Edited version of your written advice

Authorisation Number: 1051314550138

Date of advice: 29 November 2017

Ruling

Subject: Proposed demerger

Question

Will the proposed arrangement satisfy the requirements for demerger relief under Division 125 such that any capital gain or loss that Head Co makes on disposal of the existing units in New Trust to each unitholder of Unit Trust will be disregarded pursuant to section 125-155 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

1 July 2017 to 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

Overview of the Group

The corporate group consists of Australian resident and non-resident entities. The ultimate holding entity of the Group is the Unit Trust.

The units in Unit Trust are held equally by corporate trustees for multiple discretionary trusts. The units in the Unit Trust were acquired prior to 20 September 1985.

Unit Trust is a fixed trust and CGT Event E4 is capable of applying in respect of all of the units in the trust.

Unit Trust is not a complying superannuation entity for the purposes of subsection 125-65(2A) of the ITAA 1997.

Tax consolidated group

The tax consolidated group consists of an Australian group and an overseas group. The head company of the tax consolidated group (‘Head Co’) is wholly owned by the corporate trustee of the ultimate holding entity Unit Trust and is the head company of the tax consolidated group.

Holding Co is a subsidiary of the head company of the tax consolidated group and is the holding company of the overseas group. There is a distributable surplus in the accounts of Holding Co.

Holding Co owns all of the existing units in New Trust (a unit trust). New Trust has numerous subsidiaries which hold investments overseas (‘overseas subsidiaries’). The balance sheets of those subsidiaries in the relevant income year show that the investments make up the majority of the net assets.

New Trust is a fixed trust and CGT Event E4 is capable of applying in respect of all of the units in the trust.

New Trust is not a complying superannuation entity for the purposes of subsection 125-65(2A) of the ITAA 1997.

The proposed demerger

Under the proposed demerger:

● Holding Co will transfer all of its units in New Trust to the discretionary trusts for nil consideration.

● Following the transfer, the units in New Trust held by each trustee of each of the discretionary trusts will correspond to the same proportion of units held in Unit Trust.

● The discretionary trust will not resolve to distribute the New Trust units to their beneficiaries and no beneficiary will otherwise be presently entitled to any units in New Trust.

● The demerger of New Trust will be reflected in the stand-alone accounts of Holding Co through the following book entries:

● debit to accumulated gains/losses

● credit to investment in overseas subsidiaries

● The demerger of New Trust will be reflected in the consolidated accounts of Head Co through the following book entries:

● debit to retained earnings; and

● credit to underlying assets held by overseas subsidiaries

● The arm’s length value of the units in New Trust to be transferred to the discretionary trusts under the demerger, calculated in accordance with subsection 109C(4) of the ITAA 1936, will not exceed the distributable surplus of Holding Co at the time of the transfer.

● Unit Trust, as head entity of the demerger group, will not, under subsection 44(2) of the ITAA 1936, elect in writing, within one month after it directs that its unit holders (the discretionary trusts) will receive ownership interests in New Trust under the demerger, that subsections 44(3) and (4) do not apply to the total demerger dividend.

Reasons for demerger

A number of commercial reasons have been provided for the demerger.

Relevant legislative provisions

Income Tax Assessment Act 1936 (ITAA 1936)

Section 44

Section 109C

Income Tax Assessment Act 1997 (ITAA 1997)

Section 104-10

Section 125-55

Section 125-60

Section 125-65

Section 125-70

Section 125-155

Section 701-1

Reasons for decision

Summary

The proposed arrangement will satisfy the requirements for demerger relief under Division 125. Any capital gain or loss that Head Co makes on the disposal of the existing units in New Trust to each unitholder of Unit Trust will be disregarded pursuant to section 125-155 of the ITAA 1997

Detailed reasoning

Division 125 of the ITAA 1997

The object of Division 125 is to facilitate the demerging of entities by ensuring that capital gains tax considerations are not an impediment to restructuring a business: section 125-5 of the ITAA 1997.

Section 125-155 of the ITAA 1997 provides that any capital gain or capital loss a demerging entity makes from CGT event A1 happening to its ownership interests in a demerged entity under a demerger is disregarded.

The meaning of the terms ‘ownership interest’, ‘demerger’, ‘demerging entity’ and ‘demerged entity’ are considered below.

‘Ownership interest’

The meaning of ‘ownership interest’ is defined in subsection 125-60(1) of the ITAA 1997 as follows:

(a) for a company, a share in the company or an option, right or similar interest issued by the company that gives the owner an entitlement to acquire a share in the company; and

(b) for a trust, a unit or other interest in the trust or an option, right or similar interest issued by the trustee that gives the owner an entitlement to acquire a unit or other interest in the trust.

The units in New Trust will be ownership interests within the meaning of subsection 125-60(1).

‘Demerger’

A demerger happens to a demerger group. The meaning of ‘demerger group’ is given by section 125-65. Subsection 125-65(1) provides that a demerger group comprises the head entity of the group and one or more demerger subsidiaries. A company or trust is eligible to be a head entity within the meaning of subsection 125-65(3) if no other member of the group owns ownership interests in the company or trust.

