Edited version of your written advice

Authorisation Number: 1051223185556

Date of advice: 11 May 2017

Ruling

Subject: Demerger

Question 1

Will the demerger of X Co by Y Co satisfy the requirements for demerger relief under Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997) so that any capital gain or loss that Y Co makes on disposal of its shares in X Co will be disregarded pursuant to section 125-155 of the ITAA 1997?

Answer

Yes.

Question 2

Will the in specie distribution of shares in X Co to the Y Co shareholders constitute a demerger dividend, as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 3

If the answer to Question 2 is yes, will the demerger dividend be subject to franking under section 202-45 of the ITAA 1997?

Answer

N/A

Question 4

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of that Act will apply to the whole, or any part of any benefit provided to shareholders and make a further determination under subsection 45C(3) of the ITAA 1936 that a franking debit arises in the franking account of Y Co in relation to the capital component of the demerger distribution?

Answer

No.

Question 5

Will Y Co have any withholding tax obligations under section 12-210 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) in respect of any part of the demerger allocation?

Answer

No.

Relevant facts and circumstances

Background

● Y Co (Y) proposes to carry out a demerger of all of the shares in its wholly owned subsidiary, X Co (X). The demerger will form the central component of a restructuring of the Y group which seeks to create a structural separation of the composite group into two business units, each producing distinct products to different markets.

● Y announced the proposed demerger on a specified date. The demerger is proposed to occur on a specified date.

Y Co

● Y is an Australian resident company.

● Y had:

● $xx of issued share capital

● No accumulated accounting losses

● xx ordinary shares on issues (Y shares)

● A small percentage of Y shares are held by shareholders who reside outside of Australia.

● Y has not paid any dividends to shareholders since the time of its incorporation and will not pay any dividends to shareholders before the time of the demerger.

● Y has not issued any options to acquire shares in itself and will not issue any options to acquire shares in itself prior to the demerger.

X Co

● X is a company incorporated in Australia.

● X is in the business of creating, manufacturing and marketing certain products.

● X's shares are wholly-owned by Y (Y and X, are hereafter, referred to as the Y Group).

● Y held xx ordinary shares in X. The paid up share capital in X for the xx shares held by Y is $xx.

● The market value of Y's xx shares in X is $x million.

● X accounts for approximately 30% of the market value of the Y Group.

● Following the demerger, X will no longer be a subsidiary of Y.

Z Co

● Z Co (Z) is a subsidiary of Y.

● Z is in the business of developing products distinct to those produced by X.

● Following the demerger, Z will remain a subsidiary of Y.

The demerger of X

● Y proposed to demerge X by making a capital reduction to Y Shareholders by way of an in specie distribution to Y Shareholders of one (1) X share for each Y share.

● No Y shares will be cancelled under the demerger. Y Shareholders will continue to hold the same number and proportion of Y shares as they hold prior to the demerger. Y will no longer hold any shares in X after the demerger.

● The shareholders of Y approved the demerger of X (the Demerger) involving an in specie distribution by Y to its shareholders of all the shares in X.

● No asset revaluations have been or will be made as part of the demerger.

● A Director's valuation prior to the demerger valued Y at $x million with $x million attributed to the X business unit and $x million to the Z business unit.

● Since the Director's valuation was made there have been no significant disposals or events that would substantially affect the valuation of X or Z. No significant disposals or events that would substantially affect the valuation of X or Z are planned to occur before the demerger takes place.

The in specie distribution

● The in specie distribution by Y will be conducted as a return of capital with the full amount debited to the share capital account of Y. The total amount of the capital return will be $x million.

● The in specie distribution by Y to its shareholders will be made in proportion to each shareholder's existing ownership interest in Y just prior to the demerger - that is, for each share held in Y, the Y shareholder will receive an X share.

● Following the demerger, Y shareholders will hold all of the shares in X.

● Y's methodology for determining the cost base and reduced cost base of each Y share and corresponding X share is as follows:

● attribute xx% of the total cost bases of Y shares just before the demerger to the Y shares, and

● attribute xx% of the total cost bases of Y shares just before the demerger to the X shares.

Reasons for the demerger

Y's primary reason for undertaking the demerger is to separate the two business units operating within the Y Group. The commercial rationale for the demerger included, to enable each business:

● to access capital that is currently unavailable due to the two business units existing in a composite group structure;

● to have its own management and Board that can focus on the separate companies;

● to pursue its own growth agenda and strategic priorities.

Accounting for the distribution to effect the demerger

● Y will account for the market value of the in specie distribution of X shares transferred to Y Shareholders by debiting the entire demerger distribution amount to Y's share capital account.

Other matters

● Just after the demerger, more than 50% of the market value of CGT assets owned by X will be used directly in the carrying on of X's business.

● No X shares will be bought back under the demerger.

