For income tax purposes, trusts are generally deemed to dispose of their capital property every 21 years following their creation, resulting in the realization of accrual gains and losses. After a financial crisis or economic slowdown, it is not unusual for the value of common shares of a private corporation that is owned by a trust to drop significantly. Such a situation may be beneficial for a trust that wishes to avoid the 21‑year deeming rule. To achieve this goal, one possible solution is, first, that the common shares be redeemed by the company. Second, a new trust is created to acquire the common shares of the same corporation. By proceeding as such, the 21-year rule period would be refreshed and a new period of 21 years would start at the moment of the creation of the new trust. If the trust was created many years ago, such deemed disposition will be postponed for many years.
On the other hand, if the common shares of a private corporation that are owned by a trust have a significant value and the desired result is to have future growth accrue to a new trust, we could proceed by a freeze transaction. In that context, the corporation's common shares are exchanged for non-voting preferred shares and a new trust is formed to acquire the common shares of the corporation. The frozen shares are then rolled out by the first trust to its beneficiaries. If the shares involved are shares of a qualifying small business corporation, the capital gain deduction could also be crystallized as part of this transaction.
However, the freezor who implements the freeze transaction may wish to maintain the existing trust while at the same time lowering or eliminating the potential tax implication of the 21-year rule period. Thus, to that effect, the trust could immediately before its 21st anniversary exchange its common shares with accrued gains of the corporation on a tax-deferred rollover basis for fixed-value preferred shares and subscribe to new common shares. The trust would then distribute the preferred shares prior to its 21st anniversary to its beneficiaries on a tax-deferred basis and the trust's new common shares should have nominal value at its 21st anniversary.