Edited version of private advice

Authorisation Number: 1051706811586

Date of advice: 1 July 2020

Ruling

Subject: Proposed demerger

Question 1

Will the Commissioner confirm that the Company A shareholders are entitled to choose demerger roll-over under section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the Commissioner confirm that any capital gain or capital loss that arises to Company A under CGT event A1 from the disposal of its shares in Company B under the proposed demerger is disregarded under section 125-155 of the ITAA 1997?

Answer

Yes

Question 3

Will the Commissioner confirm that all, or any part, of the distribution of Company B shares to Company A shareholders that is a dividend will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) to 44(5) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 4

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of the ITAA 1936 applies to the whole, or any part, of the demerger benefit or capital benefit provided to the Company A shareholders under the proposed demerger?

Answer

No

This ruling applies for the following period(s)

The year ending 30 June 20xx

The scheme commences on

1 July 20xx

Relevant facts and circumstances

Company A

Company A is the head entity of the tax consolidated group. Members of the tax consolidated group include Company B and Company C.

Company A owns 100% of the shares in Company B and Company C.

Company A has two classes of shares on issue, including 'B' class and 'C' class shares.

Shareholders of Company A

All shareholders are Australian residents for tax purposes and have continually held their shares on capital account.

The majority of shares in Company A are post CGT assets.

None of the shareholders currently have, or had, plans to dispose any of their shares in either Company A or Company B.

Following the demerger, both companies would continue to pay annual dividends.

The proposed demerger

Company A will declare a capital reduction and dividend of to the shareholders in equal proportions to their shareholding in Company A.

Company A will demerge Company B by making an in-specie distribution of 100% of its shares in Company B to the shareholders

Reasons for the Proposed demerger

A number of commercial reasons were provided as the reason for undertaking a demerger.

Other matters

Company A will not make an election under subsection 44(2) of the ITAA 1936.

There is no intention or proposal for the sale of the shares in Company A or Company B by the Company A shareholders following the demerger.

The share capital account of Company A is not tainted within the meaning of Division 197 of the ITAA 1997.

Reasons for decision

Question 1

Will the Commissioner confirm that the Company A shareholders are entitled to choose demerger roll-over under section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

Yes, the shareholders of Company A will be entitled to choose demerger roll-over under section 125-55 of the ITAA 1997.

Detailed reasoning

Division 125 of the ITAA 1997 provides an entity CGT relief for a demerger.

Subsection 125-55(1) of the ITAA 1997 states that an entity can choose to obtain a roll-over if:

(a)  you own an ownership interest in the company (your original interest); and

(b)  the company or trust is the head entity of a demerger group; and

(c)   a demerger happens to the demerger group; and

(d)  under the demerger, a CGT event happens to your original interest and you acquire a new or replacement interest (your new interest) in the demerged entity

(a) You own an ownership interest in a company

Each of the applicants owns shares in Company A. Company A is the company referred to in paragraph 125-55(1)(a) of the ITAA 1997.

The Company A shares owned by the applicants include 'C' class shares and 'B' class shares.

The only ownership interests in Company A are the Company A shares that are owned by the applicants. Each of these shares in Company A is an ownership interest in a company (an 'original interest') pursuant to section 125-60 of the ITAA 1997.

(b) The company is the head entity of a demerger group

Subsection 125-65(1) of the ITAA 1997 provides that a demerger group consists of the head entity of the group and at least one demerger subsidiary.

Company A is the head entity of a demerger group. The demerger group consists of Company B and its subsidiaries.

(c) a demerger happens to the demerger group

The meaning of demerger is set out in section 125-70. Subsection 125-70(1) states that a demerger happens to a demerger group if:

(a)  there is a restructuring of the demerger group; and

(b)  under the restructuring:

(i)    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;... and

(c)   under the restructuring:

(i)    a CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires a new interest and nothing else; ...and

(d)  the acquisition by entities of new interests happens only because those entities own or owned original interests; and

(e)  the new interests acquired are:

(i)    if the head entity is a company - ownership interests in a company:... and

(f)    [repealed]

(g)  neither the original interests nor the new interests are in a trust that is a non-complying superannuation fund, and

(h)  the requirements of subsection (2) are met.

Restructuring of the demerger group

The demerger steps which involve the Company A shareholders acquiring interests in Company B amount to a restructuring of the Company A, which is the demerger group for the purposes of section 125-70(1)(a) of the ITAA 1997

Disposal of interests to owners

Under subparagraph 125-70(1)(b)(i) of the ITAA 1997, a restructure can be achieved by members of the demerger group disposing 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.

Company A will transfer 100% of the shares that it owns in Company B to the Company A shareholders on implementation of the demerger, therefore the requirements in subparagraph 125-70(1)(b)(i) are satisfied.

