Edited version of private advice

Authorisation Number: 1051747634034

Date of advice: 31 August 2020

Ruling

Subject: Demerger relief

Question

Is the proposed restructure a 'demerger' within the meaning of section 125-70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period(s)

1 July 20XX to 30 June 20XX

The scheme commences on

The scheme has not commenced.

Relevant facts and circumstances

1.            The Company was registered over ten years ago with Individual A and Individual B owning 50 percent each of the shares on issue.

2.            The Company has six ordinary shares on issue.

3.            The shareholders have always been Individuals A and B.

4.            Individual A is the sole director of the company.

5.            The Company operated a business for many years, with Individual A employed as the business operator.

6.            In addition to operating the business, the Company engaged its capital in accordance with its risk strategy, being investments in deposits and a managed investment portfolio. The portfolio consisted of securities and cash.

7.            The investment strategy implemented investment in growth assets in order to maximise capital growth and income which would provide a return above inflation over the long term, provide shareholders with an income to subsidise interest income on term deposits, and eventually subsidise income from the shareholder superannuation portfolio.

8.            These investments were funded initially from the retained earnings of the business, with the aim to maximise the return to the shareholders.

9.            The business ceased to generate revenue some years ago. However, it has continued to generate profits for its shareholders on its deposits and managed investment portfolio.

10.          As at 30 June 20XX, the Company had net assets of that included the investment portfolio and investment deposits.

11.          The Company has consistently generated profits each year, with returns on net assets invested ranging between four and seven percent each year.

12.          In light of their recent marital separation, Individuals A and B are considering tax efficient and practical ways to divide their jointly held assets and propose to undertake the following restructure:

(a)          create a new holding company (NewCo) and interpose NewCo between the current shareholders of the Company, being Individuals A and B and the Company. Roll-over relief is to be claimed under Division 615 of the ITAA 1997.

(b)          pay a dividend from the Company to NewCo equal to the share of the Company to be allocated to individual A under the agreed financial settlement.

(c)           the Company will then be demerged from NewCo, resulting in Individuals A and B each owning 50 percent of the Company and NewCo. Roll-over relief under Subdivision 125-B of the ITAA 1997 is to be claimed by Individuals A and B.

(d)          Individuals A and B will then exchange shares in NewCo and the Company resulting in individual A becoming the 100 percent shareholder of the Company and individual B becoming the 100 percent shareholder of NewCo. Roll-over relief under Division 126 of the ITAA 1997 is to be claimed by individuals A and B.

13.          The total net value of assets to be retained by the Company is estimated at between 50 percent and 80 percent. The Company would continue to operate as a profit motivated company, with the objective to return significant income to its shareholder, in accordance with its risk and investment strategy.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 125-B

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 subsection 125-70(1)

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

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

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

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

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 Division 126

Income Tax Assessment Act 1997 Division 615

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question

Is the proposed restructure a 'demerger' within the meaning of section 125-70?

Summary

The proposed restructure is not a 'demerger' within the meaning of section 125-70 as the 'nothing else' test in paragraph 125-70(1)(c) and the proportionality tests in subsection 125-70(2) will not satisfied.

Detailed reasoning

1.            For demerger relief to be available, there must be a 'demerger' as defined in subsection 125-70(1). The first element of that definition requires a 'restructuring' of the demerger group.

2.            Individuals A and B each own 50 percent of the shares in the Company. They are proposing a reorganisation of their current business structure to ultimately result in separate ownership of various assets. The proposed restructure is expected to be undertaken in the following four steps:

Step 1: Interpose NewCo between themselves and the Company

Step 2: A dividend will then be paid from the Company to NewCo equal to the share of the Company to be allocated to Individual B under the agreed financial settlement. NewCo will then acquire a mixture of securities to make up the agreed demerging value. The division of securities will be undertaken by selecting each security and applying the relevant proportionate percentage to it for transfer to NewCo. This would result in the portfolio held by the Company being mirrored in NewCo through the names of the securities. However, the value of assets retained by the Company is estimated to be between 50 and 80 percent of the total net assets of the Company which the Company currently holds.

Step 3: The Company will then be demerged from NewCo, resulting in Individuals A and B each owning 50 percent of both the Company and NewCo.

Step 4: A and B will each exchange shares in NewCo and the Company so that Individual A becomes the 100 percent shareholder of the Company and Individual B becomes the 100 percent shareholder of NewCo.

3.            Taxation Determination TD 2020/6 Income tax: what is a 'restructuring' for the purposes of subsection 125-70(1) of the Income Tax Assessment Act 1997? explains at paragraph two what constitutes a restructure for the purposes of a 'demerger'.

