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Ruling

Subject: Demerger

Question 1

Can Company A as trustee for the A Family Trust choose to obtain roll-over relief under Subdivision 125-B of the Income Tax Assessment Act 1997 (ITAA 1997) upon the demerger of Company B by Company C?

Advice

Yes

Question 2

Can Company C disregard under section 125-155 of the ITAA 1997 any capital gain or capital loss arising from CGT event A1 happening to its ownership interests in Company B upon the demerger of Company B by Company C?

Advice

Yes

Question 3

Will the Commissioner confirm that all or any part of the distribution of Company B shares to Company C shareholders that is a dividend will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Advice

Yes.

Question 4

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

Advice

No

This ruling applies for the following period

Income year ended 30 June 2012

The scheme is proposed to commence

During the income year ended 30 June 2012

Relevant facts and circumstances

1. The scheme to which this ruling applies involves the transfer by Company C of its wholly owned subsidiary, Company B to the shareholders of Company C under a demerger.

Ownership interests

Company A acts as Trustee for the A Family Trust.

The issued share capital of Company A comprises ordinary shares.

The issued share capital of Company B comprises ordinary shares held wholly by Company C.

The issued share capital of Company C comprises ordinary shares held by Company A.

No family trust elections or interposed entity elections have been made under Schedule 2F to the ITAA 1936, as the shares in each of Company C and Company B were acquired by their current shareholders prior to May 1997.

Neither Company C nor Company B has issued any bonus shares, returned capital or paid any share premium in the past 5 years.

There has been no transfer of any amount to Company B's share capital account that resulted in it becoming tainted under section 197-50 of the ITAA 1997.

There are no ownership interests in Company C and Company B other than those outlined above. The ownership interests are ordinary shares with standard dividend and voting rights.

Demerger

Under the demerger Company C will make an in specie distribution of 100% of its ordinary shares in Company B to the shareholders of Company C.

Accounting for the scheme

In accounting for the proposed demerger, Company C will register in its books of account the current market value of Company B by debiting an amount to share capital and the remainder to the asset revaluation reserve.

Reasons for the demerger

It is commercially desirable for Company B to be separated from the Company C group for the following reasons:

a) Company B's business operations bear no relation to the business of Company C. Company B's potential exposure to claims by creditors is entirely different to the kind of exposure faced by Company C.

(b) Arrangements are in hand to expand the business of Company B. This will require expanded management capability, which is difficult to implement under the current corporate structure. A demerger of Company B is essential to improve the efficiency of both businesses while separating risk, and allowing management to expand both businesses in the most effective way.

c) Company C and Company B operate independently of each other with negligible sharing of resources or staffing. Company C does not currently provide financial support to Company B, and it is not anticipated that Company B will require financial support from Company C after the demerger occurs. Company C and Company B will not undertake any capital raising activities (that is, by the issue of equity interests) post demerger.

d) Overall, it is proposed that the demerger will facilitate the improved management of Company B as a stand-alone entity while enabling the development and expansion of Company C's business operations. For both entities, the proposed demerger will also facilitate the borrowing of funds, improve risk profiles, and simplify reporting and insurance requirements.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6.

Income Tax Assessment Act 1936 Section 44.

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 177A.

Income Tax Assessment Act 1936 Section 177D.

Income Tax Assessment Act 1997 Section 104-10.

Income Tax Assessment Act 1997 Division 110.

Income Tax Assessment Act 1997 Division 112.

Income Tax Assessment Act 1997 Division 125.

Income Tax Assessment Act 1997 Section 125-55.

Income Tax Assessment Act 1997 Section 125-65.

Income Tax Assessment Act 1997 Section 125-70.

Income Tax Assessment Act 1997 Section 125-80.

Income Tax Assessment Act 1997 Section 125-155.

Income Tax Assessment Act 1997 Section 197-50.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for Company B and others.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

Company A as trustee for the A Family Trust will be entitled to choose demerger rollover relief under Subdivision 125-B of the ITAA 1997 upon the demerger of Company B by Company C.

