Edited version of your private ruling

Authorisation Number: 1012584662248

Ruling

Subject: Demerger

Subject

Demerger

Question 1

Can Company X shareholders choose to obtain roll-over relief under Subdivision 125-B of the Income Tax Assessment Act 1997 (ITAA 1997) upon the demerger of Company Y by Company X?

Advice

Yes

Question 2

Can Company X disregard under section 125-155 of the ITAA 1997 any capital gain or capital loss arising from CGT event A1 happening to its ownership interests in Company Y upon the demerger of Company Y by Company X?

Advice

Yes

Question 3

Will Company X shareholders be able to treat their newly acquired shares in Company Y (in consequence of the demerger) as if they were acquired at the same time as they acquired their shares in Company X for the purposes of Subdivision 115-A of the ITAA 1997, the interest in which resulted in their receipt of the shares in Company Y?

Advice

Yes.

Question 4

Will the Commissioner confirm that all or any part of the distribution of Company Y shares to Company X shareholders that is a dividend will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Advice

No, due to the operation of section 45B of the ITAA 1936, the Company Y shares received by Company X shareholders under the scheme will not constitute a demerger dividend that is neither assessable income nor exempt income.

Question 5

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or 45C of the ITAA 1936 will apply?

Advice

If the scheme were to go ahead as proposed, the Commissioner would make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the whole, or part, of the 'demerger benefit' provided under the proposed scheme.

This ruling applies for the following period

Income year ended 30 June 2014

The scheme is proposed to commence

During the income year ended 30 June 2014

Relevant facts

Overview

The scheme to which this ruling applies involves the transfer by Company X of its shares in its wholly owned subsidiary, Company Y, to the shareholders of Company X under a demerger.

Ownership interests

Company X has ordinary and X class shares on issue.

The X class shares have the same rights as ordinary paid shares.

The issued share capital of Company Y comprises ordinary shares held wholly by Company X.

All of the shares currently on issue in Company X and Company Y are post-CGT.

Demerger

Under the demerger Company X will make an in specie distribution of 100% of its ordinary shares in Company Y to the shareholders of Company X.

Reasons for the demerger

Company X has reached the size where it needs to separate into its two business parts.

The two business parts have become less integrated and have developed different objectives.

The demerger will allow the shareholders in Company Y to deal directly with their shares, introduce new equity holders, or sell the business.

Company Y will not realise its true value to shareholders while a wholly owned subsidiary of Company X.

The demerger will allow Company X shareholders and Company Y shareholders to make adjustments to their Company X shares and Company Y shares based on their interest in each business.

The demerger will allow the separate boards (with one common director) to focus on their respective business operations.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45BA

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 section 45D

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 Division 110

Income Tax Assessment Act 1997 Division 112

Income Tax Assessment Act 1997 Subdivision 115-A

Income Tax Assessment Act 1997 Division 125

Income Tax Assessment Act 1997 section 125-55

Income Tax Assessment Act 1997 section 125-60

Income Tax Assessment Act 1997 section 125-65

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 section 125-80

Income Tax Assessment Act 1997 section 125-155

Reasons for decision

Question 1

Summary

Company X shareholders will be entitled to choose demerger rollover relief under Subdivision 125-B of the ITAA 1997 upon the demerger of Company Y by Company X.

Detailed reasoning

In order for the demerger CGT outcomes contained in Division 125 of the ITAA 1997 to apply to a company or trust, a number of defined terms must be satisfied, including:

• demerger group (subsection 125-65(1) of the ITAA 1997);

• demerger (subsection 125-70(1) of the ITAA 1997);

• demerged entity (paragraph 125-70(6)(a) of the ITAA 1997); and

• demerging entity (paragraph 125-70(7)(a) of the ITAA 1997).

Demerger Group

A demerger group comprises one head entity and at least one demerger subsidiary (subsection 125-65(1) of the ITAA 1997). The demerger group in this case comprises Company X as the head entity and includes Company Y as a demerger subsidiary.

Company X will be the head entity because:

• no other member of the demerger group holds ownership interests in Company X (subsection 125-65(3) of the ITAA 1997); and

• there will be no other company or trust capable of being a head entity of a demerger group of which Company X could be a demerger subsidiary (subsection 125-65(4) of the ITAA 1997).

Company Y will be a demerger subsidiary of Company X because Company X owns ownership interests in Company Y that carry more than 20% of the rights to any distribution of income and capital, and the right to exercise more than 20% of the voting power of Company Y (subsection 125-65(6) of the ITAA 1997).

