Edited version of private advice

Authorisation Number: 1051819981791

Date of advice: 29 March 2021

Ruling

Subject: Demerger

Question 1

Will the Commissioner confirm that the proposed restructure is a 'demerger' within the meaning of section 125-70 of the Income tax Assessment Act 1997 (Cth)?

Answer

No.

Question 2

Will the Commissioner confirm that any capital gain that Company A makes from CGT Event A1 happening to its ownership interests in Company B under a demerger is disregarded under section 125-155 of the Income tax Assessment Act 1997 (Cth)?

Answer

No.

Question 3

Will the Commissioner confirm that the transfer of shares in Company B from Company A to its shareholders would, to the extent that the transfer represents a distribution of profits of Company A, be a demerger dividend which is not assessable income or exempt income pursuant to subsections 44(3) to 44(5) of the Income Tax Assessment Act 1936 (Cth)?

Answer

No.

Question 4

Will the Commissioner confirm that section 45B of the Income Tax Assessment Act 1936 (Cth) would not apply to treat the demerger dividend as assessable?

Answer

No.

This ruling applies for the following periods:

The income years ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Relevant companies

Company B was incorporated on X and currently has X Ordinary shares on issue which are 100% beneficially held by Company A.

Company B has always been 100% owner by Company A since incorporation.

Company A was incorporated on X and currently has the following shares on issue:

•         X x 'A' class shares beneficially held by X (Husband). The Husband initially acquired X x 'A' class share on incorporation and an additional allotment of X x 'A' class shares was made on X.

•         X x 'B' class share non-beneficially held by X (Wife). This share is held by the Wife as trustee for the Husband since incorporation. Therefore, the beneficial owner of the B class shares is the Husband.

Both the 'A' and 'B' class shares in Company A has the following rights:

•         The right to attend and vote at all meetings of the Company and on a show of hands to one vote for every share and on poll one vote for every share held;

•         The right to participate in the dividends (if any) declared on the class of shares of which he is a holder;

•         In a winding up of the Company to repayment of the capital paid upon such share and to participate in the division of any surplus assets or profits of the Company and in this regard to rank pari passu with all other shareholders.

Company B is an investment company with assets consisting mainly of cash, listed property trusts, listed equities and real property.

Company A is also an investment company with assets consisting mainly of cash, real property and the shares held in Company B.

The Proposed 'Demerger'

The Husband and Wife have separated and are currently negotiating a family law settlement which will involve splitting the matrimonial assets between the parties. Amongst other assets, this will include the shares in Company A and B.

They propose to request the Family Court to make Consent Orders that would include, but are not limited to, the following Orders:

•         An Order that would have the effect that the real property located X which is currently owned by Company B will be transferred to Company A. The property has an approximate market value of $X.

•         The property will be transferred at market value and will be a taxable CGT event for Company B.

•         An Order that would have the effect that the shares held by Company A in Company B will be 'demerged' so that the current shareholders of Company A will then own 100% of the shares in Company B in the same proportion as they hold the shares in Company A are held.

•         Therefore, the X Ordinary shares in Company B will be held as follows:

i)      X x Ordinary shares held by the Husband

ii)     2 x Ordinary shares held non-beneficially by the Wife for the Husband.

It is proposed that the demerger relief provisions in Division 125 of the ITAA 1997 will apply.

An order that would have the effect that the shares in Company A will be transferred from the Husband to the Wife under the CGT marriage breakdown provisions contained in Subdivision 126-A of the ITAA 1997.

An order that would have the effect that the 2 x Ordinary shares held non-beneficially by the wife for the Husband in Company B will be transferred into the Husband's name. However, there is no change in underlying ownership in respect of this transfer of shares.

The purpose of the 'demerger' is to give effect to the split of matrimonial assets between the Husband and Wife so each spouse will become the sole shareholder of their own investment company, Company B in the Husband's name and Company A in the Wife's name.

There are a number of other Orders to be sought by the parties as part of the settlement, such as those dealing with the family home.

