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Edited version of private advice

Authorisation Number: 1051717534470

Date of advice: 13 July 2020

Ruling

Subject: Demerger

Question 1

Will the Taxpayer be entitled to choose demerger rollover relief pursuant to section 125-55 of the ITAA 1997 as a result of the demerger?

Answer

Yes

Question 2

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

Answer

No

Question 3

Does the in specie distribution of shares in Y give rise to assessable income under subsection 44(1) of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2021

The scheme commences on:

Year ended 30 June 2020

Relevant facts and circumstances

X Pty Ltd (X) is a holding company for the group of companies outlined below.

There are 3 shareholders in X (collectively, the Shareholders). The Taxpayer is one of the Shareholders.

Group structure and subsidiaries

X has several subsidiary companies, some of which were incorporated in Australia (collectively, the Australian companies), while others were incorporated overseas (collectively, the Overseas companies).

One of the Australian companies is Y.

Proposed restructure

X has provided the Commissioner with information and documentation supporting the commercial reasons for the restructure.

The proposal involves the implementation of a two-step transaction:

As a result, Y will be the holding company of the Overseas Companies.

As a result, X and Y will each be the ultimate holding entity of the Australian Companies and the Overseas Companies, respectively.

In accounting for the demerger, X will register the distribution in its books of account as follows:

˗        The demerger dividend will be debited against X's revaluation reserve account, reducing it to zero. This revaluation reserve account takes into consideration the revaluation of the assets of the Overseas companies to market value.

˗        The remaining portion of the amount of the demerger dividend will be debited against X's retained earnings account.

The proposal is sought to be entered into at the earliest practical opportunity.

In respect of the demerger:

Other facts

Pattern of distributions

No dividends were paid by X in the previous 10 years.

Capital losses

None of the Shareholders have any capital losses to be applied against any capital gains.

Pre-CGT assets

All the entities within the group were incorporated post 20 September 1985, and there are therefore no pre-CGT assets in question.

Residency of Shareholders

The Shareholders are Australian tax residents.

Nature of interest after demerger

As the Y shares will be held in the same type and proportions by the shareholders as that which they hold in X, the nature and proportion of the interests held by each Shareholder in X remains the same after the demerger.

Later disposal of shares

There is no proposal to dispose of Y by the Shareholders after the demerger. There is also no intention on the part of the Shareholders to in any way deal with their interests in Y following the demerger.

Tainting of share capital account

There is no arrangement to which subsection 6(4) of the ITAA 1936 applies.

CGT assets owned by Y

Just after the proposed demerger, 50 % or more of the CGT assets owned by Y and the Overseas Companies will be used in one or more businesses carried on by these entities.

Question 1

Summary

The Taxpayer will be entitled to choose demerger rollover relief pursuant to section 125-55 of the ITAA 1997 as a result of the demerger

Reasons for decision

Subsection 125-55(1) of the ITAA 1997 provides as follows:

You can choose to obtain a roll-over if:

(a) you own an ownership interest in a company or trust (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.

The requirements in each of the above paragraphs are examined in turn below:

Paragraph 125-55(1)(a) and paragraph 125-55(1)(b)

These paragraphs will be satisfied in this case for the following reasons:

·        TheTaxpayer owns shares in X.

·        X is the head entity of a demerger group that includes demerger subsidiaries.

A 'demerger group' is defined in subsection 125-65(1) as comprising the head entity of the group and one or more demerger subsidiaries. X is the head company of the group because no other member of the group owns ownership interests in it: subsection 125-65(3).

The 'demerger subsidiaries' satisfy the ownership conditions in subsection 125-65(6) and subsection 125-65(7).

It is noted in this respect that:

·        Neither subsection 125-65(2) nor subsection 125-65(2A) apply in this case.

·        Subsection 125-65(4) does not apply as none of the demerger subsidiaries are also demerger subsidiaries of another company or trust in another demerger group.

