What is a Wasting Freeze?

A wasting freeze will gradually reduce the amount of fixed value shares from an estate freeze. This post describes a wasting freeze and considers adding leverage and making charitable gifts to accelerate the process.

Click here to read our previous post describing Estate Freeze Basics.

What is an Estate Freeze?

An estate freeze transfers the future increase in the value of certain assets to successors. This is usually done by holding an asset inside of a corporation (“holdco”) with at least two classes of shares. One share class has a fixed value, and the other share class has no fixed value (typically called “growth shares”).

A wasting freeze takes an estate freezing strategy a step further by gradually reducing the number of fixed value shares over time.

Why use a Wasting Freeze?

While an estate freeze is generally undertaken to cap the future capital gains tax liability due at death, a wasting freeze will accelerate this reduction by recognizing those gains throughout the frozen shareholder’s life.

Here are some reasons why a wasting freeze might be used:

• If tax rates are expected to rise in the future, it may be better to pay tax at the current lower rate than the future higher rate. A wasting freeze can recognize capital gains sooner rather than later.
• The frozen shareholder may require (or desire) cash. Redeeming their fixed value shares for cash may be a convenient funding method.
• By using the CDA and RDTOH accounts, the frozen shareholder can receive cash for their frozen shares in a tax efficient way.

Adding leverage

If the goal of a wasting freeze is to gradually reduce the capital gains tax liability over the life of the frozen shareholder, then adding leverage to the growth shares will accelerate this process.

With a wasting freeze, a portion of the fixed value shares are be redeemed by the holdco each year. This is done by providing cash to the fixed value shareholder in exchange for their shares.

The fixed value shareholder who is receiving cash as part of the wasting freeze could either use the cash to spend on consumption or invest in other productive assets. If these assets also grow in value, then the whole point of the estate freeze (to transfer future growth to successor shareholders) is undermined.

Alternatively, the fixed value shareholder can use the proceeds from the redemption of their fixed value shares as part of a wasting strategy to lend money back to the holdco by way of a shareholder loan or promissory note. The terms of this loan can be customized, but would ultimately add leverage to the holdco, thereby enhancing future gains.

The result of having the fixed value shareholders lend money to the frozen holdco is an acceleration of the transfer of future value to the growth shareholders without accruing future gains to the frozen shareholder.

CDA & RDTOH accounts

When dividends are received by a corporation, it adds to the Capital Dividend Account (“CDA”) and Refundable Dividend Tax on Hand (“RDTOH”) account. If your frozen holdco owns and collects dividends from stocks, the CDA balance will accumulate as time passes.

Since capital dividends can be made to shareholders tax free, the CDA can be used to make distributions to the fixed value shareholder in a tax efficient way.

Combining a Wasting Freeze with Charitable Gifts

When a gift of an appreciated security is made from your holdco to your family foundation, there is a credit to the CDA equal to the capital gain that would otherwise be recognized by a sale. This additional CDA balance can be used to redeem fixed value shares.

In this way, making gifts of appreciated public securities to your family foundation from your holdco will add to the CDA balance and can be used to accelerate a wasting freeze.

Intergenerational Wealth Transfer

If your goal is to transition your wealth to your heirs, then you’ll need to consider an estate plan that aligns with this goal. Part of what a family office does is co-ordinate your comprehensive estate plan to ensure it is reviewed regularly with your professional advisors (your accountant, your lawyer).

An estate plan doesn’t need to be comprehensively reviewed each year but reviewing items like CDA balances and other housekeeping should be done at least annually. A family office ensures these regular housekeeping matters are addressed.