Private ruling: Demerger
Date of advice: 21 July 2016
Published: September 2016

Ruling: Q1: Will the arrangement be a demerger as defined for the purposes of Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the arrangement as contemplated above, give rise to a CGT Event A1 under section 104-10 of the ITAA 1997 for Company D? | A2: Yes. | Q3: To the extent that CGT Event A1 is taken to happen, will the Company D tax consolidated group be entitled to disregard under Division 125 of the ITAA 1997 any capital gain or capital loss arising as a result of the demerger? | A3: Yes. | Q4: Will the Commissioner make a: a. determination under subsection 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45BA of the ITAA 1936 applies to render the demerger benefit as not a demerger dividend for the purposes of Australian income tax legislation? b. determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat any part of the demerger benefit (that is not a demerger dividend) as an unfranked dividend? c. further determination under subsection 45C(3) of the ITAA1936 that a franking debit arises in the franking account of Company D in relation to the capital component of the demerger distribution? | A4: a. No. b. No. c. Not applicable.

Relevant facts and circumstances: Company D is a listed company and is the head entity of a tax consolidated group. Company D demerged Company E and its subsidiaries. The demerger created two separate businesses which will operate through two independent companies, with different operating models, strategies and capital requirements. Company D undertook pre-demerger transfers of entities and assets at market value and made intra-group distributions to eliminate intra-group receivables. Company D demerged Company E by making an in-specie distribution to Company D Shareholders of all Company E Shares. Company D Shares were not cancelled under the demerger. Company D debited the in-specie distribution of Company E Shares to its share capital account.

Relevant legislative provisions: ITAA 1936 Section 6 | ITAA 1936 Subsection 6(1) | ITAA 1936 Section 45B | ITAA 1936 Subsection 45B(1) | ITAA 1936 Subsection 45B(2) | ITAA 1936 Paragraph 45B(2)(a) | ITAA 1936 Paragraph 45B(2)(b) | ITAA 1936 Subsection 45B(2)(c) | ITAA 1936 Subsection 45B(3) | ITAA 1936 Paragraph 45B(3)(a) | ITAA 1936 Paragraph 45B(3)(b) | ITAA 1936 Subsection 45B(4) | ITAA 1936 Paragraph 45B(4)(a) | ITAA 1936 Subsection 45B(5) | ITAA 1936 Paragraph 45B(5)(a) | ITAA 1936 Paragraph 45B(5)(b) | ITAA 1936 Subsection 45B(8) | ITAA 1936 Paragraph 45B(8)(a) | ITAA 1936 Paragraph 45B(8)(b) | ITAA 1936 Paragraph 45B(8)(c) | ITAA 1936 Paragraph 45B(8)(d) | ITAA 1936 Paragraph 45B(8)(e) | ITAA 1936 Paragraph 45B(8)(f) | ITAA 1936 Paragraph 45B(8)(h) | ITAA 1936 Paragraph 45B(8)(j) | ITAA 1936 Paragraph 45B(8)(k) | ITAA 1936 Subsection 45B(9) | ITAA 1936 Subsection 45B(10) | ITAA 1936 Section 45BA | ITAA 1936 Subsection 45BA(1) | ITAA 1936 Section 45C | ITAA 1936 Subsection 45C(1) | ITAA 1936 Subsection 45C(2) | ITAA 1936 Subsection 45C(3) | ITAA 1997 Section 104-10 | ITAA 1997 Subsection 104-10(1) | ITAA 1997 Subsection 104-175(1) | ITAA 1997 Section 104-230 | ITAA 1997 Subsection 125-60(1) | ITAA 1997 Paragraph 125-60(1)(a) | ITAA 1997 Paragraph 125-60(1)(b) | ITAA 1997 Subsection 125-65(1) | ITAA 1997 Subsection 125-65(3) | ITAA 1997 Subsection 125-65(4) | ITAA 1997 Subsection 125-65(6) | ITAA 1997 Paragraph 125-65(6)(a) | ITAA 1997 Paragraph 125-65(6)(b) | ITAA 1997 Section 125-70 | ITAA 1997 Subsection 125-70(1) | ITAA 1997 Paragraph 125-70(1)(a) | ITAA 1997 Paragraph 125-70(1)(b) | ITAA 1997 Subparagraph 125-70(1)(b)(i) | ITAA 1997 Paragraph 125-70(1)(c) | ITAA 1997 Subparagraph 125-70(1)(c)(ii) | ITAA 1997 Paragraph 125-70(1)(d) | ITAA 1997 Paragraph 125-70(1)(e) | ITAA 1997 Subparagraph 125-70(1)(e)(i) | ITAA 1997 Paragraph 125-70(1)(g) | ITAA 1997 Subsection 125-70(2) | ITAA 1997 Paragraph 125-70(2)(a) | ITAA 1997 Paragraph 125-70(2)(b) | ITAA 1997 Subsection 125-70(3) | ITAA 1997 Paragraph 125-70(3)(a) | ITAA 1997 Paragraph 125-70(3)(b) | ITAA 1997 Subsection 125-70(4) | ITAA 1997 Subsection 125-70(5) | ITAA 1997 Subsection 125-70(6) | ITAA 1997 Paragraph 125-70(6)(a) | ITAA 1997 Subsection 125-70(7) | ITAA 1997 Paragraph 125-70(7)(a) | ITAA 1997 Section 125-155 | ITAA 1997 Section 125-160 | ITAA 1997 Subdivision 126-B | ITAA 1997 Division 197

