Edited version of private advice

Authorisation Number: 1052104035474

Date of advice: 4 April 2023

Ruling

Subject: Proposed demerger

Question 1

Will the shareholders of Company X be able to elect to apply a demerger roll-over under section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will Company X be able to disregard any capital gain or capital loss under CGT event A1 upon the proposed transfer of its shares in Hold Co to its shareholders under the proposed demerger, pursuant to section 125-155 of ITAA 1997?

Answer

Yes

Question 3

Will the Commissioner confirm that all, or any part, of the distribution of Hold Co shares to Company X shareholders 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 will apply to the whole, or any part, of any benefit provided to the shareholders of Company X under the proposed demerger?

Answer

No

This ruling applies for the following period

Income tax year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Overview of the Group

Company X

Company X is an Australian private company.

All the shares in Company X are fully paid-up.

Company X does not have a dividend policy and has not made any dividend distributions in at least the last five years.

Shareholders of Company X

Company X currently has multiple shareholders. All the shareholders are individuals that are Australian residents for tax purposes.

The shareholders' interests in Company X are post-CGT interests.

The shareholders have negligible carried forward or anticipated capital losses.

None of the shareholders has the intention to divest any interest in Hold Co or Company X or transfer any shares either between themselves or to any other associated entities after the proposed demerger.

Proposed demerger arrangement

The arrangement which is the subject of this ruling request is the proposed demerger by which Company X is to distribute to its shareholders all of the shares in a proposed wholly owned subsidiary company, Hold Co.

Reasons for the proposed demerger

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

Other matters

There has not been and nor will there be any payment or distribution made before the proposed demerger by Company X, which would be deemed dividend under Division 7A of the ITAA 1936.

The share capital account of Company X is not tainted within the meaning of section 197-50 of the ITAA 1997.

Company X will not elect under subsection 44(2) of the ITAA 1936 that subsections 44(3) and (4) do not apply.

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 177A

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 115-30

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 Company X will be able to elect to apply a demerger roll-over under section 125-55 of the ITAA 1997 upon the proposed demerger of Hold Co by Company X.

Detailed reasoning

Division 125 of the ITAA 1997 provides entities with capital gains tax (CGT) relief for a demerger.

Under subsection 125-55(1) of the ITAA 1997, you can choose to obtain CGT roll-over relief if:

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, pursuant to subsection 125-55(2) of the ITAA 1997 you cannot choose to obtain a roll-over for an original interest if:

a)            You are a foreign resident; and

b)            The new interest you acquire under the demerger in exchange for that original interest is not taxable Australian property just after you acquire it.

Subsection 125-55(2) does not apply to the circumstances of this case as all the shareholders of Company X are Australian residents for tax purposes.

Key terms

In order for the demerger CGT outcomes contained in Division 125 of the ITAA 1997 to apply, a number of defined terms must be satisfied, including:

•                     demerger group (subsection 125-65(1) of the ITAA 1997)

•                     demerger (subsection 125-70(1) of the ITAA 1997)

•                     demerged entity (paragraph 125-70(6)(a) of the ITAA 1997), and

•                     demerging entity (paragraph 125-70(7)(a) of the ITAA 1997).

Demerger group

Subsection 125-65(1) of the ITAA 1997 provides that a demerger group comprises one head entity and at least one demerger subsidiary. The demerger group in the present case comprises Company X as the head entity and includes the proposed holding company Hold Co as a demerger subsidiary.

Company X will be the head entity because:

•                     no other member of the Group holds ownership interests in Company X (subsection 125-65(3) of the ITAA 1997), and

•                     there will be no other company or trust capable of being a head entity of a demerger group of which Company X could be a demerger subsidiary (subsection 125-65(4) of the ITAA 1997).

Hold Co will be a demerger subsidiary of Company X because Company X is to own ownership interests in Hold Co that carry more than 20% of the rights to any distribution of income and capital, and the right to exercise more than 20% of the voting power of Hold Co (subsection 125-65(6) of the ITAA 1997).

Demerger

Subsection 125-70(1) of the ITAA 1997 describes when a demerger happens. Paragraph 125-70(1)(a) of the ITAA 1997 proves that a demerger includes a restructuring of the demerger group.

In the present case, a demerger will happen to the Group because:

•                     there will be a restructuring of the demerger group (paragraph 125-70(1)(a) of the ITAA 1997) under which Company X will dispose of at least 80% (i.e. 100%) of its shares in Hold Co (which is to be incorporated to hold all Business A operations within the existing Group) to the owners of Company X (subparagraph 125-70(1)(b)(i)),

•                     under the restructuring, CGT event G1 (capital payment for shares) will happen in respect of the original shares in Company X, and the shareholders of Company X will acquire new shares in Hold Co and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997),

•                     the shareholders of Company X will acquire new interests in Hold Co only because they own the original interests in Company X (paragraph 125-70(1)(d) of the ITAA 1997) and the new interests will be shares in a company (subparagraph 125-70(1)(e)(i) of the ITAA 1997),

•                     neither Company X nor Hold Co are superannuation funds (paragraph 125-70(1)(g) of the ITAA 1997),

•                     the shareholders of Company X will acquire Hold Co shares in the same proportion and with the same rights as the existing shares they hold in Company X just before the demerger (paragraph 125-70(2)(a) of the ITAA 1997),

•                     each shareholder will hold the same proportionate market value in Hold Co and Company X after the demerger, as they hold in Company X just before the demerger (paragraph 125-70(2)(b) of the ITAA 1997),

•                     under the restructure, 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 ITAA 1936 (subsection 125-70(4) of the ITAA 1997), and

•                     under the restructure, the shareholders of Company X cannot obtain a roll-over under another provision of the ITAA 1997 for the CGT event that happens to their shares in Company X (subsection 125-70(5) of the ITAA 1997).

