Edited version of private advice

Authorisation Number: 1051717143617

Date of advice: 13 July 2020

Ruling

Subject: Demerger

Question 1

Will section 125-155 of the ITAA 1997 apply to the Taxpayer as a result of the demerger?

Answer

Yes

Question 2

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

Answer

No

This ruling applies for the following period:

Year ended 30 June 2021

The scheme commences on:

Year ended 30 June 2020

Relevant facts and circumstances

The taxpayer, X Pty Ltd (X) is a holding company for the group of companies outlined below.

There are 3 shareholders in X (collectively, the Shareholders).

Group structure and subsidiaries

X has several subsidiary companies, some of which were incorporated in Australia (collectively, the Australian companies), while others were incorporated overseas (collectively, the Overseas companies).

One of the Australian companies is Y.

Proposed restructure

X has provided the Commissioner with information and documentation supporting the commercial reasons for the restructure.

The proposal involves the implementation of a two-step transaction:

• all the shares in the Overseas companies will be transferred from X to Y. The transfer will be given effect by way of a sale of shares from X to Y for market value. In return, Y will issue X with shares in Y to the same value.

As a result, Y will be the holding company of the Overseas Companies.

• A demerger will occur in which an in specie distribution of shares in Y will be made by X. The Y shares will be distributed to, and held by, the Shareholders in the same type and proportions as that which they hold in X.

As a result, X and Y will each be the ultimate holding entity of the Australian Companies and the Overseas Companies, respectively.

In accounting for the demerger, X will register the distribution in its books of account as follows:

• The market value of the Y shares will be ascertained. The resulting amount represents the notional amount distributed to the Shareholders as part of the in specie distribution of Y shares.
• A calculation will be made of the percentage that the Y shares' market value bears to the total enterprise market value of the companies in the group.
• This percentage will be applied to the amount held in the capital account of X. The resulting amount will be debited against the share capital of X upon the demerger, representing the portion of the in specie distribution that is attributed to capital.
• The remaining portion of the value of the in specie distribution, being the market value of the Y shares less the amount of the capital component above, will be a demerger dividend.
• The demerger dividend will be debited in the following manner:

˗        The demerger dividend will be debited against X's revaluation reserve account, reducing it to zero. This revaluation reserve account takes into consideration the revaluation of the assets of the Overseas companies to market value.

˗        The remaining portion of the amount of the demerger dividend will be debited against X's retained earnings account.

The proposal is sought to be entered into at the earliest practical opportunity.

In respect of the demerger:

• Neither the X shares nor the Y shares are interests in a superannuation fund.
• The Shareholders will choose to obtain a roll-over under section 125-55(1) of the ITAA 1997.

Other facts

Pattern of distributions

No dividends were paid by X in the previous 10 years.

Capital losses

None of the Shareholders have any capital losses to be applied against any capital gains.

Pre-CGT assets

All the entities within the group were incorporated post 20 September 1985, and there are therefore no pre-CGT assets in question.

Residency of Shareholders

The Shareholders are Australian tax residents.

Nature of interest after demerger

As the Y shares will be held in the same type and proportions by the shareholders as that which they hold in X, the nature and proportion of the interests held by each Shareholder in X remains the same after the demerger.

Later disposal of shares

There is no proposal to dispose of Y by the Shareholders after the demerger. There is also no intention on the part of the Shareholders to in any way deal with their interests in Y following the demerger.

Tainting of share capital account

There is no arrangement to which subsection 6(4) of the ITAA 1936 applies.

CGT assets owned by Y

Just after the proposed demerger, 50 % or more of the CGT assets owned by Y and the Overseas Companies will be used in one or more businesses carried on by these entities.

Reasons for decision

Question 1

Summary

Section 125-155 of the ITAA 1997 will apply to the Taxpayer as a result of the demerger

Detailed reasoning

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 will be satisfied in this case, as discussed in further detail below.

