“Control shares” of a private corporation that carry voting rights but are not entitled to receive dividends, or to receive more than a nominal amount on liquidation of the corporation, play an important role in many estate plans. Control shares are often issued to a parent in the context of an estate freeze of a private corporation to allow the parent to maintain control of the corporation without significant value attaching to the control shares.
The long-standing position of the Canada Revenue Agency (the “CRA”) has been that such control shares have only nominal value and their transmission on death or otherwise would not entail a significant tax liability. The Canadian estate planning community was, therefore, taken aback and very concerned to learn that the CRA’s Vancouver office proposed to add a very significant control premium to the fair market value of control shares in two separate situations.
At the 2009 British Columbia Tax Conference and later at the Canadian Tax Foundation Conference, the CRA provided some limited comfort with respect to the valuation of control shares issued in the context of an estate freeze. At the British Columbia Tax Conference, the CRA stated that although
…non participating controlling shares have some value and may therefore bear a premium … in the context of an estate freeze of a Canadian controlled private corporation, where the freezor, as part of the estate freeze, keeps controlling non participating preference shares in order to protect his economic interest in the corporation, the CRA generally accepts not to take into account any premium that could be attributable to such shares for the purposes of subsection 70(5) of the Income Tax Act at the freezor’s death.
At the Canadian Tax Foundation Conference the CRA added that
If the freezor takes back preferred shares with a FMV that equals the FMV of the corporation, the CRA will accept that the voting shares, and the growth shares issued to children or family trusts, have no FMV at the time of the freeze.
If those voting shares are later disposed of to the children or cancelled, for no consideration, the CRA will not challenge the valuation at that time unless the facts in that particular case indicate a higher value.
- the common shareholders offer parent a buyout
- parents divorce and the asset settlement attributes value
- a third party offers to buy the shares from parent
The CRA must assess based on all the available facts.
This is certainly welcome news but does not mean that the valuation of control shares will never be an issue with the tax authorities. The CRA’s policy statements are very narrowly phrased and, among other things, the policy is limited in its application:
- it applies only in the context of an estate freeze;
- it applies only to the deemed disposition on the death of the owner of the control shares or on the disposition of the shares to the children or cancellation of the shares for no consideration;
- it does not apply to the deemed disposition of control shares on the death of the spouse beneficiary of a spousal trust;
- it does not apply to the sale of control shares to a third party or for significant consideration; and
- it may not apply after the “value shares” issued on an estate freeze have been redeemed.
Estate plans that involve control shares should be reviewed as there are strategies that can eliminate or mitigate the risk of valuation problems and it is prudent to periodically review arrangements for the transmission of control of a private corporation on the death or incapacity of the controlling shareholder.