Edited version of private advice

Authorisation Number: 1052048456239

Date of advice: 25 October 2022

Ruling

Subject: Demerger

Question

Will a capital gain or capital loss made by Head co from CGT event A1 happening to its shares in Company A be disregarded under section 125-155 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Summary

Head co is a privately owned Australian company.

Head co has 2 wholly owned subsidiaries that undertake different businesses

Company A

Company B

All shareholders are Australian residents with little to no capital losses.

Reasons for proposed demerger

Changes in the industries each subsidiary operate in has made it difficult to grow in the current structure. By demerging Head co aims to achieve the following commercial benefits:

•         Access to different financiers for Company A

•         Reduced credit risk profile for Company B

•         Greater borrowing capacity for all entities

•         Ability to undertake opportunities to grow each subsidiary that are missed as a result of the current structure.

Proposed transaction

Head co is proposing to demerge XX% of Company A by way of an in-specie distribution to its shareholders. For completeness Head co's XX% ownership in Company B will not be affected by the demerger, the scheme is aimed at separating Company A from Company B.

Company A will undertake a share split prior to the demerger to allow the ultimate beneficial owners to retain the precise interest they held prior to the demerger.

Head co will dispose of all of their shares in Company A to their Shareholders in equal proportions to their ownership proportions in the head entity prior to the demerger.

The owners of Head co will receive shares and nothing else, with each owner holding the same market value and proportion after the transaction as they did just before the demerger.

The demerger allocation will be the market value of Company A's shares.

Head co's share capital account will not be "tainted" in accordance with the "share capital tainting rules", within the meaning of Division 197 of the ITAA 1997, at the time of the demerger.

Head co shows a history of distributing regular dividends similar to the year's earnings.

Valuation

Head co will undertake a valuation at the time of the demerger that is consistent with the requirements of the ATO market valuation guidelines.

Post demerger

Company A and Company B already operate independently apart from a shared receptionist and internal accounts staff. Both companies will hire their own receptionist and account staff post demerger.

Company A will formally sub-lease the space they currently occupy from Company B. Prior to the demerger, occupancy costs are shared on a pro-rata basis.

The intercompany loan between Company A and Company B will be placed on a formal loan agreement.

Both entities already have separate management structures.

All CGT assets of Company A will be used in carrying on the business post demerger.

There are no plans to undertake an IPO, or for any of the shareholders to reduce their holdings post demerger.

Relevant legislative provisions

Section 125-155 of the Income Tax Assessment Act 1997

Reasons for decision

Section 125-155 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that any capital gains or capital losses a demerging entity makes as a result of CGT events A1, C2, C3 or K6 happening to its ownership interests in a demerged entity are disregarded.

In this case, CGT event A1 will happen when Head co (the demerging entity) disposes of its shares in Company A (demerged entity) when it transfers the Company A shares to the Shareholders of Head co (section 104-10 of the ITAA 1997).

This disposal occurs under a demerger.

The requirements of section 125-155 of the ITAA 1997 are satisfied as:

• Head co is a demerging entity as it is member of the demerger group of which Head co is head entity
• CGT Event A1 will happen when Head co's shares in the demerged entity (i.e. Company A shares) are disposed of to the shareholders
• Head co will make a capital gain as a result CGT event A1 happening; and
• The disposal of the XX% of the Company A shares will happen under the demerger.

Section 125-155 of the ITAA 1997 will apply such that Head co will disregard any capital gain or loss from CGT event A1 happening to transfer of the shares in Company A to the shareholders.