Edited version of private ruling

Authorisation Number: 1011714994616

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Ruling

Subject: Demerger

Question 1

Will any capital gain arising on the transfer of Trust 3 units to Trust 1 be disregarded for A Co under section 125-155 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will a CGT event L5 be triggered pursuant to section 104-520 of the ITAA 1997 upon Trust 3 leaving the A Co consolidated group if the allocable cost amount under section 711-20 of the ITAA 1997 for the leaving entities is a positive amount?

Answer

No

Question 3

Will the in-specie distribution of units in Trust 3 by A Co to Trust 1, be a demerger dividend, as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936), and is therefore not subject to franking under section 202-45 of the ITAA 1997?

Answer

No

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 will apply to A Co?

Answer

A Co has not been identified as a relevant taxpayer for the purpose of section 45B of the ITAA 1936. Therefore it is not necessary to answer this question.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commences on:

1 July 2010

Relevant facts

1. A corporate group currently comprises a discretionary trust (Trust 2) which holds all of the units in a unit trust (Trust 1). Trust 1 holds all of the shares in the head company of a consolidated group (A Co). Two of A Co's wholly-owned companies (B Co and C Co) are subsidiary members of the consolidated group.

2. It is proposed that these two subsidiary members of the A Co consolidated group, being B Co and C Co, be transferred to Trust 2 for an amount equal to their market value. It is proposed to carry out the group restructure in a number of steps.

3. The restructure is proposed to occur by way of a demerger as defined under Division 125 of the ITAA 1997.

4. The transfer of B Co and C Co to Trust 2 will be achieved as follows:

a. A new unit trust will be established by A Co (referred to as Trust 3). 100% of the units in Trust 3 will be held by A Co. Trust 3 will be a member of the A Co consolidated group. A Co will transfer the shares in B Co and C Co to Trust 3 at their market value in exchange for units in Trust 3 of the same value, such that B Co and C Co are interposed between A Co and Trust 3.

b. A Co will transfer 100% of its units in Trust 3 to Trust 1 at the direction of its shareholder Trust 1. The transfer will be treated as an in-specie dividend and capital return equal to the market value of the units in Trust 3. A valuation of the business will be carried out prior to the restructure. The amount allocated to capital will be the original capital invested in the business of B Co and C Co.

c. Trust 1 will provide its sole unit holder, Trust 2, with the entitlement to 100% of the units in Trust 3 by distributing the units in Trust 3 as a trust distribution equal to the dividend component to Trust 2 and cancelling units held by Trust 2 in Trust 1 up to the value of the capital distribution from A Co. The in-specie transfer will have capital reduction and dividend components. The amounts of the capital and dividend components will be determined once the transaction commences and valuations are carried out.

d. Trust 2 will treat the distribution from Trust 1 as a reduction of its investment in Trust 1 and recognise the carrying value of its investment in Trust 3.

e. Under the terms of the demerger the units in Trust 3 will be transferred to Trust 2 in the exact proportions as their holding in Trust 1. Trust 2 will hold 100% of the units in Trust 1 and will hold 100% of the units in Trust 3. Trust 2 will hold the exact proportion in Trust 3 as it holds through Trust 1.

5. Trust 2 will choose demerger roll-over relief under section 125-55 of the ITAA 1997.

6. Trust 1 will not make an election under subsection 44(2) of the ITAA 1936 that subsections 44(3) and (4) will not apply to the total of any demerger dividend paid under the restructure.

7. CGT event E4 is not capable of applying to all of the units and interests if Trust 2.

8. CGT event E4 is capable of applying to all of the units and interests if Trust 1.

9. At least 50% of the market value of all the CGT assets owned by Trust 3 will be used directly or indirectly in the businesses carried on by Trust 3 via its wholly owned subsidiaries B Co and c Co.

10. The dividend component of the in-specie distribution of Trust 3 units will be debited to the pre-CGT capital profits reserve account of A Co.

11. The capital component will be debited to share capital.

12. Trust 1's sole unit holder, Trust 2 will acquire 100% of Trust 3 units i.e. in the same proportion as it owns in Trust 1's units just before the demerger. The combined market value of each of Trust 2's interests in Trust 3 and Trust 1 immediately after the demerger will at least equal the market value of Trust 2's interest in Trust 1 immediately prior to the demerger.

