Why examine estate freezes? The importance of family-owned business in Canada cannot be overstated. The success of these businesses depends on a number of factors, including changes in ownership. While an estate freeze may not eliminate the tax liability that will arise at the time the business is transferred, proper structuring of the freeze can defer tax costs to future periods, as well as establish the amount of the tax liability that will arise at the time of the taxpayer’s death. In addition, in the process of planning and implementing an estate freeze, there are other many issues that must be addressed. The issues that we will focus on are the characteristics of the preferred shares to be issued and the proper structuring of the freeze to avoid any adverse tax consequences.


Estate Freeze

The primary purpose of an estate freeze is to establish all or part of the value of growing assets at their current fair market value, such that any future growth in the value of these assets accrues to the next generation. The resulting effect is that this future growth in the value of the assets in question will not be taxed in the hands of the current shareholder at the time of sale or at his or her death.

Although, estate freezes can be used to transfer the shares of an incorporated business as well as the assets of an unincorporated business, our discussion will revolve around transferring shares of an incorporated business. The two most commonly used methods for transferring the shares of an incorporated business are commonly referred to as the Holdco Freeze and the Internal Freeze.

Holdco Freeze

In a Holdco freeze, a holding company is incorporated and the common shares of the business are transferred on a tax free basis, to the new corporation using the provisions in Section 85 of the Income Tax Act.

In order for the transfer to be valid the transferor, who is transferring the common shares of the business to the holdco, must receive consideration of equal value in exchange for the common shares. Specifically, as consideration for the transfer, the transferor receives debt and preferred shares of the holding company. It should be noted that the transferor must elect to use the provisions in Section 85 and that shares must be taken as part of the consideration for the tax-free rollover to apply.

Section 85 allows for a tax-free rollover of property to a corporation by allowing the transferor to choose the proceeds of disposition to defer some or all of the gain. The transferor can elect between the cost of the shares and the fair value of the shares. The proceeds elected by the transferor, will be the cost of the common shares to the holding company. To entirely defer the gain the transferor should elect the cost of the shares. On the other hand, if the transferor has capital losses to utilize or is eligible for the lifetime capital gain exemption they should consider electing the proceeds above costs.

At the conclusion of a properly structured Holdco freeze, all of the future growth in the fair market value of the new corporation will be reflected in the common shares of the corporation which are generally subscribed for by the children in the family.

Internal Freeze

Whereas a Holdco freeze requires the incorporation of a new company, the capital reorganization of an existing corporation is the basis for an internal freeze.

In an internal freeze, the shareholder causes the existing corporation to undertake a capital reorganization. The shareholder gives up all of the common shares to the business in return for debt and preferred shares using Section 86 of the Income Tax Act. By using this provision of the act any accrued gains on the common shares given up are deferred. The children will then subscribe for new common shares of the corporation to which any future growth in value will accrue.

The major advantages that this estate freeze offers over the Holdco freeze are the following:

  • A new company does not have to be incorporated, and therefore the costs normally associated with incorporating and maintaining a second corporation can be avoided;
  • The Section 86 rollover used in an internal freeze is implied automatically and does not require an election to be made unlike the Section 85 rollover used in a Holdco freeze.

Other Issues


Characteristics of the Preferred Shares

The preferred shares that are issued during an estate freeze typically incorporate certain specific features. These features are generally intended to ensure that there is no future growth in the value of the shares and that the transferor: (1) maintains control of the corporation being transferred; (2) retains a source of income from the corporation in order to maintain his/her lifestyle.

The following are some of the features typically attached to the preferred shares issued in an estate freeze:

  • Voting (to maintain control of the corporation)
  • A reasonable fixed dividend (i.e. 5%to 10% annually) to ensure a source of income.
  • Non-participating beyond the regular dividend (to ensure no future growth in the value of the shares).
  • Redeemable/retractable at a value equal to the value of the common shares at the time of the freeze.


Proper Structuring of the Estate Freeze

In the course of implementing an estate freeze, proper care must be taken so as to avoid certain adverse tax consequences. Proper structuring of the freeze can prevent the following:

  • The unintentional triggering of capital gains (unless the taxpayer wishes to trigger the gains in order to make use of the capital gains deduction available on the disposition of qualified small business corporation shares);
    • The unintentional triggering of a taxable deemed dividend;
  • Corporate or regular income attribution rules;
  • Income-splitting taxes that are imposed on minors.



The purpose of this text is not to deal with the topic of estate freezes exhaustively. It is merely intended to demonstrate briefly and conceptually the use of an estate freeze as a tax-planning tool. Consequently, the appropriateness, implementation and the structure of an estate freeze should be determined, in collaboration with an accountant, a lawyer and a tax specialist.