A few weeks ago, I wrote a blog under a similar title. At the time of my writing, our Finance Minister in Ottawa, Mr. Bill Morneau, had yet to surprise us incorporated small-business owners with his plan to eliminate tax planning tools commonly used by the incorporated self-employed.

I will not go into all the proposed tax-rule changes, but I will discuss the one proposal that may impact the Capital Dividend Account tax planning I wrote about just before the announcement.

One of the biggest perks of having a corporation is that the tax rate is only 13%, up to $ 500,000 of corporate net profit. Hence, many successful corporations have retained earnings invested in an investment portfolio, or real estate earning passive income. When an investment is sold for a profit many years down the road, only half the gain is taxable, the other half is completely tax free. The tax-free rule is the same for a small private corporation, or an individual earning a salary as an employee.

So, when an individual sells an investment and pays the taxes owing, the net retained is still in the individual’s hands. However, when a corporation sells an investment and pays the taxes owing, the net retained is in the corporation, and the shareholder needs to extract money out of the company, which creates personal taxes. Under existing rules, the tax-free half of the gain (aka Capital Dividend Account) can be taken out by the shareholder tax free.

One of the changes Ottawa is considering is not to allow the extraction of the Capital Dividend Account by the shareholder to be tax free. (Do not forget that if the investment was held personally, the individual gets automatic access to the tax-free gain without further taxes.)

With the loud objections to the proposed tax changes happening as I write, it is not clear what the final law will look like.

It is very unlikely that the balances accumulated in the CDA already will simply disappear under the new law. Nonetheless, if a balance exists now, call your lawyer and accountant to take it out since it is tax free. Another suggestion would be to crystalize the gains on all investments that have increased in value. This will have the effect of adding the tax-free half to the CDA that can be extracted. It is difficult to crystalize gains on real estate without actually selling the property. But with stock portfolios, the stock can be sold and purchased back right away to crystallize the gains. Again, only stocks with gains should be sold. Selling stocks with losses will decrease the CDA balance. The goal here is to create as big a CDA balance as possible for extraction.

Note that taxes will be triggered as well from the half that is taxable. This tax will be owing even if the gain is crystallized in the future.

Note that setting up a holding company to transfer the retained earnings of the operating company will not do any good here. Ottawa wants to tax the retained earnings that were subject to the small business deduction limit, and they will surely find a way to tax the holding companies that received these retained earnings.

The proposed changes are to tax retained earnings invested in passive investments. Businesses need real estate to operate out of, and there is no word on the retained earnings being accumulated to buy land and buildings to operate out of (not to rent out).

As for the budding entrepreneurs who are just about to incorporate or reorganize the existing corporate structure, you might as well hold off until Ottawa provides more clarity.