Acquisition of new interests and nothing else

Paragraph 125-70(1)(c) of the ITAA 1997 requires that under the restructuring, a CGT event happens to an entity's original interest in Company A, the shareholder acquires a new interest and nothing else.

Company A shareholders will acquire new ownership interests in the demerged entity, Company B, and will not receive anything else.

Acquisition of new interests

CGT event A1 will happen upon the disposal of the shares in Company B. Company B shares will be acquired by Company A shareholders on the basis of their ownership of shares in Company A.

The requirement in paragraph 125-70(1)(d) of the ITAA 1997 is satisfied.

Type of new interests acquired

The interests which will be provided to the shareholders will be shares in Company B which are ownership interests in a company.

These shares will include 'C' class shares and 'B' class shares.

The requirement in paragraph 125-70(1)(e) of the ITAA 1997, that the new interest is an ownership interest in a company where the head entity is a company, is satisfied.

Non-complying superannuation fund

Company A and Company B are companies and the ownership interests in the companies are ordinary shares. The original and new interests are not interests in a trust that is a non-complying superannuation fund.

Meeting the requirements of subsection 125-70(2)

Subsection 125-70(2) of the ITAA 1997 (the continuity of proportionate interests test) provides:

Each owner (an original owner) of original interests in the head entity of the demerger group must:

(a)  acquire under the demerger, the same proportion, or as nearly as practicable the same proportion, of new interests in the demerged entity as the original owner owned in the head entity just before the demerger; and

(b)  just after the demerger, have the same proportionate total market value of ownership interests in the head entity and demerged entity as the original owner owned in the head entity just before the demerger.

The ownership interests in both Company A and Company B consist of the same number of class 'C' shares, and 'B' class shares.

The requirements of subsection 125-70(2) will be satisfied given that the disposal of the shares in Company B to the existing Company A shareholders will be distributed based on each owner's proportionate shareholding in Company A.

Each original Company A ordinary shareholder will have the same proportionate interest in the combined total market value of Company A and Company B (the demerged entity) as they had in Company A before the demerger.

(d) CGT event happens to original interest and new interest acquired in the demerged entity

CGT event G1 will happen in relation to the shares held by the shareholders in Company A to the extent that Company A makes a return of capital to its shareholders. Under the demerger steps, the Company A shareholders will acquire shares in Company B (the demerged entity).

The requirements of subsection 125-55(1) of the ITAA 1997will be satisfied for each of the shareholders because:

·         each shareholder owns an ownership interest, Company A - the original interest;

·         Company A is the head entity of a demerger group;

·         A demerger will happen to the demerger group; and

·         Under the demerger, a CGT event (CGT event G1) will happen to each shareholder's original interest and the shareholders will acquire shares in the demerged entity, Company B.

Therefore, the shareholders will be entitled to choose demerger roll-over under section 125-55 of the ITAA 1997.

Question 2

Will the Commissioner confirm that any capital gain or capital loss that arises to Company A under CGT event A1 from the disposal of its shares in Company B under the proposed demerger is disregarded under section 125-155 of the ITAA 1997?

Summary

Company A 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 B upon the demerger of Company B by Company A.

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 A is the demerging entity,

·         CGT event A1 will happen when Company A disposes of its shares in Company B and transfers them to the Company A 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 A on the disposal of its Company B shares under the demerger will be disregarded (section 125-155 of the ITAA 1997).

Question 3

Will the Commissioner confirm that all, or any part, of the distribution of Company B shares to Company A shareholders that is a dividend will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) to 44(5) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Summary

All or any part of the distribution of Company B shares to Company A 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 ITAA 1936.

Detailed reasoning

Is a dividend paid under the demerger?

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).

Therefore, the capital reduction amount will not be assessable income of the shareholders of Company A 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 distribution of the Company B shares will, in part, constitute a dividend of the Company A shareholders.

In general, a dividend satisfied by a 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, as the above requirements are satisfied, the dividend paid to the Company A shareholders under the demerger would satisfy the conditions necessary to be a demerger dividend and would therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Question 4

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of the ITAA 1936 applies to the whole, or any part, of the demerger benefit or capital benefit provided to the Company A shareholders under the proposed demerger?

Summary

The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C will apply to the whole, or any part, of any benefit provided to the Company A shareholders under the proposed arrangement.

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 transfer of shares in Company B to the Company A shareholders under the demerger constitute the relevant scheme for the purposes of section 45B of the ITAA 1936.

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 B shares provided to the Company A shareholders constitutes a demerger benefit.

The provision of those Company B 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 B shares distributed under the demerger less the demerger dividend is a capital benefit provided to the Company A shareholders.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides 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 A 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 B 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 A shareholders on the demerger would be higher if the demerger benefit was an assessable dividend. Accordingly, Company A 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 A shareholders, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c). 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.

