Edited version of private advice

Authorisation Number: 1051606897591

Date of advice: 14 February 2020

Ruling

Subject: Demerger relief

Question 1

As a consequence of section 125-155 of the ITAA 1997, can Company A disregard any capital gain under capital gains tax (CGT) event A1, C2, or C3 upon the distribution of its shares in Company B to shareholders?

Answer

Yes

Question 2

As a consequence of section 125-160 of the ITAA 1997, will CGT event J1 not happen to any member of the Company A demerger group upon the distribution of shares in Company B to Company A shareholders?

Answer

Yes

Question 3

As a consequence of the distribution of Company A shares in Company B to shareholders, is Company A required under subsection 45D(1A) of the ITAA 1936 to give a copy of a notice to its shareholders?

Answer

No

Question 4

Will section 45 of the ITAA 1936 apply to the whole or any part of the Demerger scheme?

Answer

No

Question 5

Does Company A have an obligation to withhold tax on the demerger dividend paid to non-resident shareholders under section 128B of the ITAA 1936?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2020

Relevant facts and circumstances

Company A is an Australian resident public company listed on the Australian Securities Exchange (ASX) and the head company of an income tax consolidated group for the purposes of Part 3-90.

Immediately before the demerger, Company A only had ordinary shares and certain ESS Interests (which represented not more than 3% of the total ownership interests) on issue.

The Board of Company A did not declare a dividend in the past few years and there was no interim or special dividend declared in connection with the demerger.

Before the demerger, Company B was a wholly owned subsidiary of Company A and a member of Company A's tax consolidated group.

Immediately before the demerger, Company A had on issue 100% of the number of shares Company B had on issue.

The demerger of Company B was undertaken by a reduction of share capital under section 256B of the Corporations Act 2001 (Corporations Act) and a court approved scheme of arrangement under Part 5.1 of the Corporations Act.

The shareholders of Company A voted at a meeting to approve an ordinary resolution under section 256C of the Corporations Act to reduce the share capital of Company A by an amount equal to the market value of Company B (as a proportion of the combined market values of Company A and Company B, calculated by reference to the VWAP of Company A shares and Company B shares for the first five trading days after the demerger as a proportion of the amount of the issued capital of Company B). The reduction of share capital equates to $0.X per Company A share.

On the Implementation Date, payment of the amount of the reduction of share capital (capital reduction amount) (which the shareholders of Company A were entitled to) was satisfied by an in specie transfer of all of the shares in Company B to the shareholders of Company A (Distribution).

Shares in Company B were listed for quotation on the ASX and commenced trading on a deferred settlement basis.

The Company A shareholders received a number of Company B shares for each Company A share they held on the Record Date.

No Company A shares were cancelled under the demerger. Company A shareholders continued to hold the same number and proportion of Company A shares as they held before the demerger (subject to a Sale Facility). Company A no longer held any shares in Company B after the demerger.

Under the demerger, Company A Shareholders acquired shares in Company B and nothing else.

The demerger was not legally or economically conditional on any other transaction occurring.

'Ineligible Foreign Holders' had the Company B shares to which they were entitled sold by Company A through a sale agent on the ASX who remitted the sale proceeds to the relevant shareholders. The shares of Ineligible Foreign Holders were transferred to the sale agent on the Implementation Date.

Company A had commercial reasons for the demerger.

Company A accounted for the market value of the Distribution by debiting it entirely to Company A's share capital account.

Immediately before the demerger, Company A confirmed that its share capital account is not tainted (within the meaning of Division 197 of the ITAA 1997).

Company A did not elect under subsection 44(2) of the ITAA 1936 that subsections 44(3) and (4) of the ITAA 1936 will not apply to the demerger.

ESS interests in Company A have been issued in accordance with Division 83A of the ITAA 1997 and are interest to which either Subdivision 83A-B or Subdivision 83A-C of the ITAA 1997 applies.

Reasons for decision

Question 1

Section 125-155 of the ITAA 1997 provides as follows:

Any capital gain or capital loss a demerging entity makes from CGT event A1, CGT event C2, CGT event C3 or CGT event K6 happening to its ownership interests in a demerged entity under a demerger is disregarded.

The various elements of this provision are satisfied in this case, as discussed in further detail below.

CGT event A1 happened

CGT event A1 happened to Company A when it made an in specie distribution to its shareholders (the shareholders) of its ordinary shares in Company B.

