Private ruling: Income Tax - Proposed Demerger
Published: August 2017
Ruling period: Income year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the Commissioner confirm that the proposed restructure is a 'demerger' within the meaning of section 125-70 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will the Commissioner confirm that all or any part of the in-specie distribution of shares in Company A to the Shareholder that constitutes a 'dividend' for the purposes of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) will be a 'demerger dividend' as defined in subsection 6(1) of the ITAA 1936, and that it will be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936? | A2: No | Q3: Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the whole, or a part of, any demerger benefit arising out of the proposed restructure? | A3: No | Q4: Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or a part of any capital benefit arising out of the proposed restructure? | A4: No

Relevant facts and circumstances: Background Company A is a wholesaler and provider to corporate resellers. Company A is a resident of Australia for tax purposes. The issued capital of Company A consists of one ordinary share paid to $1. The share is held by the Shareholder and was acquired after 20 September 1985 (post CGT). The Shareholder is the sole director of Company A and is also a resident of Australia for tax purposes. Reasons for the restructure The applicant has provided the following reasons for the restructure. Company A has advised that it wishes to retain the services of a Key Employee to ensure its future profitability and growth. Company A proposes to do this by issuing shares to a trustee of a trust for market value to hold for the benefit of the Key Employee. The applicant has advised that the Key Employee is an important part of Company A's business and that the Key Employee has expressed interest in being issued shares in Company A. However, Company A does not wish for the Key Employee to participate in the accumulated profits and the Key Employee does not have the capacity to pay an amount representing his share of the market value of Company A if the accumulated profits are taken into account. There is no employee share scheme in place, nor is there a proposal for an employee share scheme (in the normally understood sense) post-restructure. Proposed arrangement The proposed arrangement involves the following steps: Step 1 (122-A Roll-Over) The Shareholder will transfer his one ordinary share in Company A to a new company proposed to be the Holding Company, a resident of Australia for tax purposes. The Holding Company will have no assets other than the amount paid for the subscriber shares (which will be 1 ordinary $0.01 share). In consideration for the transfer of the Shareholder's share in Company A, the Holding Company will issue 10,000 shares ($0.01 shares) to the Shareholder (who will own 100% of the shareholding at this time). The Shareholder will choose roll-over under Subdivision 122-A of the ITAA 1997 on this part of the arrangement. As a result, Company A will become a wholly owned subsidiary of the Holding Company and the Shareholder will hold all of the issued shares in the Holding Company. Step 2 (Pre-demerger dividend) Once the Holding Company becomes the registered holder of the share in Company A, Company A will pay its accumulated profits to the Holding Company as a fully franked dividend. It is expected that the Holding Company will then loan, some or all, of the cash representing the fully franked dividend received back to Company A for use in its business. Step 3 (Proposed Demerger) The Holding Company will then transfer its share in Company A to the Shareholder. As a consequence, the Shareholder will hold 100% of the issued shares in both Company A and the Holding Company. The demerger dividend will be the value of the one ordinary share held by the Holding Company in Company A after the payment of a dividend by Company A to the Holding Company. The value of the demerger dividend has been determined by the applicant by applying an appropriate multiplier to the business' normalised profit. It is proposed that the dividend will be satisfied by a cash transfer and/or an advance. Step 4 (Employee Allotment) Company A will then issue shares to the trustee of a trust which will be held on trust for the Key Employee. The trust and the trustee would only be established in the event the Commissioner issues a favourable private ruling on the scheme. It is intended the trustee of the trust will be issued with shares that have the same rights as ordinary shares except that Company A has the right to redeem the shares where there is: A termination of employment of the key employee; A sale of all the shares in Company A or the sale of the assets of that company. The Key Employee (via the trustee of a trust) will finance and acquire a minority interest in the Company A. Post Restructure There is no intention of raising additional capital post demerger. There is no intention for the Shareholder to sell his post demerger shares in Company A or in the Holding Company.