Edited version of private advice

Authorisation Number: 1051965278498

Date of advice: 4 May 2022

Ruling

Subject: Proposed demerger

Question 1

Will the Australian Shareholders of Hold Co be able to choose to obtain demerger roll-over under section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the Australian Shareholders of Hold Co be required to make a cost base adjustment for the shares held in Hold Co under section 125-80 of the ITAA 1997 as a result of the proposed demerger?

Answer

Yes

Question 3

Will the Commissioner confirm that all, or any part, of the distribution of shares in Sub Co to the Australian Shareholders of Hold Co that is a dividend will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) to 44(5) 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 section 45C of the ITAA 1936 applies to the whole, or any part, of the demerger benefit or capital benefit provided to the Australian Shareholders of Hold Co under the proposed demerger?

Answer

No

This ruling applies for the following period:

Year ended 30 June xxxx

The scheme commences on:

1 July xxxx

Relevant facts and circumstances

Hold Co is a company incorporated in Australia. It owns all the shares in another company incorporated in Australia, Sub Co.

All the shares on issue in Hold Co and Sub Co are ordinary shares and post-CGT assets.

The shareholders are both Australian residents and non-residents for tax purposes.

The Australian resident shareholders are referred to collectively as Australian Shareholders.

Hold Co proposes to demerge Sub Co.

The demerger of Sub Co will be undertaken by a reduction of share capital.

At the time of the demerger Hold Co will transfer all its shares in Sub Co to the shareholders of Hold Co.

Market valuations in accordance with the principles stated in the ATO market valuation guidelines will be carried out immediately before the demerger.

Hold Co will account for the demerger by debiting its share capital account by the capital reduction amount. The demerger dividend, being the difference between the market value of Sub Co and the capital reduction amount, is to be debited against its Retained profit account.

Each Hold Co shareholder will acquire the same proportion of shares in Sub Co as the proportion of shares they own in Hold Co just before the demerger.

Each Hold Co shareholder will have the same proportionate total market value of shares in Hold Co and Sub Co as they own in Hold Co just before the demerger.

Hold Co's share capital account is not tainted within the meaning of Division 197 of the ITAA 1997.

Hold Co does not elect under subsection 44(2) of the ITAA 1936 that subsections 44(3) and 44(4) of the ITAA 1936 will not apply to the demerger dividend for all Hold Co shareholders.

Just after the demerger, all CGT assets owned by Sub Co will be used in carrying on Sub Co's business.

There is no transaction that has occurred or will occur that is connected with the demerger in anyway. The shareholders of Hold Co have no current plans in place to dispose of either business following the demerger or otherwise realise their interests in either business.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 subsection 104-135(3)

Income Tax Assessment Act 1997 subsection 125-55(1)

Income Tax Assessment Act 1997 subsection 125-55(2)

Income Tax Assessment Act 1997 subsection 125-60(1)

Income Tax Assessment Act 1997 subsection 125-70

Income Tax Assessment Act 1997 subsection 125-80(1)

Income Tax Assessment Act 1997 subsection 125-80(2)

Income Tax Assessment Act 1997 subsection 125-80(3)

Income Tax Assessment Act 1997 subsection 125-85(1)

Income Tax Assessment Act 1997 subsection 125-85(2)

Income Tax Assessment Act 1997 Division 197

Reasons for decision

Question 1

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise indicated.

Summary

The Australian Shareholders will be able to elect to apply demerger roll-over under section 125-55.

Detailed reasoning

Subsection 125-55(1) allows an entity to choose to obtain a roll-over where the following conditions are satisfied:

(a)   you own an ownership interest in a company or trust (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.

However, subsection 125-55(2) provides that you cannot choose to obtain a roll-over under Subdivision 125-B for an original interest if you are a foreign resident and the new interest you acquire under the demerger in exchange for that original interest is not taxable Australian property (as defined in section 855-15) just after you acquire it.