In this case the capital gain or loss under CGT event A1 was made by Company A:

·        as a 'demerging entity' (as defined under subsection 125-70(7) of the ITAA 1997); and

·        from the event which happened to its ownership interests in Company B as the 'demerged entity' (as defined in subsection 125-70(6) of the ITAA 1997.

None of CGT events C2, C3 and K6 happened to Company A in relation to the distribution.

There was a demerger

Section 125-65 of the ITAA 1997 sets out the meaning of 'demerger group', 'head entity' and 'demerger subsidiary'.

Company A and Company B were part of a 'demerger group' that consisted of:

·        Company A as the head entity as defined in subsection 125-65(3) of the ITAA 1997.

·        Company B as the demerger subsidiary as defined in subsection 125-65(6) of the ITAA 1997.

The conditions for a 'demerger' specified in section 125-70 of the ITAA 1997 are met for the following reasons:

·        There was a restructuring of the demerger group under which a member of the group (Company A) disposed of 100% of its ownership interests in another member of the demerger group (Company B) to owners of the original interests in the head entity of the group (the shareholders of Company A): paragraph 125-70(1)(a) and subparagraph 125-70(1)(b)(i) of the ITAA 1997.

·        Under the restructuring, CGT event G1 happened to the shareholders upon the distribution of the shares in Company B to them and the shareholders acquired a new interest, being the interests in Company B, and nothing else: subparagraph 125-70(1)(c)(ii) of the ITAA 1997. The acquiring of new interests by an owner of original interests may include the allocation of the owner's entitlement to new interests to a nominee to sell on the owner's behalf: note to subsection 125-70(1) of the ITAA 1997.

·        The acquisition of new interests by the shareholders under the demerger happened only because they owned shares in Company A. The in specie distribution of Company A's shares in Company B was made only to the shareholders: subparagraph 125-70(1)(d) of the ITAA 1997.

·        The new interests acquired, being shares in Company B, are the 'ownership interests in a company': paragraph 125-70(1)(e)(i) of the ITAA 1997.

·        Neither the original interests (being the shareholders' shares in Company A) nor the new interests (the shares they acquired in Company B) 'are in a trust that is a non-complying superannuation fund': paragraph 125-70(1)(g) of the ITAA 1997.

·        Disregarding the ESS interests (see next dot point), the requirements of subsection 125-70(2) of the ITAA 1997 are met, thereby satisfying the requirement in paragraph 125-70(1)(h) of the ITAA 1997. This is because:

-                  each shareholder acquired the same proportion of shares in Company B as they had in Company A just before the demerger, and

-                  just after the demerger, each shareholder had the same proportionate total market value of shareholding in Company B as it had in Company A just before the demerger.

·        Subsection 125-75(2) of the ITAA 1997 provides that employee share scheme ownership interests (which are not fully paid ordinary shares) and to which the provisions in Division 83A apply are disregarded for the purposes of subsection 125-70(2) if, just before the demerger, those interests (taking into account either or both of their number and value) represented not more than 3% of the total ownership interests in the entity.

As a consequence of section 125-155 of the ITAA 1997 being satisfied, Company A can disregard 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 A.

Question 2

Section 125-160 of the ITAA 1997 provides that CGT event J1 does not happen to a demerger entity or a member of a demerger group under a demerger.

As discussed in Question 1, a demerger satisfying the conditions in section 125-70 of the ITAA 1997 has occurred. In these circumstances, CGT event J1 did not happen to Company B or a member of the demerger group which includes Company A.

Question 3

Subsection 45D(1) of the ITAA 1936 provides that if the Commissioner makes a determination under section 45A, 45B or 45C of the ITAA 1936, the Commissioner must give a copy of the determination to the company concerned (which, in the case of a demerger benefit referred to in section 45B of the ITAA 1936, is the head entity of the demerger group).

Subsection 45D(1A) of the ITAA 1936 provides that where the Commissioner gives notice of a determination to a company in accordance with subsection 45D(1) of the ITAA 1936 that company must, in the case of a determination under section 45A or 45B of the ITAA 1936, give a copy of the notice to:

(a) the advantaged shareholder referred to in section 45A; or

(b) the relevant taxpayer referred to in section 45B.

Subsection 45D(1A) of the ITAA 1936 only applies in the event that the Commissioner gives notice of a determination to Company A in accordance with subsection 45D(1) of the ITAA 1936. Accordingly, there needs to be a consideration of whether the Commissioner will make a determination under sections 45A or 45B of the ITAA 1936 resulting in the Commissioner giving notice of a determination under subsection 45D(1) of the ITAA 1936.

