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Ruling

Subject: Capital gains tax - consolidation and demerger

Question 1

Will the Commissioner confirm that the shares held in Company D by the rulee are pre-CGT and post-CGT assets in the proportions as claimed?

Answer

Yes

Question 2

Will the Commissioner confirm that there are no tax consequences for the rulee if the shares in Company D are transferred to Company B within the rulee's tax consolidated group under section 701-1 of the Income Tax Assessment Act 1997( ITAA 1997)?

Answer

Yes.

Question 3

Will the Commissioner confirm that the proposed demerger satisfies the requirements for demerger roll-over relief under Division 125 of the TAA 1997?

Answer

Yes.

Question 4

Will the Commissioner confirm that any capital gain or loss arising to the rulee under CGT event A1 is disregarded under section 125-155 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Financial year ending 30 June 2012

Financial year ending 30 June 2013

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The rulee is Company A, which is incorporated in Australia.

Company A issued its initial shares to the sole shareholder, Mr X after 19 September 1985. Some further Company A shares were issued to the shareholder in exchange for his shares in Company D.

Of the shares held in Company D, a substantial proportion are pre-CGT by reason of:

§ earlier rollovers under repealed section 160ZZN (now archived) of the Income Tax Assessment Act 1936 (ITAA 1936), and

§ bonus issues relating to the pre-CGT shares

The applicant has provided the written elections made by Mr X under section 160ZZN. The remaining shares in Company D are post CGT shares.

Background to the demerger

Company A is considering the potential demerger of its interests in Company D by the following steps:

§ incorporating a new company (Company B Pty Ltd) which will be a wholly owned subsidiary of Company A

§ Company A will elect to form a consolidated group

§ Company A will transfer its Company D shares to Company B in exchange for the issue of shares in Company B

§ Company B will be demerged from Company A by way of an in specie distribution of the Company B shares to Mr X

§ The distribution to Mr X will be treated as partly a return of capital and partly as a dividend.

Rationale for the demerger

The purposes of the restructure are to split the Company A assets into two separate groups, legal separation of interests will allow the individual business needs to be pursued without the cross-referencing of risk, financial performance differences and exposure to very different markets and market conditions.

The rationale for Company B is predominantly to ensure that the investment in Company D remains held in corporate form rather than by Mr X personally, for asset protection reasons.

In addition, as a new holding company, Company B may be more attractive to potential investors

Background to Company D

Company D was incorporated in Australia after 19 September 1985. Initially, 100% of the shares in Company D were beneficially held by Mr X.

Subsequently, and at various times Company D issued Mr X with additional shares:

§ in exchange for pre-CGT shares held by Mr X. (The shareholder chose the roll-over in repealed section 160ZZN of the ITAA 1936in relation to those transfers).

§ as bonus shares, and

§ as a split under section 193 of the Corporations Law.

Company D allotted further shares to third parties at various times.

Accounting entries

The amount debited to the share capital account of Company A will be calculated by the proportion of the market value of the Company B shares compared to the market value of Company A. The remaining value of the Company B shares distributed will be a dividend.

The amount debited to the retained earnings account will be the balance between Company A's carrying value of Company D and the amount debited to the share capital account.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 160ZZN,

Income Tax Assessment Act 1997 section 125-65,

Income Tax Assessment Act 1997 section 125-70,

Income Tax Assessment Act 1997 section 701-1,

Income Tax Assessment Act 1997 section 703-5,

Income Tax Assessment Act 1997 section 703-10,

Income Tax Assessment Act 1997 section 703-15,

Income Tax Assessment Act 1997 section 703-20 and

Income Tax (Transitional provisions) Act 1997 subsection 102-5(1).

Reasons for decision

Note: the former section 160ZZN of the ITAA 1936 is now archived, and was rewritten as Subdivision 122-A of the ITAA 1997 with effect from the 1998-99 financial year.

Question 1

Will the Commissioner confirm that the shares held in Company D by the rulee are pre-CGT and post-CGT assets in the proportions as claimed?

Company D Shares

Mr X elected for roll-over relief under section 160ZZN of the ITAA 1936 in respect of the disposal of the various shares which had been acquired by the rulee prior to 20 September 1985, and which had been transferred to Company D in exchange for Company D shares.

160ZZN roll-over

Section 160ZZN of the ITAA 1936 provided for a roll-over in years prior to the 1998­99 financial year, where certain conditions were met as were contained in subsection 160ZZN(2) of the ITAA 1936. The conditions that are relevant to this case are:

§ An individual taxpayer who is a resident of Australia, disposes of an asset (a roll-over asset) to a company that is a resident of Australia, and

§ Receives as consideration only non-redeemable shares in the company, and

§ The market value of the share is substantially the same as the market value of the roll-over asset, and

§ Immediately after the disposal the taxpayer is the beneficial owner of all the shares in the company, and

§ The roll-over asset is not trading stock of the company immediately after the disposal, and

§ The taxpayer makes a written election to apply this subsection.