Relevant circumstances

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) by virtue of paragraph (k).

In this case, the nature of the scheme indicates that the more pertinent circumstances are those covered by paragraphs (a), (b), (i), (j) and (k) of subsection 45B(8) of the ITAA 1936.

Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or an associate (within the meaning of section 318 of the ITAA 1936) of the company.

In the present case, the proposed demerger will result in a return of capital of and a demerger dividend which are considered to be correctly attributable to share capital and profits in accordance with PSLA 2005/21. This factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions made by a company or an associate of the company.

As the company has an established and continuous pattern of paying dividends to shareholders. The demerger dividend is therefore not viewed as being in substitution for dividend distributions.

This factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(i) of the ITAA 1936 directs attention to those cases where the scheme of demerger involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests; recognising that the proceeds on disposal of such ownership interests provide the equivalent of a cash dividend in a more tax-effective form.

The demerger is not a preparatory step for any potential future disposal of Company A or Company B. Further, the demerger scheme does not involve a subsequent disposal of the Company A or Company B shares.

In this case there is no proposal for the sale of shares in Company A or Company B by the Company A shareholders following the demerger. Shareholders have expressed that they highly value the very strong performance that the Company B business have historically had and the corresponding dividends.

Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(j) of the ITAA 1936 applies to circumstances where the profits and assets of the demerging entity are attributable to or acquired under transactions with associated entities. This relevant circumstance aims to expose instances where demerger relief is being used as a vehicle for distributing corporate earnings by way of non-assessable dividend. In this case, the profits and assets of Company A and Company B are not referable to those of an associate.

Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Part IVA factors

Paragraph 45B(8)(k) requires regard to be had to any of the matters referred to in paragraphs 177D(2)(a) to (h) of the ITAA 1936.

The incorporation of the Part IVA factors into section 45B of the ITAA 1936 does not introduce a different (dominant) purpose test into section 45B. The matters are applied in the context of the 'more than incidental purpose test' in section 45B.

The eight matters in subsection 177D(2) of the ITAA 1936 constitute the essential facts and circumstances of a scheme, including the outcomes for the parties to the scheme, by reference to which the tax and non-tax objects of the scheme can be identified and contrasted from an objective point of view.

If, on the one hand, reference to the matters in subsection 177D(2) of the ITAA 1936 reveal that the essential object of a demerger is to produce changes and improvements to the business structures of the corporate group, the tax free aspect of the transfer of ownership interests to the head entity's owners is more likely to be an incidental object of the demerger.

If on the other hand reference to those matters reveals that the transfer of ownership interests from the corporate group to the head entity's shareholders is an essential object of the scheme, the tax-free aspect of the transfer would ordinarily be a substantial object of the demerger.

Paragraph 177D(2)(a)

Paragraph 177D(2)(a) of the ITAA 1936 requires an inquiry into the manner in which the scheme was entered into or carried out.

Given the commercial reasons for the demerger outlined in the application, it is considered that the essential object of the proposed demerger is to achieve the separation of each business in order for both Company A and Company B to become viable, stand-alone entities.

This is supported by the documentation provided for the business strategy and business plan.

Therefore, the tax benefit that Company A shareholders would receive is an incidental object of the demerger. As a result, it is considered that the 'manner' of the scheme will be carried out has commercial business reasons behind it, namely the separation of the Company A (and its subsidiary Company C) business and the Company B business and does not point toward there being a more than incidental purpose of obtaining the tax benefit.

Paragraph 177D(2)(b)

Paragraph 177D(2)(b) of the ITAA 1936 refers to the form and substance of the scheme. The form of a scheme is the way it presents and the substance of a scheme is a reference to its essential nature which normally would be determined from the effects of the scheme on the commercial and economic circumstances of the parties involved in the scheme.

The applicant has advised that the substance of the scheme will be consistent with its form as the practical effect of the scheme is the same as its form. Further, the commercial effects of the scheme post demerger on Company A and Company B are significant and that the demerger will leave each business unit to focus on their core business, including implementing independent governance structures which will enhance growth, that will not be possible if the two business units continue to operate as one company. Based on a review of the benefits outlined in the ruling application that both businesses expect to achieve, it is considered that this factor does not point toward there being a more than incidental purpose of obtaining the tax benefit.

It is considered that none of the matters in paragraphs (c), to (h) incline towards a requisite purpose.

Conclusion

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 on balance the proposed demerger is not being undertaken for the more than incidental purpose of obtaining a tax benefit.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C will apply to the whole, or any part, of any benefit provided to the Company A shareholders under the proposed arrangement.

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