Why would an estate freeze create a yearly taxable benefit for the founder?

A freeze is a point-in-time event: shares are exchanged, values are fixed and, in a section 85 transfer, one election is filed. Nothing in that exchange sets up a yearly taxable benefit by itself. A recurring amount would come from a separate rule that applies to the way the structure was built, which is why the details matter more than the label.

What happens once, not yearly

Section 15(1) includes a benefit a corporation confers on a shareholder in income for the year in which the benefit is conferred. A gain on the exchange itself is a gain on a disposition, taxed for the year of the disposition, and the capital gains deduction the CRA describes applies to particular dispositions such as qualified small business corporation shares. The election for a section 85 transfer is filed on CRA form T2057. These are all one-off events.

The rule that does repeat

Section 74.4 can apply when an individual transfers or lends property to a corporation and one of the main purposes may reasonably be considered to be reducing the individual’s income and benefiting a designated person, meaning a spouse or common-law partner, or a person under 18 who does not deal at arm’s length with the individual or is a niece or nephew. For periods when the corporation is not a small business corporation, and subject to further conditions in the section, the individual is deemed to receive interest at the prescribed rate on the outstanding amount of the transfer. A small business corporation is a Canadian-controlled private corporation all or substantially all of the fair market value of whose assets is attributable to assets used principally in an active business carried on primarily in Canada by it or a related corporation, to shares or debt of connected small business corporations, or to a combination of the two.

What reduces it

The deemed interest is reduced by interest actually received and by taxable dividends the individual receives on the shares taken back as consideration, so a founder holding dividend-paying freeze shares may offset some or all of it. Whether the rule reaches a particular structure is a technical question for an accountant. Our answer on how a freeze helps beneficiaries shows the planning side.