In subsection 125-70(1), a restructuring of the demerger group has its ordinary business meaning. It refers to the reorganisation of a group of companies or trusts. What constitutes a particular restructuring is essentially a question of fact. However, all the steps which occur under a single plan of reorganisation will usually constitute the restructuring. The restructuring of a demerger group is not necessarily confined to the steps or transactions under paragraph 125-70(1)(b) that deliver the ownership interests in an entity to the owners of the head entity of the demerger group, but may include previous and / or subsequent transactions in a sequence of transactions. Commercial understanding and the objectively inferred plan for reorganisation will determine which steps or transactions form part of the restructuring of the demerger group.

4.            The purpose of undertaking the four steps detailed above is to transfer securities according to a marital separation financial settlement so that each spouse will become the sole shareholder of their own investment company. These four steps are integral to achieving that outcome and are considered to satisfy the first element required under a demerger, that is, there is a restructuring of the demerger group. All four steps in this instance are considered to occur under a single plan of reorganisation notwithstanding each step may be considered legally independent of the other.[1]

5.            Where a step forms part of the restructuring of a demerger group, that particular step may affect whether or not the conditions to qualify as a demerger in subsection 125-70(1) can be satisfied, which include through paragraph 125-70(1)(h), the requirements of subsection 125-70(2).[2]

6.            Given a demerger can happen where there is a restructuring[3], the scope of the restructuring (including when it begins and ends) is relevant to the 'nothing else' condition in paragraph 125-70(1)(c) and subsection 125-70(2). These two provisions refer to features of the plan which are significant to the economic position of owners of original interests in the head entity and disqualify something from being a demerger if a restructuring changes the economic position of those owners. Consequently, whilst demerger relief is intended to facilitate business restructuring, the statutory intention[4] is that the relief should only be available where the economic position of the original owners remains the same, that is both before and after the restructure.

7.            The 'nothing else' condition in paragraph 125-70(1)(c), requires that under the restructuring:

(i)            a *CGT event happens to an original interest owned by an entity in the head entity of the group and the entity *acquires a new interest and nothing else; or

(ii)           no CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires a new interest and nothing else; ...

8.            Paragraph 15.49 of the Explanatory Memorandum to the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002 provides an explanation as to what is considered to be 'nothing else':

Roll-over is not available for an interest owner who receives something other than a new interest in the demerged entity, for example, cash. This is the case even if the interest owner also receives a new interest in the demerged entity. This exception arises from the combined effect of the proportion test and the market value test. That is, neither of these tests can be satisfied if an original owner receives something other than new interests in the demerged entity.

9.            Based on the proposed restructure both Individuals A and B will, after the implementation of the four steps detailed above, each own a company solely rather than each holding interests in both entities. This results in the economic ownership of the Company changing. Further, it is intended that NewCo will only receive securities on a proportionate basis when a dividend is paid by the Company to NewCo in Step two. Individual A in addition to his 100 percent shareholding in the Company may, in an agreed proportion of between 50 to 80 percent, retain investment deposits and cash held in the portfolio before the restructuring. Based on these facts, the requirements of the 'nothing else' test in paragraph 125-70(1)(c) will not be satisfied and a 'demerger' (within the meaning of that term in subsection

10.          125-70(1)) does not happen to the demerger group.

11.          Further, paragraph 125-70(1)(h) states that the requirements of subsection 125-70(2) are to be met. Subsection 125-70(2) sets out the following two proportionality tests:

'Each owner (an original owner) of original interests in the *head entity of the *demerger group must:

(a)          *acquire, under the *demerger, the same proportion, or as nearly as practicable the same proportion, of new interests in the *demerged entity as the original owner owned in the head entity just before the demerger; and

(b)          just after the demerger, have the same proportionate total *market value of *ownership interests in the head entity and demerged entity as the original owner owned in the head entity just before the demerger.

12.          Individuals A and B both originally own 50 percent each of the Company. After the proposed four steps are carried out this will no longer be the case. After completing all four steps, Individual A will own 100 percent of the Company and Individual B will own 100 percent of NewCo. Consequently, the proportionality requirements of interests in the demerged entity as required by paragraph 125-70(2)(a) will not be met.

13.          As equal owners of the Company, Individuals A and B currently own assets with a significant market value. Under the proposed demerger, NewCo will receive securities on a proportionate basis according to the marital separation financial agreement, which will vary according to the agreement and the Company would retain between at least half, possibly more, of its current value. It is unclear at this time whether paragraph 125-70(2)(b) will be met.

14.          As both requirements in subsection 125-70(2) need to be met, and the requirement in paragraph 125-70(2)(a) will not be met, the requirement in paragraph 125-70(1)(h) cannot be met.

15.          In summary, as the requirements of 125-70(1)(c) and 125-70(2) cannot be met the proposed restructure will not be considered a 'demerger' within the meaning of subsection 125-70(1). Note, given these integral conditions cannot be satisfied the other requirements in section 125-70 have not been considered.