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Ruling

Subject: demerger

Question 1

Will Trust 2, the unit holder of Trust 1, be entitled to choose demerger rollover pursuant to section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the units in Trust 3 acquired by Trust 2 under the demerger be taken to be acquired before 20 September 1985 pursuant to subsection 125-80(5) of the ITAA 1997?

Answer

Yes.

Question 3

Will the trust distribution from Trust 1 to Trust 2, to the extent that it is a demerger dividend, not trigger a CGT event E4 under section 104-70 of the ITAA 1997 for Trust 2?

Answer

No.

Question 4

Will the trust distribution from Trust 1 to Trust 2, to the extent that it is a demerger dividend, retain its character and be non-assessable income under subsections 44(3) to (5) of the Income Tax Assessment Act 1936 (ITAA 1936) to Trust 2?

Answer

No.

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.

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.

d. Under the terms of the restructure 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.

5. The unit holders of Trust 2 will not receive any distribution under the proposed restructure.

Reasons for the demerger

6. 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.

7. 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.

8. 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

Question 1

Summary

Trust 2 will be entitled to choose demerger roll-over as the requirements in section 125-55 of the ITAA 1997 will be met.

Detailed reasoning

Division 125

Subdivision 125-B of the ITAA 1997 sets out the consequences for owners of interests in the head entity of the demerger group. The owners of the head entity can choose to obtain roll-over if a CGT event happens to their interests in a company or trust because of a demerger of an entity from the group of which the company or trust is the head entity.

You can choose to obtain roll-over relief under subsection 125-55(1) of the ITAA 1997 if:

§ you own an ownership interest in a company or trust

§ the company or trust is the head company of a demerger group

§ a demerger happens to the demerger group, and

§ under the demerger a CGT event happens to your original interest and you acquire a new or replacement interest in the demerged entity.

Trust 2 ownership interests

For a trust an ownership interest includes a unit or other interest in a trust (subsection 125-60(1) of the ITAA 1997). Trust 2 holds all of the units (ownership interests) in Trust 1.

Head entity of a demerger group

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.

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 (subsection 104-70(1) of the ITAA 1997) 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 will be 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 the trust, 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 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 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?

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

§ there will be a restructuring (paragraph 125-70(1)(a) of the ITAA 1997), and Trust 1 will dispose of at least 80% of its Trust 3 units to the owners of Trust 1 (subparagraph 125-70(1)(b)(i) of the ITAA 1997);

§ under the restructuring, CGT event C2 will happen to Trust 1 and Trust 2 will acquire new units in Trust 3 and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997);

§ CGT event A1 will happen upon the disposal of the Trust 3 units. Trust 3 units will be acquired by Trust 2 on the basis of their ownership of units in Trust 1 (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i) of the ITAA 1997);  

§ paragraph 125-70(1)(f) of the ITAA 1997 repealed;

§ neither Trust 1 or Trust 3 are superannuation funds (paragraph125-70(1)(g) of the ITAA 1997);

§ Trust 2 will acquire Trust 3 units in the same proportion as they own Trust 1 units just before the demerger (paragraph 125-70(2)(a) of the ITAA 1997);

§ Trust 2 will own units in Trust 1 and Trust 3 that (just after the demerger) represent the same proportionate total market value as their Trust 1 units 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 under the restructure (subsection 125-70(5) of the ITAA 1997).  

Can Trust 2 choose demerger rollover?

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

§ you own a unit in a trust- Trust 2 will satisfy this requirement;

§ a company or trust is the head entity of a demerger group - this requirement is satisfied;

§ a demerger happens to the demerger group - this requirement is satisfied; and

§ under the demerger a CGT event happens to the original interest (Trust 1 Units) and a new or replacement interest is acquired in the demerged entity - this requirement will be satisfied as CGT event C2 happens to the Trust 1 units when Trust 2 receives Trust 3 units under the demerger.

Trust 2 will be eligible to choose rollover under subsection 125-55(1) of the ITAA 1997.

Question 2

Detailed reasoning

Trust 2 acquired all of its units in Trust 1 (original interests) before 20 September 1985. If Trust 2 chooses the roll-over under section 125-55 of the ITAA 1997, then pursuant to the operation of subsections 125-80(4) and (5) of the ITAA 1997 it will be taken to have acquired the units in Trust 3 before 20 September 1985.

Question 3

Summary

The trust distribution to Trust 2 will not, to any extent, be a demerger dividend.

There will not, therefore, be a CGT event E4 in respect of a demerger dividend not included in the assessable income of Trust 2.

Detailed reasoning

CGT event E4 under section 104-70 of the ITAA 1997 happens if the trustee of a trust makes a payment to a beneficiary, in respect of their unit or interest in the trust, which is not included in the beneficiary's assessable income.

To the extent (if any) that income of Trust 2 was a demerger dividend it would not be included in assessable income of Trust 2 (section 44(4) of the ITAA 1936).

A demerger dividend is 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.

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.

The demerger allocation is, therefore, the total market value represented by the ownership interests (units in Trust 3) disposed of by Trust 1 to Trust 2. The demerger dividend would be that part of the 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.

No part of the trust distribution of the units in Trust 3 to Trust 2 is assessable as a dividend, or would be assessable as a dividend were it not for subsections 44(3) to (5) of the ITAA 1936. The character of the dividends in the hands of the trustee of Trust 1 is not retained when Trust 1 makes a trust distribution to Trust 2. The assessable income of Trust 2 will include, under section 97 of the ITAA 1936, an un-dissected proportionate share (in this case 100%) of the net income of the Trust 1 trust estate. No part of the allocation will be assessable as a dividend to Trust 2.

Question 4

Summary

No part of the demerger allocation, being the trust distribution of the units in Trust 3 to Trust 2, is a demerger dividend because no part of that allocation is assessable as a dividend under subsection 44(1) of the ITAA 1936 to Trust 2 (or would be assessable as a dividend under subsection 44(1) apart from subsections 44(3) and (4) of the ITAA 1936.

The dividend character of the distribution of the units in Trust 3 in the hands of the trustee of Trust 1 does not flow through to Trust 2 when the trust distribution is made.

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 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.

The demerger allocation is the total market value of the units in Trust 3 disposed of by Trust 1 to Trust 2.

A demerger dividend is 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.

No part of the trust distribution, comprising units in Trust 3, to Trust 2 is assessable as a dividend under subsection 44(1) of the ITAA 1936 (or would be assessable as a dividend were it not for subsections 44(3) to (5) of the ITAA 1936). The units are a trust distribution to Trust 2 and as such they are assessable to Trust 2 under section 97 of the ITAA 1936. The character of the dividends paid by A Co to Trust 1 is not retained when Trust 1 makes a trust distribution to Trust 2. When Trust 2 becomes presently entitled to the income of the Trust 1 trust estate, its assessable income will include, under section 97 of the ITAA 1936, an un-dissected proportionate share (in this case 100%) of the net income of the Trust 1 trust estate.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 subsection 104-70(1)

Income Tax Assessment Act 1997 section 125-55

Income Tax Assessment Act 1997 Section 125-155

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 subsection 125-70(1)

Income Tax Assessment Act 1997 paragraph 125-70(1)(a)

Income Tax Assessment Act 1997 subparagraph 125-70(1)(b)

Income Tax Assessment Act 1997 subsection 125-70(2)

Income Tax Assessment Act 1997 subsection 125-70(4)

Income Tax Assessment Act 1997 subsection 125-70(5)

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)