Detailed reasoning

In order for the demerger CGT outcomes contained in Division 125 of the ITAA 1997 to apply to a company or trust, 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 C as the head entity and includes Company B as a demerger subsidiary.

Company C will be the head entity because:

· no other member of the demerger group holds ownership interests in Company C (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 C could be a demerger subsidiary (subsection 125-65(4) of the ITAA 1997).

Company B will be a demerger subsidiary of Company C because Company C 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 C demerger group because:

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

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

· CGT event A1 will happen upon the disposal of shares in Company B. Company B shares will be acquired by Company C shareholders on the basis of their ownership of shares in Company C (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 Company C nor Company B are superannuation funds (paragraph125-70(1)(g) of the ITAA 1997);

· Company C shareholders will acquire Company B shares in the same proportion as they own Company C shares just before the demerger (paragraph 125-70(2)(a) of the ITAA 1997);

· each of the Company C shareholders will own shares in Company C and Company B that (just after the demerger) represent the same proportionate total market value as their Company C 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 C 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 is the demerged entity since the Company C shareholders receive shares in Company B under a demerger.

Company C 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 C is the demerging entity since it disposes of 100% of its shares in Company B to the Company C shareholders under a demerger.

Can the Company C 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 C shareholders satisfy this requirement;

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

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

Capital gains and cost base adjustments for Company C

If Company C chooses demerger roll-over:

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

If Company C does not choose demerger roll-over:

the first element of the cost base and reduced cost base of those Company B shares is calculated in accordance with the rules in Division 110 and 112 of the ITAA 1997 to be equal to their market value at the time of the demerger.

Question 2

Summary

Company C can disregard under section 125-155 of the ITAA 1997 any capital gain or capital loss arising from CGT event A1 happening to its ownership interests in Company B upon the demerger of Company B by Company C.

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 C is the demerging entity,

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

this disposal happens under a demerger.

Therefore, any capital gain or loss under CGT event A1 made by Company C on the disposal of its Company B shares under the demerger will be disregarded (section 125-155 of the ITAA 1997).

Question 3

Summary

Part of the distribution of Company B shares to Company C shareholders is a dividend that will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Detailed reasoning

Is a dividend paid under the demerger?

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).

As a capital reduction amount 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 C it will not be a dividend, as defined in subsection 6(1) of the ITAA 1936.

Therefore, the capital reduction amount will not be assessable income of the shareholders of Company C for the purposes of subsection 44(1) of the ITAA 1936.

Dividend

The definition of a dividend includes any amount distributed or credited by a company to any of its shareholders. Therefore, the distribution of the Company B shares will, in part, constitute a dividend of the Company C shareholders. The total amount of the dividend will be the market value of the Company B shares at the time of the demerger excluding the amount debited to the share capital account of Company C.

In general, a dividend satisfied by a distribution of property (such as shares in a subsidiary) will be a dividend paid out of profits derived if, immediately after the distribution of that property, the market value of the assets of the company exceed the total amount (as shown in the company's books of account) of its liabilities and share capital (see paragraph 8 of Taxation Ruling TR 2003/8).

However, a demerger dividend is taken not to have been paid out of profits and is neither an assessable income nor an exempt income amount (subsections 44(3) and (4) of the ITAA 1936) where:

· the dividend is a demerger dividend (as defined in subsection 6(1) of the ITAA 1936);

· the head entity does not elect that subsections 44(3) and (4) of the ITAA 1936 do not apply to the demerger dividend (subsection 44(2) of the ITAA 1936); and

· subsection 44(5) of the ITAA 1936 is satisfied.

