An estate freeze is an estate/tax planning structure where the owner of an appreciating asset locks in or freezes the current value and associated tax liability of that asset prior to death. The future growth of that asset, as well as the accompanying tax implications, are transferred to other taxpayers, usually the owner’s children.
An estate freeze is a complex transaction that involves input from multiple professionals. While the specific details of an estate freeze are beyond the scope of this article, the transaction can be summarized as follows: A new holding company is created to hold the assets that are subject to the freeze. The owner transfers those assets to the holding company and, in turn, the holding company issues preferred non-growth shares to the owner, with the value of those shares being fixed on the date of the freeze. The holding company then issues common shares to the individual(s) who are to benefit from the future growth of the asset. The recipients of these common shares (also referred to as “growth shares”), enjoy the increase in value and also become responsible for various tax liabilities associated with that growth.
Family lawyers may be among the professionals providing advice on an estate freeze because there may be family law implications to the transaction, such as where the recipient of the growth shares separates from their spouse and must determine how those shares should be treated for the purposes of family property division. Some families wish to organize the estate freeze to exclude the growth shares from family property division and ask one spouse to sign an Interspousal, prenuptial, or postnuptial agreement, which is where a family lawyer can assist.
According to Ontario’s Family Law Act, married couples are entitled to share equally in the profits of the marriage. On separation, each spouse must determine their net family property, which is the value of all the property that the spouse owns on the date of separation (or “valuation date”) after deducting their debts and other liabilities, as well as the net value of any property owned on the date of marriage. Certain other property may be excluded from net family property altogether. A spouse whose net family property exceeds the other’s must pay to that spouse one-half the difference of their respective net family properties.
Section 4(2) of the Family Law Act contains prescribed exclusions, which are assets owned by a spouse on the date of separation that do not form part of their net family property. Property other than a matrimonial home that has been acquired by gift or inheritance from a third person is excluded, as well as income from that property if so expressly stated by the donor or testator.
Individuals planning an estate freeze sometimes choose to gift the growth shares to their children. In order to ensure that this gift will attract an exclusion under the Family Law Act, there are a few points to keep in mind.
A person claiming an exclusion has the onus of proving that exclusion. Therefore, where a party is claiming that property was gifted to them, they will need to show that the basic requirements of a gift have been met. These requirements are:
1) The donor intended to make the gift without any consideration or expectation of remuneration;
2) The donor must accept the gift; and
3) The gifted property is transferred from the donor to the donee.
If a person is unable to prove that there was a valid gift, then the growth shares would be included in their net family property on separation.
While it is possible to make out a gift based on parties’ conduct, a Declaration of Gift is a useful written instrument that can be signed by the donor at the time of an estate freeze to make it clear that the growth shares have indeed been gifted to the recipient. The recipient of the growth shares may want to sign an acknowledgement of receipt on the Declaration of Gift.
Things can get murky where the recipient of the growth shares pays some consideration as part of the organization of the estate freeze. There may be valid reasons to treat the transfer of the growth shares as a purchase under Canada’s Income Tax Act. However, doing so, even for a nominal amount, could mean that the transaction will not be viewed as a gift for Family Law Act purposes. Some commentators have interpreted existing case law to suggest that nominal consideration would not negate a gift for family law purposes, while other commentators disagree. The law in this area has not been clearly settled so there is a risk that there will be no valid gift if the shares have been purchased for nominal consideration.
Similarly, a gift in name must also be a gift in practice. It is easy to imagine scenarios where a donor attaches various conditions to the transfer of the growth shares, even if there is no monetary consideration being paid. In those situations, the transfer may not be recognized as a gift because there has not been a truly gratuitous transfer.
Where there has been a valid gift of the growth shares, still other family law issues may arise, such as constructive trust or beneficial ownership claims over the gifted shares by the recipient’s spouse which, if successful, could negate the exclusion. Such arguments have not received much judicial treatment and are beyond the scope of this article. Suffice it to say that recipients of gifted growth shares may want to consider signing a marriage contract with their spouses to confirm a mutual expectation that the growth shares were gifted and that they will be excluded from net family property.
Estate freezes are complicated transactions that require the input of various professionals. Family lawyers should be included with the professionals that are consulted on these transactions to ensure that the transaction meets the goals of the parties.