Edited version of private advice

Authorisation Number: 1052158709021

Date of advice: 1 September 2023

Ruling

Subject: Demerger

Question 1

Will the shareholders of Company A be able to obtain demerger roll-over relief under section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the dividend paid on 30 June 20XX satisfy the requirements to be a demerger dividend under subsection 44(3) and subsection 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936) so that it is non-assessable non-exempt income in the hands of the Company A shareholders?

Answer

Yes.

Question 3

Will the Commissioner make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA applies in relation to the whole or a part of the demerger benefit provided to the Company A shareholders?

Answer

No.

Question 4

Will the Commissioner make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C applies in relation to the whole, or a part, of the capital benefit?

Answer

No.

Question 5

Will section 109RA of the ITAA 1936 apply to exclude the demerger dividend from being deemed a dividend under Division 7A?

Answer

Yes.

This ruling applies for the following period

The Income Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Company A

1.    Company A is an Australian private company that is the head company of an income tax consolidated group (the Company A TCG).

2.    All the shares in Company A are ordinary shares.

3.    Company A does not have a history of paying annual dividends, nor a certain dividend policy. The decision to pay a dividend is determined annually by the directors.

The shareholders of Company A

4.    Company A currently has multiple shareholders.

5.    All the shareholders in Company A are Australian tax residents.

6.    The shareholders' interests in Company A are post-CGT interests.

7.    There were no plans, contingent or otherwise, for the shareholders to dispose of their shares (nor to realise their interests) in Company A or Company B (or any other entity or part of the Company A TCG) following the demerger.

Demerger arrangement

8.    The arrangement, which is the subject of this ruling request, is a demerger by which Company A distributed to its shareholders, all of the shares in a wholly owned subsidiary company, Company B.

9.    To affect the separation of Company B, the directors of Company A resolved on 30 June 20XX to distribute and pay a dividend to its shareholders. This dividend was satisfied via an in-specie transfer of the shares in Company B to the shareholders in proportion to their holdings in the register of members.

10.  Company A accounted for the demerger of the Company B shares as follows:

•        A return of capital amount was debited to the issued share capital account (being a share capital account as defined in section 975-300 of the ITAA 1997) of Company A. This amount, represented the relevant proportion of Company A's share capital account attributable to Company B, determined on the basis of the market value of Company B as a proportion of the total market value of Company A; and

•        A dividend was debited to the retained earnings of Company A, equal to the market value of the Company B shares as at 30 June 20XX less the return of capital amount.

11.  The valuations of Company A and Company B were undertaken in accordance with the ATO's 'Market valuations for tax purposes' guidelines.

12.  The dividend was not prohibited under section 254T of the Corporations Act 2001.

Reasons for the demerger

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

Other matters

14.  Immediately before the demerger, Company A's share capital account was not tainted (within the meaning of Division 197 of the ITAA 1997).

15.  The Company A TCG has not made any elections under Division 230 of the ITAA 1997 (i.e., in relation to the Taxation of Financial Arrangements).

16.  Company A will not make an election, as the head entity of the demerger group, under subsection 44(2) of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45BA

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 section 109RA

Income Tax Assessment Act 1936 Division 16K of Part III

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 Division 125

Income Tax Assessment Act 1997 section 125-55

Income Tax Assessment Act 1997 section 125-60

Income Tax Assessment Act 1997 section 125-65

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 section 125-75

Income Tax Assessment Act 1997 section 125-80

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 section 975-300

Corporations Act 2001 section 254T

Reasons for decision

Question 1

Summary

1.     The Company A shareholders will be able to choose to obtain demerger roll-over relief under section 125-55 of the ITAA 1997.

Detailed reasoning

2.     Subsection 125-55(1) of the ITAA 1997 allows an entity to choose to obtain a roll-over where the following conditions are satisfied:

(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.

You own an ownership interest in a company

3.     In the present circumstances, paragraph 125-55(1)(a) of the ITAA 1997 is satisfied as the Company A shareholders owned an ownership interest in a company (which is defined in paragraph 125-60(1)(a) and includes 'a share in the company').