Paragraph 125-55(1)(a) is satisfied as the shareholders of Hold Co have ownership interest in a company (as defined in paragraph 125-60(1)(a) to include 'a share in the company').

Paragraph 125-55(1)(b) is satisfied because Hold Co is the head entity of a demerger group.

The demerger group in this case comprises of Hold Co as the head entity and Sub Co as a demerger subsidiary (subsection 125-65(1)).

Hold Co is the head entity because:

•            no other member of the demerger group holds ownership interests in Hold Co (subsection 125-65(3)),

•            there is no other company or trust capable of being a head entity of a demerger group of which Hold Co could be a demerger subsidiary (subsection 125-65(4)).

Sub Co is a demerger subsidiary because Hold Co owns 100% ownership interest in Sub Co (subsection 125-65(6)).

Paragraph 125-55(1)(c) requires a demerger to happen to the demerger group.

A demerger, as defined in subsection 125-70(1), happens as:

•         there is a restructuring of a 'demerger group' consisting of Hold Co (as the head entity) and Sub Co (as a demerger subsidiary)

•         under the restructuring, Hold Co disposes of 100% of its total ownership interests in Sub Co to owners of original interests in Hold Co (the shareholders of Hold Co)

•         under the restructuring, CGT event G1 under section 104-135 happens to the Hold Co shares owned by the shareholders, and the shareholders of Hold Co acquire a new interest (shares in Sub Co) and nothing else

•         the shareholders of Hold Co acquire shares in Sub Co only because they own shares in Hold Co

•         Hold Co is a company and the shareholders of Hold Co acquire shares in another company (Sub Co)

•         neither Hold Co nor Sub Co is a trust that is a non-complying superannuation fund, and

•         the proportionality requirements of subsection 125-70(2) are met because each Hold Co shareholder will acquire the same proportion of new shares in Sub Co as they own in Hold Co just before the demerger. Each Sub Co shareholder will also have the same proportionate total market value of shares in Hold Co and Sub Co as they own in Hold Co just before the demerger.

As the requirements of subsection 125-70(1) are met, paragraph 125-55(c) is satisfied.

Paragraph 125-55(1)(d) is satisfied because CGT event G1 happens to the shareholders of Hold Co and the shareholders of Hold Co acquire shares in Sub Co.

CGT event G1 under section 104-135 happens because:

•         Hold Co makes a payment to each Hold Co shareholder by giving them property, being shares in Sub Co

•         the payment made by Hold Co to the shareholders is the market value of the Sub Co shares. Part of this payment is a reduction of share capital which is not a dividend (as defined in subsection 6(1) of the ITAA 1936) as it is an amount debited to a company's share capital account and is excluded by paragraph (d) of the definition.

•         the reduction of share capital amount is not included in the assessable income of the shareholders under section 44 of the ITAA 1936, and nor is it taken to be a dividend distribution by a liquidator under section 47 of the ITAA1936.

•         there are no other income tax provisions (apart from CGT event G1) that apply to the shareholders to include any part of the value of the Sub Co shares in their assessable income.

Conclusion

The requirements of subsection 125-55(1) are met and the Australian Shareholders will be able to choose to obtain the roll-over.

The non-resident shareholders cannot choose to obtain roll-over under section 125-55 due to the exclusion in subsection 125-55(2).

Question 2

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise indicated.

Summary

The Australian Shareholders will be required to make a cost base adjustment for the shares held in Hold Co under section 125-80.

Detailed reasoning

Under subsection 125-80(1) a capital gain or capital loss that happens to an original interest under a demerger is disregarded.

Under subsection 125-80(2):

If you choose the roll-over, the first element of the cost base and reduced cost base of:

(a) each new interest that you are not taken to have acquired before 20 September 1985, and

(b) if not all of your original interests ended under the demerger - each of your remaining original interests that you acquired on or after 20 September 1985,

is such proportion of the sum of the cost bases of all your original interests that you acquired on or after 20 September 1985 (worked out just before the demerger) as is reasonable having regard to the matters specified in subsection (3).