Reasons for decision: Summary: The arrangement is a demerger as defined for the purposes of Division 125. | Detailed Reasoning - Detailed reasoning: Demerger Subsection 125-70(1) states that a demerger happens to a demerger group if: (a) there is a restructuring of the demerger group; and (b) under the restructuring: (i) members of the demerger group dispose of at least 80% of their total ownership interests in another member of the demerger group to owners of original interests in the head entity of the demerger group; or … (c) under the restructuring: (i) a CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires a new interest and nothing else; or (ii) no CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires a new interest and nothing else; and (d) the acquisition by entities of new interests happens only because those entities own or owned original interests; and (e) the new interests acquired are: (i) if the head entity is a Company - ownership interests in a Company; or (ii) if the head entity is a trust - ownership interests in a trust; and … (g) neither the original interests nor the new interests are in a trust that is a *non-complying superannuation fund; and (h) the requirements of subsection (2) are met. Subsection 125-70(2) states that each owner (an original owner) of original interests in the head entity of the demerger group must: (a) acquire, under the demerger, the same proportion, or as nearly as practicable the same proportion, of new interests in the demerged entity as the original owner owned in the head entity just before the demerger; and (b) just after the demerger, have the same proportionate total market value of ownership interests in the head entity and demerged entity as the original owner owned in the head entity just before the demerger. A 'demerger' will happen to the demerger group of which Company D is the head entity as: • The Company D distribution will effect a restructuring of the Company D demerger group for the purposes of paragraph 125-70(1)(a) • Under the restructuring, Company D will dispose of all of its ownership interests in Company E to Company D shareholders, being the owners of original interests in Company D subparagraph 125-70(1)(b)(i) • Under the restructuring, a CGT event happened to the Company D shares, and Company D shareholders received shares in Company E being the 'new interests' and nothing else; subparagraph 125-70(1)(c)(ii) • Under the restructuring, Company D shareholders will receive shares in Company E on the basis of their shareholding in Company D; paragraph 125-70(1)(d) • Company D is a company and the new interests acquired being Company E shares also constitute ownership interests in a company; subparagraph 125-70(1)(e)(i) • Neither Company D nor Company E is a trust that is a non-complying superannuation fund; paragraph 125-70(1)(g) • The restructuring will not constitute an off-market share buy-back subject to Division 16K of Part III of the Income Tax Assessment Act 1936 (ITAA 1936); subsection 125-70(4) • No other roll-over will be available in the circumstances under another provision of the ITAA 1936 or ITAA 1997; subsection 125-70(5), and • Under the restructuring, the Commissioner accepts that for the purposes of subsection 125-70(2): • Each Company D shareholder will acquire the same proportion (or as nearly as practicable the same proportion) of shares in Company E as the proportion of shares owned in Company D just before the demerger; paragraph 125-70(2)(a), and • Just after the demerger, each Company D shareholder will own the same proportionate total market value of Company D shares and Company E shares as owned in Company D just before the demerger; paragraph 125-70(2)(b). The employee shares are excepted in accordance with the requirements of subsection 125-70(2) due to the operation of subsections 125-75(1), (2) and (3). | Summary: The arrangement as contemplated above will give rise to CGT Event A1 under section 104-10 for Company D. | Detailed Reasoning - Detailed reasoning: CGT event A1 Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset. CGT event A1 happened to Company D upon the transfer of Company E shares which are CGT assets to Company D shareholders by way of the in-specie distribution. | Summary: Any capital gain or capital loss made from the transfer by Company D of its shares in Company E by way of an in-specie distribution to Company D shareholders will be disregarded pursuant to sections 125-155 and 125-160. | Detailed Reasoning - Detailed reasoning: Section 125-155 of the ITAA 1997 provides that any capital gain or capital loss which a demerging entity makes from CGT events A1, C2, C3 or K6 happening to its ownership interests in a demerged entity under a demerger is disregarded. Section 125-160 provides that: CGT event J1 does not happen to a demerged entity or a member of the demerger group under a demerger. Section 125-155 The relevant elements of demerging entity, ownership interests, demerged entity, demerger subsidiary and demerger are considered in turn below. Demerging entity Paragraph 125-70(7)(a) states that an entity that is a member of a demerger group just before the CGT event referred to in section 125-155 happens is a 'demerging entity' if, under a demerger that happens to the group: … the entity (either alone or together with other members of the demerger group) dispose of at least 80% of their total ownership interests in another member of the demerger group to owners of original interests in the head entity of the demerger group; or … Company D as the head Company of the demerger group disposed of all of its ownership interests in Company E to owners of original interests in Company D (Company D Shareholders). Therefore Company D will be a demerging entity pursuant to paragraph 125-70(7)(a). Demerger group Subsection 125-65(1) states that a 'demerger group' comprises