In the present case, Unit Trust will be the head entity of the demerger group as no other member of the group owns ownership interests in the trust. The demerger group will also consist of the following entities:

● Unit Trust and New Trust are eligible to be members of the demerger group as they are fixed trusts and CGT event E4 is capable of applying to all of the units in the respective trusts for the purposes of subsection 125-65(2), and neither Unit Trust nor New Trust are complying superannuation entities for the purposes of subsection 125-65(2A);

● Head Co and Holding Co will be the demerger subsidiaries of Unit Trust as these entities are wholly owned by Unit Trust, thus satisfying the requirement in subsection 125-65(6) with regard to ownership interests that carry the right to receive more than 20% of any distribution of income or capital by the company or the right to exercise more than 20% of the voting power of the company; and

● New Trust will be a demerger subsidiary of Unit Trust as all of the units in New Trust are held by Holding Co, thus satisfying the requirement in subsection 125-65(7) with regard to ownership interests that carry the right to receive more than 20% of any distribution of income or capital by the trustee.

The conditions for a ‘demerger’ are set out in section 125-70 and will be met for the following reasons in the present case:

● there is a restructuring of the demerger group under which there will be a change of ownership of New Trust from Holding Co to the discretionary trusts: paragraph 125-70(1)(a);

● Holding Co will dispose of at least 80% of its total ownership interests in New Trust to the owners of Unit Trust. This will be effected by transferring for nil consideration the existing units held by Holding Co in New Trust to each of the discretionary trusts in the proportions that they hold their interests in Unit Trust: subparagraph 125-70(1)(b)(i);

● under the restructuring, CGT event H2 happens in relation to the original interests owned by the discretionary trusts in Unit Trust, however, these entities acquire new interests in New Trust and nothing else: subparagraph 125-70(1)(c)(i).

● the acquisition by the discretionary trusts of the units in New Trust will only happen because those entities own original interests in Unit Trust: paragraph 125-70(1)(d);

● the units acquired by the discretionary trusts in New Trust are the same type of ownership interests as those in the head entity, Unit Trust: subparagraph 125-70(1)(e)(ii);

● neither Unit Trust nor New Trust are non-complying superannuation funds: paragraph 125-70(1)(g);

● each of the discretionary trusts will acquire, under the demerger, the same proportion of interests in New Trust as those owned in Unit Trust just before the demerger: paragraph 125-70(2)(a);

● just after the demerger, the discretionary trusts will have the same proportionate total market value of ownership interests in New Trust and in Unit Trust as they owned in Unit Trust before the demerger: paragraph 125-70(2)(b);

● the demerger does not constitute a buy-back of shares that is an off-market purchase for the purposes of Division 16K of Part III of the ITAA 1936: subsection 125-70(4); and

● no other roll-over will be available outside of Division 125 of the ITAA 1997 for CGT event H2 that will happen to the original interests in Unit Trust: subsection 125-70(5).

‘Demerging entity’

Subsection 125-70(7) of the ITAA 1997 defines ‘demerging entity’ as follows:

(7) An entity that is a member of a demerger group just before the CGT event referred to in section 125-155 happens is a demerging entity if, under a demerger that happens to the group:

(a) the entity (either alone or together with other members of the demerger group) dispose of at least 80% of their total ownership interests in another member of the demerger group to owners of original interests in the head entity of the demerger group

. . .

Head Co will be the demerging entity by virtue of the operation of the single entity rule (‘SER’) in section 701-1 of the ITAA 1997.

The Commissioner's view on the consequences of the SER are expressed in paragraphs 7, 8 and 9 of Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997 (‘TR 2004/11’).

Relevantly, paragraph 8 of TR 2004/11 provides that:

(a) the actions and transactions of a subsidiary member are treated as having been undertaken by the head company;

(b) the assets a subsidiary member of the group owns are taken to be owned by the head company (with the exception of intra-group assets) while the subsidiary remains a member of the consolidated group;

Furthermore, in Taxation Determination TD 2004/49 Income tax: consolidation: capital gains: does the single entity rule in section 701-1 of the Income Tax Assessment Act 1997 apply in determining whether the consequences in Subdivision 125-C of the Income Tax Assessment Act 1997 apply to the head company of a consolidated group where one or more subsidiary members hold ownership interests in an entity outside the group that is being demerged? the Commissioner confirms at paragraph 6 that:

The operation of the single entity rule would extend to the definitions of demerger group, demerger and demerging entity in Subdivision 125-B of the ITAA 1997, but only for the purposes of establishing the head company's compliance with the demerger relief provisions in Subdivision 125-C of the ITAA 1997. [emphasis added]

In this regard, the SER will deem Head Co to be the entity disposing of the units in New Trust for the purposes of section 104-10 of the ITAA 1997, and thus, it is the demerging entity.

‘Demerged entity’

Subsection 125-70(6) defines ‘demerged entity’ as:

An entity that is a former member of a demerger group is a demerged entity if, under a demerger that happens to the group, ownership interests in the entity are acquired by:

(a) shareholders in the head entity of the group; or

(b) unitholders or holders of interests in the head entity of the group.

New Trust is the demerged entity for the purposes of subsection 125-70(6) as the Discretionary trusts acquire interests in New Trust under the demerger: paragraph 125-70(6)(b).

Capital gain or loss from CGT event A1 disregarded

CGT event A1 happens to Head Co as the head company of the Australian tax consolidated group in accordance with the SER contained in section 701-1

Under section 125-155 of the ITAA 1997, any capital gain or loss that Head Co (the demerging entity) makes from CGT event A1 happening at the time of the disposal of the existing units in New Trust (its ownership interests) to the unitholders of Unit Trust in proportion to their holdings, will be disregarded because the event happens to its ownership interests in a demerged entity (New Trust) under a demerger.

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).