Edited version of private advice

Authorisation Number: 1051935620819

Date of advice: 22 December 2021

Ruling

Subject: Demerger

Issues

Question 1

Are the roll-over relief requirements under section 125-55 of the Tax Assessment Act 1997 (ITAA 1997) where the Shareholders gain direct ownership of Subsidiary Company shares that were held by Holding Company?

Answer

Yes - and a consequence of choosing the roll-over under section 125-55 of the ITAA 1997 is that the Shareholders can maintain the pre-CGT status of the Subsidiary Company shares as they will be taken to have acquired all of Subsidiary Company shares before 20 September 1985 pursuant to section 125-80 of the ITAA 1997.

Question 2

Is any capital gain or capital loss arising from CGT event A1 happening to Holding Company's ownership interests in Subsidiary Company upon the demerger disregarded under section 125-155 of the ITAA 1997?

Answer

Yes.

Question 3

Is all or any part of the in-specie distribution of Subsidiary Company shares to Holding Company's shareholders that is a dividend 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

No

This ruling applies for the following period: XXXX

Relevant facts and circumstances

The entities

Holding Company owns 99.98% of the shares in Subsidiary Company.

Holding Company has two classes of shares on issue.

All of the shares in Holding Company and Subsidiary Company are pre CGT assets.

The shares are not interests in a trust that is a non-complying superannuation fund.

All of the entities are Australian residents for tax purposes.

The proposed demerger

Holding Company proposes to undertake a demerger by transferring all of its shares in Subsidiary (representing 99.98% of the issued and paid-up capital) to its shareholders such that:

•         each Holding Company shareholder will acquire the same proportion of shares in Subsidiary Company as the proportion of shares they owned in Holding Company just before the demerger; and

•         each Holding Company shareholder will have the same proportionate total market value of shares in Holding Company and Subsidiary Company as they owned in Holding Company just before the demerger.

Independent valuations will be obtained to establish the market values of Holding Company and Subsidiary Company shares.

Part of the market value of Subsidiary shares will be debited to the share capital of Holding Company and a residual amount will be debited to the reserves of Holding Company.

Reasons for the Proposed demerger

A number of commercial reasons were provided as the reasons for undertaking a demerger.

Other matters

Holding Company will not make an election under subsection 44(2) of the ITAA 1936.

There is no intention or proposal for the sale of the shares in Holding Company or Subsidiary Company by the Holding Company shareholders following the demerger.

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

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

50% or more of the CGT assets owned by Subsidiary Company will be used in carrying on its business for the purposes of subsection 44(5) of the ITAA 1936.

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 section 104-10

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 Division 125

Income Tax Assessment Act 1997 subdivision 125-B

Income Tax Assessment Act 1997 section 125-55

Income Tax Assessment Act 1997 section 125-65

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 section 125-155

Reasons for decision

Question 1

Summary

The shareholders of Holding Company will be entitled to choose demerger roll-over under section 125-55 of the ITAA 1997 and a consequence of choosing the roll-over under section 125-55 of the ITAA 1997 is that the Shareholders can maintain the pre-CGT status of Subsidiary Company shares as they will be taken to have acquired all of Subsidiary Company shares before 20 September 1985 pursuant to section 125-80 of the ITAA 1997.

Detailed reasoning

Division 125 of the ITAA 1997 provides an entity CGT relief for a demerger.

Subsection 125-55(1) of the ITAA 1997 states that an entity can choose to obtain a roll-over if:

(a)  you own an ownership interest in the company (your original interest); and

(b)  the company or trust is the head entity of a demerger group; and

(c)   a demerger happens to the demerger group; and

(d)  under the demerger, a CGT event happens to your original interest and you acquire a new or replacement interest (your new interest) in the demerged entity

A demerger will happen to the demerger group of which Holding Company is the head entity and Subsidiary Company the demerger subsidiary.

CGT event G1 will happen in relation to the shares held by the shareholders in Holding Company to the extent that Holding Company makes a return of capital to its shareholders.

