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Ruling

Subject: Proposed Demerger

Question 1

Will A Ltd have an obligation to withhold tax on any demerger dividend paid to non-residents under section 128B of the Income Tax Assessment Act 1996 (ITAA 1936)?

Answer

No

This ruling applies for the following period:

01 July 2011 to 30 June 2012

The scheme commences on:

01 July 2011

Question 2

Will A Ltd disregard any capital gain or capital loss from CGT event A1 happening on the disposal of its shares in B Ltd?

Answer

Yes

This ruling applies for the following period:

01 July 2011 to 30 June 2012

The scheme commences on:

01 July 2011

Relevant facts and circumstances

Relevant Entities

A Ltd

A Ltd is an Australian resident company listed on the ASX. A Ltd is also the head company of a consolidated tax group for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 (ITAA 1997).

A Ltd operates in two distinct business sectors.

A Ltd's share capital account is not tainted for the purposes of Division 197 of the ITAA 1997.

B Ltd

B Ltd is an Australian entity.

Shareholder profile

Resident shareholders, who are a mix of individuals, companies and superannuation funds, legally hold approximately 98% of the shares in A Ltd.

Non-resident shareholders own approximately 2% of the shares in A Ltd.

A Ltd has an employee share option plan and a number of employee share plans in place. The employees' entitlement may be adjusted on a no detriment basis.

Demerger transaction

The demerger of B Ltd from the A Ltd demerger group will be effected by a reduction in share capital of A Ltd and by payment of a demerger dividend that will be satisfied by an in specie distribution of all of the shares in B Ltd to A Ltd's shareholders.

The transfer will be done on a pro rata basis partly by way of dividend and partly by way of capital reduction. One share in B Ltd will be transferred to each A Ltd shareholder for every four A Ltd's shares that an A Ltd shareholder will hold at the record date.

Reasons for the demerger

A Ltd has advised that the key drivers for the demerger are:

§ A Ltd will be able to become a single-focus product company;

§ the A Ltd board of directors and management will be able to focus solely on one product business;

§ A Ltd will have the capacity to pursue growth opportunities in their industry; and

§ the Demerger will promote a positive market perception through the streamlining of business operations and constitutes a logical progression for B Ltd given the operating performance of their business offering potential for consolidation opportunities through acquisition or merger of compatible businesses.

Accounting for the distribution to effect the demerger

A Ltd will account for the distribution to effect the demerger by debiting its share capital by the capital reduction amount that will be determined by reference to the proportion of the relative market values of B Ltd and the A Ltd group.

The dividend amount will equal to the difference between the market value of B Ltd at the time of the demerger and the capital reduction amount. This amount will be debited to A Ltd's retained earnings.

Other matters

Just after the demerger, at least 50% of the market value of capital gains tax (CGT) assets owned by B Ltd or its subsidiaries will be used directly or indirectly in one or more businesses carried on by B Ltd or any of its subsidiaries.

Reasons for decision

Question 1

Will A Ltd have an obligation to withhold tax on any demerger dividend paid to non-residents under section 128B of the ITAA 1936?

Answer

No

Detailed reasoning

Dividends paid by a resident company to non-resident shareholders are generally subject to withholding tax under section 128B of the ITAA 1936 unless particular exclusions apply. Subsection 128B(3D) of the ITAA 1936 operates to exclude, as income subject to dividend withholding tax, a demerger dividend to which section 45B of the ITAA 1936 does not apply.

Is there a demerger dividend?

For a demerger to happen for the purposes of Division 125 of the ITAA 1997 there must be a demerger group comprising one head entity and at least one demerger subsidiary subsection 125-65(1) of the ITAA 1997. For the purposes of this scheme, the demerger group will include A Ltd as the head entity of the demerger group and B Ltd as a demerger subsidiary (TD 2004/48).

A Ltd will be the head entity of a demerger group because at the time of the restructure:

§ no other member of the demerger group will own any ownership interests in A Ltd (subsection 125-65(3) of the ITAA 1997); and

§ no other company or trust will be capable of being the head entity of a demerger group of which A Ltd could be a demerger subsidiary (subsection 125-65(4) of the ITAA 1997).

