to set up a complementary consultation with a prospective family.
Jason Pereira: Excellent. Thank you very much. Thank you for taking the time to join us yet again for Financial Planning for Canadian Business Owners. I hope you enjoyed this more of a deep dive into the steps of estate freezes and took something away from this, and that something should always be get the right advice. You can pay for legal advice or you can pay for good legal advice. There's a very big difference between the two. As always, if you enjoy this podcast, please leave a review on Apple Podcasts, Stitcher, Spotify, wherever you get your podcasts. Until next time, take care.
Producer: This podcast was brought to you by Woodgate Financial, an award-winning financial planning firm catering to high-net-worth individuals, business owners and their families. To learn more, go to woodgate.com. You can subscribe to this podcast on Apple Podcasts, Stitcher, Google Play and Spotify, or find more episodes at jasonpereira.ca. You can even ask Siri, Alexa or Google Home to subscribe for you.