Section 74.4(2) taxes the founder on deemed interest, every year the freeze is in place, once growth shares sit with a spouse or minor child and the company stops qualifying as a small business corporation.
Short answer
Because section 74.4(2) of the Income Tax Act treats an estate freeze that puts growth shares in the hands of a spouse or minor child as a transfer or loan to a corporation for that person’s benefit, and once the company stops qualifying as a small business corporation, it taxes the founder every year on a deemed interest benefit calculated at the prescribed rate on the value transferred — whether or not the corporation ever actually pays a dividend.
Section 74.4(2) applies where an individual has transferred or lent property to a corporation and one purpose was to benefit a designated person — a spouse or a minor child is the common case in a freeze. The trigger condition: “one of the main purposes of the transfer or loan may reasonably be considered to be to reduce the income of the individual”. Where the corporation is not a small business corporation, “the individual shall be deemed to have received as interest in the year the amount, if any, by which” the prescribed-rate interest on the frozen value exceeds any interest or dividends actually received.
A freeze structured while the company is a small business corporation — broadly, an active Canadian-controlled private corporation using substantially all its assets in an active business — is outside section 74.4(2) entirely. Real estate or accumulated surplus pushing the asset mix past that threshold is exactly what tends to happen as a frozen company matures. Preferred shares with no growth potential for the designated person also keep a freeze outside the rule.
The tax-on-split-income (TOSI) rules are a different regime, with age thresholds that are easy to mix up. Section 120.4(4) applies to “a specified individual who has not attained the age of 17 years before a taxation year” — a minor’s rule, taxing most split income at the top rate regardless of amount. A separate, later threshold applies where “the individual has attained the age of 17 years but not the age of 24 years before the year” — the age-24 gate inside the “excluded shares” test, a distinct mechanism, not the same rule described twice. TOSI exposure survives fixing 74.4(2) and has to be assessed on its own facts.
In the Case Files library, an estate freeze that taxed the founder every year is the direct example: growth shares to a spouse and minor children, and an annual income inclusion with no dividend behind it. the valuation the family used to move shares to the next generation was not the one the CRA used and the 21-year clock, and a beneficiary who had moved away show adjacent places where a family transfer’s tax result turns on a status — the CRA’s accepted value, or a beneficiary’s residency — rather than the deal itself.
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