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 6(1) | Income Tax Assessment Act 1936 section 44 | Income Tax Assessment Act 1936 subsection 44(3) | Income Tax Assessment Act 1936 subsection 44(4) | Income Tax Assessment Act 1936 section 45B | Income Tax Assessment Act 1936 subsection 45B(2) | Income Tax Assessment Act 1936 paragraph 45B(2)(a) | Income Tax Assessment Act 1936 paragraph 45B(2)(b) | Income Tax Assessment Act 1936 paragraph 45B(2)(c) | Income Tax Assessment Act 1936 subsection 45B(3) | Income Tax Assessment Act 1936 paragraph 45B(3)(a) | Income Tax Assessment Act 1936 paragraph 45B(3)(b) | Income Tax Assessment Act 1936 subsection 45B(4) | Income Tax Assessment Act 1936 paragraph 45B(5)(a) | Income Tax Assessment Act 1936 section 45BA | Income Tax Assessment Act 1936 section 45C | Income Tax Assessment Act 1997 Division 125 | Income Tax Assessment Act 1997 section 125-65 | Income Tax Assessment Act 1997 subsection 125-65(1) | Income Tax Assessment Act 1997 section 125-70 | Income Tax Assessment Act 1997 subsection 125-70(1) | Income Tax Assessment Act 1997 paragraph 125-70(1)(a) | Income Tax Assessment Act 1997 paragraph 125-70(1)(c) | Income Tax Assessment Act 1997 subsection 125-70(2)

Reasons for decision: Summary: The proposed restructure is not a 'demerger' within the meaning of section 125-70 of the ITAA 1997 as the requirements under paragraphs 125-70(1)(a), 125-70(1)(c) and subsection 125-70(2) are not met. | Detailed Reasoning - Demerger requirements: For demerger relief to apply a demerger must happen under a restructuring and the conditions of subsection 125-70(1) of the ITAA 1997 must be met. Relevantly, under the restructuring, at least 80% of the ownership interests in a member of a demerger group must be disposed of to shareholders in the head entity of the demerger group. | Detailed Reasoning - Demerger: 'Demerger' is defined in subsection 6(1) of the ITAA 1936 to have the meaning given by section 125-70 of the ITAA 1997. Subsection 125-70(1) of the ITAA 1997 states that: A demerger happens to a demerger group if: There is a restructuring of the demerger group; and Under the restructuring: Members of the demerger group dispose of at least 80% of their total ownership interest in another member of the demerger group to owners of original interests in the head entity of the demerger group; or And Under the restructuring: A CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires new interest and nothing else; or No CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires new interest and nothing else; and The acquisition by entities of new interests happens only because those entities own or owned original interests; and The new interests acquired are: If the head entity is a company - ownership interests in a company; or If the head entity is a trust - ownership interest in a trust. (Repealed by No 168 of 2006) Neither the original interests nor the new interests are in a trust that is a non-complying superannuation fund; and The requirements of subsection (2) are met. Subsection 125-70(2) states that: Each owner (an original owner) of original interest in the head entity of the demerger group must: Acquire, under the demerger, the same proportion, or as nearly as practicable the same proportion, of new interest in the demerged entity as the original owner owned in the head entity just before the demerger; and 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. What comprises a 'restructuring' for the purposes of subsection 125-70(1) of the ITAA 1997, while not defined, is determined by the facts in any given case, and is not necessarily limited by the terms of section 125-70, to the transaction which delivers ownership of at least 80% of a member of a demerger group, to the shareholders in the group's head entity. The term 'restructuring' is not defined for the purposes of Division 125 of the ITAA 1997. As a result it takes on its ordinary meaning, having regard to its legislative context and the purpose or object of the statute. The Macquarie Dictionary Online defines 'restructure' as 'to change the organisation or structure of'. Regard must be given to the relevant commercial reasons behind these events, transactions or steps for the purpose of identifying the 'restructuring' under Division 125 of the ITAA 1997. It is necessary to identify a starting point and finishing point in the series of events within the context of these commercial reasons. Therefore, a demerger for the purpose of Division 125 is not limited only to the step which transfers ownership interest in a demerged entity to owners of the head entity In this context the restructuring will effectively define the group to which the requirements of section 125-70 of the ITAA 1997 are to be