CGT and the aged care system

Summary: CGT and inherited aged care bonds; the work test; dividend imputation credits; and CGT on subdivided blocks of land.

Key take-out: If dividend imputation credits are removed, SMSFs with all members in pension phase may need to change their investment mix.

Question: Following a recent CGT question on inheritance I would appreciate your thoughts on the following circumstances. Is any CGT payable if a widower enters the residential aged care system, sells their principle place of residence to help fund the refundable accommodation bond as they seem to require you to do, ultimately passes away and leaves the refunded bond plus other cash assets to non dependent adult children in their will?

Answer: The Australian Tax Office states that for a dwelling to be classed as a principle place of residence, you and your family must live in it, your personal belongings must be in it, it must be the address to which your mail is delivered, and it must be your address as registered on the electoral roll.

Under this definition, the unit requiring the refundable accommodation bond should qualify as a principle place of residence. It is my experience that upon the death of a resident, the amount paid to the estate is usually less than the original bond paid, which means there would be no capital gain, but a small capital loss instead.

If a small profit is made, it should not be taxable when received by the beneficiaries of the estate, due to the unit being considered the principle place of residence. When the cash from the refunded bond passes from the estate to the beneficiaries, it along with the other cash – which also does not generally attract a capital gain – will not be subject to capital gains tax.

Question: Do I meet the 40 hour work test rule if I minded my grandchildren during one period of school holidays while my son and daughter-in-law worked? I did more than 10 hours work in week one and less than 30 hours in week two. Times and days are shown on my invoices to them.  Monies were paid into my bank account under the invoice numbers. 

Answer: To meet the work test, a person must be self-employed or must work for 40 hours in 30 continuous days as an employee. In your situation, given you provided an invoice, you would not be considered an employee, so would be reliant on being classed as self-employed.

Generally, for someone to be considered self-employed they need to be carrying on a business. There is no single factor determining whether someone carries on a business. It instead depends on a number of factors such as intending to make a profit, repeating similar types of activities, and the activity being planned, organised and carried out in a business-like manner.

Unless you offer this child minding service to other people, and have provided these services for payment, I do not think you would meet the business test and therefore could not be classed as self-employed. As a result, I do not believe you would meet the 40 hour work test, but you could request a binding ruling from the ATO as to whether you would pass the work test.

Question: The proposed changes by the Labor Party to dividend imputation tax refunds affects SMSFs and personal investors. Is there any strategies to minimise the effects of the changes should Labor win the election for a personal investor outside of super?

Answer: If Labor were to win government and pass legislation removing the ability of excess imputation credits to create a tax refund, any adversely affected SMSF or personal investors would have strategies available to them to try and minimise the policy's impact, but these strategies will tend to work only for individuals and SMSFs with accumulation accounts.

There is very little that SMSFs with all members in pension phase can do. In this situation, the shares and managed fund investments owned by the super fund will need to be critically analysed to assess whether, after removing the extra income currently generated by the refund of franking credits, there are other investments producing a better overall return.

For individuals and SMSFs with all members in pension phase, the percentage of the investment portfolio invested in Australian shares will need to be reduced.

When I construct a portfolio for clients in the drawdown phase of their investment life, I allocate no more than 50 per cent of the portfolio to equity markets. The other 50 per cent is allocated to fixed interest, unlisted direct property trusts, alternative investments and cash.

By alternative investments, I mean those managed funds in which the underlying investments do not fit neatly into any of the normal asset classes, such as infrastructure funds. Although these funds invest in listed infrastructure companies, history shows that despite being affected by downturns in share markets, they tend to return to fair value more quickly due to their guaranteed revenue streams.

For the 50 per cent allocated to share markets, a portion of this – depending on a client's risk tolerance – would be allocated to overseas share markets. This is often done either via index funds or managed funds which have produced long-term returns above the index funds.

An investment portfolio with a spread of investments over the different investment classes – whether it is within a SMSF with accumulation fund members or for an individual – should result in franking credits being used to offset the tax payable on the other income earned.

Question: We were thinking of buying a block of land, subdividing it and building six townhouses. One of these we would live in and one we would rent temporarily before selling. What would the tax implications be of doing this, Capital Gains Tax or revenue in nature?

Answer: As you are building the other four townhouses with a view to selling them at a profit, the ATO would deem you to be carrying on a business, rather than simply purchasing investment assets. In this situation, any profits made on those four townhouses would be taxed as normal revenue and would not receive any CGT discounts.

You should seek professional advice from an accountant specialising in these areas. If you do not make the right decisions, you will not only pay more tax on each of the townhouses you sell, but you will also have to pay the goods and services tax on the value of the townhouses sold. This would mean less tax is paid, as you would be making a smaller profit, but it would also mean you are earning less cash after tax.

If you have a question for Max Newnham please email it directly to max@taxbiz.com.au