Demerger

Subsection 125-70(1) of the ITAA 1997 describes when a demerger happens. A demerger will happen to the Company X demerger group because:

• there will be a restructuring (paragraph 125-70(1)(a) of the ITAA 1997), and Company X will dispose of at least 80% of its Company Y shares to the owners of Company X (subparagraph 125-70(1)(b)(i) of the ITAA 1997);

• under the restructuring, CGT event G1 will happen to the Company X shares when the return of capital is made under the demerger, and Company X shareholders will acquire new shares in Company Y and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997);

• CGT event A1 will happen upon the disposal of shares in Company Y. Company Y shares will be acquired by Company X shareholders on the basis of their ownership of shares in Company X (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i) of the ITAA 1997);  

• paragraph 125-70(1)(f) of the ITAA 1997 repealed;

• neither Company X nor Company Y are superannuation funds (paragraph 125-70(1)(g) of the ITAA 1997);

• Company X shareholders will acquire Company Y shares in the same proportion as they own Company X shares just before the demerger (paragraph 125-70(2)(a) of the ITAA 1997);

• each of the Company X shareholders will own shares in Company X and Company Y that (just after the demerger) represent the same proportionate total market value as their Company X shares represented (just before the demerger) (paragraph 125-70(2)(b) of the ITAA 1997);

• under the scheme, there will be no buy-back of shares for the purposes of Division 16K of Part III of the ITAA 1936 (subsection 125-70(4) of the ITAA 1997); and

• there will be no rollover available under another provision for any CGT events that happen to the Company X shares under the restructure (subsection 125-70(5) of the ITAA 1997).  

Company Y is the demerged entity 

Relevantly, subsection 125-70(6) of the ITAA 1997 defines a demerged entity to be a former member of a demerger group in which ownership interests are acquired by shareholders of the head entity under a demerger.

In the present circumstances, Company Y is the demerged entity since the Company X shareholders receive shares in Company Y under a demerger.

Company X is the demerging entity

Relevantly, subsection 125-70(7) of the ITAA 1997 defines a demerging entity to be a member of a demerger group who disposes of at least 80% of its total ownership interests in another member of the demerger group to owners of original interests in the head entity under a demerger.

In the present circumstances, Company X is the demerging entity since it disposes of 100% of its shares in Company Y to the Company X shareholders under a demerger.

Can the Company X shareholders choose demerger rollover?

Subsection 125-55(1) of the ITAA 1997 relevantly provides that demerger rollover may be chosen if:

• a shareholder owns a share in a company - the Company X shareholders satisfy this requirement;

• the company is the head entity of a demerger group - this requirement is satisfied;

• a demerger happens to the demerger group - this requirement is satisfied; and

• under the demerger a CGT event happens to the original interest (Company X shares) and a new or replacement interest is acquired in the demerged entity - this requirement will be satisfied as CGT event G1 happens to the Company X shares when the Company X shareholders receive Company Y shares under the demerger.

Therefore Company X shareholders will be eligible to choose rollover under subsection 125-55(1) of the ITAA 1997.

Capital gains and cost base adjustments for Company X

If Company X chooses demerger roll-over:

• the first element of the cost base and reduced cost base of each Company X share and each corresponding Company Y share they acquire under the demerger, will be the sum of their original cost bases (just before the demerger) of the Company X shares, apportioned over those Company X and Company Y shares on a reasonable basis having regard to the market values (just after the demerger) of the Company X shares and Company Y shares, or a reasonable approximation of those market values (subsections 125-80(2) and (3) of the ITAA 1997);

If Company X does not choose demerger roll-over:

• the first element of the cost base and reduced cost base of those Company Y shares is calculated in accordance with the rules in Division 110 and 112 of the ITAA 1997 to be equal to their market value at the time of the demerger.

Question 2

Summary

Company X can disregard under section 125-155 of the ITAA 1997 any capital gain or capital loss arising from CGT event A1 happening to its ownership interests in Company Y upon the demerger of Company Y by Company X.

Detailed reasoning

Section 125-155 of the ITAA 1997 provides that a demerging entity may ignore capital gains or capital losses arising from certain CGT events (including CGT event A1) happening to its ownership interests in a demerged entity under a demerger.

In the present case:

• Company X is the demerging entity;

• CGT event A1 will happen when Company X disposes of its shares in Company Y and transfers them to the Company X shareholders (per section 104-10 of the ITAA 1997); and

• this disposal happens under a demerger.

