Private ruling: Demerger relief
Published: December 2012
Ruling period: Income year ending 30 June 2013
Date scheme commenced: N/A

Ruling: Q1: Does A Co disregard an capital gain or capital loss arising from a CGT event happening to its shares in B Co, pursuant to section 125-155 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes, A Co disregards any capital gain or capital loss arising from CGT event A1 happening on the disposal of its shares in B Co to A Co's shareholders, pursuant to section 125-155 of the ITAA 1997.

Relevant facts and circumstances: A Co is a resident company that owns more than 20% of the shares in B Co, also a resident company. 1. A Co disposes of all of its shares in B Co to A Co's shareholders in the form of an in specie distribution. 2. The number of B Co shares distributed to each of A Co's shareholders is (as nearly as practicable) in the same proportion as the number of A Co shares held by each shareholder. 3. Each of A Co's shareholders has, just after the distribution, shares in A Co and in B Co with the same proportionate total market value as they had in A Co just before the distribution. 4. The distribution is accounted for by A Co partly as a return of capital with the balance coming from retained earnings. The sum of the two amounts is the market value of the shares disposed of at the time of disposal. 5. The fraction of share capital returned is (as near as practicable) equal to the market value (just before the distribution) of the B Co shares disposed of divided by the market value (just before the distribution) of all the shares in A Co. 6. The only roll-over available to A Co's shareholders in relation to the occurrence of CGT event G1 in relation to their shares in A Co due to the return of capital as part of the distribution is the roll-over they are entitled to under section 125-55 of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10 | Section 104-25 | Section 104-30 | Section 104-70 | Section 104-135 | Section 104-175 | Section 104-230 | Division 125 | Section 125-60 | Subsection 125-60(1) | Section 125-65 | Subsection 125-65(1) | Subsection 125-65(2) | Subsection 125-65(3) | Subsection 125-65(4) | Subsection 125-65(5) | Subsection 125-65(6) | Subsection 125-65(7) | Section 125-70 | Paragraph 125-70(1)(a) | Paragraph 125-70(1)(b) | Paragraph 125-70(1)(c) | Paragraph 125-70(1)(d) | Paragraph 125-70(1)(e) | Paragraph 125-70(1)(g) | Paragraph 125-70(1)(h) | Subsection 125-70(2) | Subsection 125-70(4) | Subsection 125-70(5) | Subsection 125-70(6) | Subsection 125-70(7) | Section 125-155 | Section 125-160 | Section 125-165 | Section 125-170 | Subsection 125-170(2) | Subsection 995-1(1) | Income Tax Assessment Act 1936 Division 16K of Part III | Section 159GZZZK