B Ltd will be a demerger subsidiary of A Ltd at the time of the restructure, because at that time, A Ltd will have the right to receive more than 20% of any distribution of income or capital by B Ltd. (paragraph 125-65(6)(a) of the ITAA 1997)

A demerger will happen for the purposes of section 125-70 of the ITAA 1997 to the A Ltd demerger group because:

§ There will be a restructuring under paragraph 125-70(1)(a) of the ITAA 1997 and at least 80% of the shares that A Ltd owns in B Ltd will be transferred to A Ltd's shareholders (subparagraph 125-70(1)(b)(i) of the ITAA 1997);

§ under the restructuring, CGT event G1 will happen to ordinary shares owned by A Ltd's shareholders who will receive nothing other than new shares in B Ltd (subparagraph 125-70(1)(c)(i) of the ITAA 1997);

§ A Ltd's shareholders will acquire shares in B Ltd under the restructure only because they are shareholders of A Ltd (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i) of the ITAA 1997);

§ at the time of the restructure, neither the shares in A Ltd nor B Ltd will be interests in a trust that is a superannuation fund within the meaning of that term in section 10 of the Superannuation Industry (Supervision) Act 1993 (paragraph 125-70(1)(g) of the ITAA 1997);

§ each A Ltd shareholder will acquire the same proportion of shares in B Ltd as the shares they owned in A Ltd just before the demerger, and just after the demerger each A Ltd shareholder will have the same proportionate total market value of A Ltd shares and B Ltd shares as they owned in A Ltd just before the demerger (subsections 125-70(2) and 125-70(3) of the ITAA 1997);

§ the restructure will not constitute an off-market share buy-back for the purposes of Division 16K of Part III of the ITAA 1936 (subsection 125-70(4) of the ITAA 1997); and

§ no other roll-over will be available outside of Division 125 of the ITAA 1997 for CGT event G1 that will happen to ordinary shares owned by A Ltd's shareholders (subsection 125-70(5) of the ITAA 1997).

Accordingly, the distribution of shares in B Ltd to A Ltd's shareholders will happen under a demerger and the dividend component paid will constitute a demerger dividend (section 125-70 of the ITAA1997).

Does section 45B apply to this demerger dividend?

Section 45B of the ITAA 1936

Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation purposes if:

(a) components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger; or

(b) certain payments, allocations and distributions are made in substitution for dividends (subsection 45B(1) of the ITAA 1936).

Where the requirements of subsection 45B(2) of the ITAA 1936 are met, paragraph 45B(3)(a) of the ITAA 1936 empowers the Commissioner to make a determination that section 45BA of the ITAA 1936 applies in relation to a demerger.

The effect of section 45BA applying to a demerger benefit is that the amount of the demerger benefit, or the part of the benefit, is taken not to be a demerger dividend.

Are the requirements of subsection 45B(2) satisfied?

Subsection 45B(2) of the ITAA 1936 provides that section 45B of the ITAA 1936 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.

Demerger benefit and Capital benefit

Subsection 45B(4) of the ITAA 1936 defines the phrase 'provided with a demerger benefit' as follow:

A person is provided with a demerger benefit if in relation to a demerger:

(a) a company provides the person with ownership interests in that or another company; or

(b) something is done in relation to an ownership interest owned by the person that has the effect of increasing the value of an ownership interest (which may or may not be the same ownership interest) owned by the person.

Subsection 45B(5) of the ITAA 1936 defines the phrase 'provided with a capital benefit' as follow:

A reference to a person being provided with a capital benefit is a reference to any of the following:

(a) the provision of ownership interests in a company to the person;

(b) the distribution to the person of share capital or share premium;

(c) something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) that is held by the person.

However, if the provision of interests, the distribution or the thing done involves the person receiving a 'demerger dividend' then, to that extent, it cannot be treated as a capital benefit (subsection 45B(6) of the ITAA 1936). In other words, to the extent that the provision of a demerger benefit is not a demerger dividend it will also constitute the provision of a capital benefit.

As A Ltd's shareholders will receive an ownership interest (shares) in B Ltd they will be "provided with a demerger benefit". Accordingly paragraph 45B(2)(a) is satisfied.

