ATO ID 2004/637: Demerger: original pre-CGT interests - consequences for shareholders under Division 725 if new interests in demerged entity are issued at a discount
Date of decision: 16 July 2004
Year of income: Year ended 30 June 2005
Business line: Public Groups and International

Issue
If a direct value shift happens under a demerger because new interests in a demerged entity are issued at a discount, can the cost bases and reduced cost bases of those interests be increased under section 725-250 of the Income Tax Assessment Act 1997 (ITAA 1997) if they were issued in respect of pre-CGT original interests?

Decision
Yes. The cost bases and reduced cost bases of the new interests in the demerged entity can be increased under section 725-250 of the ITAA 1997 as no adjustments are made to the cost base and reduced cost base of both the new interests and the original interests under Division 125 of the ITAA 1997.

Facts
There are three Australian resident shareholders (original interest holders) in Company A, an Australian resident company. Each shareholder is an associate of the other shareholders. All of the shares were acquired before 20 September 1985. Company A is the owner of the only share (a post-CGT share) on issue in subsidiary Company B. Company A has not made a choice to form a consolidated group. Under an arrangement, Company B (the demerged entity) issues shares to the shareholders in Company A, in the same proportions as their Company A shareholdings. No consideration is to be provided to Company B for the shares. The arrangement satisfies the definition of a demerger in section 125-70 of the ITAA 1997. As a result of the issue of shares at a discount by Company B, there is a reduction in the market value of the share that Company A holds in Company B, resulting in a direct value shift. The conditions set out in section 725-50 of the ITAA 1997 for there to be consequences under Division 725 of the ITAA 1997 as a result of the direct value shift are satisfied.

Reasons for decision
Summary: Division 725 of the ITAA 1997 does not apply to an original interest holder where the specific terms of section 125-95 of the ITAA 1997 apply. That section provides that where cost base and reduced cost base adjustments are required under sections 125-80, 125-85 or 125-90 of the ITAA 1997, no further cost base and reduced cost base adjustments are required to be made under the Act as a result of something that happens under the demerger. Cost base and reduced cost base adjustments are required under sections 125-80, 125-85 or 125-90 of the ITAA 1997 where the original interests were acquired on or after 20 September 1985. No adjustments are required under those sections where the original interests were acquired before 20 September 1985. Accordingly, as the new interests are issued in respect of the three shareholders' original interests that were acquired before 20 September 1985, and the conditions in section 725-50 of the ITAA 1997 are satisfied, increases may be made to the cost bases and reduced cost bases of those new interests under section 725-250 of the ITAA 1997 as a result of the direct value shift.

Legislative references: Income Tax Assessment Act 1997 Division 125 section 125-70 section 125-80 section 125-85 section 125-90 section 125-95 Subdivision 165-CC Division 725 section 725-50 section 725-250
Related ATO interpretative decisions: ATO ID 2003/1050 | ATO ID 2004/635 | ATO ID 2004/636
Subject references: CGT demerger exemption CGT share value shifting arrangements Cost base adjustments for value shift