Private ruling: Proposed demerger of Entity C by Entity B
Date of advice: 1 December 2015
Published: February 2016
Ruling period: 1 July 2015 to 30 June 2016
Date scheme commenced: The scheme is in contemplation.

Ruling: Q5: Will the Commissioner confirm that any capital gain or loss the Taxpayer makes on distributing the Entity C shares to testamentary trusts be disregarded in accordance with Division 128 of the ITAA 1997 if the Entity C demerger occurs prior to the vesting of the Entity B shares in the ultimate beneficiaries? Advice Yes


Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 6(1) | Income Tax Assessment Act 1936 section 44 | Income Tax Assessment Act 1936 section 45B | Income Tax Assessment Act 1936 Division 7A | Income Tax Assessment Act 1997 Division 125 | Income Tax Assessment Act 1997 Division 128

Reasons for decision: Summary: The Taxpayer will be entitled to choose demerger roll-over relief pursuant to section 125-55 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: In order for the demerger capital gains tax (CGT) outcomes contained in Division 125 of the ITAA 1997 to apply to shareholders and members of a company group, 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). | Detailed Reasoning - Demerger Group: A demerger group comprises one head entity and at least one demerger subsidiary (subsection 125-65(1) of the ITAA 1997). The demerger group in this case comprises Entity B as the head entity and includes Entity C as a demerger subsidiary. Entity B will be the head entity because: • no other member of the Entity B Group owns ownership interests in Entity B (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 Entity B could be a demerger subsidiary (subsection 125-65(4) of the ITAA 1997). Entity C will be a demerger subsidiary of Entity B because Entity B owns ownership interests in Entity C 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 Entity C (subsection 125-65(6) of the ITAA 1997). | Detailed Reasoning - Demerger: Subsection 125-70(1) of the ITAA 1997 describes when a demerger happens. A demerger will happen to the Entity B demerger group because: • there will be a restructuring (paragraph 125-70(1)(a) of the ITAA 1997), and Entity B will dispose of at least 80% of its Entity C shares to the owners of Entity B (subparagraph 125-70(1)(b)(i) of the ITAA 1997); • under the restructuring, CGT event G1 will happen and Entity B shareholders will acquire new shares in Entity C and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997); • Entity C shares will be acquired by Entity B shareholders on the basis of their ownership of shares in Entity B (paragraph 125-70(1)(d) and subparagraph 125-70(1)(e)(i) of the ITAA 1997); • neither Entity B nor Entity C, are superannuation funds (paragraph125-70(1)(g) of the ITAA 1997); • Entity B shareholders will acquire Entity C shares in the same proportion as they own Entity B shares just before the demerger (paragraph 125-70(2)(a) of the ITAA 1997); • each of the Entity B shareholders will own shares in Entity B and Entity C that (just after the demerger) represent the same proportionate total market value as their Entity B shares represented (just before the demerger) (paragraph 125-70(2)(b) of the ITAA 1997); • under the scheme, there will be no buy-back of shares for the purposes of Division 16K of Part III of the ITAA 1936 (subsection 125-70(4) of the ITAA 1997); and • there will be no roll-over available under another provision for any CGT events that happen to the Entity B shares under the restructure (subsection 125-70(5) of the ITAA 1997). | Detailed Reasoning - Entity C is the demerged entity: Relevantly, 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, Entity C will be the demerged entity since the Entity B shareholders will receive shares in Entity C under a demerger. Entity B is the demerging entity Relevantly, 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, Entity B will be the demerging entity since it will dispose of 100% of its shares in Entity C to the Entity B shareholders under a demerger. | Detailed Reasoning - Can the Entity B shareholders choose demerger roll-over?: Subsection 125-55(1) of the ITAA 1997 relevantly provides that demerger roll-over may be chosen if: • a shareholder owns a share in a company - the Entity B shareholders will satisfy this requirement; • the company is the head entity of a demerger group - this requirement will be satisfied; • a demerger happens to the demerger group - this requirement will be satisfied; and • under the demerger a CGT event happens to the original interest (Entity B shares) and a new or replacement interest is acquired in the demerged entity - this requirement will be satisfied as CGT event G1 will happen to the Entity B shares when the Entity B shareholders receive Entity C shares under the demerger. Therefore the Taxpayer (as a shareholder of Entity B) will be eligible to choose roll-over under subsection 125-55(1) of the ITAA 1997. | Detailed Reasoning - Capital gains and cost base adjustments for the Taxpayer: If the Taxpayer chooses demerger roll-over: • it will disregard any capital gain made in respect of CGT event G1 that happens to its