Reasons for decision: Detailed Reasoning - Applicable law: 1. Where a group satisfying the definition of 'demerger group' in section 125-65 of the ITAA 1997 restructures in a manner that meets the requirements of section 125-70 of the ITAA 1997 (such that a 'demerger' happens to the group), the demerger rules provide specific relief from the income tax consequences that would otherwise have arisen. Some elements of this relief concern the owners of 'ownership interests' in the head entity of a demerger group, and some concern 'demerging entities'. It is the latter form of relief that is relevant to the present case. Demerger group 2. A demerger group consists of a 'head entity' and one or more 'demerger subsidiaries' (subsection 125-65(1) of the ITAA 1997). Members of the demerger group must either be companies or trusts (section 125-65 of the ITAA 1997, subsections (3), (6) and (7)). However, a trust cannot be a member of the demerger group unless CGT event E4 is capable of applying to all of the units and interests in the trust (subsection 125-65(2) of the ITAA 1997). 3. A company or trust that is the head entity has no 'ownership interest' held in it by other members of the demerger group (subsection 125-65(3) of the ITAA 1997). Further, if a company or trust is provisionally assumed to be the head entity of a demerger group, but it and all the entities that would (consistent with the assumption) be its demerger subsidiaries are themselves demerger subsidiaries of a company or trust in another demerger group, the first-mentioned company or trust is not a head entity of a demerger group (subsection 125-65(4) of the ITAA 1997). 4. A company or trust is a 'demerger subsidiary' of another company or trust that is a member of the group if the other company, in its own right or together with other group members, owns or has the right to acquire ownership interests in the company or trust that carry between them: · the right to receive more than 20% of any distribution of income or capital by the company or trustee, and · (in the case of a company) the right to exercise, or control the exercise of, more than 20% of the voting power of the company (section 125-65 of the ITAA 1997, subsections (6) and (7)). 5. An 'ownership interest' in a company or trust is a share in the company or unit or other interest in the trust, or an option, right or similar interest issued by the company or trustee entitling the owner to acquire a share in the company or a unit or other interest in the trust (subsection 125-60(1) of the ITAA 1997). Demerger 6. The definition of 'demerger' for the purposes of the ITAA 1997 and the ITAA 1936 is pointed to by subsection 995-1(1) of the ITAA 1997, which states that a demerger has the meaning given by section 125-70 of the ITAA 1997. Paragraph 125-70(1)(a) 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 (see paragraph 125-70(1)(b) of the ITAA 1997): · members of the demerger group dispose of at least 80% of their total ownership interests in the demerged entity to owners of original interests in the head entity of the group; or · at least 80% of the total ownership interests of members of the demerger group in the demerged entity end and new interests are issued to owners of original interests in the head entity; or · the demerged entity issues sufficient new ownership interests in itself such that owners of original interests in the head entity own at least 80% of the total ownership interests in the demerged entity; or · some combination of the above three processes happens with the effect that members of the demerger group stop owning at least 80% of the total ownership interest owned by members of the demerger group in another member of the group. 7. Section 125-70 of the ITAA 1997 sets out additional requirements (in subsection (1), paragraphs (c), (d), (e), (g) and (h) and subsection (2)) as follows: · whether or not a CGT event (for example, CGT event G1 or CGT event E4) happens to an original interest owned by an entity in the head entity, the entity acquires a new interest and nothing else · entities acquire new interests only because they own or owned original interests · the new interests must be ownership interests in a company if the head entity is a company trust if the head entity is a trust · neither the original interests nor new interests are in a trust that is a superannuation fund (as defined by section 10 of the Superannuation Industry (Supervision) Act 1993 ) · the proportion of new interests acquired by each owner (the 'original owner') of original interests must equate as nearly as practicable to the proportion of original interests owned by the original owner · each original owner must, just after the demerger, have the same proportionate total market value of ownership interests in the head entity and demerged entity as they had in the head entity just before the demerger. 8. An off-market share buy-back is not a demerger (subsection 125-70(4) of the ITAA 1997). There is also no demerger if the circumstances are such that an owner of original interests could have obtained a roll-over under the income tax law apart from Division 125 of the ITAA 1997 for each CGT event that happened to those interests under those circumstances (subsection 125-70(5) of the ITAA 1997). Demerged entity 9. A 'demerged entity' is defined to be a former member of a demerger group where, under a demerger that happens to the group, ownership interests in the former member are acquired by shareholders, or unitholders or holders of interests in, the head entity of the group (subsections 125-70(6) and (7) of the ITAA 1997). Demerging entity 10. A 'demerging entity' is an entity that is a member of a demerger group just before the CGT event referred to in section 125-155 of the ITAA 1997 happens, and under a demerger that happens to the demerger group, the entity, alone or together with other members of the group, stops owning at least 80% of the ownership interests owned by members of the group in another member of the group because of one or a combination of the processes described in the first three dot points in paragraph Error! Reference source not found. . Demerger relief 11. Paragraphs 15.5 and 15.6 of the Explanatory Memorandum to the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002 (the EM) explain the context of demerger relief as follows: 15.5 The CGT relief and dividend exemption will facilitate the demerging of entities by ensuring that tax considerations are not an impediment to restructuring a business. These amendments are based on Recommendation 19.4 of A Tax System Redesigned, and recognise that there should be no taxing event for a restructuring that leaves members in the same economic position as they were just before the restructuring. 15.6 The CGT relief provided for demergers complements the scrip for scrip roll-over provided under Subdivision 124-M of the ITAA 1997. A Tax System Redesigned recommended tax relief for both demergers and for takeovers and mergers achieved by scrip for scrip exchanges. 12. The Review of Business Taxation - A Tax System Redesigned , Commonwealth of Australia 1999 recommended (see recommendation 19.4 at p. 618) that demerger relief be provided 'where a widely held entity splits its operations into one or more new entities and issues membership interests in these entities to the original members in the same nature and proportion as their original membership interest.' It went on to explain the recommendation (at p. 619) as follows: The Review considers that where an entity undertakes a reorganisation of its operations, leaving members in the same economic position as they were immediately before the reorganisation, there should be no taxing event. … [E]quity holders may face CGT and/or income tax … This acts as an impediment to entities restructuring their operations and may therefore lead to a reduction in the overall efficiency of the economy. The provision of relief will enable widely-held entities to restructure their operation with a minimum of difficulty for members. CGT consequences for demerging entities 13. Section 125-155 of the ITAA 1997 states that any capital gain or capital loss a demerging entity makes due to one of CGT events A1, C2, C3 or K6 happening to its ownership interests in the demerged entity under the demerger is disregarded. CGT event J1 does not happen to the demerged entity or demerging entities (section 125-160 of the ITAA 1997). Sections 125-165 and 125-170 of the ITAA 1997 deal with value shifting due to the market value of a CGT asset decreasing because of a demerger. | Detailed Reasoning - Application to the facts: 14. A Co is the head entity of a demerger group consisting of itself and B Co (paragraphs 1 - 5 , fact 0 ). A Co disposes of all of its shares in B Co (paragraph 6 , fact 1 ). With regard to the additional requirements listed in paragraph 7 : · CGT event G1 happens to the shareholders' shares in A Co due to the return of capital (fact 4 ), and the shareholders receive new shares in B Co and nothing else (fact 1 ). · A Co's shareholders received shares in B Co only because they owned shares in A Co. · The new interests received by A Co's shareholders in B Co are shares in a company, and A Co is a company (facts 0 , 1 ). · Neither A Co nor B Co is a trust that is a superannuation fund (fact 0 ). · Each shareholder of A Co was allocated shares in B Co in similar proportion to the shares they held in A Co (fact 2 ). · Each of A Co's shareholders has, just after the distribution, shares in A Co and in B Co with the same proportionate total market value as they had in A Co just before the distribution (fact 4 ). 15. With regard to the requirements in paragraph 8 , the in specie distribution (fact 1 ) is not an off-market buy-back, and there was no roll-over that the shareholders in A Co could obtain in relation to the CGT event G1 mentioned above other than the roll-over provided for under section 125-55 of the ITAA 1997 (fact 6 ). 16. Accordingly, all of the requirements for there to be a demerger under section 125-70 of the ITAA 1997 are met. Consequently (as explained in paragraph 13 ), section 125-155 of the ITAA 1997 applies, and A Co disregards any capital gain or capital loss arising from CGT event A1 occurring due to the disposal of its shares in B Co. The rulings in the register have been edited and may not contain all the factual details relevant to each decision. Do not use the register to predict ATO policy or decisions.

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