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Revisiting estate freezes: A COVID-19 silver lining for business owners

To say that 2020 has been rough for most business owners is an understatement. The pandemic has created a host of issues businesses have had to deal with on the fly. But one silver lining that has come out of this challenging year is the opportunity to reassess succession and estate plans, and potentially save on future capital gains tax.

Because of the difficult business environment, the value of many businesses has fallen in the past year, some temporarily and some permanently. If there has been a permanent decline in value, conducting an estate freeze or re-visiting a previous estate freeze may actually help a business owner when it comes to tax and estate planning. Put another way, now may be the ideal time to review your planning.

An estate freeze is a tax planning tool used to lock in the value of a company held in the business owner’s name and assign future gains in value of the company to family members and/or employees who previously may not have owned shares. An estate freeze can be used for any kind of business, from an active, operating business to a passive, investment holding company.

Here’s a simple example of how an estate freeze can reduce a tax bill down the road. If a business was worth $2 million a year ago and is now worth $1 million, doing an estate freeze now will allow the business owner to pay eventual capital gains tax on the $1 million current value instead of the previous $2 million.

If the value of the business goes up after the estate freeze, the increased value and capital gains tax would ultimately be paid by the family members or employees, who became shareholders on the estate freeze, when they dispose of the shares. This may allow a deferral of the capital gains tax and to spread the value of the business out across different family members and employees, many of whom will not have used their lifetime capital gains exemptions.

The CRA of course must be satisfied however that there was a bona fide business valuation prepared or the taxman can challenge this type of planning and impute some very unfavourable tax consequences – more on that a bit later.

In the early days of COVID-19, most business owners rightfully put all thoughts about succession and estate planning on the backburner in order to focus on the day-to-day management and survival of their business. Cash flow and cash preservation were the most important things on their minds as they focused on keeping employees paid and keeping the lights on.

As we have slowly become more comfortable with our new pandemic reality, we are now seeing many business owners taking a long and detailed look at their estate and succession plan and re-assessing how best to pass on wealth to the next generation or a spouse, ensuring there is longevity to the business. The exit strategy for the business owner may look different today than it did last year, but having a plan and executing on that plan will be paramount.

To achieve this, many business owners are conducting estate freezes as a way of rewarding long-standing and essential employees with a stake in the business. While COVID-19 may have delayed the retirement plans for many business owners, this strategy can be an important step to reward and retain the key staff who will one day take over the business. Conducting an estate freeze allows the owner to minimize their capital gains tax on the current or future sale to the employee(s) while taking an important step to secure the future of the business and its lasting legacy.

Business owners who have been fortunate enough to see an increase in revenue and profitability during COVID-19 should also consider an estate freeze, especially if their good run is expected to continue well into the future. This may allow for more favourable tax treatment down the road on an eventual sale.

Any business owner considering an estate freeze should consult a chartered business valuator (CBV) for assistance with this process. Having a CBV involved ensures a rigid, thorough process to ensure all relevant factors are included and the valuation would pass a review by CRA, should they challenge the planning process and the value ascribed to the business.

About Kody Wilson, CPA, CA, CBV

Partner, Tax and Advisory Services

Nothing makes me more proud than helping my clients achieve their business and personal goals. What attracted me to the tax profession initially was the opportunity to break down a complex topic into simple strategies business owners could work with. What keeps me in the profession is my desire to keep building great relationships with current and future clients so that I can help them plan for and achieve their long-term professional and financial ambitions.

I enjoy getting to know each client and their business very well and using that knowledge to advise them on tax and estate planning, mergers and acquisitions, compensation strategies and corporate reorganizations. I am a chartered business valuator and lead the valuations department of GGFL. I work with clients on current and forward-looking valuations and consult with them on ways to increase the value of a business or department prior to a sale or to help guide strategic plans. Being at the cross-section of the tax and valuation world allows me to help my clients achieve the best possible financial results.

I joined GGFL in 2012 after working in the assurance and taxation departments of an international accounting firm as well as the audit and appeals departments of Canada Revenue Agency. I became a partner of the firm in 2019.