CGT event A1 happens to X

CGT event A1 will happen to X when it makes an in specie distribution to its shareholders of its shares in Y, for the following reasons:

• Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset.
• The shares held in Y are a 'CGT asset' given that they are a 'kind of property' (paragraph 108-5(1)(a)).
• There will be a 'disposal' given that there is change of ownership from X to its shareholders by the in specie distribution of shares whereby both legal and beneficial ownership of the shares are transferred to X's shareholders.

In this case, the capital gain or loss under CGT event A1:

• is made by X as a 'demerging entity' (as defined under subsection 125-70(7)); and
• is made by X from the event happening to its ownership interests in Y as the 'demerged entity' (as defined in subsection 125-70(6).

There is a demerger

In this case, there will be a 'demerger' under the terms of section 125-70 given that:

• There will be a prima facie restructuring of a 'demerger group' comprising X as the head entity of the group (subsection 125-65(1)) and Y as one of its demerger subsidiaries (subsection 125-65(1)): paragraph 125-70(1)(a);
• The restructuring will satisfy the conditions in paragraph 125-70(1)(b)(i) as a member of the demerger group (X) will dispose 100% of its ownership interests in another member of the demerger group (Y) to owners of the original interests in the head entity of the group (the Shareholders).
• The restructuring will satisfy the conditions in paragraph 125-70(1)(c)(i) given that under the restructuring, a CGT event will happen to the Shareholders' interest in X, and the Shareholders will acquire a new interest (and nothing else) in Y.

The relevant CGT event in this case would be CGT event G1, which concerns capital payments for shares. CGT event G1 would apply in this case for the following reasons:

• Paragraph 104-135(1)(a) would be satisfied.

X will make a payment to the Shareholders in respect of the shares it owns in X. This payment is comprised of the in specie distribution of 100% of X's shares in Y to the Shareholders: paragraph 104-135(1)(a).

Under section 103-5 and section 104-135, the 'payment' can include giving property and therefore covers in specie distributions of shares.

CGT event A1 does not apply in the manner contemplated under paragraph 104-135(1)(a) since there is no disposal of any share owned by the Shareholders in X.

CGT event C2 does not apply in the manner contemplated under paragraph 104-135(1)(a) since the proposal does not involve an end to the Shareholders' ownership of their shares in X under any of the circumstances prescribed under subsection 104-25(1).

• Paragraph 104-135(1)(b) would be satisfied.

There is at least some part of the payment that is not a dividend. 'Dividend' in this regard is defined in subsection 6(1) of the ITAA 1936 to include distributions made by a company to any of its shareholders but excludes 'property distributed by a company to shareholders.... where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company'.

It is proposed that the value of the Y shares distributed will be partly debited against X's share capital account.

The portion of the distribution debited against the share capital account is not a 'dividend' and consequently paragraph 104-135(1)(b) would be satisfied.

It is also noted that there is no evidence on the facts provided in this case to suggest the existence of an arrangement under subsection 6(4) which provides an exception to the abovementioned rule.

• Paragraph 104-135(1)(c) would be satisfied.

The payment will not be included in the Shareholders' assessable income. Part of the payment that is debited to the share capital account is a return of capital; the remaining part will be a 'demerger dividend' which is not assessable income or exempt income: subsection 44(4). This takes into account the assumption that the condition in subsection 44(5) applies.

·        The acquisition of new interests by the Shareholders under the proposal will happen only because they own shares in X. The in specie distribution of X's shares in Y is made only to its shareholders. Consequently paragraph 125-70(1)(d) will be satisfied.

·        The new interests acquired by the Shareholders are the 'ownership interests in a company' (paragraph 125-70(1)(e)(i)), being shares in Y.

·        Neither the original interests (being the shares in X) nor the new interests (the shares in Y) 'are in a trust that is a non-complying superannuation fund': paragraph 125-70(1)(g).

·        The requirements of subsection 125-70(2) will be met thereby satisfying the requirement in paragraph 125-70(1)(h). This is because:

• Each Shareholder will acquire the same proportion of shares in Y as it had in X just before the proposed demerger; and
• Just after the demerger, each Shareholder will have the same proportionate total market value of shareholding in X and Y as it had in X just before the demerger.

