Can an Estate Freeze be Reversed (Thawed)?

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

As the name implies, an estate freezes effectively freezes those assets that have been subjected to the legal procedure of an estate freeze. Nevertheless, there may well arise circumstances at a later date that you no longer benefit from having those assets effectively frozen. In those circumstances, is there a legal process to reserve your original actions, such that you are effectively thawing or defrosting particular assets that were frozen pursuant to your earlier estate freeze.

The rationale for reversing an existing estate freeze can include:

  • Decline in Asset Value (Refreeze):

    • This is one of the most common reasons. If the value of the frozen asset (e.g., a business or real estate) declines significantly after the initial freeze, the original fixed value of the preferred shares held by the "freezor" (the original owner) might now exceed the actual fair market value of the company or asset.

    • In this scenario, a "refreeze" (often referred to as a "thaw and refreeze") might be implemented. This involves adjusting the value of the freezor's preferred shares downwards to reflect the current, lower market value. This is beneficial because it reduces the future capital gains tax liability on the preferred shares in the freezor's estate. The CRA has generally accepted these "refreeze" transactions, provided the decline in value was genuine and not a manufactured tax-avoidance scheme.

  • Changes in Family Circumstances:

    • Heirs fall out of favor: Relationships can change, and the freezor might no longer wish for the initial beneficiaries to receive the future growth.

    • New beneficiaries: There might be new family members (e.g., new grandchildren) who the freezor wishes to include in the wealth transfer.

    • Beneficiaries no longer interested: The next generation might decide they don't want to be involved in the business or asset.

    • Relocation of beneficiaries: If beneficiaries move to a different tax jurisdiction (e.g., the United States), the existing freeze structure might become less tax-efficient or even problematic.

  • Changes in Business or Investment Strategy:

    • The business might undergo a significant change, such as a major sale, merger, or acquisition, that makes the existing freeze structure impractical or no longer optimal.

    • The freezor might decide they want to participate in the future growth of the asset again.

  • Tax Law Changes:

    • Changes in Canadian tax legislation could render an existing estate freeze less effective or create new opportunities that require a different structure.

  • 21-Year Deemed Disposition Rule for Trusts:

    • If a family trust was used in the estate freeze, trusts in Canada are generally subject to a "21-year deemed disposition rule," meaning that every 21 years, the trust is deemed to dispose of its capital assets at fair market value. This can trigger a significant tax bill. A thaw or refreeze might be part of a strategy to manage this 21-year rule, potentially by distributing the growth shares out of the trust before the deadline.

Reversing an estate freeze typically involves another corporate reorganization or transaction, often relying on provisions in the Income Tax Act similar to those used for the initial freeze (e.g., Section 86 or Section 51 reorganizations). Common methods include:

  • Redemption of Preferred Shares: The company can redeem the preferred shares held by the freezor. This will trigger a capital gain (or loss) for the freezor on the redemption, based on the frozen value.

  • Exchange of Preferred Shares for Common Shares: The freezor might exchange their fixed-value preferred shares for new common (growth) shares in the company, thereby regaining participation in the future appreciation of the asset.

  • Issuance of New Preferred Shares (Refreeze): As mentioned, if the value has declined, new preferred shares with a lower redemption value might be issued in exchange for the original preferred shares.

  • Distribution from a Trust: If a family trust holds the common (growth) shares, the trust could distribute those shares back to the freezor (if they are also a beneficiary of the trust) or to other beneficiaries, effectively unwinding part or all of the freeze.

Neverthelesss, as with any tax planning strategy and its implementation, there are important considerations that need to be addressed in advance of reversing an estate freeze, as well as performing the unfreezing process, including:

  • Tax Implications: Reversing a freeze almost always has tax implications. It's crucial to understand the capital gains, deemed dividends, or other tax consequences that may arise.

  • Professional Advice: Due to the complexity, it is absolutely essential to consult with tax accountants, legal advisors, and potentially business valuators. They can analyze your specific situation, determine the best course of action, and ensure compliance with tax laws.

  • Documentation: All transactions involved in reversing or refreezing must be meticulously documented to withstand potential scrutiny from the Canada Revenue Agency.

  • Cooperation of Other Shareholders: If there are other shareholders (e.g., children or the family trust), their cooperation and agreement will be necessary for the reversal.

Significance of Professional Advice: As with most tax planning strategies, an estate freeze is a complex technical process, which requires the application of strict rules to the particular facts and circumstances. It is highly recommended to seek advice from an accountant and a tax lawyer to ensure legal compliance and to properly structure the transaction for your specific circumstances and objective outcomes.

For knowledgeable and experienced tax law representation for estate freezes and other tax planning strategies, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

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