Entity B shares (subsection 125-80(1) of the ITAA 1997); • the first element of the cost base and reduced cost base of the Taxpayer's Entity B shares and the corresponding Entity C shares the Taxpayer acquires under the demerger, will be the sum of its original cost bases (just before the demerger) of the Entity B shares, apportioned over those Entity B and Entity C shares on a reasonable basis having regard to the market values (just after the demerger) of the Entity B shares and Entity C shares, or a reasonable approximation of those market values (subsections 125-80(2) and (3) of the ITAA 1997). If the Taxpayer does not choose demerger roll-over: • it will not be entitled to disregard any capital gain made in respect of CGT event G1 that happens to its Entity B shares under the demerger; • the cost base and reduced cost base of the Entity B shares and Entity C shares will be calculated in the same manner set out in the preceding paragraph. | Summary: The Entity C shares received by the Taxpayer under the scheme will be a demerger dividend that is neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) 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. 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 section 6D of the ITAA 1936) of Entity B it will not be a dividend, as defined in section 6(1) of the ITAA 1936. Therefore, the capital reduction amount will not be assessable income of Entity C 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 in specie distribution of the Entity B shares will, in part, constitute a dividend of the Entity B shareholders. The total amount of the dividend will be the market value of the Entity C shares at the time of the demerger excluding the amount debited to the share capital account of Entity B. In general, a dividend satisfied by an in specie 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, each of these conditions will be satisfied. Therefore, the dividend paid to the Taxpayer by Entity B under the proposed demerger will be neither assessable income nor exempt income as a result of the application of subsections 44(3) to (5) of the ITAA 1936. Nevertheless, to the extent that section 45BA of the ITAA 1936 applies, the demerger dividend will be assessable income of the Taxpayer. | Summary: The Commissioner will not make a determination under paragraphs 45B(3)(a) or 45B(3)(b) of the ITAA 1936 that section 45BA or section 45C of the ITAA 1936 applies in relation to the whole, or part, of any demerger benefit or capital benefit provided to the Taxpayer. | Detailed Reasoning - Detailed reasoning: Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation 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 (subsection 45B(1) of the ITAA 1936). Subsection 45B(2) of the ITAA 1936 provides (relevantly) that the section applies if: (a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company; (b) under the scheme the taxpayer obtains a tax benefit as defined in subsection 45B(9) of the ITAA 1936; and (c) having regard to the relevant circumstances of the scheme, it would be concluded that the scheme was entered into or carried out for a more than incidental purpose of enabling the taxpayer to obtain the tax benefit. Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) empowers the Commissioner to make a determination that either section 45BA of the ITAA 1936 applies in relation to a demerger benefit or section 45C of the ITAA 1936 applies in relation to a capital benefit. In this case, while the conditions of paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 are met, the requisite purpose of enabling the Taxpayer to obtain a tax benefit (by way of a demerger benefit or a capital benefit) is not present. Accordingly, the Commissioner will not make a determination under paragraphs 45B(3)(a) or 45B(3)(b) of the ITAA 1936 that either sections 45BA or 45C of the ITAA 1936 applies to the whole, or any part, of the demerger benefit or capital benefit provided to the Taxpayer under the demerger. | Summary: Division 7A of the ITAA 1936 will not apply to the distributions that will be made under the proposed demerger. | Detailed Reasoning - Detailed reasoning: Division 7A of the ITAA 1936 applies to treat certain distributions to entities connected with a private company as an assessable dividend. In particular section 109C of the ITAA 1936 treats certain payments made by a private company as a dividend where: ...the private company pays an amount to the entity during the year and either: (a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or (b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time. Further, paragraph 109C(3)(c) of the ITAA 1936 specifically includes a transfer of property as a payment within the meaning of the section. Prima facie, the transfer of Entity C shares to Entity B shareholders may satisfy this requirement. However, the outline to Division 7A of the ITAA 1936 notes that '... this Division does not apply to demerger dividends. (see Subdivision DA).' The operative provision is contained in section 109RA of the ITAA 1936 which provides that the Division does not apply to a demerger dividend to which section 45B of the ITAA 1936 does not