Tax benefit

The meaning of the phrase 'obtaining of a tax benefit' is defined in subsection 45B(9) of the ITAA 1936 as follow:

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 a dividend.

A Ltd's shareholders will obtain a tax benefit within the meaning of subsection 45B(9) of the ITAA 1936 due to the dividend exemptions and CGT roll-over relief provided for under the Demergers measure. The Demergers measure ensure that the owner of the head entity (here A Ltd's shareholders) is not subject to tax on the demerger benefit at the time of the demerger and thus subject to less tax than if it had been an assessable dividend. Therefore, paragraph 45B(2)(b) is satisfied.

A more than incidental purpose of enabling a taxpayer to obtain a tax benefit

Section 45B of the ITAA 1936 only applies if, 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 to obtain a tax benefit. In the majority of matters this will be the critical issue determining whether the provision applies or not.

As mentioned above, A Ltd's shareholders will obtain a tax benefit under the proposed demerger of B Ltd. However, whether it constitutes a more than incidental purpose of the scheme is determined objectively with regard to the relevant circumstances listed in subsection 45B(8).

Accordingly, having regard to the relevant circumstances of the scheme as set out in subsection 45B(8) of the ITAA 1936, it could not be concluded that any of the parties to the scheme entered into or carried out the scheme for a more than incidental purpose of enabling A Ltd's shareholders to obtain a tax benefit.

Therefore, the Commissioner will not make determination that section 45BA applies.

Will section 45C of the ITAA 1936 apply?

Where the requirements of subsection 45B(2) of the ITAA 1936 are met, paragraph 45B(3)(b) of the ITAA 1936 empowers the Commissioner to make a determination that section 45C of the ITAA 1936 applies in relation to a demerger.

In this case, while the conditions of paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 will be met (see the above), the requisite purpose of enabling A Ltd's shareholders to obtain a tax benefit (by way of a demerger benefit or a capital benefit) is not present.

Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the scheme to which this Ruling relates.

As a consequence, it is concluded that section 45B does not apply to the demerger dividend.

Will A Ltd have a withholding tax obligation?

Since section 45B will not apply to the demerger dividend in the present circumstances, subsection 128B(3D) will therefore apply to preclude the application of dividend withholding tax to the demerger dividend paid to A Ltd's non-resident shareholders under the demerger.

Question 2

Will A Ltd disregard any capital gain or capital loss from CGT event A1 happening on the disposal of its shares in B Ltd?

Answer

Yes

Detailed reasoning

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 (section 125-155 of the ITAA 1997).

CGT event A1 will happen when A Ltd disposes of its B Ltd's shares to A Ltd's shareholders.

For A Ltd to disregard any capital gain or capital loss made from CGT event A1 happening on the disposal of its shares in B Ltd:

§ the disposal must occur under a 'demerger' as defined under section 125-70 of the ITAA 1997;

§ A Ltd must be considered to be a 'demerging entity' as defined under subsection 125-70(7); and

§ B Ltd's shares that will be disposed of by A Ltd must represent A Ltd's ownership interests in a 'demerged entity' for the purposes of Division 125 of the ITAA 1997.

It was determined in the answer to Question 1 that the disposal of B Ltd's shares by A Ltd to A Ltd's shareholders happens under a demerger.

The ordinary shares in B Ltd are ownership interests within the meaning of that term in subsection 125-60(1) of the ITAA 1997.

In addition, B Ltd will be a 'demerged entity' at the time of the restructure within the meaning of that term in subsection 125-70(6) of the ITAA 1997. This is because it will be a former member of the A Ltd demerger group and B Ltd's shares will be acquired by the shareholders of A Ltd (as head entity of that group).

Is A Ltd the 'demerging entity'?

A 'demerging entity' is a member of a demerger group that disposes of at least 80% of its ownership interests in another member of the demerger group to owners of original interests in the head entity under a demerger (subsection 125-70(7) of the ITAA 1997).

A Ltd will be a 'demerging entity' because it will dispose of 100% of its existing B Ltd's shares to A Ltd's shareholders (subparagraph 125-70(7)(a)).

Accordingly any capital gain or capital loss from CGT event A1 happening on the disposal of B Ltd's shares to A Ltd's shareholders will be disregarded under section 125-155 of the ITAA 1997.