Edited version of your private ruling

Authorisation Number: 1012485145659

Ruling

Subject: Demerger

Question 1

Will the transfer of shares in Company Y to Shareholder B satisfy the requirements of Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997) such that Shareholder B can choose a demerger roll-over under section 125-55 of the ITAA 1997?

Answer

Yes

Question 2

Will any dividends paid to Shareholder B under the scheme be demerger dividends that are neither assessable income nor exempt income, pursuant to subsections 44(3) and 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 3

Will the Commissioner make a determination under paragraph 45B(3)(a) or 45B(3)(b) of the ITAA 1936 that section 45BA or 45C of the ITAA 1936 applies to the whole, or any part, of any benefit provided to Shareholder B under the demerger?

Answer

No

This ruling applies for the following periods:

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Overview

The scheme that is the subject of this ruling involves the proposed demerger of Company Y by Company X.

Company X

Company X is the head company of a consolidated group for tax purposes.

Company X has four different classes of shares on issue.

Shareholder B owns a B class share in Company X that was acquired before 20 September 1985.

Company Y

Company Y is a wholly-owned subsidiary of Company X

At the time of the proposed demerger, Company Y's share structure will mirror those of Company X.

All of the shares currently on issue in Company Y are post-CGT.

Proposed demerger of Company Y from Company X

Company X proposed to undertake a restructure under which 100% of its shareholding in Company Y will be distributed to the holders of shares in Company X (Company X Shareholders).

Under the proposal, the owners of shares in Company X will receive shares in Company Y (and nothing else) in the same proportion to their existing shareholding of ordinary and other classes of shares in Company Y.

Accounting for the proposed demerger

The dividend and return of capital will be satisfied by an in-specie transfer of all of the shares in Company Y to the Company X Shareholders.

The dividend will be debited to the retained profits of Company X.

The return of capital will be debited to the share capital account of Company X.

Each account will be debited for an amount equal to the proportion of the market value of Company Y to the market value of Company X multiplied by the balance of the relevant account.

Under the proposed transaction, each of the Company X Shareholders will receive shares in Company Y in proportion to the market value of their current shareholdings in Company X, as determined by an independent market valuation prepared at the time of the demerger.

Reasons for the proposed demerger

Reasons for the proposed demerger include:

· Attracting equity investors to raise capital;

· Implementing an employee share scheme, and

· Separating the distinct groups to enable increased efficiency and overall improvements.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-135(5)

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 subsection 125-55(1)

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

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

Income Tax Assessment Act 1997 subsection 125-65(4)

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

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)(i)

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

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

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

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

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

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

Income Tax Assessment Act 1997 paragraph 125-70(2)(a)

Income Tax Assessment Act 1997 paragraph 125-70(2)(b)

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

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

Income Tax Assessment Act 1997 subsection 125-70(6)

Income Tax Assessment Act 1997 paragraph 125-70(6)(a)

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

Income Tax Assessment Act 1997 paragraph 125-70(7)(a)

Income Tax Assessment Act 1997 subsection 125-80(2)

Income Tax Assessment Act 1997 subsection 125-80(3)

Income Tax Assessment Act 1997 subsection 125-80(5)

Income Tax Assessment Act 1936 Division 16K of Part III

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 6(1)(d)

Income Tax Assessment Act 1936 section 6(D)

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 subsection 44(2)

Income Tax Assessment Act 1936 subsection 44(3)

Income Tax Assessment Act 1936 subsection 44(4)

Income Tax Assessment Act 1936 subsection 44(5)

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 subsection 45B(1)

Income Tax Assessment Act 1936 subsection 45B(2)

Income Tax Assessment Act 1936 paragraph 45B(2)(a)

Income Tax Assessment Act 1936 paragraph 45B(2)(b)

Income Tax Assessment Act 1936 paragraph 45B(2)(c)

Income Tax Assessment Act 1936 subsection 45B(3)

Income Tax Assessment Act 1936 paragraph 45B(3)(a)

Income Tax Assessment Act 1936 paragraph 45B(3)(b)

Income Tax Assessment Act 1936 subsection 45B(4)

Income Tax Assessment Act 1936 paragraph 45B(5)(a)