·        Subsection 125-65(5) does not apply as no member of the group has ownership interests in a listed public company or listed widely-held trust that chooses that the member not be a member of the demerger group.

Paragraph 125-55(1)(c)

This paragraph will be satisfied as a 'demerger' under section 125-70 is proposed to happen to the demerger group.

Specifically, the conditions for a 'demerger' specified in section 125-70 will be met for the following reasons:

CGT event G1 applies in this case for the following reasons:

˗        Paragraph 104-135(1)(a) is satisfied.

X will make a payment to the Taxpayer in respect of the shares the Taxpayer owns in X: paragraph 104-135(1)(a). This payment is comprised of the Taxpayer's portion of the in specie distribution of 100% of X's shares in Y. Under section 104-135, the payment can include giving property.

CGT event A1 does not apply in the manner contemplated under paragraph 104-135(1)(a) since there is no disposal of any share owned by the Taxpayer in X.

CGT event C2 does not apply in the manner contemplated under paragraph 104-135(1)(a) since the proposal does not involve an end to the Taxpayer's ownership of its shares in X under any of the circumstances prescribed under subsection 104-25(1).

˗        Paragraph 104-135(1)(b) is satisfied.

There is at least some part of the payment that is not a dividend. 'Dividend' in this regard is defined in subsection 6(1) of the ITAA 1936 to include distributions made by a company to any of its shareholders; but excludes 'property distributed by a company to shareholders.... where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company'. It is proposed that the value of the Y shares distributed will be partly debited against X's share capital account.

The portion of the distribution debited against the share capital account is not a 'dividend' and consequently paragraph 104-135(1)(b) will be satisfied.

It is also noted that there is no evidence on the facts provided in this case to suggest the existence of an arrangement under subsection 6(4) which provides an exception to the abovementioned rule.

˗        Paragraph 104-135(1)(c) is satisfied.

The payment will not be included in the Taxpayer's assessable income. Part of the payment that is debited to the share capital account is a return of capital; the remaining part will be a 'demerger dividend' under subsection 6(1), being part of the demerger allocation 'that is assessable as a dividend under subsection 44(1) or that would be so assessable apart from subsections 44(3) and (4)'. A demerger dividend is not assessable income or exempt income: subsection 44(4) of the ITAA 1936.

˗        each Shareholder in X will acquire the same proportion of shares in Y as it had in X just before the proposed demerger; and

˗        just after the demerger, each Shareholder will have the same proportionate total market value of shareholdings in both X and Y as it had in X just before the demerger.

The Y shares to be transferred will be of the same class and proportion as the shares each Shareholder currently holds in X. The proportionate market value of each of the Shareholders' shares in both X and Y just after the demerger will be the same as that of each of their original interests in X just before the demerger.

Paragraph 125-55(1)(d)

As mentioned above, under the terms of the proposed demerger CGT event G1 will happen to the Taxpayer's interest in X. The Taxpayer will obtain a new interest (shares) in Y.

Accordingly, paragraph 125-55(1)(d) will be satisfied.

Exceptions in subsection 125-55(2)

As the Taxpayer is not a foreign resident, the exception in subsection 125-55(2) does not apply to it.

As the conditions in section 125-55 will be satisfied under the terms of the proposed demerger, the Taxpayer may choose to obtain a roll-over under that provision.

Question 2

Summary

The Commissioner will not make a determination under subsection 45B(3) that section 45BA or section 45C will apply.

Detailed reasoning

Subsection 45B(3) of the ITAA 1936 allows the Commissioner to make a determination in relation to a demerger benefit and a capital benefit. For this provision to apply, the relevant scheme must fall within the scope of section 45B.

Subsection 45B(2), which details various conditions for the application of section 45B, provides as follows:

45B(2)

This section applies if:

(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 application of the conditions in each of the above paragraphs is considered below.

