Edited version of private ruling

Authorisation Number: 1011919396845

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Ruling

Subject: Demerger of Company B by Company A

Question 1

Will the Commissioner of Taxation (the Commissioner) confirm that shareholder D will be entitled to choose demerger rollover relief pursuant to section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice

Yes

Question 2

Will the Commissioner confirm that all or any part of the in specie distribution of the Company B shares to shareholder D that is a dividend will constitute a demerger dividend, and therefore be non-assessable income of shareholder D for the purposes of subsections 44(3) and 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Advice

On the basis of the information provided in regard to the proposed demerger, the Company B shares shareholder D receives under the proposed demerger will not be a distribution of profits and therefore would not be included in their assessable income as a dividend under subsection 44(1) of the ITAA 1936. Further it will not be a demerger dividend as defined in subsection 6(1) of the ITAA 1936.

Question 3

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

Advice

Yes, however the Commissioner has answered this question on the basis that it is proposed that shareholder D will receive a capital benefit only on the proposed demerger.

Question 4

Will the Commissioner confirm that Division 7A of the ITAA 1936 will not apply to any distributions made under the demerger arrangement?

Advice

Yes

Facts

Overview:

The scheme that is the subject of this ruling involves the proposed demerger of Company B by Company A.

Company A

Company A is the head company of a consolidated group for tax purposes.

Company A has ordinary and 'A class' shares on issue.

Shareholder D is a Company A shareholder.

Shareholder D owns one A class share in Company A that was acquired after 19 September 1985.

Company B

Company B is a wholly-owned subsidiary of Company A.

At the time of the proposed demerger, Company B will have ordinary and A class shares on issue.

Proposed demerger of Company B by Company A

Pre-demerger restructuring

Company A proposes to undertake a restructure under which 100% of its shareholding in Company B will be distributed to the holders of ordinary and A class shares in Company A (Company A shareholders). Under the proposal, the owners of ordinary shares in Company A will receive ordinary shares in Company B (and nothing else) in the same proportion to their existing shareholding of ordinary shares in Company A. The owners of A class shares in Company A will receive A class shares in Company B (and nothing else) in the same proportion to their existing shareholding of A class shares in Company A.

Accounting for the distribution

In accounting for the proposed demerger, Company A will make a debit to its share capital account.

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 45C.

Income Tax Assessment Act 1936 Division 7A.

Income Tax Assessment Act 1936 Section 109L.

Income Tax Assessment Act 1936 Section 109C.

Income Tax Assessment Act 1936 Section 177D.

Income Tax Assessment Act 1936 Section 177F.

Income Tax Assessment Act 1997 Division 125.

Income Tax Assessment Act 1997 Section 125-60.

Income Tax Assessment Act 1997 Section 125-65.

Income Tax Assessment Act 1997 Section 125-70.

Reasons for decision

Question 1

Summary

Company A shareholders will be entitled to choose demerger rollover relief pursuant to section 125-55 of the ITAA 1997.

Detailed reasoning

In order for the demerger CGT outcomes contained in Division 125 of the ITAA 1997 to apply to shareholders and members of a company group, 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).

Demerger Group

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 comprises Company A as the head entity and includes Company B as a demerger subsidiary.

Company A will be the head entity because:

· no other member of the Company A Group holds ownership interests in Company A (subsection 125-65(3) of the ITAA 1997); and

· there will be 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) of the ITAA 1997).

Company B will be a demerger subsidiary of Company A because Company A owns ownership interests in Company B that carry 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).

Demerger

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

· there will be a restructuring (paragraph 125-70(1)(a) of the ITAA 1997), and Company A will dispose of at least 80% of its Company B shares to the owners of Company A (subparagraph 125-70(1)(b)(i) of the ITAA 1997);

· under the restructuring, CGT event G1 will happen to Company A shares and Company A shareholders will acquire new shares in Company B and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997);

· Company B shares will be acquired by 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) of the ITAA 1997);  

· neither Company A nor Company B are superannuation funds (paragraph125-70(1)(g) of the ITAA 1997);

· The owners of ordinary shares in Company A will acquire ordinary shares in Company B in the same proportion as the ordinary shares that they owned in Company A just before the demerger. The owners of A class shares in Company A will acquire A class shares in Company B in the same proportion to the A class shares that they owned in Company A just before the demerger (paragraph 125-70(2)(a) of the ITAA 1997);

· each of the Company A shareholders will 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) of the ITAA 1997);

· under the scheme, there will be no buy-back of shares for the purposes of Division 16K of Part III of the ITAA 1936 (subsection 125-70(4) of the ITAA 1997); and

· there will be no rollover available under another provision for any CGT events that happen to the Company A shares under the restructure (subsection 125-70(5) of the ITAA 1997).  

Company B is the demerged entity 

Relevantly, subsection 125-70(6) of the ITAA 1997 defines a demerged entity to be a former member of a demerger group in which ownership interests are acquired by shareholders of the head entity under a demerger.