Therefore, any capital gain or loss under CGT event A1 made by Company X on the disposal of its Company Y shares under the demerger will be disregarded (section 125-155 of the ITAA 1997).

Question 3

Summary

Company X shareholders will be able to treat their newly acquired shares in Company Y (in consequence of the demerger) as if they were acquired at the same time as they acquired their shares in Company X for the purposes of Subdivision 115-A of the ITAA 1997.

Detailed reasoning

For the purpose of determining eligibility for a discount capital gain, the Company Y shares received by a Company X shareholder will be taken to have been acquired on the date the shareholder acquired, for CGT purposes, the corresponding Company X shares (item 2 in the table in subsection 115-30(1) of the ITAA 1997). This is the case whether demerger roll-over relief is chosen or not.

Question 4

Summary

The Company X shares received by the Company X shareholders under the scheme will not be a demerger dividend that is neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Detailed reasoning

Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income a dividend, as defined in subsection 6(1) of the ITAA 1936, paid to a shareholder out of company profits.

Capital reduction amount

The definition of a dividend in subsection 6(1) of the ITAA 1936 excludes amounts debited against an amount standing to the credit of the share capital account of the company (paragraph (d) of the subsection 6(1) of the ITAA 1936 definition of a dividend). As the capital reduction amount will be debited against an amount standing to the credit of the share capital account (as that term is defined in section 6D of the ITAA 1936) of Company X, it will not be a dividend as defined in section 6(1) of the ITAA 1936.

Therefore, the capital reduction amount will not be assessable income of the Company X shareholders for the purposes of subsection 44(1) of the ITAA 1936.

Dividend

The definition of a dividend includes any amount distributed or credited by a company to any of its shareholders. Therefore, the in specie distribution of the Company Y shares will, in part, constitute a dividend of the Company X shareholders. The total amount of the dividend will be the market value of the Company Y shares at the time of the demerger excluding the amount debited to the share capital account of Company X.

In general, a dividend satisfied by an in specie distribution of property (such as shares in a subsidiary) will be a dividend paid out of profits derived if, immediately after the distribution of that property, the market value of the assets of the company exceed the total amount (as shown in the company's books of account) of its liabilities and share capital (see paragraph 8 of Taxation Ruling TR 2003/8).

However, a demerger dividend is taken not to have been paid out of profits and is neither an assessable income nor an exempt income amount (subsections 44(3) and (4) of the ITAA 1936) where:

• the dividend is a demerger dividend (as defined in subsection 6(1) of the ITAA 1936);

• the head entity does not elect that subsections 44(3) and (4) of the ITAA 1936 do not apply to the demerger dividend (subsection 44(2) of the ITAA 1936); and

• subsection 44(5) of the ITAA 1936 is satisfied.

In the present circumstances, the dividend paid to the Company X shareholders under the demerger satisfies the conditions necessary to be a demerger dividend.

Amount not taken to be a demerger dividend

However, the concept of a demerger dividend is also subject to the dividend integrity measure in sections 45B to 45D of the ITAA 1936. In particular, section 45BA of the ITAA 1936 explains that where a determination under paragraph 45B(3)(a) of the ITAA 1936 is made, the whole or part of the demerger benefit is taken not to be a demerger dividend.

In the circumstances described in the ruling application, the Commissioner would make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies in relation to the whole, or part, of the demerger benefit. As a result, no part of the dividend paid to the Company X shareholders under the demerger will be taken to be a demerger dividend. The Company X shareholders would therefore be required to include the value of this dividend in their assessable income under subsection 44(1) of the ITAA 1936.

Question 5

Summary

If the scheme were to go ahead as proposed, the Commissioner would make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the whole, or part, of the 'demerger benefit' provided under the proposed scheme.

Detailed reasoning

Subsection 45B(1) of the ITAA 1936 provides that the purpose of section 45B is to ensure that relevant amounts are treated as dividends for tax purposes if the capital and profit components of a demerger allocation do not reflect the circumstances of the demerger, or certain payments, allocations or distributions are made in substitution for dividends.

Subsection 45B(2) of the ITAA 1936 sets out the conditions that must be met in order for section 45B to apply. Relevantly, this section applies if:

• there is a scheme under which a person is provided with a demerger benefit or capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); and

• under the scheme a taxpayer, who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and

• having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).

Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) empowers the Commissioner to make a determination under either or both of section 45BA in relation to a demerger benefit and section 45C in relation to a capital benefit.

The effect of a determination made under paragraph 45B(3)(a) of the ITAA 1936 is that part or all of a demerger benefit will be treated as not being a demerger dividend (subsection 45BA(1) of the ITAA 1936).