Section 45A

Section 45A of the ITAA 1936 applies when a company streams the provision of 'capital benefits' to shareholders who would derive a greater benefit from the capital benefits than other shareholders and it is reasonable to assume that the other shareholders have received, or will receive, dividends (subsection 45A(1) of the ITAA 1936).

The phrase 'provision of a capital benefit' to a shareholder includes the distribution to the shareholder of share capital (subsection 45A(3) of the ITAA 1936). The reduction of share capital for the benefit of Company A shareholders (satisfied through the in specie transfer of the Company B shares) means that there was the provision of a capital benefit to the shareholders.

In this case, subsection 45A(1) of the ITAA 1936 does not apply in this case in circumstances where:

·        the capital return was made to all shareholders in direct proportion to their shareholdings, such that there was no streaming as required by subsection 45A(1) of the ITAA 1936, and

·        there is no evidence that any shareholder will receive a dividend in circumstances where Company A is currently in a retained loss position and last paid a dividend in 2016.

Accordingly, the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 in relation to the capital benefits provided to the shareholders.

Section 45B

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

Section 45B(2) of the ITAA 1936 applies where:

(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, a taxpayer 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 scheme was entered into or carried out for a more than incidental purpose of enabling the taxpayer to obtain the tax benefit.

The in specie distribution of Company B shares to Company A shareholders under the demerger constituted the provision of a demerger benefit and, to the extent the value of the Company B shares was debited to Company A's share capital account, also represented the provision of a capital benefit (paragraphs 45B(2)(a), 45B(4)(a) and 45B(5)(a), and subsection 45B(6) of the ITAA 1936).

As the provision of Company B shares would generally result in a lesser amount of tax payable by Company A shareholders than the amount that would be payable if the provision of those shares was instead an assessable dividend, Company A shareholders would obtain a tax benefit (paragraph 45B(2)(b) and subsection 45B(9) of the ITAA 1936).

The relevant circumstances of the scheme which the Commissioner is required to have regard to in determining whether or not the requisite purpose exists are set out in subsection 45B(8) of the ITAA 1936.

Having regard to these relevant circumstances, the Commissioner considers that the requisite purpose of enabling one or more of Company A's shareholders or other taxpayers to obtain a tax benefit did not exist.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 in relation to the demerger benefit or capital benefits provided to the shareholders.

In circumstances where the Commissioner will not make a determination under section 45A or section 45B of the ITAA 1936 there is no determination under subsection 45D(1) of the ITAA 1936 and therefore subsection 45D(1A) of the ITAA 1936 does not apply.

Question 4

Section 45 of the ITAA 1936 applies where a company streams the provision of shares and the payment of minimally franked dividends to its shareholders in such a way that the shares are received by some but not all shareholders and shareholders who do not receive shares instead receive minimally franked dividends. Minimally franked dividends are dividends which are franked to less than 10%.

If these conditions are satisfied, the value of the share at the time it is provided to the shareholder is taken to be an unfrankable dividend paid by the company to the shareholder at that time out of the company's profits.

Section 202-45 of the ITAA 1997 exhaustively defines what is meant by an 'unfrankable' distribution (distributions that are not unfrankable are frankable: section 202-40). Subparagraph 202-45(h)(i) of the ITAA 1997 includes within the definition an amount that is taken to be an unfranked dividend for any purpose under section 45 of the ITAA 1926. Paragraph 202-45(i) of the ITAA 1997 includes a demerger dividend within the definition.

All Company A shareholders were entitled to receive a number of Company B share for each Company A share owned. A sales agent acquired Company B shares from the Ineligible Overseas Foreign Holders. The proceeds from the Sale Facility for these shareholders were remitted to them in consideration for the disposal of their Company B shares to the sale agent.

Therefore, there is no streaming, and section 45 will not apply to the Company B shares received by Company A Shareholders under the demerger.

Question 5

Subsection 128B(4) of the ITAA 1936provides that a person who derives income to which section 128B applies that consists of a dividend is liable to pay income tax on that income at the rate declared by Parliament.

Subsection 128B(1) states that section 128B applies to income derived on or after 1 January 1968 by a non-resident that consists of a dividend paid by an Australian resident company. However, this is subject to certain exceptions including that set out in subsection 128B(3D), which states that section 128B does not apply to a demerger dividend to which section 45B does not apply.

No demerger dividend arose on the demerger of Company B from Company A.

In these circumstances, Company A is not required to withhold an amount under section 128B from a demerger dividend received by non-resident shareholders as no demerger dividend was received under the demerger.