THE PERFECT PLANNING COMPANION - CCH

1 Canadian Estate PLANNING GuideExcerpt: [ 4600] Internal Freezes and [ 4625] Stock Dividend FreezesEXCERPT #2 THE PERFECT PLANNINGCOMPANIONC anadian EstatePlanning GuideA REAL LIFE EXAMPLED etermine for yourself whether or not the Canadian Estate PLANNING Guideis worth the out the following pages that have been reproduced in their entirety from the Guide. You ll beimpressed by their thoroughness and by ExpertsThe Canadian Estate PLANNING Guideis the collaborative product of some of Canada s leading tax Louis JD, CA and Samantha Prasad Weiss BA, LLB, both with the law firm Minden Gross LLP, alongwith Robert Spenceley BA, MA, LLB, analyst with CCH Canadian, and Joseph Frankovic LLB, LLM, PhD, CFA,tax lawyer and member of the adjunct faculty of Osgoode Hall Law School, lead a host of contributors whoseexpertise make this Guide truly in three user-friendly formatsPrint: $630CD-ROM: $581 (single-user license)Online.

2 $574 (single-user license)David Louis JD, CASamantha Prasad WeissBA, LLBR obert SpenceleyBA, MA, LLBJ oseph FrankovicLLB, LLM, PhD, CFATRY BEFORE YOU BUYTake advantage of our free trial offer, available in print, on CD-ROM or over the Internet. For more information or to place an order, simply call the appropriate toll-free number :1-866-470-1124 British Columbia:1-866-894-5105 Ontario, Saskatchewan, Manitoba, Atlantic Canada and Territories:1-800-996-9914To r o n t o :416-228-6175 Quebec:1-800-363-8304, ext. 267 Please quote Promo Code [ 4600] Internal Freezes to [ 4625] Stock Dividend FreezesThe use of a holding corporation ( Holdco ) to imple-ment a freeze is not the only method of achieving thisobjective in respect of a pre-existing corporation.

3 Analternative approach is an internal freeze , whereby theshares of Opco are frozen directly by converting thepre-existing shares typically common into diagram at 4750 illustrates a typical internal freezeconfiguration. As usual, the freezor ( Freezor ) holds sharesof the corporation having the following attributes: redeemable/retractable at the value of the pre-existingshares at the time of the freeze; voting (either as an attribute of the redeemable/retractable shares or with the voting shares sequesteredin a separate class which has virtually no rights apartfrom the votes themselves); non-cumulative dividends either fixed or to a ceiling,usually based on the redemption/retraction amount( , up to .75% per month); plus the usual preferences on dissolution, and so on (for amore detailed discussion of freeze share attributes,reference should be made to 4752 and 4850 et seq.)

4 The growth shares are held either directly by one or morechildren, or as is more commonly the case, through a familytrust, which will have the usual discretionary features,with the issue of Freezor ( , lineal descendants) asbeneficiaries (see 4780et seq. for variations).Methodology There are a variety of ways to arrive at this most common provision for effecting an internalfreeze is Section 86 of the Income Tax Act. However, it isalso possible to utilize Section 85 of the Act, , by effectinga standard Section 86 reorganization, but also filing aSection 85 election form. ( This is also known as an offsideSection 86 reorganization or, even more simply, an offside86 .) In more unusual circumstances, an estate freezecould be effected through an amalgamation pursuantto Section 87 of the Act, , where two corporations areinvolved in the freeze.

5 It is also possible to effect anestate freeze via a stock dividend. Conceptually, at least,Section 51 (share and debt conversions) could also be used.[ 4605] Holdco versus internal freeze someconsiderations The most commonly-cited advantage to internal freezesis that they do not require the formation of a secondcorporation; accordingly, legal and accounting fees maybe decreased. However, the following should also beconsidered: The use of a Holdco affords a degree of creditorprotection, , by allowing the payment of dividends to Holdco the proceeds can then be lent back to Opco if necessary, on a secured ESTATE PLANNING GUIDEV irtually all practitioners will agree that an estate freeze is the cornerstone of estate and suc-cession PLANNING for a family business.

6 There are several methods of implementing a freeze,most commonly, a holding company freeze, or an "internal freeze" , reorganizing the cor-poration itself. The following excerpt From the Canadian Estate PLANNING Guideshows howthe service presents a an extensive discussion of the tax issues and considerations pertainingto internal freezes, as well as a comparison of the benefits of this methodology vis- -vis aholding company freeze. This excerpt is an example of how the Canadian Estate PlanningGuideis a key tool to assist you in providing comprehensive and up-to-date estate planningadvice to your The use of a Holdco may facilitate continuation of Opco's status as a small business corporation on a tax-efficient basis.

7 As noted at 4769, the basic test of small business corporation status is that substantiallyall of the corporation's assets must be devoted to Canadian active business activities. Accordingly, it is possible to implement freeze structures utilizing a Holdco, whereby excess cash or other assets can be jettisoned to the holding corporation as a tax-free inter-corporate dividend, leaving Opco pure .Of course, if a Holdco is already in place, and a freeze ofHoldco is desired, it is probably preferable to effect aninternal freeze in respect of Holdco general, implementing an internal freeze does not avoidany of the issues previously commented on. The valuationissues are similar; freeze shares received in exchange forcommon shares must have virtually the same attributes,and the implications of redeeming such shares do notchange.

8 [ 4610] Section 86 Freezes As stated previously, Section 86 of the Act is the mostcommon method of effecting an estate freeze. Manyrulings, technical interpretations, and articles have beenwritten on Section 86 freezes, so that the technical issuespertaining to Section 86 freezes are, by and large, following are prerequisites to the application ofSubsection 86(1), which provides for the rollover:Reorganization of capital There must be a reorganization of the capital of acorporation. The meaning of this term is not specificallydefined in the Income Tax Act, but pertains to corporatelaw principles. Accordingly, most practitioners followrelevant corporate law procedures, , pertaining to fundamental changes (for example, provisions analogousto section 168 of the Ontario Business Corporations Act).

9 Although it might be possible to have a reorganizationof capital through other means, practitioners typicallyeffect a section 86 reorganization by means of Articles of Amendment, the wording of which follows thecorporate provisions relating to reorganizations. (For thisreason, it is common to effect the conversion as a change of the common shares to freeze shares that is, following the wording of relevant corporateprovisions.) The significance of the reorganization ofcapital requirement has lessened because of recentamendments to Section 51 of the Act, which allows a rollover for share conversions without the necessity of a pre-existing convertibility feature in respect of theshares which are exchanged. Accordingly, provided thatno non-share consideration is received, an exchangewhich does not qualify under Section 86 may qualifyunder Section 51 of the of all shares of a class The taxpayer must in the course of the reorganizationof capital dispose of capital property that was all ofthe shares of a particular class of the capital stock ownedby the taxpayer.

10 In most estate freezes, status as capitalproperty should not be problematic , since Freezoris not in the business of trading these , it is also required that all of the shares of theparticular class owned by the taxpayer be dis-posed of;Section 86 will not be available if the taxpayer disposesof only some of the shares of a class. However, it will beavailable if the taxpayer holds other classes of shareswhich are not included in the reorganization of this respect, a potential pitfall might arise if Freezorreceives shares of the same class as a result of thereorganization. It could then be arguable that the taxpayerhas not disposed of all of the shares of a particular example of this problem could occur in respect of apartial freeze.