ATO Interpretative Decision

ATO ID 2004/637

Income Tax

Demerger: original pre-CGT interests - consequences for shareholders under Division 725 if new interests in demerged entity are issued at a discount
FOI status: may be released

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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.

Issue

If a direct value shift happens under a demerger because new interests in a demerged entity are issued at a discount, can the cost bases and reduced cost bases of those interests be increased under section 725-250 of the Income Tax Assessment Act 1997 (ITAA 1997) if they were issued in respect of pre-CGT original interests?

Decision

Yes. The cost bases and reduced cost bases of the new interests in the demerged entity can be increased under section 725-250 of the ITAA 1997 as no adjustments are made to the cost base and reduced cost base of both the new interests and the original interests under Division 125 of the ITAA 1997.

Facts

There are three Australian resident shareholders (original interest holders) in Company A, an Australian resident company. Each shareholder is an associate of the other shareholders. All of the shares were acquired before 20 September 1985.

Company A is the owner of the only share (a post-CGT share) on issue in subsidiary Company B. Company A has not made a choice to form a consolidated group.

Under an arrangement, Company B (the demerged entity) issues shares to the shareholders in Company A, in the same proportions as their Company A shareholdings. No consideration is to be provided to Company B for the shares. The arrangement satisfies the definition of a demerger in section 125-70 of the ITAA 1997.

As a result of the issue of shares at a discount by Company B, there is a reduction in the market value of the share that Company A holds in Company B, resulting in a direct value shift. The conditions set out in section 725-50 of the ITAA 1997 for there to be consequences under Division 725 of the ITAA 1997 as a result of the direct value shift are satisfied.

Reasons for Decision

Division 725 of the ITAA 1997 does not apply to an original interest holder where the specific terms of section 125-95 of the ITAA 1997 apply. That section provides that where cost base and reduced cost base adjustments are required under sections 125-80, 125-85 or 125-90 of the ITAA 1997, no further cost base and reduced cost base adjustments are required to be made under the Act as a result of something that happens under the demerger. Cost base and reduced cost base adjustments are required under sections 125-80, 125-85 or 125-90 of the ITAA 1997 where the original interests were acquired on or after 20 September 1985. No adjustments are required under those sections where the original interests were acquired before 20 September 1985.

Accordingly, as the new interests are issued in respect of the three shareholders' original interests that were acquired before 20 September 1985, and the conditions in section 725-50 of the ITAA 1997 are satisfied, increases may be made to the cost bases and reduced cost bases of those new interests under section 725-250 of the ITAA 1997 as a result of the direct value shift.

Note: If the new interests are taken to be acquired before 20 September 1985, then the increase adjustments under section 725-250 of the ITAA 1997 will only have practical consequences for shareholders that are companies (for example, a company required to calculate an unrealised net loss under Subdivision 165-CC of the ITAA 1997).

Date of decision: 16 July 2004

Year of income: Year ended 30 June 2005

Legislative References:
Income Tax Assessment Act 1997
   Division 125
   section 125-70
   section 125-80
   section 125-85
   section 125-90
   section 125-95
   Subdivision 165-CC
   Division 725
   section 725-50
   section 725-250

Related ATO Interpretative Decisions
ATO ID 2003/1050
ATO ID 2004/635
ATO ID 2004/636

Keywords
CGT demerger exemption
CGT share value shifting arrangements
Cost base adjustments for value shift

Siebel/TDMS Reference Number: 3631053

Business Line: Public Groups and International

Date of publication: 30 July 2004

ISSN: 1445-2782

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