Paragraph 45B(2)(a)

'Scheme' is defined in section 995-1 of the Income Tax Assessment Act 1997 as 'any arrangement' or 'any scheme, plan, proposal, action, course of action, or course of conduct, whether unilateral or otherwise'. Being a proposed plan or course of action contemplated by the group, the demerger will be considered a 'scheme' under the terms of the prescribed definition.

The relevant scheme in this case to which section 45B applies is the business restructure that comprises the establishment of Y; the subsequent transfer of the shares in the Overseas companies from X to Y by way of sale; and the demerger.

The distribution of the Y shares to the Taxpayer will be considered a 'demerger benefit' and a 'capital benefit' for the following reasons:

Under the terms of the demerger, X will provide the Taxpayer with shares in Y, and the Taxpayer will thereby be considered to have been provided with a demerger benefit as defined in paragraph 45B(4)(a).

In this case, part of the distribution is a capital benefit, while the other is a dividend. By virtue of the former, paragraph 45B(5)(a) will be satisfied in this case.

In respect of the part of the distribution that is characterised as a dividend:

˗        subsection 45B(6) provides that 'a person is not provided with a capital benefit to the extent that the provision of interests, the distribution or the thing done referred to in subsection (5) involves the person receiving a demerger dividend'.

˗        'Demerger dividend' is defined in subsection 6(1) of the ITAA 1936 as 'part of a demerger allocation that is assessable as a dividend under subsection 44(1) or that would be so assessable apart from subsections 44(3) and (4)'. Section 44 applies in respect of 'dividends' paid to the shareholder, which in turn is defined in subsection 6(1) to exclude property distributed by a company to shareholders where the amount of the value of the property is debited against an amount standing to the credit of the share capital account of the company.

˗        Not all of the Y share distribution will be debited against an amount standing to the credit of Xs share capital account. The portion of the distribution that is not debited to the share capital account is a 'demerger dividend". This amount cannot be regarded as a 'capital benefit' pursuant to subsection 45B(6).

In respect of the part of the distribution that is a capital benefit:

˗        The portion of the distribution debited against the share capital account will be a 'capital benefit' under the terms of paragraph 45B(5)(a), being ownership interests in Y that are not demerger dividends.

˗        This amount will also be a 'capital benefit' under paragraph 45B(5)(b), being a distribution 'of share capital'; noting the application and effect of subsection 45B(7) in conjunction with the various definitions prescribed in Subdivision 974-E.

Paragraph 45B(2)(b)

The meaning of 'obtains a tax benefit' is prescribed in subsection 45B(9) as follows:

A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the demerger benefit had been an assessable dividend or the capital benefit had been an assessable dividend.

As considered above, the Taxpayer will be entitled to choose the demerger rollover relief pursuant to section 125-55 of the ITAA 1997 as a result of the demerger.

This means that, when the rollover choice is exercised under subsection 125-55(1), the Taxpayer will obtain a 'tax benefit' since no CGT event will be triggered at the time of the distribution - specifically any capital gains and the cost base adjustments in CGT event G1 under section 104-135 will be ignored on the exercise of the rollover choice; this is compared to the situation in which the distribution is treated as an assessable dividend and brought into account in the year of the distribution.

Paragraph 45B(2)(c)

The relevant circumstances which must be considered in the assessment of whether there exists a more-than-incidental purpose of enabling a taxpayer to obtain a tax benefit are outlined in subsection 45B(8).

They are considered in turn below.

Paragraph 45B(8)(a)

This paragraph prescribes the following 'relevant circumstance':

'the extent to which the demerger benefit or capital benefit is attributable to capital or the extent to which the demerger benefit or capital benefit is attributable to profits (realised and unrealised) of the company or of an associate (within the meaning in section 318) of the company;..'

On the facts of this case:

˗        The market value of the Y shares is ascertained. This represents the notional amount distributed to the Shareholders as part of the in specie distribution of Y shares.

˗        The percentage that the Y shares market value bears to the total enterprise market value of the companies in the group is calculated.