Demerged entity

Subsection 125-70(6) of the ITAA 1997 defines a 'demerged entity' to be a former member of a demerger group in which ownership interests are acquired by shareholders of the head entity under a demerger.

In the present circumstances, the proposed Hold Co will be the demerged entity since the shareholders of Company X will receive shares in Hold Co under a demerger.

Demerging entity

Subsection 125-70(7) of the ITAA 1997 defines a 'demerging entity' to be a member of a demerger group who disposes of at least 80% of its total ownership interests in another member of the demerger group to owners of original interests in the head entity under a demerger.

In the present circumstances, Company X is the demerging entity since it will dispose of 100% of its shares in Hold Co to its shareholders under a demerger.

Paragraph 125-55(1)(a) - own an ownership interest in a company

An ownership interest is defined under paragraph 125-60(1)(a) of the ITAA 1997 as a share in the company.

As all the shareholders of Company X own shares in Company X, this condition is satisfied.

Paragraph 125-55(1)(b) - the company is a head entity of a demerger group

As discussed above, the demerger group in the present case comprises Company X as the head entity and includes the proposed company Hold Co as a demerger subsidiary. Company X is the head entity as it is wholly owned by its shareholders.

Paragraph 125-55(1)(c) - a demerger happens to the demerger group

As discussed above, a demerger will happen to the Group as the proposed steps to the demerger satisfy the requirements for a demerger to happen pursuant to subsection 125-70(1) of the ITAA 1997. Relevantly, Company X will transfer all of its interests in Hold Co (which is to be incorporated to be the holder of Business A) to its shareholders. All shareholders will receive interests in Hold Co in the same proportion and with the same rights as their existing ownership interests in the Group just before the demerger and nothing else.

Paragraph 125-55(1)(d) - a CGT event happens to original interests and the shareholders acquire a new or replacement interest in the demerged entity

In the present circumstances, CGT event G1 will happen in respect of the shareholders' original interests in Company X under the proposed demerger. Upon the proposed steps, the shareholders will acquire replacement interests in the demerged entity being Hold Co.

Conclusion

As all the relevant requirements under subdivision 125-B of the ITAA 1997 are satisfied, the demerger roll-over relief will be available to the shareholders of Company X. Therefore, the shareholders will be able to elect to apply the roll-over relief under section 125-55 upon the demerger of Hold Co by Company X.

Question 2

Summary

Company X will be able to disregard any capital gain or capital loss under CGT event A1 upon the proposed transfer of the Hold Co shares to its shareholders under the proposed demerger, pursuant to section 125-155 of ITAA 1997.

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.

In the present case:

•                     Company X is the demerging entity,

•                     CGT event A1 will happen when Company X disposes of the Hold Co shares by way of an in-specie distribution to its shareholders (per section 104-10 of the ITAA 1997), and

•                     this disposal will happen under a demerger.

Therefore, any capital gain or capital loss under CGT event A1 made by Company X on the proposed transfer of the Hold Co shares to its shareholders under the proposed demerger will be disregarded pursuant to section 125-155 of the ITAA 1997.

Question 3

Summary

All or any part of the distribution of Hold Co shares to the shareholders of Company X 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).

As the capital reduction amount will be debited against an amount standing to the credit of the share capital

account (as that term is defined in subsection 6(1) of the ITAA 1936) of Company X it will not be a dividend, as

defined in subsection 6(1).

Therefore, the capital reduction amount will not be assessable income of the shareholders of Company X 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 the Hold Co shares will, in part, constitute a dividend of the Company X shareholders. The total amount of the dividend will be the market value of the Hold Co shares at the time of the demerger excluding the amount debited to the share capital account of Company X.

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, the dividend paid to the Company X 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 seek to make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of the ITAA 1936 apply to the whole, or any part, of any benefit provided to the shareholders of Company X under the proposed demerger.

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).

When 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 of the ITAA 1936 in relation to a demerger benefit and section 45C of the ITAA 1936 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 the Hold Co shares to the shareholders of Company X under the proposed demerger arrangement constitutes a relevant scheme for the purposes of section 45B of the ITAA 1936.

Demerger benefit and capital benefit

The provision of ownership interests to a shareholder under a demerger constitutes the shareholder being provided with a demerger benefit (subsection 45B(4) of the ITAA 1936).

Therefore, under the proposed scheme, the market value of the Hold Co shares to be provided to the shareholders of Company X constitutes a demerger benefit.