Reasons for decision

Question 1

Will the Commissioner confirm that the proposed restructure is a 'demerger' within the meaning of section 125-70 of the Income tax Assessment Act 1997 (Cth) (ITAA 1997)?

Summary

No, the proposed restructure does meet the requirements of a 'demerger' within the meaning of section 125-70 of the ITAA 1997.

Detailed reasoning

The demerger provisions

In order for the demerger CGT outcomes contained in Division 125 of the ITAA 1997 to apply to a company or trust, a number of defined terms must be satisfied, including:

•         demerger group (subsection 125-65(1) of the ITAA 1997)

•         demerger (subsection 125-70(1) of the ITAA 1997)

•         demerged entity (paragraph 125-70(6)(a) of the ITAA 1997), and

•         demerging entity (paragraph 125-70(7)(a) of the ITAA 1997).

Section 125-155 of the ITAA 1997 states that:

Any *capital gain or *capital loss a *demerging entity makes from *CGT event A1, *CGT event C2, *CGT event C3 or *CGT event K6 happening to its *ownership interests in a *demerged entity under a *demerger is disregarded.

Relevant definitions

The term 'demerging entity' is defined in subsection 125-70(7) of the ITAA 1997as follows:

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 interest in another member of the demerger group to owners of original interests in the *head entity of the demerger group; or

(b)           ...

...

A 'demerged entity' is an entity that was a member of a demerger group to which a demerger happened under which ownership interests in the entity were acquired by shareholders in the head entity of the group (if the head entity was a company) or unitholders or holders of interests in the head entity (if the head entity was a trust) (subsection 125-70(6) of the ITAA 1997).

An 'ownership interest' in a company is 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 (paragraph 125-60(1)(a) of the ITAA 1997). An ownership interest in a trust is 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 (paragraph 125-60(1)(b) of the ITAA 1997).

A 'demerger group' comprises a head entity and one or more demerger subsidiaries (subsection 125-65(1)). Either may be a company, or a trust in relation to which CGT event E4 is capable of applying to all of the units and interests in it (subsection 125-65(2) of the ITAA 1997).

A company or trust is the head entity of a demerger group if:

•         no other member of the group owns ownership interests in it (subsection 125-65(3) of the ITAA 1997), and

•         it is not a demerger subsidiary of a company or trust in another demerger group (subsection 125-65(4) of the ITAA 1997, unless it is a listed company or listed widely held trust in which one or more members of the other group hold a total of less than 80% of its ownership interests and it chooses that a sufficient number of those members are not members of its demerger group (subsection 125-65(5) of the ITAA 1997).

A company or trust is a demerger subsidiary of another company or trust that is a member of a demerger group if the other company or trust, alone or together with other members of the group, owns, or has the right to acquire, ownership interests in the company or trust that carry between them:

•         the right to receive more than 20% of any distribution of income or capital by the company or trustee; and

•         in the case of a company, the right to exercise, or control the exercise of, more than 20% of the voting power of the company (subsections 125-65(6) and (7) of the ITAA 1997).

A 'demerger' happens to a demerger group if there is a restructuring of the group (paragraph 125-70(1)(a) of the ITAA 1997) such that:

•         under the restructuring, by one or a combination of the following means, members of the demerger group stop owning at least 80% of the total ownership interests owned by members of the group in another member of the group:

-        disposal of the ownership interests to owners of original interests in the head entity of the group

-        ending of the ownership interests and issuing of new interests to owners of original interests in the head entity; or

-        dilution of the ownership interests through the issue of new ownership interests in the other member to owners of original interests in the head entity (paragraph 125-70(1)(b) of the ITAA 1997)

•         under the restructuring, whether or not a CGT event happens to an original interest owned by an entity in the head entity, the entity acquires only a new interest and nothing else (paragraph 125-70(1)(c) of the ITAA 1997)

•         entities acquire new interests only because they own or owned original interests (paragraph 125-70(1)(d) of the ITAA 1997)

•         if the head entity is a company the new interests must be ownership interests in a company; or if the head entity is a trust, the new interests must be ownership interests in a trust (paragraph 125-70(1)(e) of the ITAA 1997)

•         neither the original interests nor the new interests are in a trust that is a non-complying superannuation fund (paragraph 125-70(1)(g) of the ITAA 1997); and

•         each owner (an 'original owner') of original interests in the head entity must:

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

-        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 (paragraph 125-70(1)(h) of the ITAA 1997 and subsection 125-70(2) of the ITAA 1997).