● Y's share capital account is not tainted within the meaning of Division 197.

● Y has not made an election under subsection 44(2) of the ITAA 1936.

● None of the entities within the Y Group is a superannuation fund or trust.

Relevant legislative provisions

Income Tax Assessment Act 1936, Subsection 6(1)

Income Tax Assessment Act 1936, Subsection 44(1)

Income Tax Assessment Act 1936, Subsection 44(3)

Income Tax Assessment Act 1936, Subsection 44(4)

Income Tax Assessment Act 1936, Subsection 44(5)

Income Tax Assessment Act 1936, Section 45B

Income Tax Assessment Act 1936, Subsection 45B(1)

Income Tax Assessment Act 1936, Subsection 45B(2)

Income Tax Assessment Act 1936, Paragraph 45B(2)(a)

Income Tax Assessment Act 1936, Paragraph 45B(2)(b)

Income Tax Assessment Act 1936, Subsection 45B(3)

Income Tax Assessment Act 1936, Paragraph 45B(3)(a)

Income Tax Assessment Act 1936, Paragraph 45B(3)(b)

Income Tax Assessment Act 1936, Subsection 45B(4)

Income Tax Assessment Act 1936, Subsection 45B(5)

Income Tax Assessment Act 1936, Subsection 45B(6)

Income Tax Assessment Act 1936, Subsection 45B(8)

Income Tax Assessment Act 1936, Subsection 45B(9)

Income Tax Assessment Act 1936, Section 45BA

Income Tax Assessment Act 1936, Subsection 45BA(1)

Income Tax Assessment Act 1936, Subsection 45BA(2)

Income Tax Assessment Act 1936, Section 45C

Income Tax Assessment Act 1936, Subsection 45C(3)

Income Tax Assessment Act 1936, Subsection 177A(1)

Income Tax Assessment Act 1997, Section 104-10

Income Tax Assessment Act 1997, Division 125

Income Tax Assessment Act 1997, Subsection 125-60(1)

Income Tax Assessment Act 1997, Paragraph 125-60(1)(a)

Income Tax Assessment Act 1997, Paragraph 125-60(1)(b)

Income Tax Assessment Act 1997, Subsection 125-65(1)

Income Tax Assessment Act 1997, Subsection 125-65(3)

Income Tax Assessment Act 1997, Subsection 125-65(4)

Income Tax Assessment Act 1997, Subsection 125-65(6)

Income Tax Assessment Act 1997, Section 125-70

Income Tax Assessment Act 1997, Subsection 125-70(1)

Income Tax Assessment Act 1997, Paragraph 125-70(1)(a)

Income Tax Assessment Act 1997, Subparagraph 125-70(1)(b)(i)

Income Tax Assessment Act 1997, Subparagraph 125-70(1)(c)(i)

Income Tax Assessment Act 1997, Paragraph 125-70(1)(d)

Income Tax Assessment Act 1997, Subparagraph 125-70(1)(e)(i)

Income Tax Assessment Act 1997, Paragraph 125-70(1)(g)

Income Tax Assessment Act 1997, Paragraph 125-70(1)(h)

Income Tax Assessment Act 1997, Subsection 125-70(2)

Income Tax Assessment Act 1997, Paragraph 125-70(2)(b)

Income Tax Assessment Act 1997, Subsection 125-70(5)

Income Tax Assessment Act 1997, Subsection 125-70(7)

Income Tax Assessment Act 1997, Paragraph 125-70(7)(a)

Income Tax Assessment Act 1997, Section 125-155

Income Tax Assessment Act 1997, Section 202-45

Income Tax Assessment Act 1997, Section 975-300

Income Tax Assessment Act 1997, Subsection 975-300(3)

Income Tax Assessment Act 1997, Subsection 995-1(1)

Tax Administration Act 1953, Section 12-210

Reasons for decision

Question 1

Division 125 of the ITAA 1997 allows members of a demerger group to disregard certain capital gains and capital losses that arise as a result of a demerger. Section 125-155 of the ITAA 1997 automatically disregards capital gains or capital losses that a demerging entity makes from CGT event A1, C2, C3 or K6 happening to its ownership interests in a demerged entity under a demerger if the conditions in Division 125 of the ITAA 1997 are satisfied.

Subsection 125-60(1) of the ITAA 1997 defines ownership interest to include a share in a company. Prior to the demerger, Y will hold 100% of the shares in X. Accordingly; Y has an ownership interest in X.

Y will disregard a capital gain arising from CGT event A1, C2, C3 or K6 happening when it disposes of its ownership interests in X if Y is a demerging entity, and the capital gain is from a CGT event happening to its ownership interests in a demerged entity under a demerger (section 125-155 of the ITAA 1997).