Income Tax Assessment Act 1936 subsection 45B(6)

Income Tax Assessment Act 1936 subsection 45B(8)

Income Tax Assessment Act 1936 paragraph 45B(8)(a)

Income Tax Assessment Act 1936 paragraph 45B(8)(b)

Income Tax Assessment Act 1936 paragraph 45B(8)(c)

Income Tax Assessment Act 1936 paragraph 45B(8)(d)

Income Tax Assessment Act 1936 paragraph 45B(8)(e)

Income Tax Assessment Act 1936 paragraph 45B(8)(f)

Income Tax Assessment Act 1936 paragraph 45B(8)(g)

Income Tax Assessment Act 1936 paragraph 45B(8)(h)

Income Tax Assessment Act 1936 paragraph 45B(8)(i)

Income Tax Assessment Act 1936 paragraph 45B(8)(j)

Income Tax Assessment Act 1936 paragraph 45B(8)(k)

Income Tax Assessment Act 1936 subsection 45B(9)

Income Tax Assessment Act 1936 section 45BA

Income Tax Assessment Act 1936 subsection 45BA(1)

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 subsection 45C(1)

Income Tax Assessment Act 1936 subsection 45C(2)

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 paragraph 177D(b)

Income Tax Assessment Act 1936 subparagraph 177D(b)(i)

Income Tax Assessment Act 1936 subparagraph 177D(b)(ii)

Income Tax Assessment Act 1936 subparagraph 177D(b)(iii)

Income Tax Assessment Act 1936 subparagraph 177D(b)(iv)

Income Tax Assessment Act 1936 subparagraph 177D(b)(v)

Income Tax Assessment Act 1936 subparagraph 177D(b)(vi)

Income Tax Assessment Act 1936 subparagraph 177D(b)(vii)

Income Tax Assessment Act 1936 subparagraph 177D(b)(viii)

Reasons for decision

Question 1

Summary

As a shareholder of Company X, Shareholder B will be entitled to choose demerger rollover relief pursuant to section 125-55 of the ITAA 1997.

Detailed reasoning

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:

(a) demerger group (subsection 125-65(1) of the ITAA 1997);

(b) demerger (subsection 125-70(1) of the ITAA 1997);

(c) demerged entity (paragraph 125-70(6)(a) of the ITAA 1997); and

(d) 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 X as the head entity and includes Company Y as a demerger subsidiary.

Company X will be the head entity because:

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

Company Y will be a demerger subsidiary of Company X because Company X owns ownership interests (ordinary shares) in Company Y 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 Y (subsection 125-65(6) of the ITAA 1997).

A demerger happens

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

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

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

(c) Company Y shares will be acquired by Company X shareholders on the basis of their ownership of shares in Company X (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i) of the ITAA 1997);

(d) neither Company X nor Company Y are superannuation funds (paragraph 125-70(1)(g) of the ITAA 1997);

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

(f) each of the Company X shareholders will own shares in Company X and Company Y that (just after the demerger) represent the same proportionate total market value as their Company X shares represented (just before the demerger) (paragraph 125-70(2)(b) of the ITAA 1997);

(g) 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

(h) there will be no rollover available under another provision for any CGT events that happen to the Company X shares under the restructure (subsection 125-70(5) of the ITAA 1997).

Company Y is the demerged entity 

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 Y is the demerged entity since the Company X shareholders receive shares in Company Y under a demerger.

Company X is the demerging entity

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

Can Shareholder B 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 - Shareholder B satisfies 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 X 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 X shares when Shareholder B receives Company Y shares under the demerger.

Therefore Shareholder B, the holder of a B Class Company X share, will be eligible to choose demerger rollover under subsection 125-55(1) of the ITAA 1997.

Capital gains and cost base adjustments for Shareholder B

Shareholder B is entitled to disregard any capital gain made as a result of CGT Event G1 happening to their Company X shares as they were acquired before 20 September 1985 (subsection 104-135(5) of the ITAA 1997). This will be the case irrespective of whether they choose demerger rollover.

If Shareholder B chooses demerger rollover:

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

If Shareholder B does not choose demerger rollover:

the first element of the cost base and reduced cost base of those Company Y 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

The in-specie distribution of Company Y shares Shareholder B receives under the proposed scheme will be a demerger dividend that is neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Detailed reasoning

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, unless an exception applies. 