The Y shares to be transferred will be of the same class and proportion as the shares each Shareholder currently holds in X. The proportionate market value of each of the Shareholders' shares in both X and Y just after the demerger will be the same as that of each of their original interests in X just before the demerger.

It follows from the above that the conditions in section 125-155 will be satisfied upon the demerger, and therefore the provision will apply to X.

Question 2

Summary

The Commissioner will not make a determination under subsection 45B(3) that section 45BA or section 45C will apply.

Detailed reasoning

Subsection 45B(3) of the ITAA 1936 allows the Commissioner to make a determination in relation to a demerger benefit and a capital benefit. For this provision to apply, the relevant scheme must fall within the scope of section 45B.

Subsection 45B(2), which details various conditions for the application of section 45B, provides as follows:

This 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; and

(b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and

(c) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer (the relevant taxpayer) to obtain a tax benefit.

The application of the conditions in each of the above paragraphs is considered below.

Paragraph 45B(2)(a)

'Scheme' is defined in section 995-1 of the Income Tax Assessment Act 1997 as 'any arrangement' or 'any scheme, plan, proposal, action, course of action, or course of conduct, whether unilateral or otherwise'. Being a proposed plan or course of action contemplated by the group, the demerger will be considered a 'scheme' under the terms of the prescribed definition.

The relevant scheme in this case to which section 45B applies is the business restructure that comprises the establishment of Y; the subsequent transfer of the shares in the Overseas companies from X to Y by way of sale; and the demerger.

The distribution of the Y shares to the Taxpayer will be considered a 'demerger benefit' and a 'capital benefit' for the following reasons:

• A person is 'provided with a demerger benefit' if 'a company provides the person with ownership interests in that or another company': paragraph 45B(4)(a).

Under the terms of the demerger, X will provide the Taxpayer with shares in Y, and the Taxpayer will thereby be considered to have been provided with a demerger benefit as defined in paragraph 45B(4)(a).

• A person is also 'provided with a capital benefit' if a company provides 'ownership interests in a company to a person': paragraph 45B(5)(a).

In this case, part of the distribution is a capital benefit, while the other is a dividend. By virtue of the former, paragraph 45B(5)(a) will be satisfied in this case.

In respect of the part of the distribution that is characterised as a dividend:

• subsection 45B(6) provides that 'a person is not provided with a capital benefit to the extent that the provision of interests, the distribution or the thing done referred to in subsection (5) involves the person receiving a demerger dividend'.
• 'Demerger dividend' is defined in subsection 6(1) of the ITAA 1936 as 'part of a demerger allocation that is assessable as a dividend under subsection 44(1) or that would be so assessable apart from subsections 44(3) and (4)'. Section 44 applies in respect of 'dividends' paid to the shareholder, which in turn is defined in subsection 6(1) to exclude property distributed by a company to shareholders where the amount of the value of the property is debited against an amount standing to the credit of the share capital account of the company.
• Not all of the Y share distribution will be debited against an amount standing to the credit of Xs share capital account. The portion of the distribution that is not debited to the share capital account is a 'demerger dividend". This amount cannot be regarded as a 'capital benefit' pursuant to subsection 45B(6).

In respect of the part of the distribution that is a capital benefit:

• The portion of the distribution debited against the share capital account will be a 'capital benefit' under the terms of paragraph 45B(5)(a), being ownership interests in Y that are not demerger dividends.
• This amount will also be a 'capital benefit' under paragraph 45B(5)(b), being a distribution 'of share capital'; noting the application and effect of subsection 45B(7) in conjunction with the various definitions prescribed in Subdivision 974-E.

Paragraph 45B(2)(b)

The meaning of 'obtains a tax benefit' is prescribed in subsection 45B(9) as follows:

A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the demerger benefit had been an assessable dividend or the capital benefit had been an assessable dividend.