In the present circumstances, the dividend paid to the Company C shareholders under the demerger would satisfy the conditions necessary to be a demerger dividend and would therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Question 4

Summary

If the scheme were to go ahead as proposed, the Commissioner would not make a determination under paragraphs 45B(3)(a) or 45B(3)(b) of the ITAA 1936 that sections 45BA or 45C of the ITAA 1936 applies to the whole, or part, of the 'demerger benefit' or 'capital benefit' provided under the proposed scheme.

Detailed reasoning

Subsection 45B(1) of the ITAA 1936 provides that the purpose of section 45B is to ensure that relevant amounts are treated as dividends for tax purposes if the capital and profit components of a demerger allocation do not reflect the circumstances of the demerger, or certain payments, allocations or distributions are made in substitution for dividends.

Subsection 45B(2) of the ITAA 1936 sets out the conditions that must be met in order for section 45B to apply. Relevantly, this section applies if:

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

Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) empowers the Commissioner to make a determination under either or both of section 45BA in relation to a demerger benefit and section 45C in relation to a capital benefit.

The effect of a determination made under paragraph 45B(3)(a) of the ITAA 1936 is that part or all of a demerger benefit will be treated as not being a demerger dividend (subsection 45BA(1) of the ITAA 1936).

The effect of a determination made under paragraph 45B(3)(b) of the ITAA 1936 is that part or all of a capital benefit will be an unfranked dividend paid to the relevant taxpayer out of profits (subsections 45C(1) and (2) 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 of the ITAA 1936. 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 transfer of shares in Company B to the Company C shareholders under the demerger constitutes the relevant scheme for the purposes of section 45B of the ITAA 1936.

Demerger benefit and capital benefit

The provision of ownership interests to a shareholder under a demerger constitutes the shareholder being provided with a demerger benefit (subsection 45B(4) of the ITAA 1936). Therefore, under the proposed scheme, the market value of the Company B shares provided to the shareholders of Company C constitutes a demerger benefit.

The provision of those Company B shares also constitutes a capital benefit to the extent it is not a demerger dividend (paragraph 45B(5)(a) and subsection 45B(6) of the ITAA 1936). As such, the market value of the Company B shares distributed under the demerger less the demerger dividend is a capital benefit provided to the Company C shareholders.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides, inter alia, that a relevant taxpayer 'obtains a tax benefit' if an amount of tax payable by that taxpayer would, apart from the operation of section 45B, be less than the amount that would have been payable if the 'demerger benefit' had been an assessable dividend or the capital benefit had been a dividend.

As a result of the demerger, the Company C shareholders would, apart from the operation of section 45B of the ITAA 1936, receive a demerger dividend equal to the market value of the shares in Company B at the time of the demerger less the amount debited to share capital that is neither assessable income nor exempt income. The tax payable by Company C shareholders on the demerger would be higher if the demerger benefit was an assessable dividend. Accordingly, Company C shareholders will obtain a tax benefit for the purposes of section 45B.

More than incidental purpose

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

The relevant circumstances include the tax and non-tax (i.e. business and other financial) implications of the scheme, the latter covered largely by the matters in paragraph 177D(b) of the ITAA 1936, which are included in subsection 45B(8) by virtue of paragraph (k).

In this case, the nature of the scheme indicates that the more pertinent circumstances are those covered by paragraphs (a), (b), (d), (i) and (k) of subsection 45B(8) of the ITAA 1936.

Paragraph 45B(8)(a) of the ITAA 1936 directs attention to the composition, as between share capital and profits (realised and unrealised), of the demerger benefit provided to the head entity's owners. If the composition of the demerger benefit is inconsistent with the substance (that is, the capital and profit it is attributable to) this would tend to a conclusion that the requisite purpose exists.

In the present case, the proposed demerger will result in a return of capital and any amount distributed in excess of this will be a demerger dividend sourced from retained earnings. It is accepted that this reasonably reflects the circumstances of the demerger.

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions made by a company or an associate of the company. In this case, there is nothing to suggest that the present distribution is in substitution for a dividend.