When the Australian Shareholders choose demerger roll-over:

•            any capital gain they make when CGT event G1 happens to their Hold Co shares under the demerger is disregarded (subsection 125-80(1)), and

•            they are required to apportion the cost base and reduced cost base of the original interest between the original interest and the new interest (subsection 125-80(2)) having regard to the matters specified in subsection 125-80(3), being:

(i)      the market values of the original interests and the new interests immediately after the demerger; or

(ii)     an anticipated reasonable approximation of those market values.

Question 3

All legislative references are to the Income Tax Assessment Act 1936 unless otherwise indicated.

Summary

The dividend distribution to the Australian Shareholders will constitute a demerger dividend, and therefore be neither assessable income nor exempt income.

Detailed reasoning

The assessable income of a shareholder includes a dividend under subsection 44(1), which states:

The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) includes:

(a)     if the shareholder is a resident:

(i)      dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source;

...

The definition of 'dividend' is provided in subsection 6(1) and includes:

(a)    any distribution made by a company to any of its shareholders, whether in money or other property; and

(b)    any amount credited by a company to any of its shareholders as shareholders;

...

but does not include

(d)    money paid or credited by a company to a shareholder.... 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; ....

Hold Co will implement the transfer of Sub Co shares to the shareholders of Hold Co by:

•          debiting an amount to Hold Co's share capital account, and

•          debiting the balance to the Retained profit account.

As such, the shareholders will not receive a dividend to the extent that the transfer of the Sub Co shares is debited to Hold Co's share capital account.

The shareholders will receive a dividend to the extent that the market value of the Sub Co shares transferred to them exceed the amount debited to Hold Co's share capital account.

Under subsections 44(3) and 44(4), this dividend will not be assessable income or exempt income of the shareholders because:

•          the dividend is a 'demerger dividend' (as defined in subsection 6(1) to mean that part of a demerger allocation that is assessable as a dividend under subsection 44(1)));

•          Hold Co does not elect that subsections 44(3) and 44(4) will not apply to the total demerger dividend for all the shareholders (subsection 44(2)); and

•          the condition in subsection 44(5) is satisfied because just after the demerger, all the CGT assets owned by Sub Co will be used in carrying on its business.

Accordingly, the dividend received by the Australian Shareholders will be non-assessable non-exempt income in accordance with subsections 44(4).

Question 4

All legislative references are to the Income Tax Assessment Act 1936 unless otherwise indicated.

Summary

The Commissioner will not make a determination under subsection 45B(3) that section 45BA or section 45C applies to the proposed demerger.

Detailed reasoning

Under subsection 45B(3) the Commissioner may make a determination that section 45BA applies to all or part of the demerger benefit, or that section 45C applies to all or part of the capital benefit.

Section 45BA concerns the effect of determination under section 45B for demerger benefits.

Section 45C concerns the effect of determination under section 45A and 45B for capital benefits.

Section 45A

Section 45A applies when a company streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that the capital benefits are received by 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)).

The 'provision of a capital benefit' to a shareholder includes the distribution to the shareholder of share capital (subsection 45A(3)). The reduction of share capital by Hold Co for the benefit of its shareholders means that there is the provision of a capital benefit to the shareholders of Hold Co.

There is the provision of a capital benefit to all of the shareholders in direct proportion to their shareholdings, such that there is no streaming of the provision of capital benefits.

Accordingly, the Commissioner will not make a determination under subsection 45A(2) that section 45C applies in relation to the capital benefits provided to the shareholders of Hold Co.

Section 45B

The purpose of section 45B is to ensure that relevant amounts are treated as dividends for taxation purposes if components of a demerger allocation as between capital and profit do not reflect the circumstances of a demerger, or certain payments, allocations and distributions are made in substitution for dividends.

Section 45B only applies if, 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 to obtain a tax benefit.

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).

Having regard to these relevant circumstances in this case, the Commissioner considers that the requisite purpose of enabling the shareholders of Hold Co, or other taxpayers, to obtain a tax benefit does not exist.

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