The term 'restructuring' in paragraph 125-70(1)(a) has its ordinary business meaning, which is the reorganisation of a group of companies or trusts. All steps occurring under a single plan or reorganisation (generally the proposal that is presented to the affected owners of original interests in the head entity of the demerger group) will usually constitute the restructuring. These may include transactions occurring before and / or after the transactions mentioned in paragraph 125-70(1)(b) of the ITAA 1997, so must be taken into account in determining whether the conditions in subsections 125-70(1) and (2) of the ITAA 1997 are satisfied.

Even where those conditions are satisfied, certain exceptions may apply.

TD 2020/6

TD 2020/6 Income tax: what is a 'restructuring' for the purposes of subsection 125-70(1) of the Income Tax Assessment Act 1997, requires the Commissioner to look at all of the facts and circumstances in determining the scope of the 'restructure' of the Taxpayers as part of a marital separation of companies for the purpose of the demerger provisions.

As outlined above, a demerger happens if there is a restructuring of the demerger group.  By identifying what is and isn't included in the restructuring, we can identify what proportion of interests are held by the parties at the point in time that is 'just after the demerger'.

TD 2020/6 provides that "Commercial understanding and the objectively inferred plan for reorganisation will determine which steps or transactions form part of the restructuring of the demerger group".

The objectively inferred purpose of the restructuring of the Taxpayers is to transfer securities according to a marital separation of assets so that each spouse will become the sole shareholder of each company. The steps which are integral to achieving that outcome and are considered to satisfy the first element required under a demerger, that is, that there is a restructuring of the demerger group are:

1.    Real property located at X, which is currently owned by Taxpayer 1 transferred to Taxpayer

2.    Shares held by Taxpayer 2 in Taxpayer 1 demerged so that the current shareholders of Taxpayer 2 will then own 100% of the shares in Taxpayer 1 in the same proportion as they hold the shares in Taxpayer 2.

3.    Shares held by the husband in Taxpayer 2 will be transferred to the Wife.

4.    2 x Ordinary shares held non-beneficially by the Wife for the Husband in Taxpayer 1 will be transferred into the Husband's name (no change in underlying ownership).

All four steps in this instance are considered to occur under a single plan of reorganisation notwithstanding each step may be considered legally independent of the other (Refer to paragraph 3 of TD 2020/6.)

Based on the proposed restructure both individuals will, after the implementation of the four steps detailed above, each own a company solely. Therefore, just after the demerger, the husband does not have the same proportionate total market value of ownership interests in the head entity and demerged entity as he did just before the demerger, as is required by paragraph 125 70(1)(h) and subsection 125 70(2) of the ITAA 1997 for there to be a demerger to a demerger group under paragraph 125-70(1)(a) of the ITAA 1997.

For completeness, the restructure does not begin and end at the start and end of the single Order relating to the demerger of Taxpayer 2 and Taxpayer 1 (i.e. step 2 above), since such an interpretation of 'restructure' would not give effect to the purpose of undertaking the proposed 'demerger'. Defining the restructure this narrowly excludes other steps which are inherently involved to meet the objectively inferred purpose of allowing the spouses to each control their own investment company. It is necessary for steps 3 and 4 above to occur for this to be achieved.

Question 2

Will the Commissioner confirm that any capital gain that Taxpayer 2 makes from CGT Event A1 happening to its ownership interests in Taxpayer 1 under a demerger is disregarded under section 125-155 of the Income tax Assessment Act 1997 (Cth)?

