Edited version of your written advice

Authorisation Number: 1051223481446

Date of Advice: 10 May 2017

Ruling

Subject: Proposed demerger of Company Y by Company X

Question 1

Will the Commissioner confirm that the Company X shareholder will be entitled to choose demerger roll-over relief pursuant to section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Can Company X 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 Y upon the demerger of Company Y by Company X?

Answer

Yes

Question 3

Will the Commissioner confirm that all or any part of the in specie distribution of the Company Y shares to the Company X shareholder 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)?

Answer

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 applies to the whole, or a part, of any demerger benefit or capital benefit provided under the proposed demerger?

Answer

Yes

This ruling applies for the following period:

1 July 2016 to 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Background

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

Company X

Company X is an Australian private company with fully paid ordinary shares on issue.

Company X has more than 20 unrelated shareholders.

Company X was incorporated in 20XX.

Company X is a company and has developed products since its incorporation.

Company Y

Company Y is an Australian private company with fully paid ordinary shares on issue.

Company Y was incorporated in 20XX.

Company Y was incorporated by Company X in order to separate different products developed for specific industries.

Company X owns a majority of the shares on issue in Company Y. An unrelated investment company owns the remaining shares.

Reasons for the demerger

Company X proposes to undertake a demerger for the following commercial reasons:

(a) Company X understands the investors for the two businesses will be vastly different and that commercially it will make sense for the businesses to be separated.

(b) Company Y is seeking future capital investment to scale up its product roadmap and go to market activities. Company Y has already successfully achieved a third party investment from an unrelated investor, and has opportunities to pursue further investment from both that investor and other sources of venture capital. Once demerged, Company Y will become a standalone specialised business and its performance will become much more transparent to the market. Demerging will allow them greater access to capital as it will be separately identifiable from Company X's other business ventures.

(c) Company X will require funding in the short term for products unrelated to Company Y that will need an injection of capital to develop and commercialise. Company X has recently secured funding with an overseas based venture capital fund on the basis that the agreement would be executed after Company Y is demerged.

(d) Changes to the current management structure have been identified and implemented.

Other matters

The scheme of demerger does not involve the prearranged latter disposal of ownership interests.

The share capital account of Company X is not tainted within the meaning of Division 197 of the ITAA 1997.

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 177D

Income Tax Assessment Act 1997 Division 125

Reasons for decision

Question 1

Summary

The Company X shareholder will be entitled to choose demerger roll-over 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:

● 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 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 Company X Group owns 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 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).

Demerger

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

● 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);

● under the restructuring, CGT event G1 will happen and Company X shareholders will acquire new shares in Company Y and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997);

● 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);

● neither Company X nor Company Y are superannuation funds (paragraph125-70(1)(g) of the ITAA 1997);

● 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);

● 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);

● 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 roll-over 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

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

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

Can the Company X shareholder choose demerger roll-over?

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

● a shareholder owns a share in a company - the Company X shareholders will satisfy this requirement;

● the company is the head entity of a demerger group - this requirement will be satisfied;

● a demerger happens to the demerger group - this requirement will be 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 will happen to the Company X shares when the Company X shareholders receive Company Y shares under the demerger.

Therefore the Company X shareholder will be eligible to choose roll-over under subsection 125-55(1) of the ITAA 1997.

Question 2

Summary

Company X 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 Y upon the demerger of Company Y by Company X.

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 X is the demerging entity,

● CGT event A1 will happen when Company X disposes of its shares in Company Y and transfers them to Company X 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 X on the disposal of its Company Y shares under the demerger will be disregarded (section 125-155 of the ITAA 1997).

Question 3

Summary

All or any part of the in specie distribution of Company Y shares to Company X shareholder 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 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 the 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 X it will not be a dividend, as defined in section 6(1) of the ITAA 1936.

Therefore, the capital reduction amount will not be assessable income of Company Y 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 X 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 the Company X shareholder by Company X under the proposed 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.

Question 4

Summary

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

Detailed reasoning

Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation purposes if:

(a) components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger; or

(b) certain payments, allocations and distributions are made in substitution for dividends (subsection 45B(1) of the ITAA 1936).

Subsection 45B(2) of the ITAA 1936 provides (relevantly) that the section applies if:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company;

(b) under the scheme the Company X shareholder obtains a tax benefit as defined in subsection 45B(9) of the ITAA 1936; and

(c) having regard to the relevant circumstances of the scheme, it would be concluded that the scheme was entered into or carried out for a more than incidental purpose of enabling the Company X shareholder to obtain the tax benefit.

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

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.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or 45C of the ITAA 1936 applies to the whole, or any part, of the demerger benefit or capital benefit provided to the Company X shareholder under the demerger.