As considered above, the Taxpayer will be entitled to choose the demerger rollover relief pursuant to section 125-55 of the ITAA 1997 as a result of the demerger.

This means that, when the rollover choice is exercised under subsection 125-55(1), the Taxpayer will obtain a 'tax benefit' since no CGT event will be triggered at the time of the distribution - specifically any capital gains and the cost base adjustments in CGT event G1 under section 104-135 will be ignored on the exercise of the rollover choice; this is compared to the situation in which the distribution is treated as an assessable dividend and brought into account in the year of the distribution.

Paragraph 45B(2)(c)

The relevant circumstances which must be considered in the assessment of whether there exists a more-than-incidental purpose of enabling a taxpayer to obtain a tax benefit are outlined in subsection 45B(8).

They are considered in turn below.

Paragraph 45B(8)(a)

This paragraph prescribes the following 'relevant circumstance':

'the extent to which the demerger benefit or capital benefit is attributable to capital or the extent to which the demerger benefit or capital benefit is attributable to profits (realised and unrealised) of the company or of an associate (within the meaning in section 318) of the company;..'

On the facts of this case:

• The in specie distribution of Y shares is a distribution of a capital asset of X which will result in a debit to X's share capital account. It will also involve a distribution of a demerger dividend, which will result in debits to X's retained earnings account and revaluation reserve account.
• The manner in which the distribution is to be accounted for is by way of a method of apportionment as follows:

• The market value of the Y shares is ascertained. This represents the notional amount distributed to the Shareholders as part of the in specie distribution of Y shares.
• The percentage that the Y shares market value bears to the total enterprise market value of the companies in the group is calculated.
• This percentage is applied to the capital account of X. The resulting amount will be debited against the share capital of X upon the demerger, representing the part of the in specie distribution that is attributed to capital.
• The remaining portion of the value of the in specie distribution, being the market value of the Y shares less the amount of the capital component above, will be a demerger dividend. This amount will be debited against X's retained earnings account and revaluation reserve account.

The Commissioner considers that the above is a reasonable method of apportionment on the facts of this case. While this alone is not determinative of this issue, it is taken into account as a material consideration in the assessment of the scheme as a whole.

Paragraph 45B(8)(b)

This paragraph provides:

'the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318) of the company;'

In this regard it is noted that X has never paid dividends to its shareholders.

Paragraphs 45B(8)(c) to (f)

These paragraphs require an examination of the tax characteristics of the particular shareholder in question in determining the relevant circumstances of the scheme.

In general, the characteristics of the Taxpayer as provided to the Commissioner, and the provisions to which they relate, have been noted.

Paragraph 45B(8)(h)

This paragraph requires that regard be had to whether the interest held by the owners of the head entity after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of the share capital.

In this case the Taxpayer's ownership interests in X will not be altered as a result of the distribution. Moreover, the ATO view as set out in paragraph 70 of PS LA 2005/21 is noted:

In the context of demerger, this circumstance would be limited to demergers where the transfer of ownership interests involves 'distributions' (that is, returns) of share capital or share premium. Ordinarily however, a demerger should not disturb the head entity shareholder's existing ownership interest in the way described, owing to the requirements of the proportion test in subsection 125-70(2) of the ITAA 1997. As a consequence, it is unlikely that this circumstance will have significant relevance for demergers.

Paragraph 45B(8)(i)

Under this provision, if the scheme involves the provision and subsequent disposal of ownership interests, the period for which the ownership interests are held and the time at which the arrangement for the disposal of those shares is entered into are taken into account as relevant considerations.

In this case there is no proposal to dispose of Y after the demerger. It has also been stated in the facts of this case that there is also no intention on the part of the Shareholders to in any way deal with their interests in Y following the demerger.

