Edited version of private advice

Authorisation Number: 1052158729223

Date of advice: 1 September 2023

Ruling

Subject: Demerger

Question 1

Will any capital gain or capital loss made from the disposal of the shares in Company B by Company A on 30 June 20XX to the shareholders of 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

The Income Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Company A

1.    Company A is an Australian private company that is the head company of an income tax consolidated group (the Company A TCG).

2.    All the shares in Company A are ordinary shares.

3.    Company A does not have a history of paying annual dividends, nor a certain dividend policy. The decision to pay a dividend is determined annually by the directors.

The shareholders of Company A

4.    Company A currently has multiple shareholders.

5.    All the shareholders in Company A are Australian tax residents.

6.    The shareholders' interests in Company A are post-CGT interests.

7.    There were no plans, contingent or otherwise, for the shareholders to dispose of their shares (nor to realise their interests) in Company A or Company B (or any other entity or part of the Company A TCG) following the demerger.

Demerger arrangement

8.    The arrangement, which is the subject of this ruling request, is a demerger by which Company A distributed to its shareholders, all of the shares in a wholly owned subsidiary company, Company B.

9.    To affect the separation of Company B, the directors of Company A resolved on 30 June 20XX to distribute and pay a dividend to its shareholders. This dividend was satisfied via an in-specie transfer of the shares in Company B to the shareholders in proportion to their holdings in the register of members.

10.  Company A accounted for the demerger of the Company B shares as follows:

•         A return of capital amount was debited to the issued share capital account (being a share capital account as defined in section 975-300 of the ITAA 1997) of Company A. This amount, represented the relevant proportion of Company A's share capital account attributable to Company B, determined on the basis of the market value of Company B as a proportion of the total market value of Company A; and

•         A dividend was debited to the retained earnings of Company A, equal to the market value of the Company B shares as at 30 June 20XX less the return of capital amount.

11.  The valuations of Company A and Company B were undertaken in accordance with the ATO's 'Market valuations for tax purposes' guidelines.

12.  The dividend was not prohibited under section 254T of the Corporations Act 2001.

13.  A capital gain was made by Company A as a result of the above, being the difference between the market value of the Company B shares and the CGT cost base of the Company B shares under the exit allocable cost amount process in Division 711 of the ITAA 1997.

Reasons for the demerger

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

Other matters

15.  Immediately before the demerger, Company A's share capital account was not tainted (within the meaning of Division 197 of the ITAA 1997).

16.  The Company A TCG has not made any elections under Division 230 of the ITAA 1997 (i.e., in relation to the Taxation of Financial Arrangements).

17.  Company A will not make an election, as the head entity of the demerger group, under subsection 44(2) 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 Division 16K of Part III

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 section 125-65

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 section 125-75

Income Tax Assessment Act 1997 section 125-155

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 Division 711

Income Tax Assessment Act 1997 section 975-300

Corporations Act 2001 section 254T

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

Summary

1.     Any capital gain or capital loss made by Company A on the disposal of its shares in Company B on 30 June 20XX to the Company A shareholders is disregarded pursuant to section 125-155.

Detailed reasoning

2.     Division 125 contains relief from the possible CGT consequences of a demerger. In particular, it provides that certain capital gains or capital losses made by members of a demerger group under the demerger be disregarded.

3.     Specifically, section 125-155 states:

Any *capital gain or *capital loss a *demerging entity makes from *CGT event A1, *CGT event C2, *CGT event C3 or *CGT event K6 happening to its *ownership interests in a *demerged entity under a *demerger is disregarded.

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

•         demerger group (subsection 125-65(1));

•         demerger (subsection 125-70(1));

•         demerged entity (subsection 125-70(6)); and

•         demerging entity (subsection 125-70(7)).

Demerger Group

5.     A demerger group comprises one head entity and at least one demerger subsidiary (subsection 125-65(1)). The demerger group in this case comprised Company A as the head entity and included Company B as a demerger subsidiary.

6.     Company A was the head entity because:

•        no other member of the demerger group held ownership interests in Company A (subsection 125-65(3)); and

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

7.     Company B was a demerger subsidiary of Company A because Company A owned ownership interests in Company B that carried 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 Company B (subsection 125-65(6)).

Demerger

8.     Subsection 125-70(1) describes when a demerger happens. A demerger happened to the Company A demerger group because:

•        there was a restructuring (paragraph 125-70(1)(a)), and Company A disposed of at least 80% of its shares in Company B to the owners of Company A (subparagraph 125-70(1)(b)(i));

•        under the restructuring, a CGT event happened to the shares in Company A when the in-specie distribution was made under the demerger (CGT event G1), and the Company A shareholders acquired new shares in Company B and nothing else (subparagraph 125-70(1)(c)(ii));

•        shares in Company B were acquired by the Company A shareholders on the basis of their ownership of shares in Company A (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i));

•        paragraph 125-70(1)(f) has been repealed;

•        neither Company A nor Company B are superannuation funds (paragraph 125-70(1)(g));

•        the requirements of paragraph 125-70(1)(h) are satisfied as:

(i) the Company A shareholders acquired shares in Company B in the same proportion as they owned shares in Company A just before the demerger (paragraph 125-70(2)(a));

(ii) the Company A shareholders owned shares in Company A and Company B that (just after the demerger) represented the same proportionate total market value as their Company A shares represented (just before the demerger) (paragraph 125-70(2)(b));

•        under the scheme, a buy-back of shares for the purposes of Division 16K of Part III of the ITAA 1936 did not occur (subsection 125-70(4)); and

•        there was no rollover available under another provision for any CGT events that happened to the Company A shares under the restructure (subsection 125-70(5)).

Company B is the demerged entity

9.     Subsection 125-70(6) 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.

10.  In the present circumstances, Company B is the demerged entity since the Company A shareholders received shares in Company B under a demerger.

Company A is the demerging entity

11.  Subsection 125-70(7) 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.

12.  In the present circumstances, Company A is the demerging entity since it disposed of 100% of its shares in Company B to the Company A shareholders under a demerger.

Conclusion

13.  As previously highlighted, section 125-155 provides that any capital gain or capital loss made by a demerging entity from certain CGT events (including CGT event A1) happening to its ownership interests in a demerged entity under a demerger is disregarded.

14.  As detailed above, in the present case:

•        Company A is the demerging entity,

•        CGT event A1 happened when Company A disposed of its shares in Company B to its shareholders (per section 104-10), and

•        this disposal happened under a demerger.

15.  Therefore, any capital gain or capital loss made by Company A when CGT event A1 happened on the disposal of its shares in Company B under the demerger is disregarded.