Edited version of private advice

Authorisation Number: 1051935852320

Date of advice: 21 December 2021

Ruling

Subject: Demerger relief

Question

Will any capital gain or capital loss that XYZ Co makes from CGT event A1 happening to its shareholding in Ally Co be disregarded pursuant to section 125-155 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer

Yes.

This ruling applies for the following period

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

On 1 June 20XX, ABC Pty Ltd as Trustee for ABC Discretionary Trust ('the Discretionary Trust') acquired 100% of the shares in XYZ Pty Ltd ('XYZ Co') from a third party. At that time, XYZ Co owned 100% of Ally Pty Ltd ('Ally Co').

The third-party vendor's offer was to acquire Ally Co as a subsidiary of XYZ Co. The Discretionary Trust was not afforded the opportunity to acquire 100% of the shares in XYZ Co and, separately, 100% of the shares in Ally Co.

XYZ Co continues to own 100% of the shares in Ally Co.

The scheme which is the subject of this ruling request is the demerger by XYZ Coof Ally Co to the Discretionary Trust.

The Discretionary Trust

The Discretionary Trust is an Australian resident discretionary trust and is primarily an investment and holding trust. The Discretionary Trust is not a trading entity.

The Discretionary Trust owns 100% of the shares in XYZ Co, which it acquired for $2 million.

XYZ Co

XYZ Co is an Australian resident company. XYZ Co was incorporated in 20XX and it provides business services.

XYZ Co has share capital of $100.

XYZ Co owns 100% of the shares in Ally Co.

Ally Co

Ally Co is an Australian resident company. Ally Co was incorporated in 20XX and provides computer software under a subscription-based model. Ally Co's clients are businesses across Australia.

Ally Co has $100 share capital.

The current 'fair value' of Ally Co is $XX million based on an internal valuation of the company on a 'Software as a Service' basis.

The demerger

Prior to the demerger

•         XYZ Co will undertake an asset revaluation of its investment in Ally Co from $100 to the current 'fair value' of $XX million.

The demerger

•         XYZ Co will declare a dividend of $XX million to be paid to the Discretionary Trust.

•         XYZ Co will resolve to undertake a capital return of $50 to be paid to the Discretionary Trust.

•         XYZ Co will make an in-specie distribution of 100% of the shares in Ally Co to the Discretionary Trust in satisfaction of the dividend and capital return.

•         XYZ Co will not elect that subsections 44(3) and (4) of the ITAA 1936 do not apply to the dividend, under subsection 44(2) of the ITAA 1936.

•         The number and class of shares which will be transferred under the demerger will correspond to the proportion and class of shares the Discretionary Trust currently holds in XYZ Co (100%).

•         No XYZ Co shares will be cancelled.

•         The Discretionary Trust will be eligible for the roll-over in section 125-55 of the ITAA 1997 and will choose to obtain it.

After the Demerger

The Discretionary Trust does not plan to dispose of any of its shares in Ally Co after the Demerger and there is no post-separation capital raising proposed to occur in accordance with Tax 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?

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 104-10

Section 125-60

Section 125-65

Section 125-70

Section 125-155

Reasons for decision

CGT event A1 happens when XYZ Co disposes of its shares in Ally Co to the Discretionary Trust pursuant to section 104-10 of the ITAA 1997.

Pursuant to section 125-155 of the ITAA 1997, any capital gain or capital loss a 'demerging entity' makes from CGT event A1 happening to its 'ownership interests' in a 'demerged entity' under a 'demerger' is disregarded.

To determine whether section 125-155 of the ITAA 1997 applies, it is necessary to ascertain whether each of the defined terms has been satisfied. Each of these has been considered below:

Ownership interests

Pursuant to paragraph 125-60(1)(a) of the ITAA 1997, shares in a company are an 'ownership interest'. Therefore, the shares that XYZ Co owns in Ally Co are ownership interests.

A demerger

A 'demerger' happens to a 'demerger group' if the conditions in section 125-70 of the ITAA 1997 are satisfied.

Pursuant to subsection 125-65(1) of the ITAA 1997, a 'demerger group' comprises the head entity of the group and one or more subsidiaries. Pursuant to subsection 125-65(3) of the ITAA 1997, a company or trust is the head entity of a 'demerger group' if no other member of the group owns ownership interests in the company or trust.