applied by referring to the group as it stood immediately before the restructuring began. Demerger Group A demerger group comprises one head entity and at least one demerger subsidiary (subsection 125-65(1) of the ITAA 1997). The restructuring should include all the steps that bring about or result in the satisfaction of the requirements in section 125-70 of the ITAA 1997. Without the interposition of the Holding Company there would be no demerger group. As the interposition of the Holding Company is not a consequence of another distinct commercial event it is within the relevant restructuring. The incorporation of the Holding Company, the transfer of the Shareholder's share in Company A in exchange for shares, the payment of a fully franked dividend from Company A to the Holding Company, the transfer by the Holding Company of Company A to the Shareholder and the issuing of shares in Company A to the Shareholder as trustee of a trust are all wholly entered into and carried out to enable the demerger to occur. This is the restructuring. As the initial step of the scheme does not commence with a demerger group including the Holding Company as head entity and Company A as a demerger subsidiary and putative demerged entity, the requirement in paragraph 125-70(1)(a) of the ITAA 1997 that there is a restructuring of the demerger group as described in subsection 125-65(1) is not satisfied. Requirement of paragraph 125-70(1)(c) - the 'nothing else' test One of the requirements that must be satisfied in subsection 125-70(1) of the ITAA 1997 for a demerger to happen to a demerger group is the 'nothing else' test. Specifically, paragraph 125-70(1)(c), requires that under the restructuring: 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 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; … Paragraph 15.49 of the Explanatory Memorandum to the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002 provides an explanation as to what is considered to be 'nothing else': Roll-over is not available for an interest owner who receives something other than a new interest in the demerged entity, for example, cash. This is the case even if the interest owner also receives a new interest in the demerged entity. This exception arises from the combined effect of the proportion test and the market value test. That is, neither of these tests can be satisfied if an original owner receives something other than new interests in the demerged entity. Under the proposed restructuring the Shareholder will, in addition to the shares in Company A, also receive shares in the Holding Company, therefore, the requirement of the 'nothing else' test in paragraph 125-70(1)(c) of the ITAA 1997 is not met, and a 'demerger 'within the meaning of that term in subsection 125-70(1) does not happen to the demerger group. Requirement of subsection 125-70(2) - the 'same proportion' test A condition of a demerger is that ownership interests in the demerger group are maintained. There are 2 tests under subsection 125-70(2) of the ITAA 1997 that determine whether this condition is met. The first test is that proportionate interests in the head entity and in the demerged entity remain the same, so far as is practicable. The second test is that the proportionate market values of the interests in the demerger group as a whole are maintained pre- and post-demerger. A demerger for the purpose of Division 125 of the ITAA 1997 must result in continuity of the underlying ownership of the demerged entity. The issue in this case, as discussed above, is that under the restructuring there is no head entity of a demerger group. In this case, the proposed restructuring involves the Shareholder (who owns 100% of the interests in Company A) acquiring less than 100% of the new interests in Company A. This is because Company A will issue additional shares a trustee of a trust (for benefit of the Key Employee). Even if it was considered that the Holding Company was the head entity it is still the case that the Shareholder will not acquire the same proportion of new interests as they hold in the original entity. It is considered that the final step in the scheme is part of the restructuring and is not subsequent to the 'demerger'. As discussed, regard must be given to the relevant commercial reasons behind these events or transactions for the purpose of identifying the 'restructuring' under Division 125 of the ITAA 1997. It is necessary to identify a starting point and finishing point in the series of events within the context of these commercial reasons. Therefore, a demerger for the purpose of Division 125 of the ITAA 1997 is not limited only to the step which transfers ownership interest in a demerged entity to owners of the head entity. This is evident in the fact that the applicant has stated that the reason for the demerger is so that Company A can issue shares to a trustee of a trust for market value to hold for the benefit of a key employee. Without