Summary

No, any capital gain that Taxpayer 2 makes from CGT Event A1 happening to its ownership interests in Taxpayer 1 will not be disregarded under section 125-155 of the ITAA 1997, because the event does not occur under a demerger.

Detailed reasoning

Section 125-155 states that:

Any *capital gain or *capital loss a *demerging entity makes from *CGT event A1, *CGT event C2, *CGT event C3 or *CGT event K6 happening to its *ownership interests in a *demerged entity under a *demerger is disregarded.

For the reasons outlined in response to Question 1 above, the proposed restructure does meet the requirements for there to be a demerger to a demerger group under paragraph 125-70(1)(a) of the ITAA 1997. Since any capital gain that Taxpayer 2 makes from CGT Event A1 happening to its ownership interests in Taxpayer 1 does not occur 'under a demerger', it will not be disregarded under section 125-155 of the ITAA 1997.

Question 3

Will the Commissioner confirm that the transfer of shares in Taxpayer 1 from Taxpayer 2 to its shareholders would, to the extent that the transfer represents a distribution of profits of Taxpayer 2, be a demerger dividend which is not assessable income or exempt income pursuant to subsections 44(3) to 44(5) of the Income Tax Assessment Act 1936 (Cth)?

Summary

No, since there is no demerger to a demerger group under paragraph 125-70(1)(a) of the ITAA 1997, subsections 44(3) to 44(5) of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) do not apply.

Detailed reasoning

Dividend

A dividend includes 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, a dividend does not include moneys paid or credited, or property distributed, by a company to shareholders where the amount of the money or the value of the property is debited against an amount standing to the credit of the company's share capital account (subsection 6(1) of the ITAA 1936).

Assessable income

Subsection 44(1) provides that the assessable income of a shareholder of a company (whether resident or non-resident) includes:

•         if the shareholder is a resident, dividends paid to the shareholder by the company out of profits derived by it from any source

•         if the shareholder is a non-resident, dividends paid to the shareholder by the company to the extent to which they are paid out of profits derived by it from sources in Australia.

However, subsection 44(2) states that subsections 44(3) and (4) apply to a demerger dividend unless the head entity of the relevant demerger group makes an election within the prescribed time that they not apply.

Subsection 44(3) states that section 44 applies to a demerger dividend as if it had not been paid out of profits, which means a demerger dividend is not included in the assessable income of shareholders in the head entity under subsection 44(1).

Subsection 44(4) provides that a demerger dividend is not assessable income and is not exempt income.

Demerger dividend

A 'demerger dividend' is that 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) (subsection 6(1)).

A 'demerger allocation' is the sum of the market values of the allocations represented by

•         the ownership interests issued by a demerged entity in itself under a demerger to the owners of ownership interests in the head entity of the relevant demerger group, and

•         the ownership interests disposed of by a member of the demerger group under the demerger to those owners (subsection 6(1)).

As outlined in response to question 1, there is no demerger to a demerger group under paragraph 125-70(1)(a) of the ITAA 1997.

Accordingly, to the extent that the transfer of shares in Taxpayer 1 from Taxpayer 2 to its shareholders represents a distribution of profits of Taxpayer 2, this amount is not a demerger dividend. Therefore, subsections 44(3) and (4) to not apply to that amount. As such, the amount is not excluded from being assessable income or not exempt income of the shareholders of Taxpayer 2 under subsection 44(4) of the ITAA 1936.

Question 4

Will the Commissioner confirm that section 45B of the ITAA 1936 would not apply to treat the demerger dividend as assessable?

Summary

Since there is no demerger dividend, section 45B of the ITAA 1936 would not apply.

Detailed reasoning

Section 45B

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).

Application

The requirements of subsection 45B(2) of the ITAA 1936 are not met because there is no provision of ownership interests to a shareholder under a demerger (subsection 45B(4) of the ITAA 1936). There is no demerger dividend for s45B of the ITAA 1936 to apply to.

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