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Ruling

Subject: demerger

Question 1

Will the capital gain or capital loss under CGT event A1 or CGT event K6 that happens under the demerger of Trust 3 to Trust 2 be disregarded for Trust 1 under section 125-155 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the in-specie distribution which consists of units in Trust 3 established to hold the shares in B Co and C Co made by A Co to Trust 1, be a demerger dividend, which is non assessable non exempt income under subsections 44(3) to (5) of the Income Tax Assessment Act 1936 (ITAA 1936) to Trust 1?

Answer

No

Question 3

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA of the ITAA 1936 or section 45C of the ITAA 1936 will apply to Trust 1?

Answer

Trust 1 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.

Question 4

Will section 109RA of the ITAA 1936 apply to prevent the demerger dividend from being a dividend to which Division 7A of the ITAA 1936 applies to Trust 1 as the shareholder of A Co?

Answer

Not applicable.

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 Trust 3 is interposed between A Co and, B Co and C Co.

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. 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.

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

2. 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.

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

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

Reasons for the demerger

5. 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.

6. 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.

7. 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.

Question 1

Section 125-155 of the ITAA 1997

Summary

A capital gain or capital loss made by Trust 1 when it disposes of the units in Trust 3 will be disregarded under section 125-155 of the ITAA 1997.

Detailed reasoning

Subdivision 125-C allows members of a demerger group to disregard certain capital gains and losses that arise as a result of the demerger. Section 125-155 automatically disregards capital gains or 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.

Trust 1 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).

It is first necessary to determine who will be the members of the demerger group.

Is there a demerger group?

A demerger group comprises of 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).

As CGT event E4 is not capable of applying to all 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 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 (subsection 125-65(3) of the ITAA 1997).

Demerger subsidiary

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

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).

Is there a demerger?

A demerger happens to a demerger group if the conditions of subsection 125-70(1) of the ITAA 1997 (which incorporates the conditions of subsection 125-70(2)) are satisfied, and the exceptions in subsections 125-70(4) of the ITAA 1997 and 125-70(5) of the ITAA 1997 do not apply.

A demerger under section 125-70 of the ITAA 1997 will happen to the demerger group comprising Trust 1 (the head entity) and including demerger subsidiary members A Co, Trust 3, B Co and C Co.

Demerged entity

Trust 3 will be the demerged entity as Trust 1's unit holder (Trust 2) will acquire ownership interests in Trust 3 under the demerger (subsection 125-70(6) of the ITAA 1997).

Is Trust 1 a demerging entity?

A 'demerging entity' is defined in subsection 125-70(7) of the ITAA 1997 to include a member of the demerger group which (either alone or together with other members of the demerger group) disposes of at least 80% of its total ownership interests in another member of the demerger group to owners of the original interests in the head entity.

Trust 1, who is a member and head entity of the demerger group, will dispose of 100% of the units in Trust 3 to Trust 2 (the owner of the original interests in the head entity). Trust 1 is, therefore, a demerging entity as defined in subsection 125-70(7) of the ITAA 1997.

Will section 125-155 of the ITAA 1997 apply to disregard the capital gain or capital loss made by Trust 1?

Under section 125-155 of the ITAA 1997 any capital gain or capital loss a demerging entity makes from a 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.

When Trust 1 disposes of the units in Trust 3 to Trust 2 there will be a change of beneficial ownership such that a CGT event A1 will happen (section 104-10 of the ITAA 1997).

As Trust 1 is a demerging entity, any capital gain or capital loss it makes from CGT event A1 happening on the disposal of its units in Trust 3 to Trust 2 will be disregarded under section 125-155 of the ITAA 1997.

Question 2

Demerger dividend

Summary

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.

Detailed reasoning

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 because they are not disposed of by A Co to Trust 2 (the owner of the ownership interests in the head entity of a demerger group). As there are no such interests, there is no market value represented by such interests, and no demerger allocation.

As the dividend is not a demerger dividend, subsections 44(3) to (5) of the ITAA 1936 will not apply, and the dividend will be included in Trust 1's assessable income under subsection 44(1) of the ITAA 1936.

Question 3

Section 45B of the ITAA 1936

Summary

It is not necessary to rule on this question as Trust 1 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.

Trust 1 has not been identified as the 'relevant taxpayer' for the purpose of section 45B of the ITAA 1936.

Question 4

Section 109RA of Division 7A of the ITAA 1936

Summary

As the dividends paid by A Co to Trust 1 are not considered to be demerger dividends, section 109RA of the ITAA 1936 will have no application.

Detailed reasoning

Section 109RA of the ITAA 1936 states that Division 7A of the ITAA 1936 does not apply to demerger dividends to which section 45B of the ITAA 1936 does not apply.

As the dividends paid by A Co to Trust 1 are not considered to be demerger dividends, section 109RA of the ITAA 1936 will have no application.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-70

Income Tax Assessment Act 1997 Subdivision 125-C

Income Tax Assessment Act 1997 subsection 125-60(1)

Income Tax Assessment Act 1997 subsection 125-65(1)

Income Tax Assessment Act 1997 subsection 125-65(2)

Income Tax Assessment Act 1997 subsection 125-65(3)

Income Tax Assessment Act 1997 subsection 125-65(6)

Income Tax Assessment Act 1997 subsection 125-65(7)

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 subsection 125-70(7)

Income Tax Assessment Act 1997 section 125-155

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 subsection 44(2)

Income Tax Assessment Act 1936 subsections 44(3)

Income Tax Assessment Act 1936 subsections 44(4)

Income Tax Assessment Act 1936 Subsection 44(5)

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 Section 109RA