13. B Co and C Co will exit the consolidated group with substantial positive net assets for financial reporting purposes resulting in the group's allocable cost amount for the leaving entities being a positive amount.

14. The only assets of Trust 3 when it leaves the consolidated group will be the issued equity of the two exiting entities, B Co and C Co, and it will not have any liabilities.

15. A Co made a written election before 30 June 2011 that the amendments made to section 705-125 of the ITAA 1997 by Tax Laws Amendment (2010 Measures No. 1) Act 2010 will apply to A Co in working out the pre-CGT proportion for entities that are subsidiary members of the consolidated group. The proportion of membership interests in B Co and C Co that have pre-CGT status is 100% unless affected by section 711-70 of the ITAA 1997 and section 711-75 of the ITAA 1997.

Reasons for the demerger

16. The purpose of the proposed transactions is to separate the business of B Co and C Co from that of the A Co consolidated group in order to allow that business to seek separate funding of debt and if appropriate, equity, in order to improve its competitive position in its market.

17. In order to allow the business of B Co and C Co to pursue its own business strategy, it will be separated from that of A Co and the consolidated group by way of a demerger. It is anticipated that the restructure will achieve improved business efficiency by allowing the separate businesses to operate on a stand alone basis.

18. It is anticipated that the separation will improve the business's efficiency and ability to fund itself. It will also provide a clear separation of management of the two businesses. It will allow the management team of the business in B Co & C Co to be allocated an equity interest. It is anticipated that the ability to offer equity is likely to increase the motivation and the performance of the management team. There is no current plan to sell either of the businesses to third parties.

Reasons for decision.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

A capital gain or capital loss made by A Co when it disposes of the units in Trust 3 will not be disregarded under section 125-155 of the ITAA 1997. A Co is not a demerging entity, as defined in subsection 125-70(7) of the ITAA 1997, as it does not (either alone or together with other members of the demerger group) dispose of any ownership interests in a demerging entity to the owners of ownership interests in the head entity of the demerger group.

Detailed reasoning

Subdivision 125-C of the ITAA 1997 allows members of a demerger group to disregard certain capital gains and capital losses that arise as a result of the demerger. Section 125-155 of the ITAA 1997 automatically disregards capital gains or capital losses that a demerging entity makes from CGT event A1, C2, C3 or K6 happening to its ownership interests in a demerged entity under a demerger where the conditions in Division 125 of the ITAA 1997 are satisfied.

A Co will disregard a capital gain arising from CGT event A1, C2, C3 or K6 happening when it transfers the units in Trust 3 to Trust 1 if it is a demerging entity, and the capital gain is from a CGT event happening to its ownership interests in a demerged entity under a demerger (section 125-155 of the ITAA 1997).

An entity is a 'demerging entity' if it satisfies one of the paragraphs specified in subsection 125-70(7) of the ITAA 1997.

To determine whether A Co is a demerging entity, it is necessary to determine the members of the demerger group, and in particular who will be the head entity of the demerger group.

Is there a demerger group?

A demerger group comprises the head entity of the group and one or more demerger subsidiaries (subsection 125-65(1) of the ITAA 1997).

Head entity

Subsection 125-65(3) of the ITAA 1997 states that:

A company or trust is the head entity of a demerger group if no other member of the group owns ownership interests in the company or trust.

For a company, an ownership interest includes a share in the company. For a trust, an ownership interest includes a unit or other interest in the trust (paragraphs 125-60(1)(a) and (b) of the ITAA 1997).

A trust cannot be a member of a demerger group unless CGT event E4 is capable of applying to all of the units and interests in the trust (subsection 125-65(2) of the ITAA 1997).

CGT event E4 happens under subsection 104-70(1) of the ITAA 1997 if:

§ the trustee of a trust makes a payment to you in respect of your unit or interest in the trust (except for CGT event A1, C2, E1, E2, E6 or E7 happening in relation to it), and

§ some or all of the payment (the non-assessable part) is not included in your assessable income.

As CGT event E4 is not capable of applying to all of the units and interests in Trust 2 it cannot be a member of a demerger group.

Trust 2 is therefore not eligible to be the head entity of the demerger group. This conclusion is in accordance with the note in subsection 125-65(2) of the ITAA 1997 which states that 'A discretionary trust cannot be a member of a demerger group'.