The provision of ownership interests in a company to a shareholder under a demerger also constitutes a capital benefit to the extent it is not a demerger dividend (paragraph 45B(5)(a) and subsection 45B(6) of the ITAA 1936).

Accordingly, the market value of the Hold Co shares to be distributed under the proposed demerger less the demerger dividend amount will be a capital benefit to the shareholders of Company X.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides, inter alia, 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 proposed demerger, the shareholders of Company X would, apart from the operation of section 45B of the ITAA 1936, receive a demerger dividend equal to the market value of the Hold Co shares at the time of the demerger less the capital reduction amount that is neither assessable income nor exempt income. The tax payable by the shareholders on the demerger would be higher if the demerger benefit was an assessable dividend. Accordingly, the shareholders of Company X will obtain a tax benefit for the purposes of section 45B of the ITAA 1936.

More than an incidental purpose

Given that the proposed demerger is a scheme that will provide a tax benefit to the shareholders of Company X, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c) of the ITAA 1936. 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) of the ITAA 1936 by virtue of paragraph (k).

Paragraph 45B(8)(a)

Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or an associate (within the meaning of section 318 of the ITAA 1936) of the company. In the circumstances of the capital benefit provided under this scheme, it is considered that they appropriately reflect a return of share capital to the Company X shareholders.

In the present case, the proposed demerger will result in a return of capital and a demerger dividend sourced from

realised and unrealised profits which are considered to be an appropriate allocation of share capital and profits in

accordance with Law Administration Practice Statement PS LA 2005/21 - Application of section 45B of the Income

Tax Assessment Act 1936 to demergers (PSLA 2005/21). Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(b)

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions made by a company or an associate of the company. In this case, it should not be concluded that the present distribution is in substitution for a dividend. There is nothing to suggest that the present distribution is in substitution for a dividend. Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraphs 45B(8)(c) to (f) of the ITAA 1936 require an examination of the tax characteristics of the particular shareholder in question in determining the relevant circumstances of the scheme.

Paragraph 45B(8)(c)

Paragraph 45B(8)(c) of the ITAA 1936 considers whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income.

Based on the facts provided, the relevant shareholders have negligible carried forward or anticipated capital losses. Therefore, it is considered that this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(d)

Paragraph 45B(8)(d) of the ITAA 1936 considers whether some or all of the ownership interests in the company held by the relevant taxpayer were acquired before 20 September 1985.

All shares issued by Company X are post-CGT assets that were acquired after 20 September 1985. Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(e)

Paragraph 45B(8)(e) of the ITAA 1936 requires consideration of whether the shareholders of the head entity are non-residents.

The shareholders of Company X are all Australian tax residents. Therefore, it is considered that this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(f)

Paragraph 45B(8)(f) of the ITAA 1936 considers whether the cost base (for the purposes of the ITAA 1997) of the relevant ownership interest is not substantially less than the value of the capital benefit.

Paragraph 68 of PS LA 2005/21 discusses that the decision to demerge could be influenced by the opportunity to obtain a distribution that allows a CGT rollover, in a situation that would otherwise result in a capital gain.

However, it is considered that the commercial reasons for the proposed demerger as outlined in the facts should be weighed against any benefit that may arise from the deferral of any taxing point. Accordingly, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(h)

Paragraph 45B(8)(h) of the ITAA 1936 requires consideration of schemes that involve the distribution of share capital or share premium.

Under the scheme, there will be a distribution of a percentage of Company X's share capital to its shareholders. Notwithstanding this, the proposed demerger should not disturb the shareholders' existing ownership interests in Company X in the way described, owing to the requirements of the proportion test in subsection 125-70(2) of the ITAA 1997 discussed above being met.

Accordingly, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(i)

Paragraph 45B(8)(i) of the ITAA 1936 directs attention to those cases where the scheme of demerger involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests; recognising that the proceeds on disposal of such ownership interests provide the equivalent of a cash dividend in a more tax-effective form.

In the present case there is no proposal for the sale or transfer of any shares in Company X or Hold Co by the shareholders of Company X following the demerger. Further, no plans currently exist for divesting any part of Business A or the existing Group, or for the exchange of interests in Company X or Hold Co between the shareholders following the proposed demerger. Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(j)

Paragraph 45B(8)(j) of the ITAA 1936 applies to circumstances where the profits and assets of the demerging entity are attributable to or acquired under transactions with associated entities. This relevant circumstance aims to expose instances where demerger relief is being used as a vehicle for distributing corporate earnings by way of non-assessable dividend. In this case, there are no profits derived by Company X or assets held by Company X

that are attributable to transactions with Hold Co or other related parties. Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(k) - The Part IVA matters

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

After considering the relevant facts including the commercial reasons for the demerger, it is considered that none of the factors in paragraphs 177D(2)(a) to (h) of the ITAA 1936 incline for, or against, a conclusion as to the requisite purpose.

Conclusion

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 the proposed demerger is not being undertaken for more than an incidental purpose of obtaining a tax benefit.

Accordingly, the Commissioner will not seek to make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of the ITAA 1936 apply to the whole, or any part, of any benefit provided to the shareholders of Company X under the proposed demerger arrangement.