The effect of a determination made under paragraph 45B(3)(b) of the ITAA 1936 is that part or all of a capital benefit will be an unfranked dividend paid to the relevant taxpayer out of profits (subsections 45C(1) and (2) of the ITAA 1936).

Scheme

A 'scheme' for the purposes of section 45B of the ITAA 1936 is taken to have the same meaning as provided in subsection 177A(1) of Part IVA of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan, or proposal. In particular, a scheme is anything that satisfies any of the terms in the statutory definition.

In the present circumstances, the following features are considered to constitute the relevant scheme for the purposes of section 45B of the ITAA 1936:

• the transfer of shares in Company Y to the Company X shareholders under the demerger.

Demerger benefit and capital benefit

The provision of ownership interests to a shareholder under a demerger constitutes the shareholder being provided with a demerger benefit (subsection 45B(4) of the ITAA 1936). Therefore, under the proposed scheme, the market value of the Company Y shares provided to the shareholders of Company X constitutes a demerger benefit.

The provision of those Company Y shares also constitutes a capital benefit to the extent it is not a demerger dividend (paragraph 45B(5)(a) and subsection 45B(6) of the ITAA 1936). As such, the market value of the Company Y shares distributed under the demerger less the demerger dividend is a capital benefit provided to the Company X shareholders.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides, inter alia, that a relevant taxpayer 'obtains a tax benefit' if an amount of tax payable by that taxpayer would, apart from the operation of section 45B, be less than the amount that would have been payable if the 'demerger benefit' had been an assessable dividend or the capital benefit had been a dividend.

As a result of the demerger, the Company X shareholders would, apart from the operation of section 45B of the ITAA 1936, receive a demerger dividend equal to the market value of the shares in Company Y at the time of the demerger less the amount debited to share capital that is neither assessable income nor exempt income. The tax payable by Company X shareholders on the demerger would be higher if the demerger benefit was an assessable dividend. Accordingly, the Company X shareholders will obtain a tax benefit for the purposes of section 45B.

More than incidental purpose

Given that the proposed demerger is a scheme that provides a tax benefit to the Company X shareholders, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c) of the ITAA 1936. This paragraph provides that the section will apply if enabling the shareholder to obtain the tax benefit is a more than incidental purpose of the scheme.

The requisite purpose is to be determined having regard to the relevant circumstances of the scheme which are listed inclusively in subsection 45B(8) of the ITAA 1936. Each of the circumstances must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose.

The relevant circumstances include the tax and non-tax (i.e. business and other financial) implications of the scheme, the latter covered largely by the matters in subsection 177D(2) of the ITAA 1936, which are included in subsection 45B(8) of the ITAA 1936 by virtue of paragraph (k).

In examining the current demerger proposal in relation to the "relevant circumstances" stated in subsection 45B(8) of the ITAA 1936, the Commissioner took into account the following factors:

• The facts indicate that the demerger is being done to facilitate the shareholders disposing of their shares in both Company X and Company Y after the demerger, rather than to promote any business efficiencies in either Company.

• The substance and effect of the scheme involves the Company X shareholders obtaining significant tax and financial benefits from the demerger and subsequent sale of their shares. It is possible that shareholders would be entitled to the CGT discount concession on the sale of these shares;

• The purposes mentioned did not disclose any change or improvement to the businesses of the demerger group, apart from managerial changes which were not dependent on undertaking a demerger;

• In the absence of substantial business reasons for the demerger, the significant tax benefits obtained by the shareholders assume greater significance.

• The essential nature of the scheme allowed shares to be received by shareholders in a tax free form. In addition there has been a transformation of profits into a capital asset in the hands of the shareholders, who may then be able to utilise the small business CGT concessions on the later disposal of the shares.

Conclusion

Given the absence of substantive commercial reasons for the demerger, the tax benefit the Company X shareholders receive in the form of a distribution of Company Y shares points towards there being a more than incidental purpose of obtaining the tax benefit.

Determination under paragraph 45B(3)(a) of the ITAA 1997

Having regard to the 'relevant circumstances' of the proposed scheme, as set out in subsection 45B(8) of the ITAA 1936, it is considered that the proposed demerger is being undertaken for the more than incidental purpose (if not the dominant purpose) of obtaining a tax benefit.

Accordingly, if the scheme were to go ahead as proposed, the Commissioner would make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the 'demerger benefit' provided under the proposed scheme. The effect of such a determination would be that the whole or part of the demerger benefit would be taken to not be a demerger dividend.

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