apply. In the present circumstances the Commissioner is of the view that section 45B of the ITAA 1936 does not apply to the arrangement, therefore Division 7A of the ITAA 1936 has no application. | Summary: Any capital gain or loss that the Taxpayer may make when the demerged Entity C shares are distributed to the testamentary trusts will be disregarded pursuant to Division 128 of the ITAA 1997, to the extent the Entity C shares that are demerged form part of a deceased estate and are held in accordance with the terms of the testamentary trusts established by the deceased's Will until the Entity B shares vest in the ultimate beneficiaries of the testamentary trusts. | Detailed Reasoning - Detailed reasoning: Subsection 128-15(3) of the ITAA 1997 states that: • any capital gain or capital loss the legal personal representative makes if the asset passes to a beneficiary in your estate is disregarded. Paragraphs 2 and 3 of Practice Statement PS LA 2003/12 state that: the Commissioner will not depart from the ATO's long-standing administrative practice of treating the trustee of a testamentary trust in the same way that a legal personal representative is treated for the purposes of Division 128 of the ITAA 1997, in particular subsection 128-15(3). Accordingly, subject to the operation of CGT event K3 in section 104-215 of the ITAA 1997 (about assets passing to a tax-advantaged entity), any capital gain or capital loss that arises when an asset owned by a deceased person passes to the ultimate beneficiary of a trust created under the deceased's will is disregarded. In these circumstances, provided the ultimate beneficiaries don't: • acquire the Entity C shares from a legal personal representative of the deceased or a trustee of a testamentary trust under a power of sale (In which case the shares wouldn't pass under the Will for CGT purposes; see subsection 128-20(2) of the ITAA 1997); • there is no earlier disposal of the Entity C shares by a legal personal representative or a trustee of a testamentary trust; • and CGT event K3 is not triggered. The administrative practice in PS LA 2003/12 will apply so that no CGT taxing point will be recognised on the passing of the Entity C shares to the ultimate beneficiaries under the deceased's Will until those shares cease being owned by the ultimate beneficiaries.

Question 1: Will the Commissioner confirm that the Taxpayer will be entitled to choose demerger roll-over relief pursuant to section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Question 2: Will the Commissioner confirm that all or any part of the in specie distribution of the Entity C shares to the Taxpayer 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 Income Tax Assessment Act 1936 (ITAA 1936)? | Question 3: Will the Commissioner confirm that section 45B of the ITAA 1936 would not apply to treat any part of the demerger allocation as assessable? | Question 4: Will the Commissioner confirm that Division 7A of the ITAA 1936 will not apply to any distributions made under the demerger arrangement? | Facts and circumstances: The scheme that is the subject of this ruling involves the separation by Entity B of Entity C by way of a demerger. | Entity B is the head company of a consolidated group for tax purposes. | Entity B has ordinary and X class shares on issue. | The shareholders in Entity B acquired their shares post CGT and are Australian residents for taxation purposes. | The Taxpayer is an Entity B shareholder. | Entity C is a wholly-owned subsidiary of Entity B. | At the time of the proposed demerger, Entity C will have ordinary and X class shares on issue. | All of the shares currently on issue in Entity C were acquired after 20 September 1985. | Demerger implementation steps: Entity B proposes to undertake a restructure under which 100% of its shareholding in Entity C will be distributed to the Entity B shareholders. Under the proposal, the owners of the ordinary shares in Entity B will receive ordinary shares in Entity C (and nothing else) in the same proportion to their existing shareholding of ordinary shares in Entity B. The owners of X class shares in Entity B will receive X class shares in Entity C (and nothing else) in the same proportion to their existing shareholding of X class shares in Entity B. | Reasons for the demerger: The applicant has advanced a number of reasons for the proposed demerger including facilitating the development of each entities commercial strategy, greater flexibility in financing arrangements and separating two distinct and separate businesses that can operate independently of one another. | Other matters: The shareholders of Entity B are Australian residents and will each choose roll-over relief under section 125-55 of the ITAA 1997. | Entity B will not make an election under subsection 44(2) of the Income Tax Assessment Act 1936 (ITAA 1936) that subsections 44(3) and 44(4) will not apply to the total of any demerger dividend arising under the restructure. | Entity B confirms that CGT assets representing at least 50% of the market value of all the CGT assets of Entity C will be used directly or indirectly in the business carried on by Entity C just after the demerger.