In the present circumstances, Company B will be the demerged entity since the Company A shareholders will receive shares in Company B under a demerger.

Company A is the demerging entity

Relevantly, subsection 125-70(7) of the ITAA 1997 defines a demerging entity to be a member of a demerger group who disposes of at least 80% of its total ownership interests in another member of the demerger group to owners of original interests in the head entity under a demerger.

In the present circumstances, Company A will be the demerging entity since it will dispose of more than 80% of its shares in Company B to the Company A shareholders under a demerger.

Can the Company A shareholders choose demerger rollover?

Subsection 125-55(1) of the ITAA 1997 relevantly provides that demerger rollover may be chosen if:

· a shareholder owns a share in a company - the Company A shareholders will satisfy this requirement;

· the company is the head entity of a demerger group - this requirement will be satisfied;

· a demerger happens to the demerger group - this requirement will be satisfied; and

· under the demerger a CGT event happens to the original interest (Company A shares) and a new or replacement interest is acquired in the demerged entity - this requirement will be satisfied as CGT event G1 will happen to the Company A shares when the Company A shareholders receive Company B shares under the demerger.

Therefore Company A shareholders will be eligible to choose rollover under subsection 125-55(1) of the ITAA 1997.

Capital gains and cost base adjustments for shareholder D

If shareholder D chooses demerger roll-over:

· they will disregard any capital gain made in respect of CGT event G1 that happens to their Company A shares (subsection 125-80(1) of the ITAA 1997);

· the first element of the cost base and reduced cost base of shareholder D's Company A share and the corresponding Company B share shareholder D acquires under the demerger, will be the sum of their original cost bases (just before the demerger) of the Company A shares, apportioned over those Company A and Company B shares on a reasonable basis having regard to the market values (just after the demerger) of the Company A shares and Company B shares, or a reasonable approximation of those market values (subsections 125-80(2) and (3) of the ITAA 1997).

If shareholder D does not choose demerger roll-over:

· they will not be entitled to disregard any capital gain made in respect of CGT event G1 that happens to their Company A share under the demerger;

· the cost base and reduced cost base of the Company A share and Company B share will be calculated in the same manner set out in the preceding paragraph.

Question 2

Summary

The distribution of Company B shares that shareholder D will receive under the proposed scheme will not be a demerger dividend that is neither assessable income nor exempt income for the purposes of subsections 44(3) and 44(4) of the ITAA 1936.

Detailed reasoning

A demerger dividend, as defined under subsection 6(1) of the ITAA 1936, means 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 apart from subsections 44(3) and (4) of the ITAA 1936.

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).

Given the capital reduction amount in this case will be debited against an amount standing to the credit of the share capital account (as that term is defined in section 6D of the ITAA 1936) of Company A, it will not be a dividend as defined in section 6(1) of the ITAA 1936.

Accordingly there is no dividend that arises to shareholder D under the proposed demerger that can be included in their assessable income for the purposes of subsection 44(1) of the ITAA 1936.

Question 3

Summary

The Commissioner would not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the capital benefit received by the Company A shareholders under the proposed demerger.

Detailed reasoning

Section 45B of the ITAA 1936 applies where certain capital payments are made to shareholders in substitution for dividends. Specifically, the provision applies where:

· there is a scheme under which a person is provided with a 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 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).

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. 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 following features are considered to constitute the relevant scheme for the purposes of section 45B of the ITAA 1936:

· the transfer of shares in Company B to Company A shareholders under the demerger.

Tax benefit

The distribution under the proposed demerger provides Company A shareholders with a capital benefit (as defined in subsection 45B(5) of the ITAA 1936) as they would generally pay less tax on the payments received under the proposed demerger than they would on an equivalent amount of dividend (a 'tax benefit' as defined in subsection 45B(9)).

More than incidental purpose

Given that the proposed demerger is a scheme that provides a tax benefit to Company A shareholders, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c) of the ITAA 1936. 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.

Having regard to the relevant circumstances of the scheme, as listed under subsection 45B(8) of the ITAA 1936, it is considered that the return of capital provided to Company A shareholders under the proposed demerger is attributable to a percentage of the paid up capital in the accounts of Company A rather than its profits. Furthermore the pattern of distributions by Company A does not indicate that the return of capital is being made in substitution of dividends.

Accordingly, the Commissioner would not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the capital benefit provided to Company A shareholders under the proposed demerger.

Question 4

Summary

Division 7A of the ITAA 1936 will not apply to the distributions made under the proposed demerger.

Detailed reasoning

Subsection 109L(2) of the ITAA 1936 would exclude any part of the payment (being the distribution of shares) from being a dividend for the purpose of 109C of the ITAA 1936.

Subsection 109L(2) of the ITAA 1936 provides that a private company is taken to not have paid a dividend under section 109C or 109D where another provision of the Act has the effect of it not being included in assessable income.

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).