As all of the above conditions were satisfied, Mr X was eligible and did choose the roll-over under section 160ZZN of the ITAA 1936 at various times.

Consequences of the roll-over for the shareholder

Paragraph 160ZZN(7)(a) of the ITAA 1936 provided that the shares issued in consideration for the disposal of the roll-over asset will be taken to have been acquired before 20 September 1985 (pre-CGT) if the roll-over asset was acquired before that date.

Paragraph 160ZZN(7)(b) of the ITAA 1936 provided the rules for working out the cost base of those shares that were post-CGT. However under subsection 102-5(1) of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997), you work out a cost base of the asset by applying the new law to circumstances that occurred before the 1998-99 financial year.

Consequently a substantial portion of the Company D shares held beneficially by Mr X were taken to be pre-CGT. A number of Company D shares were post-CGT.

Consequences of the roll-over for Company D

Paragraph 160ZZN(2)(e) of the ITAA 1936 provided that roll-over assets that are pre-CGT are taken to be pre-CGT when transferred to the company.

Consequently, the shares transferred to Company D were taken to be a mixture of both pre and post-CGT shares.

Further Company D share issues

At a later time, Company D issued a number of bonus shares for every share held. The bonus share issue was paid wholly out of the share premium account of Company D.

If no part of the bonus shares issue was a dividend or taken to be a dividend, then to the extent of the bonus shares issued in respect of pre-CGT shares, those bonus shares will be pre-CGT.

Of the Company D shares held by Mr X that were pre-CGT, then the bonus shares issued in respect of the pre-CGT shares are also pre-CGT.

The remaining bonus shares are post-CGT.

Company D issued further shares to Mr X in respect of further roll-overs under section 160ZZN of the ITAA 1936 for shares acquired by Mr X after 19^th September 1985.

Subsequently Company D subdivided the shares into a larger number of shares in accordance with section 193 of the Corporations Law (Corp Law) at the time.

Taxation Determination TD 95/30 (now withdrawn) states that the subdivision of shares in accordance with section 193 of the Corp Law does not constitute a disposal by the shareholder for capital gains tax purposes. In addition, paragraph 2 of TD 95/30 states:

The subdivided or consolidated shares have the same date of acquisition as the original shares to which they relate. For example, if the original shares were acquired pre-CGT, the subdivided or consolidated shares also have a pre-CGT status.

Company A

At a later time Mr X transferred all of the ordinary Company D shares to Company A in exchange for ordinary shares issued to Mr X.

Mr X elected for roll-over relief under section 160ZZN of the ITAA 1936 in respect of the transfer of the Company D shares.

Under paragraph 160ZZN(2)(e) of the ITAA 1936, those Company D shares that were pre-CGT in the hands of Mr X, are taken to be pre-CGT when acquired by Company A.

For those Company D shares that were acquired by Mr X on or after 20 September 1985, Company A will have acquired them for their indexed cost base in the hands of Mr X on that later date (paragraph 160ZZN(2)(f) of the ITAA 1936, as affected by subsection 102-5(1) of the ITTPA 1997).

Of the Company D shares (the roll-over asset) that were taken to have been acquired by Company A before 20 September 1985, then the same proportion of Company A shares issued as consideration for the transfer, are also taken to have been acquired by Mr X before that date.

Question 2

Will the Commissioner confirm that there are no tax consequences for the rulee if the shares in Company D are transferred to Company B within the rulee's tax consolidated group under section 701-1 of the Income Tax Assessment Act 1997( ITAA 1997)?

Consolidated groups

Paragraph 703-5(1)(a) of the ITAA 1997 provides that a consolidated group comes into existence on the day specified in a choice made by a company under section 703-50 of the ITAA 1997.

A 'consolidatable group' has the meaning given by section 703-10 of the ITAA 1997 which says that a consolidatable group consists of a single head company and all the subsidiary members of the group. A consolidatable group cannot consist of a head company alone.

In addition, a head company and a subsidiary company must meet the requirements in the table in subsection 703-15(2) of the ITAA 1997 and not be excluded by any of the items in the table in subsection 703-20(2) of the ITAA 1997.

Is Company A a head company of a consolidatable group?

Company A meets the requirements of item 1 in the table in subsection 703-15(2) of the ITAA 1997 and is not one of those excluded entities listed in subsection 703-20(2) of the ITAA 1997.

Is Company B a subsidiary member of a consolidatable group?

Company B meets the requirements of item 2 in the table in subsection 703-15(2) of the ITAA 1997 and it is not excluded by any of the items in subsection 703-20(2) of the ITAA 1997. 

In this case Company A may make a choice to form a consolidated group with Company B in accordance with sections 703-5 and 703-50 of the ITAA 1997.