An entity is a 'demerging entity' if it satisfies one of the paragraphs specified in subsection 125-70(7) of the ITAA 1997. In order to determine whether Y satisfies one of the paragraphs specified in subsection 125-70(7) of the ITAA 1997, it is necessary to determine the members of the demerger group, and in particular who will be the head entity of the demerger group.

A demerger group comprises the head entity of the group and one or more demerger subsidiaries (subsection 125-65(1) of the ITAA 1997).

Head entity

Subsection 125-65(3) of the ITAA 1997 provides that a company or trust is the head entity of a demerger group if no other members of the group owns ownership interests in the company or trust. For a company, an ownership interest includes a share in a company (paragraph 125-60(1)(a) of the ITAA 1997). For a trust, an ownership interest includes a unit or other interest in the trust (paragraph 125-60(1)(b) of the ITAA 1997).

Y is the head entity of the demerger group on the basis that:

● no other member of the demerger group owns ownership interests in Y; and

● there is no other company or trust that would be capable of being the head entity of a demerger group of which Y could be a demerger subsidiary.

Demerger subsidiary

Subsection 125-65(6) of the ITAA 1997 states that a company is a 'demerger subsidiary' of another company or trust that is a member of a demerger group if the other company or the trust, either alone or together with other members of the group, owns or has the right to acquire ownership interests in, the company that carry between them:

● the right to receive more than 20% of any distribution of income or capital by the company, or

● the right to exercise, or control the exercise of, more than 20% of the voting power of the company.

X is a demerger subsidiary on the basis that another entity, Y, owns ownership interests that carry the right to:

● receive 100% of any distribution of income or capital of X; and

● exercise 100% of the voting power in X.

Demerger group

The demerger group in this case will comprise Y as the head entity of a demerger group of at least one demerger subsidiary (X).

In accordance with paragraph 125-70(7)(a) of the ITAA 1997, Y will qualify as a demerging entity as it will dispose of 100 percent (i.e. at least 80 percent) of its ownership interests in X, another member of the demerger group, to Y shareholders, who were owners of the original interests in Y.

Demerger

The requirements for a demerger are contained in section 125-70 of the ITAA 1997. A demerger will happen to the Y Group as:

● there will be a restructuring for the purposes of paragraph 125-70(1)(a) of the ITAA 1997, and under the restructuring Y will dispose of 100 percent of its existing shares in X to Y shareholders for the purposes of subparagraph 125-70(1)(b)(i) of the ITAA 1997;

● CGT event G1 will happen to Y shares, and Y shareholders will acquire new shares in X and nothing else for the purposes of subparagraph 125-70(1)(c)(i) of the ITAA 1997;

● under the restructure, X shares will be acquired by Y shareholders on the basis of their ownership of shares in Y for the purposes of paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i) of the ITAA 1997;

● neither Y nor X will be a trust that was a superannuation fund for the purposes of paragraph 125-70(1)(g) of the ITAA 1997;

● each Y shareholder will acquire X shares in the same proportion as they owned Y shares just before the demerger for the purposes of paragraph 125-70(2)(b) of the ITAA 1997; and

● subsections 125-70(4) of the ITAA 1997 (dealing with off-market share buy-backs) and 125-70(5) of the ITAA 1997 (which addresses roll-over available under another provision) will have no application.

Conclusion

Y will dispose of all of its ownership interests in X to Y shareholders, who were owners of the original interests in Y. That is, Y will dispose of ownership interests in another member of a demerger group to the owners of the head entity of the demerger group.

Accordingly, when Y (the demerging entity) disposes of its ownership interests in X (the demerged entity) to the Y shareholders under the demerger arrangement, any capital gain or capital loss that it makes will be disregarded under section 125-155 of the ITAA 1997.

Question 2

Subsection 6(1) of the ITAA 1936 defines a 'dividend' as including any distribution made by a company to any of its shareholders, whether in money or other property and any amount credited by a company to any of its shareholders as shareholders. However, paragraph (d) of the definition of 'dividend' excludes a distribution that is debited against an amount standing to the credit of the share capital account of the company.

The term 'share capital account' is defined in section 975-300 as an account that a company keeps of its share capital, or any other account created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital. Subsection 975-300(3) states that an account is not a share capital account if it is tainted. The share capital account of Y is not tainted within the meaning of Division 197.

The in specie distribution to Y shareholders of X shares will be recorded as a $x million debit to Y's share capital account. No other property will be distributed to Y shareholders as part of the demerger and no other account or reserve will be debited as a result of the distribution of X shares to Y shareholders. This amount will therefore not be a dividend for the purposes of subsection 6(1) of the ITAA 1936 and will not be assessable as a dividend under subsection 44(1) of the ITAA 1936.

Central to the demerger dividend relief provisions are the concepts of 'demerger dividend' and 'demerger allocation'. These terms are defined in subsection 6(1) of the ITAA 1936.

