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Edited version of your written advice

Authorisation Number: 1013030869750

Date of advice: 28 June 2016

Ruling

Subject: Application of demerger relief and section 45B of proposed demerger of SubCo from HeadCo

Question 1

If Shareholder chooses to obtain the demerger rollover, is any capital gain arising to him or her pursuant to step 3 of the proposed transaction disregarded under section 125-80 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

Will Shareholder's cost base in their newly-issued shares in SubCo be the same as the cost base for their shares in HeadCo?

Answer

Yes

Question 3

Is any dividend paid to Shareholder as a result of the demerger not assessable and not exempt under subsections 44(3) to (5) of the Income Tax Assessment Act 1936 (Cth)?

Answer

Yes

Question 4

Will section 45B of the Income Tax Assessment Act 1936 (Cth) apply to the demerger?

Answer

No

Question 5

Will section 109RA of the Income Tax Assessment Act 1936 (Cth) apply to prevent any demerger dividend from being a dividend to which Division 7A applies?

Answer

Yes

This ruling applies for the following period:

Years ending 30 June 20XX and 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

Entities

HeadCo's influence over SubCo, and the influence of HeadCo shareholders

Current management issues

Inability to buy back shares to allow HeadCo shareholders to exit their investment

Proposed transaction

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6.

Income Tax Assessment Act 1936 Section 45B.

Income Tax Assessment Act 1936 Section 109RA.

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

All legislative references are to the Income Tax Assessment Act 1997 (Cth) ('ITAA97') unless otherwise specified.

Overview of the relevant law

Demerger relief provides a rollover for CGT purposes so that a parent company can spin out a subsidiary to its owners without triggering a taxing point.

Where demerger relief under Division 125 applies, the original owner is entitled to disregard a capital gain arising from their disposal of their original interest in the head entity (Question 1). The original owner's cost base for the new interest they receive in the demerged entity is the same as their cost base for the original interests (Question 2).

If a demerger involves the payment of a dividend, it is not assessable and not exempt income (Question 3).

However, there is an integrity provision to address the specific risk that a 'demerger' may be manufactured in order to obtain an exemption for the payment of a dividend; this integrity provision is found in section 45B of the Income Tax Assessment Act 1936 (Cth) (Question 4).

Furthermore, section 109RA of the Income Tax Assessment Act 1936 (Cth) provides that a demerger dividend is not picked up under Division 7A (which would undo part of the intended benefit of demerger relief), unless section 45B applies, in which case demerger relief is not intended to apply (Question 5). Question 5 is straightforward: if the answer to question 4 is no, then the answer to question 5 is yes, and vice versa.

Is the transaction a demerger for the purposes of Division 125?

Yes, the transaction is a demerger. It meets the requirements set out in subsections 125-70(1) and (2) as follows:

What CGT events occur, and what is the effect of demerger relief on them?

In short, the effect of demerger relief is that any capital gains or losses arising from the proposed demerger are disregarded.

Under the proposed transaction, HeadCo shareholders such as Shareholder will each receive shares in SubCo in satisfaction of a return of paid-up share capital declared by HeadCo. This will constitute a payment by HeadCo to those respective shareholders in respect of their shares in HeadCo, which is CGT event G1. This payment will not be a dividend and therefore not otherwise included in the shareholders' assessable income. A taxpayer makes a capital gain from CGT event G1 if the non-assessable component of the payment is more than the share's cost base.

However, any capital gain or loss which a HeadCo shareholder such as Shareholder makes under the transaction will be disregarded under subsection 125-80(1) if they elect to obtain a roll-over.

CGT event A1 may happen when HeadCo disposes of its shares in SubCo to the HeadCo shareholders. This would result in a capital gain to the extent to which the market value of those shares exceeds their cost base in HeadCo's hands.

However, any capital gain or loss which a demerging entity (such as HeadCo) makes from CGT event A1 happening in relation to its ownership interests in a demerged entity (such as the SubCo shares) is disregarded under section 125-155 if they elect to obtain a rollover.

What is the cost base of the new interests (the SubCo shares) in Shareholder's hands?

Under Division 125, the total of all of the cost bases of the original interests are spread over new interests and remaining original interests based on proportionate market value after a demerger. In this case, since shares in HeadCo were replaced with shares in SubCo, Shareholder's total cost base for the new shares in SubCo will be the same as his total cost base for their shares in HeadCo.

Is any dividend from HeadCo a demerger dividend?

A dividend is ordinarily assessable income under section 44. However, a 'demerger dividend' is not assessable and not exempt income under section 44(4).

The term 'demerger dividend' refers to the part of a 'demerger allocation' that is assessable as a dividend under section 44. A 'demerger allocation' includes, relevantly, the market value of the ownership interests disposed of under a demerger. Therefore, in the context of this ruling, if the distribution of the shares in SubCo by HeadCo to its shareholders was characterised as a dividend, it would be a demerger allocation and therefore a demerger dividend.

In the proposed transaction, no dividend is expected to arise. However, if one did arise, it would be a demerger dividend and therefore non-assessable non-exempt income.

Does section 45B apply?

Section 45B is an integrity provision which applies when a demerger is motivated by the pursuit of the exemption from tax of demerger dividends, rather than any other commercial or business considerations. In particular, section 45B is concerned with:

The point is that the attribution of any property release under a demerger, as between capital and profits, should reflect the extent to which the head entity has retained profits.

Section 45B applies where:

Both 'demerger benefit' and 'capital benefit' include the provision of an ownership interest such as a share, regardless of whether it is paid for. In this case, the provision of the SubCo shares to Shareholder is therefore both a 'demerger benefit' and a 'capital benefit'. (However, it is not a 'capital benefit' because it is a demerger dividend.)

A taxpayer obtains a tax benefit under the proposed transaction, but not from the fact that the provision of the SubCo shares (the demerger benefit/capital benefit) is not an assessable dividend. No retained profits are released. At the start of the scheme, HeadCo has no retained profits; at the end of the scheme, SubCo's retained profits remain intact. When, at some point in the future, SubCo's profits are released, they will still be dividends. The scheme does not give rise to a tax benefit that is relevant for the purposes of section 45B.

Even if such a tax benefit were found, the clear purpose of the demerger is to relieve SubCo from the management problems caused by its ownership structure and, incidentally, to allow the HeadCo shareholders to participate in any share buyback that SubCo may enter into. This purpose has nothing, even incidentally, to do with obtaining the exemption of a dividend from tax.

Accordingly, section 45B does not apply.


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