How does it work? Does it matter if the beneficiaries gets either common or prefered. Wouldnt taxes have to be eventually be paid out by the donor?
Usually someone with lots of wealth does this.
Basically a Holding Corp is set up. By a person, lets say parents in this case
The Assets that the Parent(s) hold are transferred into the corp. Usually there are tax laws that allow property to be transferred over at somewhere between Cost and FMV. Usually done at Cost in Canada its called a section 85 rollover.
So an example would be parents rolling $10m into a corp. In which they take back voting preferred shares to maintain controll of the corp. Lets say at a cost base of $5m
So their preferred shares are valued at $10m with a cost base of $5m
The corp then issues Common Shares B that have no voting rights to the kids. This allows the parents to maintain control and the kids to then take part in growth above $10m. The kids cost base of their shares are then $0 or $1.
The parents then when they sell the preferred or die usually. There is a deemed disposition on their preferred shares for $10m less cost base of $5m so $5m cap gain is paid.
So yes eventually taxes are paid out by the person or persons who transfer the money in. Depending on tax laws in the area. If there was no tax free transfer then tax would most likely be paid on transfer in since its a deeemed disposition. In that case usually a loan would be taken back from the person who transferred the assets in and would recieve interest payments from the loan.
thanks for taking the time to explain. shouldnt the childrens cost base equal the market value so that they also dont end up with huge difference in market and cost base?
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No the children’s cost base is what if anything they paid for the common shares that they receive. The purpose of the estate freeze is to effectively tax any growth of the corp in the children’s hands. At the time the children receive the shares they are valued at the market value of the company.
Example had the parents roll $10m in with their shares valued at $10m
If the kids paid $1 for their shares the market value would be $1 as the company is now worth $10,000,001.
- You will not have any fair mkt. Value to the common shares transferred as there will be control and liquidity disc. to these 2. The pref shares are bonds that ceases to exist at death or capped at face value. No tax
- You will not have any fair mkt. Value to the common shares transferred as there will be control and liquidity disc. to these 2. The pref shares are bonds that ceases to exist at death or capped at face value. No tax
Structure:
i. Voting preferred shares: The value of these shares is equal to the current value of 100% of the corporation. These shares are held by the older generation. These shares pay a fixed rate like bonds; thus, their value does not appreciate greatly. ii. Non-voting common shares: The value of common shares increase with the future appreciation in the value of the corporation. • Due to the voting power attached to preferred shares, the control of the company is retained by the older generation.