this final step, no purpose exists, and therefore, this step is considered to be part of the restructuring for the purposes of Division 125 of the ITAA 1997. The requirements under subsection 125-70(2) of the ITAA 1997 are, therefore, not met. Accordingly, the proposed restructure is not a 'demerger' within the meaning of subsection 125-70(1) of the ITAA 1997. | Summary: As a demerger under section 125-70 of the ITAA 1997 does not happen, the in-specie distribution of shares in Company A to the Shareholder will not happen under a demerger and will therefore not be a demerger dividend as defined in subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: 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. Relevantly, the definition of a dividend includes any amount distributed or credited by a company to any of its shareholders. However the definition of a dividend, specifically 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). To the extent that the in-specie distribution of the share in Company A is not debited to the share capital account of the Holding Company the distribution will be a dividend (as defined in subsection 6(1) of the ITAA 1936) paid out of profits. A demerger dividend is defined in subsection 6(1) of the ITAA 1936 to be: that part of a demerger allocation that is assessable as a dividend under subsection 44(1) of the ITAA 1936 or that would be so assessable apart from subsections 44(3) and (4). Subsections 44(3) and 44(4) of the ITAA 1936 states that: 44(3) This section applies to the demerger dividend as if it had not been paid out of profits. 44(4) A demerger dividend is not assessable income or exempt income. In the present case, the in-specie distribution of the share in Company A not debited to the share capital account will be a dividend paid by the Holding Company out of profits to the Shareholder. The dividend must form part of a demerger allocation in order to be a demerger dividend. A 'demerger allocation' is defined in subsection 6(1) of the ITAA 1936. For the purpose of this proposed demerger paragraph (b) of the definition is relevant and states that the demerger allocation is: The total market value of the allocation represented by the ownership interests disposed of by a member of the demerger group under a 'demerger' to the owners of the ownership interests in the head entity. The word 'demerger' when it appears in this definition has the meaning given by section 125-70 of the ITAA 1997. As the proposed restructure is a not a demerger for the purpose of Division 125 of the ITAA 1997 the in-specie distribution by the Holding Company of its share in Company A to the Shareholder is not a demerger dividend for the purpose of subsections 44(3) and 44(4) of the ITAA 1936. The dividend is, therefore, assessable to the Shareholder in accordance with subsection 44(1) of the ITAA 1936. | Detailed Reasoning - Summary and reasoning: Paragraph 45B(3)(a) of the ITAA 1936 allows the Commissioner to make a determination that section 45BA of the ITAA 1936 applies in relation to the whole, or a part, of the demerger benefit. Subsection 45B(4) of the ITAA 1936 makes it clear that a demerger benefit can only be received in relation to a demerger. A demerger is defined in subsection 6(1) of the ITAA 1936 as having the meaning given by section 125-70 of the ITAA 1997. Since, in the present circumstances, a demerger for the purposes of section 125-70 of the ITAA 1997 does not happen, no demerger benefit arises. Therefore the Commissioner will not make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the whole, or any part, of any demerger benefit provided under the scheme, as no such benefit arises under the current scheme. | Detailed Reasoning - Summary and reasoning: Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. It allows the Commissioner to make a determination that section 45C of the ITAA 1936 applies to a capital benefit. Specifically, the provision applies where: There is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); Under the scheme a taxpayer (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and HHaving 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 the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) of the ITAA 1936 empowers the Commissioner to make a determination that section 45C of the ITAA 1936 applies in relation to a capital benefit. In accordance with paragraph 45B(5)(a), a reference to a person being provided with a capital benefit is a reference to the provision of ownership interests in a company to the person. The transfer by the Holding Company of its share in Company A to the Shareholder constitutes the provision of a capital benefit. Under the scheme, the Holding Company proposes to debit $1.00 to the share capital account for the transfer of the share in Company A. Based on the information provided, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the proposed capital reduction amount of $1.00.