A 'demerger dividend' is defined in subsection 6(1) of the ITAA 1936 as that part of a demerger allocation that is assessable as a dividend under subsection 44(1) of the ITAA 1936, or that would be so assessable but for subsections 44(3) and 44(4) of the ITAA 1936.

Where a restructure is undertaken by way of a disposal of ownership interests, a 'demerger allocation' is the total market value of the allocation represented by the ownership interests disposed of by a member of a demerger group under a demerger to the owners of ownership interests in the head entity (paragraph (b) in subsection 6(1) of the ITAA 1936). The demerger allocation may consist of an otherwise assessable dividend component, a return of capital or a combination of capital and profit.

The in specie distribution to Y shareholders of X shares debited to Y's share capital account represents the entire demerger allocation. Therefore, because there is no difference between the demerger allocation and the amount debited against the share capital account, there is no demerger dividend. Accordingly, Y's shareholders will not receive a demerger dividend as part of the demerger. The $x million debited against the share capital account will therefore not be a demerger dividend for the purposes of subsection 6(1) of the ITAA 1936.

Question 3

As the dividend is not a demerger dividend as defined in subsection 6(1) of the ITAA 1936, section 202-45 of the ITAA 1997, which provides that a demerger dividend is unfrankable, will have no application.

Question 4

Subsection 45B(1) of the ITAA 1936 provides that the purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts are treated as dividends for taxation purposes if:

(a) components of a demerger allocation as between capital and profit do not reflect the circumstances of a demerger; or

(b) certain payments, allocations and distributions are made in substitution for dividends.

Subsection 45B(2) of the ITAA 1936 sets out the conditions under which section 45B of the ITAA 1936 will apply to a demerger. Relevantly, the subsection provides that:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company; and

(b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and

(c) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer (the relevant taxpayer) to obtain a tax benefit.

The Commissioner is empowered under subsection 45B(3) of the ITAA 1936, when the requirements of subsection 45B(2) of the ITAA 1936 are met, to make a determination that sections 45BA or 45C of the ITAA 1936 apply, respectively, in relation to a demerger benefit (see paragraph 45B(3)(a) of the ITAA 1936) or capital benefit (paragraph 45B(3)(b) of the ITAA 1936).

The effect of section 45BA of the ITAA 1936 applying to a demerger benefit is that the amount of the demerger benefit, or part of the benefit, is taken not to be a demerger dividend.

The effect of section 45C of the ITAA 1936 applying to a capital benefit is that the amount of the capital benefit, or part of the benefit, is taken to be an unfranked dividend.

It can be seen that section 45B of the ITAA 1936 turns on a test of whether there is a more than incidental purpose (rather than 'dominant' purpose) on the part of anyone who entered into or carried out the scheme, of enabling the relevant taxpayer to obtain a tax benefit.

Under the scheme, the Y shareholders will obtain a tax benefit because the demerger benefit fully comprises a capital benefit which would be subject to less tax than if it had been an assessable dividend, due to the operation of the CGT roll-over concession in Division 125 of the ITAA 1997.

Paragraph 45B(2)(a) of the ITAA 1936 will be satisfied as there is a scheme under which a person is to be provided with a demerger benefit or a capital benefit by a company (Y). Paragraph 45B(2)(b) of the ITAA 1936 is also satisfied as Y's shareholders will obtain a tax benefit within the meaning of subsection 45B(9) of the ITAA 1936.

Paragraph 45B(2)(c) of the ITAA 1936 sets out an objective purpose test for the Commissioner to consider having regard to the 'relevant circumstances' of the scheme as set out in subsection 45B(8) of the ITAA 1936.

Having regard to the relevant circumstances of the scheme as set out in subsection 45B(8), it cannot be concluded that the scheme is to be entered into or carried out for a more than incidental purpose of enabling Y shareholders to obtain a tax benefit.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA of the ITAA 1936 applies in relation to the demerger benefit or that section 45C of the ITAA 1936 applies to the capital benefit under the scheme to which this ruling relates.

Question 5

Section 12-210 of Schedule 1 to the TAA 1953 states:

A Company that is an Australian resident must withhold an amount from a *dividend it pays if:

(a) according to the register of the company's members, the entity, or any of the entities, holding the *shares on which the dividend is paid has an address outside of Australia; or

(b) that entity, or any of those entities, has authorised or directed the company to pay the dividend to an entity or entities at a place outside Australia.

As explained in the answer to Question 2 above, the in specie distribution to Y shareholders of X shares, being debited against an amount standing to the credit of the share capital account, is not a 'dividend' as defined in subsection 6(1) of the ITAA 1936. Therefore, it will not be included in the assessable income of Y shareholders under subsection 44(1) of the ITAA 1936 and Y will not have any withholding tax obligations under section 12-210 of Schedule 1 to the TAA 1953 in respect of any part of the demerger allocation.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).