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    December 2012
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    Estate Planning: Time to reconsider the Partnership Freeze

    Trevor Parry

    After so much political tumult of recent weeks I thought it might be therapeutic to return to tax planning. The issue of succession planning is something that should be front and center for most involved in our industry. Barring the Mayans being correct, several trillion dollars of wealth will pass from the baby boomer generation to their children in the next couple of decades. Governments of all levels and across the political spectrum are aware of this. While certainly some have pointed to the pools of registered assets as a likely target it is business enterprises that generate and constitute the vast bulk of this wealth transfer.

    We have seen the tried and true estate freeze be the cornerstone of most succession planning for many businesses. A corporation is created (or reorganized) under section 85 of the Income Tax Act with the founding generation taking back preferred shares equivalent to the value of the company on the “freeze” date, and the future growth of the business represented by the common shares, now held by the children, or by the family trust. This planning works for most situations but has several limitations.

    What if the founding generation is unsure which child or children will rise to the occasion and lead the company to new levels of success? It would be unfair to reward all with the same shareholdings if only a few or one will carry the company. What if the family enterprise holds a great deal of land which is not yet developed (or in early stages of development) and is held as inventory.

    Even the best drafters of corporate structures cannot see into the future, and trying to balance expectations and hopes with share provisions can be impossible. The rollover provisions of the Act do not allow real property held as inventory to be transferred on a deferred tax basis into a corporation as other assets are.

    Businesses should take a good look at an alternative means of “freezing” the business. A partnership, carefully drafted, may accomplish what is required. Partnerships are all about flexibility and there is no rule barring a transfer of land inventory to them. They key is careful drafting of the Limited Partnership Agreement and strict adherence to it.

    If the partnership units replicate the characteristics of their corporate cousin’s success can be achieved. The founding generation would receive units equivalent in value to their transferred property and could also receive general partnership units, likely held in a corporation that they control. The children, provided that they work and contribute to the business, could receive the growth units.

    The Federal Court of Appeal and Tax Court of Canada have dealt with only one case where a freeze was attempted through a partnership. In that case, Krauss v. R. the taxpayer was unsuccessful for a variety of fact specific reasons. The structure in that case did not replicate the elements of a freeze corporation and the children’s had an obscene payout for virtually no contribution. Krauss proves the classic dictum of tax practice, “Pigs get fat and hogs get slaughtered”.

    The partnership has not enjoyed wide use as a freeze vehicle. The Americans have decades of experience accomplishing freezes through the use of Family Limited Partnerships. Given that left unplanned the governments of this country will gorge themselves on the hard work of others, it is time for novel thinking and forward planning to be attempted.

    The MONEY® Network