Single entity rule

The single entity rule in section 701-1 of the ITAA 1997 deems subsidiary members to be parts of the head company rather than separate entities during the period that they are members of the consolidated group.

Taxation Ruling TR 2004/11 states that dealings that are solely between members of the same consolidated group (intra-group dealings) will not result in ordinary or statutory income or a deduction to the group's head company.

Paragraph 9 of TR 2004/11 states:

An example of an intra-group dealing is the transfer of a capital gains tax (CGT) asset from one group member to another. This transfer is not treated for income tax purposes as a disposal or acquisition in the hands of the head company. Although the legal transfer of the CGT asset between the subsidiary members occurs at general law, it has no income tax consequences as the group's head company is taken to be the owner of the asset both before and after the transfer.

It is intended that Company A will make a choice to form a consolidated group with Company B, and subsequently transfer the Company D shares to Company B.

In this situation the disposal of the Company D shares will have no capital gains tax consequences for Company A under the single entity rule in section 701-1 of the ITAA 1997.

Question 3

Will the Commissioner confirm that the proposed demerger satisfies the requirements for demerger roll-over relief under Division 125 of the TAA 1997?

Demerger provisions in Division 125 of the ITAA 1997

In order for the demerger capital gains tax (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).

The 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 the demerger subsidiary.

Company A satisfies the definition of the head entity of a demerger group because:

(a) Company B does not have any ownership interests in it (subsection 125-65(3) of the ITAA 1997); and

(b) there is no other entity capable of being the 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 the demerger subsidiary of Company A because it is proposed that Company A will own shares in Company B that carry the right to receive more than 20% of any distribution of income and capital, and the right to exercise more than 20% of the voting power (subsection 125-65(6) of the ITAA 1997).

A demerger happens

Subsection 125-70(1) of the ITAA 1997 provides a number of conditions that must be satisfied in order for a demerger to happen to a demerger group.

In the case of the Company A demerger group, a demerger happens for the purposes of subsection 125-70(1) of the ITAA 1997 because the following conditions will be satisfied.

A restructure happens

There will be a restructuring (paragraph 125-70(1)(a) of the ITAA 1997), under which Company A will dispose of 100% of the shares it owns in Company B to its shareholder (subparagraph 125-70(1)(b)(i) of the ITAA 1997).

Under the restructure, the Company A shareholder (Mr X) will acquire new shares in Company B and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997).

Company A shareholder

The shares in Company B will be distributed to Mr X on the basis of his ownership of shares in Company A (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i) of the ITAA 1997).

Just before the restructure, Mr X is an Australian resident and he beneficially owned all of the shares in Company A.

Neither the original interests that Mr X holds in Company A or the new interests he will receive in Company B will be interests in trusts that are superannuation funds within the meaning of that term under section 10 of the Superannuation Industry (Supervision) Act 1993 (paragraph125-70(1)(g) of the ITAA 1997).

Proportionate distribution of demerged entity shares

The number of Company B shares received by Mr X will be in direct proportion to the number of shares he owns in Company A just before the demerger happens (paragraph 125-70(2)(a) of the ITAA 1997).

Just after the demerger, Mr X will own the same proportionate total market value of shares in Company B as he held in Company A just before the demerger (paragraph 125-70(2)(b) of the ITAA 1997).

Not a buy-back and no other rollover available

The demerger does not constitute a 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

No rollover will be available under another provision for any CGT events occurring to the Company A shares as a result of the restructure scheme (subsection 125-70(5) of the ITAA 1997).

Company B is the demerged entity

Subsection 125-70(6) of the ITAA 1997 defines a demerged entity as being 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 shareholder will receive shares in this entity, which were formerly held by Company A, under the demerger.

Company A is the demerging entity

Taxation Determination TD 2004/48 confirms that the head company of the consolidated group can satisfy the requirements of a demerging entity in subsection 125-70(7) of the ITAA 1997.

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.

Company A will dispose of 100% of its shares in Company B directly to its shareholder (Mr X) under the demerger, Company A qualifies as the demerging entity for the purposes of subsection 125-70(7) of the ITAA 1997.

Question 4

Will the Commissioner confirm that any capital gain or loss arising to the rulee under CGT event A1 is disregarded under section 125-155 of the ITAA 1997?

Detailed reasoning

Section 125-155 of the ITAA 1997 provides that a demerging entity may ignore capital gains or capital losses arising from certain CGT events (including CGT event A1) happening to its ownership interests in a demerged entity under a demerger.

In the present case:

§ Company A is the demerging entity,

§ CGT event A1 will happen when Company A disposes of its shares in Company B and transfers them to the Company A shareholder, Mr X (per section 104-10 of the ITAA 1997), and

§ this disposal happens under a demerger.

As a consequence, any capital gain or loss arising from CGT event A1 to Company A on the disposal of its Company B shares that were acquired on or after 20 September 1985 (post-CGT shares) under the demerger will be disregarded (section 125-155 of the ITAA 1997).