Paragraph 45B(8)(j)

This provision requires consideration of any profits or assets of the demerging entity that might be attributable to, or acquired under transactions with, associated entities. In PS LA 2005/21, it is stated at paragraph 82 that:

'..this relevant circumstance exposes whether the demerger relief is being used as a device for distributing corporate earnings to owners of the head entity. If it is established that part of the profits or assets of the demerging entity are referable to those of an associate and are not explainable by the demerging entity's need to be a viable, stand-alone entity, this is suggestive of a purpose of enabling a taxpayer to obtain a tax benefit by way of non-assessable dividend...' (emphasis added).

In this case, the Commissioner has taken into account the basis for the expressed need of the demerging entity, together with the Australian companies, to be a 'stand-alone entity', in light of his consideration of the primary purpose of the demerger as asserted and substantiated by the taxpayer.

Paragraph 45B(8)(k)

This paragraph requires that regard be had to 'any of the matters referred to in subsection 177D(2)', which are matters prescribed for the purposes of determining the 'dominant purpose' test in Part IVA. In the context of section 45B, however, they are to be applied in determining the 'more than incidental' test specific to the provision.

The factors prescribed in subsection 177D(2) focus on indicia that may reveal the true objectives of the relevant scheme. It is recognised that many of the considerations taken into account under this provision may overlap with those already mentioned above.

The circumstances which the Commissioner considers relevant to the assessment of the scheme in this case, and the corresponding paragraphs in subsection 177D(2) to which they relate, are as follows:

• The manner in which the scheme is carried out (paragraph 177D(2)(a)) is the business restructure which includes the demerger.

An inquiry into the manner of the scheme is an objective inquiry into the reasons a taxpayer had for entering into it (see paragraph 86 in PS LA 2005/21).

In this regard, it is submitted in the Application, and it has been accepted for the purposes of this Ruling, that the demerger would achieve what is perceived as a necessary commercial objective.

• The substance of the scheme (paragraph 177D(2)(b)) can be discerned from its effects: paragraph 88 in PS LA 2005/21. In this respect, this consideration overlaps to some extent with that in paragraph 177D(2)(d), under which regard must be had to the result in relation to the operation of the tax acts that, but for this Part (or section 45B, in this context), would be achieved by the scheme.

The effects of the scheme on the parties to the demerger are primarily the (anticipated) commercial positions of X and Y following the demerger, as well as the capital benefit or demerger benefit afforded to X and its shareholders.

The question as to whether the capital and demerger benefits are sufficiently outweighed by the commercial objectives of the proposal such that they may be regarded as merely an incidental purpose of the scheme is determined by taking into account the previous and following other considerations.

• The time at which the scheme was entered into is also a relevant consideration under paragraph 177D(2)(c).

The Taxpayer's submissions have been considered in this regard. The timing of the scheme is consistent with its stated commercial objective.

• Paragraphs 177D(2)(e) to (h) require a consideration of the change in the financial position of, or other consequences to, the taxpayer or any person who has a connection with the taxpayer, as a result of the scheme. They also require a consideration of the nature of the relationship between the taxpayer and such a person.

In the present case, the demerger results in the acquisition by the Taxpayer and other X shareholders of shares in Y; that is, an asset owned previously by X is now directly owned by the Taxpayer, which as stated in PS LA 2005/21 'delivers to the head entity's shareholders an asset which they can liquidate, exchange or use as financial security'.

However, again it is noted that there is no proposal to dispose of Y after the demerger, nor any intention on the part of the Shareholders to deal with their interests in Y following the demerger.

It is accepted that the economic substance of the relationship between the Shareholders and the entities in the group will be preserved upon the demerger.

Upon taking into account the abovementioned circumstances, it is the Commissioner's view that the scheme will not be carried out for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit under paragraph 45B(2)(c).

The matters which the Commissioner has considered persuasive in reaching this conclusion are as follows:

• The scheme is driven largely by the commercial objective articulated in the Application and considered above.
• The tax benefit obtained by a taxpayer is, on the basis of the submissions provided, merely incidental to the primary purposes of the demerger.

For these reasons, the Commissioner will not make a determination under subsection 45B(3) in respect of this scheme.