Although the Discretionary Trust owns ownership interests in XYZ Co, as a discretionary trust it cannot be a member of a demerger group (see subsection 125-65(2) of the ITAA1997 and the Note in that subsection). Therefore, XYZ Co is the head entity of the 'demerger group' ('the XYZ Group'), as no other member of the XYZ Group owns an ownership interest in it.

We also note the following:

•         Subsection 125-65(2A) of the ITAA 1997 does not apply as no member of the XYZ Group is a corporation sole or a complying superannuation entity,

•         Subsection 125-65(4) of the ITAA 1997 does not apply as none of the demerger subsidiaries are also demerger subsidiaries of another company or trust in another demerger group,

•         Subsection 125-65(5) of the ITAA 1997 does not apply as no member of the XYZ Group has ownership interests in a listed public company or listed widely-held trust that chooses that the member not be a member of the XYZ Group.

Therefore, the 'demerger group' consists of XYZ Co as head entity, and Ally Co.

A 'demerger' will happen to the XYZ Group because:

•         there will be a restructuring of the XYZ Group (paragraph 125-70(1)(a) of the ITAA 1997), and

•         under the restructuring, XYZ Co will dispose of 100% of its total ownership interests in Ally Co (a member of the XYZ Group) to the Discretionary Trust (the owners of original interests in XYZ Co, the head entity of the XYZ Group) (subparagraph 125-70(1)(b)(i) of the ITAA 1997), and

•         under the restructuring, CGT event G1 happens to the shares owned by the Discretionary Trust in XYZ Co (the head entity) and the Discretionary Trust acquires a new interest, being the shares in Ally Co, and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997), and

•         the acquisition by the Discretionary Trust of shares in Ally Co happens only because the Discretionary Trust owned original interests in XYZ Co (paragraph 125-70(1)(d) of the ITAA 1997), and

•         the new interests acquired by the Discretionary Trust are shares in Ally Co, a company ((s125-70(1)(e)(i)),

•         neither the original interests nor the new interests in Ally Co are in a trust that is a non-complying superannuation fund (paragraph 125-70(1)(g) of the ITAA 1997), and

•         the requirements of subsection 125-70(2) of the ITAA 1997 are met (see below) (paragraph 125-70(1)(h)).

Additionally, the requirements of subsection 125-70(2) of the ITAA 1997 are met because:

•         Under the Demerger, the Discretionary Trust will acquire 100% of the shares in Ally Co, which is the same proportion as XYZ Co owned in Ally Co; and

•         Just after the Demerger, the Discretionary Trust will have the same proportionate total market value of shares in XYZ Co and Ally Co as the Discretionary Trust owned in XYZ Co just before the Demerger.

Furthermore, the exceptions contained in subsections 125-70(4) and 125-70(5) of the ITAA 1997 do not apply as there will be no buy-back of shares that is an off-market purchase for the purposes of Division 16K of Part III of the Income Tax Assessment Act 1936 ('ITAA 1936)' and the Discretionary Trust is not entitled to any other CGT roll-over outside of Division 125 for CGT event G1 that will happen in relation to its XYZ Co' shares.

Demerged Entity

Pursuant to paragraph 125-70(6)(a) of the ITAA 1997, an entity that is a former member of a demerger group is a demerged entity if, under a demerger that happens to the group, ownership interests in the entity are acquired by shareholders in the head entity of the group.

Under the Demerger, Ally Co will be a former member of the XYZ Group, and the ownership interests in Ally Co will be acquired by the Discretionary Trust, the shareholder of XYZ Co, the head entity of the XYZ Group.

Therefore, Ally Co will be a 'demerged entity'.

Demerging Entity

Pursuant to paragraph 125-70(7)(a) of the ITAA 1997, an entity that is a member of a 'demerger group' just before the CGT event referred to in section 125-155 happens is a 'demerging entity' if, under a demerger that happens to the group, the entity (either alone or together with other members of the demerger group) disposes of at least 80% of their total ownership interests in another member of the demerger group to owners of original interests in the head entity of the demerger group.

Under the Demerger, XYZ Co is a member of the XYZ Group just before CGT A1 happens.

Further, under the Demerger, XYZ Co will dispose of 100% of its total ownership interests in Ally Co, another member of the XYZ Group, to the Discretionary Trust, being the owners of the shares of XYZ Co, the head entity of the demerger group.

Therefore, XYZ Co is a 'demerging entity'.

In summary

As XYZ Co is a demerging entity, any capital gain or capital loss it makes from CGT event A1 happening to its shares in Ally Co, the demerged entity, under the demerger is disregarded.