the head entity of the group and one or more demerger subsidiaries. The demerger group includes Company D as the head entity of the group, and Company E and its subsidiaries as demerger subsidiaries. Head entity of demerger group Subsection 125-65(3) states that a Company is the 'head entity of a demerger group' if no other member of the group owns ownership interests in the Company. Company D is the head entity of the Company D demerger group because at the time of the restructure no other member of the demerger group owns ownership interests in Company D; subsection 125-65(3). Further, Company D is not a subsidiary of another Company or trust that would be the head entity of a demerger group; subsection 125-65(4). Demerger subsidiary Subsection 125-65(6) states that: A Company is a demerger subsidiary of another Company that is a member of a demerger group if the other Company, either alone or together with other members of the group, owns, or has the right to acquire, ownership interests in the Company that carry between them: (a) the right to receive more than 20% of any distribution of income or capital by the Company; or (b) the right to exercise, or control the exercise of, more than 20% of the voting power of the Company. Company E and its subsidiaries will each constitute a demerger subsidiary of the demerger group of which Company D is the head entity. Ownership interest Paragraph 125-60(1)(a) states that an 'ownership interest' in a Company is: … a share in the Company …; and Just before the in-specie distribution of Company E shares, Company D held all the issued shares in Company E, and therefore Company D held ownership interests in Company E pursuant to paragraph 125-60(1)(a). Demerged entity Paragraph 125-70(6)(a) states that an entity that is a former member of a demerger group is a 'demerged entity' if, under a demerger that happens to the group, ownership interests in the entity are acquired by: (a) shareholders in the head entity of the group; or … Shares in Company E, being the relevant ownership interests, were acquired by Company D shareholders, being the shareholders in Company D, the head entity of the demerger group. Company E is the demerged entity for the purposes of section 125-155. Demerger See detailed reasoning for Question 1 above. CGT event A1 See detailed reasoning for Question 2 above. CGT event A1 happened to Company D as a result of the in-specie distribution of Company E shares to Company D shareholders under the demerger. CGT events C2, C3 or K6 did not happen to Company D. Conclusion for section 125-155 As all the requirements of section 125-155 were satisfied in the circumstances of the demerger, any capital gain or capital loss that Company D made as a result of CGT event A1 happening upon its disposal of Company E shares to Company D shareholders by way of the in-specie distribution under the demerger will be disregarded. Section 125-160 Section 125-160 states that CGT event J1 does not happen to a demerged entity or a member of a demerger group under a demerger. CGT event J1 (subsection 104-175(1)) is concerned with a Company that stops being a 100% subsidiary of another Company or other companies following a Subdivision 126-B roll-over. As a result of the Company D distribution, Company E and its wholly owned subsidiaries will no longer be 100% subsidiaries of Company D. As discussed above: • For section 125-155, the Company D distribution will effect a 'demerger' that satisfies the requirements of subsection 125-70(1) • The relevant demerged entity is Company E, and • Company E is a member of the demerger group that includes Company D as the head entity of the demerger group, and Company D's subsidiaries include Company E and subsidiaries of Company E. Conclusion for section 125-160 Section 125-160 operates such that CGT event J1 did not happen to Company E or to another member of the demerger group as a result of the demerger. | Summary: The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA of the ITAA 1936 applies. The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies, and therefore will not make a further written determination in accordance with subsection 45C(3) of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Determination under section 45B Subsection 45B(1) of the ITAA 1936 states that the purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts distributed to shareholders of a company are treated as dividends for tax purposes if: (a) components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger, or (b) certain payments, allocations and distributions are made in substitution for dividends. Where the requirements of subsection 45B(2) of the ITAA 1936 are met, the Commissioner may, where applicable, make a determination that: • under paragraph 45B(3)(a) of the ITAA 1936, the whole or part of a demerger benefit is not a demerger dividend (subsection 45BA(1) of the ITAA 1936), or • under paragraph 45B(3)(b) of the ITAA 1936, the whole or part of a capital benefit is an unfranked dividend paid to the relevant taxpayer out of profits (subsections 45C(1) and 45C(2) of the ITAA 1936). Subsection 