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).

In the present circumstances, the capital reduction amount will be debited against an amount standing to the credit of Company X's share capital account (as that term is defined in section 6D of the ITAA 1936), therefore it will be not be a dividend as defined in section 6(1) of the ITAA 1936.

Consequently, the capital reduction amount will not be assessable income of the Company X shareholders 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 in-specie distribution of the Company Y shares will, in part, constitute a dividend of the Company X shareholders. The total amount of the dividend will be the market value of the Company Y shares at the time of the demerger excluding the amount debited to the share capital account of Company X.

In general, a dividend satisfied by an in-specie 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, each of these conditions will be satisfied. Therefore, the dividend paid to Company X shareholders by Company X, under the demerger will be neither assessable income nor exempt income as a result of the application of subsections 44(3) to (5) of the ITAA 1936. Nevertheless, to the extent that section 45BA of the ITAA 1936 applies, the demerger dividend will be assessable income of the Company X shareholders.

Question 3

Summary

The Commissioner will not make a determination under paragraph 45B(3)(a) or 45B(3)(b) of the ITAA 1936 that section 45BA or 45C of the ITAA 1936 applies to the whole, or any part, of any benefit provided to Shareholder B under the demerger.

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.

The conditions that must be met in order for section 45B of the ITAA 1936 to apply are set out in subsection 45B(2). Relevantly, that section applies if:

(a) 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

(b) 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

(c) 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).

Each of the key terms referred to in subsection 45B(2) of the ITAA 1936 is considered below.

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. 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, it is considered that the transfer of Company Y shares under a demerger to the Company X shareholders 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 Y shares provided to the Company X shareholders constitutes a demerger benefit.

The provision of those Company Y 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 Y shares distributed under the demerger less the demerger dividend is a capital benefit provided to the Company X 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, Shareholder B would, apart from the operation of section 45B of the ITAA 1936, receive a demerger dividend equal to the market value of the Company Y shares 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 Shareholder B on the demerger would be higher if the demerger benefit was an assessable dividend. Accordingly, Shareholder B 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 X 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).

It is acknowledged that the relevant circumstances enumerated in paragraphs 45B(8)(a), 45B(8)(c) and 45B(8)(e) to 45B(8)(k) tend to neither incline for, nor against a conclusion as top the relevant purpose, However, paragraph 45B(8)(b) and 45B(8)(d) tend to incline for the relevant purpose.

The following observations in relation to the scheme are of particular relevance in coming to the objective conclusion as to purpose:

In the Commissioner's view, the distribution of the dividend that would result from the demerger of Company Y from Company X is extraordinary when compared with the pattern of the dividend distributions made prior to the proposed demerger.

By undertaking a demerger, Company X shareholders acquire direct ownership of Company Y and in doing so; secure a tax effective mode of accessing the profits of the company in the form of a demerger dividend that is neither assessable income nor exempt income.

Although all shares in Company Y were acquired post 19 September 1985 rendering these shares post-CGT, upon the demerger happening, the Company Y shares will be deemed pre-CGT assets in the hands of Shareholder B by virtue of subsection 125-80(5) of the ITAA 1997. Therefore Shareholder B would receive pre-CGT interests in Company Y, that, but for the demerger, have a post-CGT status when held by Company X. Although Shareholder B has submitted that he has no intention or current plans of disposing of his interests in either Company Y or Company X, this factor still inclines for the requisite purpose being present.

Having regard to the relevant circumstances of the scheme set out in subsection 45B(8) of the ITAA 1936, it would not be concluded that any of the parties to the scheme entered into or carried out the scheme for more than an incidental purpose of obtaining a tax benefit in the form of a demerger benefit and a capital benefit.

It follows that the tax benefit, whilst substantial, is an outcome that occurs incidentally to the commercial purposes outlined in the application.

Conclusion

The Commissioner will not make a determination under paragraph 45B(3)(a) or 45B(3)(b) of the ITAA 1936 that sections 45BA or 45C of the ITAA 1936 will apply to any part of the demerger benefit or capital benefit provided under the scheme.