Articles
Family trusts- Part II
Author: Philippe Richer
In Part I, I explained how you could set up a family trust as part of an estate freeze to plan for your succession and the payment of taxes on your death. In Part II, I’ll cover why this strategy is not for everyone or every business. As outlined in the example in Part I, a freeze and the establishment of a family trust can save you hundreds of thousands of dollars in taxes.
Timing is Everything
However, it always depends on timing. In the example I provided, you and your spouse froze your shares’ value when they were worth $500 000.00 each. The business then grew fivefold to $5 000 000.00. Your timing was perfect. What happens if your timing is not so good? If you wait too long and the company grows in value to $5 million when only you and your spouse are shareholders, your Lifetime Capital Gains Exemption (LCGE) of $971,190 in 2023 won’t cover your capital gains. You will have missed the boat. Your only hope is to employ this strategy to protect future growth. But if you freeze your shares at $5 million and establish a family trust, you need continued growth. Can you count on the same growth rate? Going from $1 million to $5 million is no easy task. To capitalize on the family trust, you must count on continued growth.
You Need Growth
There’s the rub. Who amongst us can count on that rate of growth? All of us in business know how difficult it is to grow. Growth rarely occurs as a matter of fate. It takes planning, leadership, investment, determination, and drive. In addition to all of the stuff in your control, you must also count on a little luck. The economy, new technology, and unforeseen disasters have derailed the best laid out plans. Not every business plans to grow. Many business owners have reached a level of revenue and income they are comfortable with. That doesn’t mean they don’t work hard. It simply means they are happy in maintenance mode. They don’t want to reinvest every penny into the business or borrow money to switch to a growth track. If this is you, a family trust won’t help. It will only cost you money to set it up and manage it every year (filing tax returns).
Retirement
This strategy also only works if you intend on keeping your frozen shares for distribution to your estate. It is a tax planning strategy. As discussed in Part I, at death, CRA “deems” that you sold all of your shares at fair market value. This “deemed” sale triggers capital gains the same way a regular sale of shares does. If you need the money from the frozen shares to fund your retirement, this strategy won’t help either. While you are alive, you can only benefit from the LCGE if you sell your shares. If you plan to include your children in the business, then they are the only realistic buyers. They may not have the funds or the ability to borrow. If this is the case, then you can have the company redeem your shares over time. The company pays you to buy back its shares. This redemption is funded from cash flow. Unfortunately, the LCGE is a capital gains exemption. The Income Tax Act states a “deemed dividend” occurs when a company redeems shares. The LCGE does not apply to dividends. As you can see, a freeze and family trust does not provide any benefit other than helping your lawyer and accountant’s cash flow.
Considerations Other Than Income Tax
Professionals often tout a family trust as a method to protect the company from family dissolution. Suppose you bring your children into the business via a family trust (the children are beneficiaries of the trust, which is the shareowner). In that case, the company shares are protected in the event that child divorces. Because the trust has discretionary power to distribute the funds as the trust sees fit, the “assets” or funds do not belong to any beneficiaries until they receive them. A clear ownership break exists between the beneficiaries and the trust. A divorcing spouse cannot bring the assets of the trust into the family property division. But this is an expensive way to deal with family property matters. Those matters can be tackled with a properly drafted cohabitation agreement (prenup).
Final Thoughts
While I may appear critical of the “freeze + Family Trust” strategy, I believe it offers a great solution if your circumstances fit the strategy. If you have a viable business and you plan to grow, knock yourself out. Talk to your accountant and lawyer. But if not, and you need the funds for retirement, or if you intend on maintaining the business as it is, you should carefully review your options. Other options include issuing shares to your children, establishing a holding company or selling your shares altogether. Each one of these options carries its own set of risks and benefits. As with everything in law, a perfect solution doesn’t exist. Each situation will have its own characteristics leading to a unique solution. But there is one thread that unites all options: careful planning. If you are 63 and plan on retiring from the business at 65, it’s likely too late. Whatever strategy you implement, give yourself lots of time.
Disclaimer – Legalese
This article is presented for informational purposes only. The content does not constitute legal advice or solicitation and does not create a solicitor-client relationship (this means that I am not your lawyer until we both agree that I am). If you are seeking advice on specific matters, please contact one of our lawyers at 204.925.1900. We cannot consider any unsolicited information sent to the author as solicitor-client privileged (this means confidential).