Therefore, the shareholders will be entitled to choose demerger roll-over under section 125-55 of the ITAA 1997.

If the roll-over is chosen, a capital gain or capital loss a taxpayer makes from a CGT event happening under the demerger to an original interest the taxpayer owns is disregarded (subsection 125-880(1) of the ITAA 1997) - including any capital gain arising from CGT event G1. In this case, shareholders can disregard any capital gain as a result of CGT event G1 applying as their share were acquired before 20 September 1985 (subsection 104-135(5) of the ITAA 1997).

Where an owner's original interests were all acquired before 20 September 1985 and demerger roll-over relief is chosen, all new interests acquired in the demerger are treated as pre-CGT assets (subsections 125-80(4) and 125-80(5) of the ITAA 1997). Accordingly, no cost base adjustments are necessary.

Question 2

Summary

Holding Company 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 Subsidiary Company upon the demerger of Subsidiary Company by Holding Company.

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.

Holding Company is the demerging entity.

CGT event A1 will happen when Holding Company disposes of its shares in Subsidiary Company and transfers them to the Holding Company shareholders (per section 104-10 of the ITAA 1997).

This disposal happens under a demerger.

Therefore, any capital gain or loss under CGT event A1 made by Holding Company on the disposal of its Subsidiary Company shares under the demerger will be disregarded (including under section 125-155 of the ITAA 1997).

Question 3

Summary

All or any part of the distribution of Subsidiary Company shares to Holding Company shareholders 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).

Therefore, the capital reduction amount will not be assessable income of the shareholders of Holding Company 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 distribution of Subsidiary Company shares will, in part, constitute a dividend of Holding Company shareholders.

In general, a dividend satisfied by a 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, as the above requirements are satisfied, the dividend paid to the Holding Company shareholders under the demerger would satisfy the conditions necessary to be a demerger dividend and would therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) 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 section 45C will apply to the whole, or any part, of any benefit provided to Holding Company A shareholders under the proposed arrangement.

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.

Subsection 45B(2) of the ITAA 1936 sets out the conditions that must be met in order for section 45B to apply. Relevantly, this section applies if:

•         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

•         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

•         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).

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 of the ITAA 1936. 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, the transfer of shares in Subsidiary Company to Holding Company shareholders under the demerger constitute the relevant scheme for the purposes of section 45B of the ITAA 1936.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides 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, the tax payable by Holding Company shareholders on the demerger would be higher if the demerger benefit was an assessable dividend. Accordingly, Holding Company shareholders 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 Holding Company 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.

Relevant circumstances

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 subsection 177D(2) of the ITAA 1936, which are included in subsection 45B(8) by virtue of paragraph (k).

Part IVA factors

Paragraph 45B(8)(k) requires regard to be had to any of the matters referred to in paragraphs 177D(2)(a) to (h) of the ITAA 1936.

The incorporation of the Part IVA factors into section 45B of the ITAA 1936 does not introduce a different (dominant) purpose test into section 45B. The matters are applied in the context of the 'more than incidental purpose test' in section 45B.

The eight matters in subsection 177D(2) of the ITAA 1936 constitute the essential facts and circumstances of a scheme, including the outcomes for the parties to the scheme, by reference to which the tax and non-tax objects of the scheme can be identified and contrasted from an objective point of view.

If, on the one hand, reference to the matters in subsection 177D(2) of the ITAA 1936 reveal that the essential object of a demerger is to produce changes and improvements to the business structures of the corporate group, the tax-free aspect of the transfer of ownership interests to the head entity's owners is more likely to be an incidental object of the demerger.

If on the other hand reference to those matters reveals that the transfer of ownership interests from the corporate group to the head entity's shareholders is an essential object of the scheme, the tax-free aspect of the transfer would ordinarily be a substantial object of the demerger.

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 on balance 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 section 45C will apply to the whole, or any part, of any benefit provided to Holding Company shareholders under the proposed arrangement.