Trust 1 is the head entity of the demerger group for the purposes of subsection 125-65(3) of the ITAA 1997. Trust 1 is the head entity of the demerger group as CGT event E4 is capable of applying to all of the units and interests in Trust 1, no other entity in the group owns ownership interests in Trust 1, and no other member of the group meets the requirements to be a head entity (subsections 125-65(2) and (3) of the ITAA 1997).

Demerger subsidiary

Subsection 125-65(6) of the ITAA 1997 states that a company is a 'demerger subsidiary' of another company or a trust that is a member of a demerger group if the other company or the trust, either alone or together with other members of the group, owns, or has the right to acquire ownership interests in, the company that carry between them:

§ the right to receive more than 20% of any distribution of income or capital by the company, or

§ the right to exercise, or control the exercise of, more than 20% of the voting power of the company.

As A Co is a company and 100% owned by Trust 1 it will be a demerger subsidiary.

Subsection 125-65(7) of the ITAA 1997 states that a trust is a 'demerger subsidiary' of another trust or a company that is a member of a demerger group if the other trust or the company, either alone or together with other members of the group, owns, or has the right to acquire, ownership interests in the trust that carry between them the right to receive more than 20% of any distribution of income or capital by the trustee.

As Trust 3 is a trust and will be 100% owned by A Co it will also be a demerger subsidiary (subsection 125-65(7) of the ITAA 1997).

Similarly, as B Co and C Co are companies and will be 100% owned by Trust 3 they will be demerger subsidiaries (subsection 125-65(6) of the ITAA 1997).

Demerger group

Trust 1 will, therefore, be the head entity of a demerger group of at least one demerger subsidiary (A Co, Trust 3, B Co and C Co).

Will section 125-155 of the ITAA 1997 apply to disregard capital gain or capital loss made by A Co?

A Co will dispose of all its ownership interests (being units) in the Trust 3 to the head entity of the group (Trust 1). A Co will not dispose of ownership interests in another member of a demerger group to the owners of the head entity of the demerger group. It would be Trust 1 who would dispose of all the Trust 3 units to the owners of the head entity of the demerger group.

A Co is not a demerging entity for the purposes of section 125-155 of the ITAA 1997, as it does not come within the meaning of a 'demerging entity' in subsection 125-70(7) of the ITAA 1997.

Therefore, any capital gain or capital loss made by A Co on the disposal of its units in Trust 3 to Trust 1 will not be disregarded under section 125-155 of the ITAA 1997.

Question 2

Summary

It is expected that Trust 3, B Co and C Co will exit the consolidated group with substantial positive net assets for financial reporting purposes resulting in the group's allocable cost amounts (ACAs) for the leaving entities being positive amounts.

If the ACAs for the leaving entities are positive amounts CGT event L5 will not happen when they leave the consolidated group.

Detailed reasoning

Under section 104-520 of the ITAA 1997, CGT event L5 happens if:

§ an entity ceases to be a subsidiary member of a consolidated group or a MEC group; and

§ in working out the group's ACA for the entity, the amount remaining after applying step 4 of the table in section 711-20 of the ITAA 1997 is negative.

When the units in Trust 3 are disposed of, Trust 3, B Co and C Co will cease to be subsidiary members of the consolidated group.

The time of the CGT event L5 is when the entity ceases to be a subsidiary member of the group (subsection 104-520(2) of the ITAA 1997).

The head company makes a capital gain equal to the negative amount remaining after applying step 4 (subsection 104-520(3) of the ITAA 1997).

The first three steps in working out the ACA under subsection 711-20(1) of the ITAA 1997 concern the adding up of the terminating values of the assets that the leaving entity takes with it, to which is added the value of deductions inherited by the leaving entity (not reflected in the terminating value of the assets) and the liabilities owed by members of the group to the leaving entity at the leaving time.

Step 4 of the calculation under subsection 711-20(1) of the ITAA 1997 requires the subtraction of an amount worked out under section 711-45 of the ITAA 1997 from the result of the first three steps. Subsection 711-45(1) of the ITAA 1997 provides that:

For the purposes of step 4 in the table in subsection 711-20(1), the step 4 amount is worked out by adding up the amounts of each thing (an accounting liability) that, in accordance with the leaving entity's *accounting principles for tax cost setting, is a liability of the leaving entity just before the leaving time.