The company is the head entity of a demerger group

4.     Paragraph 125-55(1)(b) of the ITAA 1997 is also satisfied because Company A was the head entity of a demerger group.

5.     A demerger group comprises one head entity and at least one demerger subsidiary (subsection 125-65(1) of the ITAA 1997). The demerger group in this case comprised Company A as the head entity and included Company B as a demerger subsidiary.

6.     Company A was the head entity because:

•        no other member of the demerger group held ownership interests in Company A (subsection 125-65(3) of the ITAA 1997); and

•        there was no other company or trust capable of being a head entity of a demerger group of which Company A could be a demerger subsidiary (subsection 125-65(4)).

7.     Company B was a demerger subsidiary of Company A because Company A owned ownership interests in Company B that carried more than 20% of the rights to any distribution of income and capital, and the right to exercise more than 20% of the voting power of Company B (subsection 125-65(6) of the ITAA 1997).

A demerger happens to the demerger group

8.     Paragraph 125-55(1)(c) of the ITAA 1997 requires a demerger to happen to the demerger group.

9.     Subsection 125-70(1) of the ITAA 1997 describes when a demerger happens. A demerger happened to the Company A demerger group because:

•        there was a restructuring (paragraph 125-70(1)(a)), and Company A disposed of at least 80% of its shares in Company B to the owners of Company A (subparagraph 125-70(1)(b)(i));

•        under the restructuring, a CGT event happened to the shares in Company A when the in-specie distribution was made under the demerger (CGT event G1), and the Company A shareholders acquired new shares in Company B and nothing else (subparagraph 125-70(1)(c)(ii));

•        shares in Company B were acquired by the Company A shareholders on the basis of their ownership of shares in Company A (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i));

•        paragraph 125-70(1)(f) has been repealed;

•        neither Company A nor Company B are superannuation funds (paragraph 125-70(1)(g));

•        the requirements of paragraph 125-70(1)(h) are satisfied as:

(i) the Company A shareholders acquired shares in Company B in the same proportion as they owned shares in Company A just before the demerger (paragraph 125-70(2)(a));

(ii) the Company A shareholders own shares in Company A and Company B that (just after the demerger) represent the same proportionate total market value as their Company A shares represented (just before the demerger) (paragraph 125-70(2)(b));

•        under the scheme, a buy-back of shares for the purposes of Division 16K of Part III of the ITAA 1936 did not occur (subsection 125-70(4)); and

•        there was no rollover available under another provision for any CGT events that happened to the Company A shares under the restructure (subsection 125-70(5)).

10.  As the requirements of subsection 125-70(1) of the ITAA 1997 are met, paragraph 125-55(1)(c) is satisfied.

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

11.  Paragraph 125-55(1)(d) of the ITAA 1997 is satisfied because CGT event G1 happened to the Company A shares and the Company A shareholders acquired shares in the demerged entity (Company B).

Conclusion

12.  The requirements of subsection 125-55(1) of the ITAA 1997 are met and therefore the Company A shareholders are able to choose to obtain the demerger roll-over relief under section 125-55 upon the demerger of Company B by Company A.

Question 2

Summary

13.  The dividend paid on 30 June 20XX satisfies the requirements to be a demerger dividend under subsections 44(3) and 44(4) of the ITAA 1936 and is non-assessable, non-exempt income in the hands of the Company A shareholders.

Detailed reasoning

Assessable dividends

14.  Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividend, as defined in subsection 6(1), paid to the shareholder out of profits derived by the company from any source, if the shareholder is a resident of Australia.

Dividend

15.  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).

16.  Taxation Ruling TR 2003/8 Income tax: distributions of property by companies to shareholders - amount to be included as an assessable dividend (TR 2003/8) highlights that, where dividends are taken to be paid out of profits, they would fall within the scope of subsection 44(1) of the ITAA 1936.

17.  In this regard, paragraph 13 of TR 2003/8 explains that:

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.

18.  Accordingly, in this case, the distribution of the shares in Company B, in part, constitutes a dividend paid to the Company A shareholders. The total amount of the dividend is the market value of the Company B shares at the time of the demerger, excluding the amount debited to the share capital account of Company A.