45B(2) of the ITAA 1936 Subsection 45B(2) of the ITAA 1936 provides that section 45B of the ITAA 1936 applies if: (a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a Company; and (b) under the scheme, a taxpayer (the relevant taxpayer ), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and (c) 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 (the relevant taxpayer ) to obtain a tax benefit. Each of paragraphs 45B(2)(a), (b) and (c) of the ITAA 1936 must be present for section 45B of the ITAA 1936 to apply. These are discussed in turn below. Paragraph 45B(2)(a) of the ITAA 1936 - scheme, demerger benefit or capital benefit, and person Scheme A 'scheme' for the purposes of section 45B of the ITAA 1936 is taken to have the same meaning as provided in subsection 995-1(1); subsection 45B(10) of the ITAA 1936. That definition is widely drawn and includes any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The demerger of Company D by way of an in-specie distribution of Company E shares will constitute a scheme for the purposes of paragraph 45B(2)(a) of the ITAA 1936. Provision of a demerger benefit or capital benefit A person is 'provided with a demerger benefit' as defined in paragraph 45B(4)(a) of the ITAA 1936 if, under a demerger: a Company provides the person with ownership interests in … another Company, or … The provision by Company D of shares in Company E to Company D shareholders, constitutes the 'provision of a demerger benefit' under paragraph 45B(4)(a) of the ITAA 1936. A person is 'provided with a capital benefit' as defined in paragraph 45B(5) of the ITAA 1936 is a reference to: (a) the provision of ownership interests in a Company to the person; [or] (b) the distribution to the person of share capital or share premium; … As Company D debited the in-specie distribution of Company E Shares to its share capital account, Company D provided its shareholders with a capital benefit as well as a demerger benefit for the purposes of section 45B. Person A person includes a Company, subsection 6(1) of the ITAA 1936. Eligible Company D Shareholders who receive Company E Shares under the demerger are persons. Paragraph 45B(2)(b) - obtains a tax benefit The phrase 'obtains a tax benefit' is defined in subsection 45B(9) of the ITAA 1936 and occurs when: • an amount of tax payable, or • any other amount payable under the ITAA 1936 or ITAA 1997 would apart from the operation of section 45B of the ITAA 1936: • be less than the amount that would have been payable, or • would be payable at a later time than it would have been payable • if the demerger benefit or the capital benefit had instead been an assessable dividend. Under the demerger, Company D shareholders obtained a tax benefit within the meaning of subsection 45B(9) of the ITAA 1936 due to the Division 125 CGT roll-over relief. If the in-specie distribution were instead an assessable dividend, some if not all shareholders would have been subject to tax on the assessable dividend. Company D shareholders that received Company E shares under the demerger obtained a tax benefit for the purposes of subsection 45B(9) and paragraph 45B(2)(b) of the ITAA 1936. Paragraph 45B(2)(c) of the scheme - purpose: relevant circumstances Paragraph 45B(2)(c) of the ITAA 1936 requires the Commissioner to consider the 'relevant circumstances of the scheme' set out under subsection 45B(8) of the ITAA 1936 to determine whether any part of the scheme was entered into for a purpose, of enabling a relevant taxpayer to obtain a tax benefit. However, the list of relevant circumstances set out in subsection 45B(8) of the ITAA 1936 is not exhaustive and regard may be had to other relevant circumstances. The test of purpose is an objective one. The question is whether, objectively, it would be concluded that a person who entered into or carried out the scheme did so for the purpose of enabling the taxpayer to obtain a tax benefit. The purpose does not have to be the most influential or prevailing, but it must be more than an incidental purpose. The relevant circumstances set out in subsection 45B(8) of the ITAA 1936 include: (a) the extent to which the demerger benefit or capital benefit is attributable to capital or the extent to which the demerger benefit or capital benefit is attributable to profits (realised and unrealised) of the Company or of an associate (within the meaning in section 318) of the Company; (b) the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the Company or by an associate (within the meaning in section 318) of the Company; (c) whether the relevant taxpayer has capital losses that, apart from the scheme, would be unutilised (within the meaning of the Income Tax Assessment Act 1997 ) at the end of the relevant year of income; (d) whether some or all of the ownership interests in the Company or in an associate (within the meaning in section 318) of the Company held by the relevant taxpayer were acquired, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985; (e) whether the relevant taxpayer is a non-resident; (f) whether the cost base (for the purposes of the Income Tax Assessment Act 1997 ) of the relevant ownership interest is not substantially less than the value of the applicable demerger benefit or capital benefit; … (h) if the scheme involves the distribution of share capital or share premium - whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital or share premium; … (j) for a demerger only: (i) whether the profits of the demerging entity and demerged entity are attributable to transactions between the entity and an associate (within the meaning in section 318) of the entity; and (ii) whether the assets of the demerging entity and demerged entity were acquired under transactions between the entity and an associate (within the meaning in section 318) of the entity; (k) any of the matters referred to in subsection 177D(2). With regard to the reasons for the demerger, the Commissioner accepts that the demerger was carried out for substantive business reasons and that the components of the demerger distribution as to share capital and profits of Company D 'reflect the circumstances of the demerger'. The paragraph 45B(8)(a) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. Company D's pattern of distributions indicate that the paragraph 45B(8)(b) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. Under the capital reduction, CGT event G1 happened to Company D shareholders. Company D shareholders are entitled to Division 125 CGT rollover to defer any capital gain made pursuant to the CGT event happening (shareholders cannot make a capital loss under CGT event G1, rather they reduce the cost base of their Company D shares by the amount of the capital reduction, or the amount is disregarded as a result of adopting the Division 125 CGT rollover). The paragraph 45B(8)(c) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. As all Company D Shares were acquired or are taken to have been acquired on or after 20 September 1985, the paragraph 45B(8)(d) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. As non-residents hold a low percentage of all Company D Shares, the paragraph 45B(8)(e) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. As the cost base of Company D Shares is not substantially less than the in-specie distribution of Company E Shares, the paragraph 45B(8)(f) of the ITAA 1936 factor moderately supports a conclusion as to requisite purpose. As Company D Shareholders retain the same interest in Company D as previously, and hold the Company E assets more directly as Company E Shareholders, the paragraph 45B(8)(h) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. Company D and Company E undertook some pre-demerger restructuring at market value and intra-group distributions prior to the demerger to ensure proper separation of the businesses. The Commissioner is satisfied that these transactions did not give rise to profits of Company D and/or Company E, nor substantially altered the assets of Company D and Company E. The paragraph 45B(8)(j) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. As to the paragraph 45B(8)(k) of the ITAA 1936 factor which in turn refers to subsection 177D(2) of the ITAA 1936, we note that it was observed in Mills v Federal Commissioner of Taxation 2011 ATC 20-247 at 131 - which was concerned with the application of section 177EA of the ITAA 1936 - that many of the matters referred to in subsection 177D(2) of the ITAA 1936 have no application beyond the extent to which those matters were taken into account in having regard to the other circumstances in subsection 177EA(17) of the ITAA 1936. The Commissioner considers that it is prudent to adopt the same approach for paragraph 45B(8)(k) of the ITAA 1936 which draws subsection 177D(2) of the ITAA 1936 into the analysis in an analogous way to that in subsection 177EA(17) of the ITAA 1936. The Commissioner considers that having regard to the form and substance of the scheme, the timing of the scheme, and so on, the analysis under subsection 177D(2) of the ITAA 1936 does not add to the analysis considered in paragraphs 45B(8)(a)-(j) above. The paragraph 45B(8)(k) of the ITAA 1936 factor does not support a conclusion as to requisite purpose. Based on the above, the Commissioner will not reach the requisite conclusion as to purpose under paragraph 45B(2)(c) of the ITAA 1936. As the paragraph 45B(2)(c) of the ITAA 1936 requirement will not be satisfied, subsection 45B(2) of the ITAA 1936 in turn will not be satisfied, and therefore section 45B of the ITAA 1936 will not apply. | Detailed Reasoning - Conclusion: The Commissioner will not make a determination under section 45B(3) of the ITAA 1936 that section 45BA and/or subsection 45C(1) of the ITAA 1936 apply to the demerger of Company E by Company D. As the Commissioner will not make a determination under subsection 45B(3) in respect of whole or a part of the capital benefit provided under the demerger, the Commissioner is unable to make a further determination under subsection 45C(3) of the ITAA 1936 that a franking debit arises in the franking account of Company D.

Reasons for decision: All legislative references are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless specified otherwise.