Even in the absence of an official estate tax, when a high net worth individual dies in Canada, the tax burden on the estate may be significant. That is because all of the assets of the estate are treated as if they were sold at the time of death, with taxes due on any gain in value that was realized during the owner's lifetime.
But effective advance-planning can significantly mitigate the tax impact.
A particularly advantageous strategy is the "estate freeze." For business owners and individuals who have accumulated considerable investment assets, a freeze can reduce or delay the ultimate tax bill, often for decades.
The tax liability of the owner at the time of death is then limited to the fair market value of the business at the time of the freeze; future growth of the business will be taxed in the hands of the beneficiaries.
For family-owned enterprises, an added benefit of this strategy is that adult children may see their role in the business in a new light, says chartered accountant Thomas Hill. "Often adult children are already working in the business, but they see it as a job. When they become owners of the business, they step up their leadership skills-development and commitment."
The owner's interest in the business is exchanged for preferred shares, which may be redeemed, over time, at the fair market value of the corporation at the time of the freeze. These shares can have voting rights that enable them to maintain control of the company, and may also include a dividend that provides annual income.
Directly or through a trust, common shares are issued to the family members or key managers who will eventually control the company.
But the first step in the process is to determine whether an estate freeze is the best strategy, says Mr. Hill. "The parents or business owners must be aware that they are giving up future growth. It only works if their retirement needs are already taken care of."
For HNW individuals who have accumulated assets of other kinds, such as real estate or securities, a similar freeze on all or a portion of the portfolio can be implemented with the use of a holding company.
During an economic slowdown, a second freeze may be beneficial if tax mitigation is the ultimate aim. The original freeze shares are exchanged for new preferred shares at the new, lower value of the company. As the economy recovers and the business increases in value, the gains accrue to the common share owners and are only taxable upon their deaths.
It is wise to seek professional advice before implementing any tax mitigation strategy, cautions Mr. Hill. "I've seen situations in which individuals have simply 'gifted' small business shares or other assets to their children. They believed that because it was a gift, there is no tax to be paid. That's not true, of course, and it can create a large tax bill."