If the amount that remains after subtracting step 4 is positive, that amount will be the old group's ACA for the leaving entity.

The applicant is anticipating that the tax value of assets leaving with B Co and C Co will be significantly greater than the value of liabilities at the joining time. It is expected that Trust 3, B Co and C Co will exit the consolidated group with substantial positive net assets for financial reporting purposes resulting in the group's ACAs for the leaving entities being positive amounts.

If group's ACAs for all of the entities that cease to be subsidiary members of the consolidated group are positive after applying step 4 of the table in section 711-20 of the ITAA 1997, CGT event L5 will not happen.

Question 3

Summary

The dividend paid by A Co to Trust 1 when it transfers the units in Trust 3 is not a demerger dividend because it is not part of a demerger allocation.

As the dividend is not a demerger dividend, section 202-45 of the ITAA 1997 which provides that a demerger dividend is unfrankable will have no application.

Detailed reasoning

Is a dividend paid?

Subsection 6(1) of the ITAA 1936 defines a 'dividend' as including 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.

Under the restructure, A Co will make an in-specie distribution to Trust 1 consisting of the units in Trust 3. The dividend component amount of the in-specie distribution of units in Trust 3 will be debited to a profits reserve account of A Co, and the capital component will be debited to share capital. Consequently the in-specie distribution of the shares may be a dividend. The caveat being that subsection 44(1) of the ITAA 1936 requires a dividend to have been paid by the company out of profits in order for it to be assessable income of the recipient shareholder.

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) definition of a dividend).

The in-specie distribution made by A Co to Trust 1 will include a capital component that will be debited to share capital. As the capital reduction amount will be debited against an amount standing to the credit of A Co's share capital account (as that term is defined in section 6D of the ITAA 1936) it will not be a dividend as defined in subsection 6(1) of the ITAA 1936.

Therefore, as the capital reduction amount will not be a dividend it will not be included in the assessable income of the shareholder of A Co (being Trust 1) 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 in-specie distribution of the Trust 3 units will, in part, constitute a dividend for the A Co shareholder. The total amount of the dividend will be the market value of the units in Trust 3 at the time of the demerger less the amount debited to the share capital account of A Co.

The amount of a dividend in respect of a distribution of property (including shares held by the company in another company) to a shareholder in their capacity as a shareholder will be the money value of the property at the time it is distributed, reduced by the amount debited to a share capital account of the distributing company in respect of the distribution (see paragraph 6 of Taxation Ruling TR 2003/8).

Generally, a dividend satisfied by an in-specie 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).

The dividend component of the in-specie distribution of Trust 3 units will result in a debit to its pre CGT capital profits reserve account of A Co. To the extent that distribution is debited to the pre CGT capital profits reserve, it would be considered a distribution of profits and therefore a dividend for the purposes of subsection 6(1) of the ITAA 1936.

Is there a demerger dividend?

Central to the demerger dividend relief provisions are the concepts of 'demerger dividend' and 'demerger allocation'. These terms are defined in subsection 6(1) of the ITAA 1936.

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) of the ITAA 1936, or that would be so assessable but for subsections 44(3) and (4) of the ITAA 1936.

Where a restructure is undertaken by way of a disposal of ownership interests, a demerger allocation is 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 (paragraph (b) in subsection 6(1) of the ITAA 1936). The demerger allocation may consist of an otherwise assessable dividend component, a return of capital or a combination of capital and profit.

The dividend component of the in-specie distribution from A Co to Trust 1, comprising the units in Trust 3 is not a demerger dividend because it is not part of a demerger allocation. This is because they are not disposed of by A Co to the owner of the ownership interests in the head entity of a demerger group.

As the dividend is not a demerger dividend as defined in subsection 6(1) of the ITAA 1936, section 202-45 of the ITAA 1997, which provides that a demerger dividend is unfrankable, will have no application.

Question 4

Summary

It is not necessary to rule on this question as A Co is not the relevant taxpayer for the purpose of section 45B of the ITAA 1936.

Detailed reasoning

Section 45B - schemes to provide certain benefits

Section 45B of the ITAA 1936 applies to a scheme under which a taxpayer (referred to as the relevant taxpayer) obtains a tax benefit.

A Co has not been identified as the 'relevant taxpayer' for the purpose of section 45B of the ITAA 1936.