Paragraph 45B(8)(d) looks at the CGT status of the ownership interest in the head entity, and as a result of the demerger, the CGT status of the ownership interests in the demerged entity. In other words, the decision to deliver ownership interests under a demerger could be influenced by owners of the head entity receiving new pre-CGT interests.

As a direct result of the demerger scheme, Company C shareholders will receive pre-CGT interests in Company B, that, but for the demerger, would have a post-CGT status when held by Company B. Therefore, Company C shareholders will have the ability to dispose of their newly acquired pre-CGT interests in Company B, subject to the possible application of CGT event K6, free of tax. Even if CGT event K6 were triggered at the time of any disposal, the Company C shareholders would be able to access the 50% CGT discount.

The receipt of new pre-CGT ownership interests for the Company C shareholders would incline towards the requisite purpose.

Paragraph 45B(8)(i) of the ITAA 1936 directs attention to those cases where the scheme of demerger involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests; recognising that the proceeds on disposal of such ownership interests provide the equivalent of a cash dividend in a more tax-effective form. This proposed demerger scheme does not involve the later disposal of ownership interests.

45B(8)(k) Part IVA matters

The eight matters in paragraph 177D(b) of the ITAA 1936 constitute the essential facts and circumstances of a scheme, including the outcomes for the parties to the scheme, by reference to which the tax and non-tax objects of the scheme can be identified and contrasted from an objective point of view.

If, on the one hand, reference to the matters in paragraph 177D(b) reveal that the essential object of a demerger is to produce changes and improvements to the business structures of the corporate group, the tax free aspect of the transfer of ownership interests to the head entity's owners is more likely to be an incidental object of the demerger.

If on the other hand reference to those matters reveals that the transfer of ownership interests from the corporate group to the head entity's shareholders is an essential object of the scheme, the tax-free aspect of the transfer would ordinarily be a substantial object of the demerger.

As stated in paragraph 87 of PS LA 2005/21, an inquiry into the manner of the scheme is an objective inquiry as to the reasons for entering into it. In the context of the policy intent behind the demerger's measure, 'manner' is examinable from the perspective of the scheme being a business restructure. In considering section 45B of the ITAA 1936, it will be more likely to apply to a demerger where the decision to execute a restructure cannot be explained by reasons other than the tax-free distribution to shareholders.

Given the substantive commercial reasons for the demerger outlined in the application, it is considered that the essential object of the proposed demerger is to produce changes and improvements to the business structures of Company B and Company C. Therefore, the tax benefit that Company C shareholders would receive is an incidental object of the demerger. As a result, it is considered that the 'manner' of the scheme does not point toward there being a more than incidental purpose of obtaining the tax benefit.

Subparagraph 177D(b)(ii) of the ITAA 1936 refers to the form and substance of the scheme. The form of a scheme is the way it presents and the substance of a scheme is a reference to its essential nature which normally would be determined from the effects of the scheme on the commercial and economic circumstances of the parties involved in the scheme.

The commercial effects of the scheme post demerger on Company B and Company C are significant.

The proposed scheme takes the form of a demerger that accords with the steps that satisfy the definition of demerger in section 125-70 of the ITAA 1997. The substance of the scheme conforms to a business restructure which creates discrete, independent businesses capable of enhancing their purported efficiency.

Taking into account the matters referred to in subparagraphs 177D(b)(i) to (viii) of the ITAA 1936, it is considered that the tax free aspect of the transfer of ownership interests in Company B to the Company C shareholders is an incidental object of the demerger.

Conclusion - Subsection 45B(8)

Having regard to the 'relevant circumstances' of the proposed scheme, as set out in subsection 45B(8) of the ITAA 1936, it is considered that the proposed demerger is not being undertaken for the more than incidental purpose of obtaining a tax benefit.

Therefore, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or 45C of the ITAA 1936 will apply to the whole, or part, of the 'demerger benefit' or 'capital benefit' provided under the proposed scheme.