Demerger dividend

19.  Subsections 44(3) and 44(4) of the ITAA 1936, however, provide that a 'demerger dividend' is treated as if it had not been paid out of profits and is not assessable income or exempt income.

20.  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) or that would be so assessable apart from subsections 44(3) and 44(4).

Demerger allocation

21.  Subsection 6(1) of the ITAA 1936 defines demerger allocation to mean:

(a)  the total market value of the allocation represented by the ownership interests issued by the demerged entity in itself under a demerger to the owners of ownership interests in the head entity of the demerger group; or

(b)  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; or

(c)   the total of both of those market values.

22.  The market value of the Company B shares will be the demerger allocation. The demerger allocation paid by Company A to the Company A shareholders is made up of a return of capital and a demerger dividend.

23.  This dividend satisfies the definition of a demerger dividend under subsection 6(1) of the ITAA 1936, and subsections 44(3) and 44(4) will apply provided subsection 44(5) is satisfied.

24.  Subsection 44(5) of the ITAA 1936 requires that, just after the demerger, CGT assets owned by the demerged entity or a demerger subsidiary representing at least 50% by market value of all the CGT assets (or a reasonable approximation of market value) owned by the demerged entity and its demerger subsidiaries are used, directly or indirectly, in one or more business carried on by one or more of those entities.

25.  In the present circumstances, the demerged entity, Company B, carries on a business with the majority of its assets used in carrying on this business. Accordingly, just after the demerger, at least 50% of the market value of all the CGT assets owned by Company B are used directly or indirectly in the business carried on by that entity. The requirements of subsection 44(5) of the ITAA 1936 are, therefore, satisfied and will not apply to exclude subsections 44(3) and 44(4).

26.  It is also noted that Company A, as the head entity of the demerger group, will not make an election, under subsection 44(2) of the ITAA 1936, to not apply subsections 44(3) or 44(4).

Questions 3 & 4

Summary

27.  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 a part, of any benefit provided to the Company A shareholders under the demerger.

Detailed reasoning

28.  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.

29.  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)); 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)); and

•        having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into the scheme or carried out the scheme or any part of the scheme did so for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

30.  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.

31.  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)).

32.  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 45C(2)).

Scheme

33.  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. 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.

34.  In the present circumstances, the distribution of the Company B shares to the Company A shareholders under the demerger constitutes a scheme for the purposes of section 45B of the ITAA 1936.

Demerger benefit and capital benefit

35.  Pursuant to subsection 45B(4) of the ITAA 1936, a person is provided with a demerger benefit in relation to a demerger if a company provides the person with ownership interests in that or another company. Therefore, the distribution of the Company B shares to the Company A shareholders constitutes a demerger benefit.

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

Tax benefit

37.  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.

38.  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 the Company A shareholders would be higher if the demerger benefit was an assessable dividend. Accordingly, the Company A shareholders will obtain a tax benefit for the purposes of section 45B.

More than incidental purpose

39.  Given that the 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.

40.  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

41.  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 45B(8)(k).

42.  Having regard to the relevant circumstances of the scheme, as set out in subsection 45B(8) of the ITAA 1936, it is considered that the demerger was not undertaken for a more than incidental purpose of obtaining a tax benefit.

Conclusion

43.  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 arrangement.

Question 5

Summary

44.  Section 109RA of the ITAA 1936 will apply to exclude the demerger dividend from being deemed a dividend under Division 7A.

Detailed reasoning

45.  The distribution of the Company B shares by Company A to the Company A shareholders involved the provision of property. Accordingly, on face value, section 109C of the ITAA 1936 would potentially apply to the demerger.

46.  Section 109RA of the ITAA 1936, however, stipulates that Division 7A does not apply to a demerger dividend to which section 45B does not apply.

47.  As detailed above, it is considered that the dividend paid as part of the distribution of Company B shares will be a demerger dividend and section 45B of the ITAA 1936 will not apply. Accordingly, the exception in section 109RA will apply and Division 7A will have no application to this dividend.

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