˗        This percentage is applied to the capital account of X. The resulting amount will be debited against the share capital of X upon the demerger, representing the part of the in specie distribution that is attributed to capital.

˗        The remaining portion of the value of the in specie distribution, being the market value of the Y shares less the amount of the capital component above, will be a demerger dividend. This amount will be debited against X's retained earnings account and revaluation reserve account.

The Commissioner considers that the above is a reasonable method of apportionment on the facts of this case. While this alone is not determinative of this issue, it is taken into account as a material consideration in the assessment of the scheme as a whole.

Paragraph 45B(8)(b)

This paragraph provides:

'the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318) of the company;'

In this regard it is noted that X has never paid dividends to its shareholders.

Paragraphs 45B(8)(c) to (f)

These paragraphs require an examination of the tax characteristics of the particular shareholder in question in determining the relevant circumstances of the scheme.

In general, the characteristics of the Taxpayer as provided to the Commissioner, and the provisions to which they relate, have been noted.

Paragraph 45B(8)(h)

This paragraph requires that regard be had to whether the interest held by the owners of the head entity after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of the share capital.

In this case the Taxpayer's ownership interests in X will not be altered as a result of the distribution. Moreover, the ATO view as set out in paragraph 70 of PS LA 2005/21 is noted:

In the context of demerger, this circumstance would be limited to demergers where the transfer of ownership interests involves 'distributions' (that is, returns) of share capital or share premium. Ordinarily however, a demerger should not disturb the head entity shareholder's existing ownership interest in the way described, owing to the requirements of the proportion test in subsection 125-70(2) of the ITAA 1997. As a consequence, it is unlikely that this circumstance will have significant relevance for demergers.

Paragraph 45B(8)(i)

Under this provision, if the scheme involves the provision and subsequent disposal of ownership interests, the period for which the ownership interests are held and the time at which the arrangement for the disposal of those shares is entered into are taken into account as relevant considerations.

In this case there is no proposal to dispose of Y after the demerger. It has also been stated in the facts of this case that there is also no intention on the part of the Shareholders to in any way deal with their interests in Y following the demerger.

Paragraph 45B(8)(j)

This provision requires consideration of any profits or assets of the demerging entity that might be attributable to, or acquired under transactions with, associated entities. In PS LA 2005/21, it is stated at paragraph 82 that:

'..this relevant circumstance exposes whether the demerger relief is being used as a device for distributing corporate earnings to owners of the head entity. If it is established that part of the profits or assets of the demerging entity are referable to those of an associate and are not explainable by the demerging entity's need to be a viable, stand-alone entity, this is suggestive of a purpose of enabling a taxpayer to obtain a tax benefit by way of non-assessable dividend...' (emphasis added).

In this case, the Commissioner has taken into account the basis for the expressed need of the demerging entity, together with the Australian companies, to be a 'stand-alone entity', in light of his consideration of the primary purpose of the demerger as asserted and substantiated by the taxpayer.

Paragraph 45B(8)(k)

This paragraph requires that regard be had to 'any of the matters referred to in subsection 177D(2)', which are matters prescribed for the purposes of determining the 'dominant purpose' test in Part IVA. In the context of section 45B, however, they are to be applied in determining the 'more than incidental' test specific to the provision.

The factors prescribed in subsection 177D(2) focus on indicia that may reveal the true objectives of the relevant scheme. It is recognised that many of the considerations taken into account under this provision may overlap with those already mentioned above.

The circumstances which the Commissioner considers relevant to the assessment of the scheme in this case, and the corresponding paragraphs in subsection 177D(2) to which they relate, are as follows:

An inquiry into the manner of the scheme is an objective inquiry into the reasons a taxpayer had for entering into it (see paragraph 86 in PS LA 2005/21).

In this regard, it is submitted in the Application, and it has been accepted for the purposes of this Ruling, that the demerger would achieve what is perceived as a necessary commercial objective.

