Mortality and Tax: Freezing Time and Growth
By: Ken Lee | KLee Tax and Financial Services Co.
Published: 25 August 2025 4:00AM EST
Photo Credit: Eastport Financial
All references to a spouse include common-law partners. All references to the ‘Act’ mean the Income Tax Act, RSC 1985, c. 1 (5th Supp.), as amended. All references to the ‘Regulations’ mean the Income Tax Regulations. The following should not be construed as legal nor tax advice. Consultation with your usual tax/legal professional is advised. Please contact us to discuss the contents of the article herein.
Good morning Toronto! Currently, reports indicate that Boomers control about half of the wealth in Canada. As many of these boomers are retiring, or fast approaching retirement age, one of the largest generational wealth transfers in Canadian history is now underway. One of the key tools available for business owners to use in navigating is estate freezes. This article will discuss estate freezes and their value in helping the Owner-Manager preserve wealth, plan for succession, and minimize tax burdens when passing the business down to the next generation.
An estate freeze is a transaction that allows a business owner to 'freeze' the current value of their assets and transfer future growth to another party. This is generally accomplished by exchanging their common shares (that have appreciation potential) with preferred shares with a fixed value. New common shares are then issued to the other party. With an estate freeze, when the owner eventually passes away, the proceeds of disposition of their shares are based on the business's value at the time of the estate freeze.
The transaction itself is relatively simple. The owner's common shares are first exchanged for preferred shares that will have a fixed value equal to the company's current FMV. Normally, exchanging shares results in a deemed disposition event that triggers capital gains. However, this deemed disposition can be deferred using a §86 rollover.
As the name suggests, §86 rollovers stem from §86 of the Act, which allows shareholders to exchange shares of one class for another class of shares in the same corporation on a tax-deferred basis, provided that the exchange is reported on the shareholder’s next tax return.
At the end of this step, the adjusted cost basis of the common shares is carried over to the preferred shares. Instead of the value of the company in the future, the frozen value of the business (FMV at the time of the freeze) becomes the amount that will be 'realized' on the owner's death.
Example 1
Richard self-publishes his music with his record company, which was worth $1 million, 2 years ago. Around that time, he performed an estate freeze, issuing common shares to his daughter, Annie, who subscribed to the shares for one dollar ($1). The company is currently worth $1.2 million. Annie is interested in moving abroad and is curious about what tax consequences, if any, will arise as a consequence of her potential non-resident status.
- Richard's capital gains on his death will be calculated on the difference between his cost basis and the FMV of the shares at the time of the estate freeze, $1 million.
- Annie's shares are currently worth the amount of growth since the freeze, $200k.
- Under ITA §128.1(4)(b), Canadian tax residents who become non-resident are deemed to have triggered a deemed disposition of all of their property, with some exceptions, immediately before ceasing residency. Hence, Annie will trigger $200k of capital gains on ceasing residency.*
*Annie can avail of §220(4.5) to defer payment of any capital gains from the deemed disposition until the property is actually sold by filing T1244. Furthermore, if Annie were to reestablish Canadian residency, she could make an election to “unwind” the previous deemed disposition under §128.1(6) if she still holds the shares.
However, when the children subscribe to new common shares, they may also gain voting control of the corporation, which may not be desirable if the owner wishes to retain control over business decisions. To combat this, a common method is to issue non-voting common shares to the children. Another possibility is to use a discretionary family trust that will subscribe to the new common shares. In this arrangement, the parent can act as the trustee, retaining control over how/when the income/capital is distributed. However, in a trust arrangement, capital property is generally subject to the 21-year rule. Proper planning is required to manage these tax consequences. For example, the trust can potentially distribute the shares to the beneficiaries on a tax-deferred basis shortly before the 21st anniversary.
Regardless of whether the common shares are subscribed to by a trust or by the children, the corporation can pay dividends* on those shares. However, if the children are not substantively involved in the business, the Tax on Split Income (TOSI) rules would likely apply, subjecting the paid dividends to the highest marginal tax rate.
*Dividends must be distributed to preferred shares before common shares.
On top of the freeze, provided that the corporation meets the definition of a Qualified Small Business Corporation (QSBC), the owner and each shareholder may be able to separately claim the Lifetime Capital Gains Exemption (LCGE)*, which currently shelters over $1 million of capital gains from tax. Thus, by issuing shares to multiple family members and/or a trust, the future growth of the corporation can be spread across multiple shareholders, allowing each to utilize their own LCGE.
*To qualify for the LCGE, the shares must meet certain criteria regarding share ownership, ownership period, and the percentage of the CCPC's assets used to actively carry out business activities in Canada. The specifics of these requirements are not within the scope of this article and will be discussed in a future post.
Finally, estate freezes should also include mechanisms to be partly unwound, providing for the possibility of transferring capital back to the owner. Situations, such as changes to family dynamics or business strategy, may require changes to the original structure. For example, if the shares were distributed to a family trust AND the owner (or related family member) is a capital beneficiary in said trust, it may be possible to distribute the shares on a tax-deferred basis under §107(2) of the Act. In addition, it may also be possible to redeem the preferred shares for common shares using another §86 rollover if structured as a share-for-share exchange.
In conclusion, estate freezes are a powerful tool for business owners who are seeking to preserve wealth, manage succession, and minimize tax liability. While theoretically simple, careful planning must be undertaken to ensure that the freeze is flexible and does not trigger other provisions of the Act.
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