The effects of the scheme on the parties to the demerger are primarily the (anticipated) commercial positions of X and Y following the demerger, as well as the capital benefit or demerger benefit afforded to X and its shareholders.

The question as to whether the capital and demerger benefits are sufficiently outweighed by the commercial objectives of the proposal such that they may be regarded as merely an incidental purpose of the scheme is determined by taking into account the previous and following other considerations.

The Taxpayer's submissions have been considered in this regard. The timing of the scheme is consistent with its stated commercial objective.

In the present case, the demerger results in the acquisition by the Taxpayer and other X shareholders of shares in Y; that is, an asset owned previously by X is now directly owned by the Taxpayer, which as stated in PS LA 2005/21 'delivers to the head entity's shareholders an asset which they can liquidate, exchange or use as financial security'.

However, again it is noted that there is no proposal to dispose of Y after the demerger, nor any intention on the part of the Shareholders to deal with their interests in Y following the demerger.

It is accepted that the economic substance of the relationship between the Shareholders and the entities in the group will be preserved upon the demerger.

Upon taking into account the abovementioned circumstances, it is the Commissioner's view that the scheme will not be carried out for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit under paragraph 45B(2)(c).

The matters which the Commissioner has considered persuasive in reaching this conclusion are as follows:

For these reasons, the Commissioner will not make a determination under subsection 45B(3) in respect of this scheme.

Question 3

Summary

The in specie distribution of shares in Y will not give rise to assessable income under subsection 44(1) of the ITAA 1997.

Paragraph 44(1)(a) provides:

The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) includes:

(a) if the shareholder is a resident:

(i)               dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and

(ii)              all non-share dividends paid to the shareholder by the company;

As discussed earlier, the Y share distribution:

·        Will be debited against an amount standing to the credit of X's share capital account.

Prima facie we take it that the dividends are, pursuant to subsection 44(1)(a)(i), taken to be paid out of profits. In this regard we refer to TR 2003/8, which in paragraph 13 states:

In most cases a company which distributes property to its shareholders and debits part of the value of that property to its share capital account would debit the remaining part to another account or reserve. Where that account or reserve does not represent share capital, it would, for subsection 44(1) purposes, represent profits derived by the company so that the amount debited to it would be included in the shareholder's assessable income under that subsection.

·        Based on the considerations above, the amount (including the amount debited to the revaluation reserve account):

·        is considered a dividend paid out of X's profits, and therefore falls within the scope of section 44(1);

·        in turn also falls within the definition of 'demerger dividend' under subsection 6(1) since it is the part of the demerger allocation that would (but forsubsections 44(3) and (4)) be assessable under subsection 44(1).

Subsection 44(3) provides:

This section applies to the demerger dividend as if it had not been paid out of profits.

Subsection 44(4) provides:

A demerger dividend is not assessable income or exempt income

Therefore the portion of the distribution that is a demerger dividend is not assessable income.

Further, subsection 44(5) does not apply as, just after the proposed demerger, 50 % or more of the CGT assets owned by Y and the Overseas Companies will be used in one or more businesses carried out by these entities.

In respect of the amount debited against X's share capital account:

·        The definition of 'dividend' under subsection 6(1) specifically excludes:

(d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company.

·        However, pursuant to subsection 6(4), the above paragraph does not apply if:

'...under an arrangement:

(a)   a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property; and

(b)   the company pays or credits any money, or distributes property to another person, and debits its share capital account with the amount of the money or the value of the property so paid, credited or distributed...'

·        In such cases, such an amount will be considered to be a dividend and, as a consequence, would fall within the scope of subsection 44(1B) of the ITAA 1936. This would in turn bring it within the scope of subsection 44(1).

However, in the present case, there is no arrangement to which subsection 6(4) of the ITAA 1936 applies. Therefore the exclusion in paragraph 6(1)(d) applies, with the consequence that this amount would fall outside the scope of subsection 44(1).

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