The ATO has finalized its position on “restructuring” in demergers overnight, with the release of Taxation Determination TD 2020/6 confirming its position in Draft TD 2019/D1.
Demerger relief consists of:
- Capital Gains Tax relief – where shareholders in the head entity of a demerger group can obtain CGT “roll-over” relief, thus deferring the taxing point (Div 125 of the Income Tax Assessment Act (ITAA) 1997), or where the demerger group is itself not subject to CGT on the disposal of the demerged group, with capital gains or capital losses made by the demerging entity being disregarded Subdivision 125-C of the ITAA 1997); and
- Dividend relief: where the dividend component of a demerger distribution is not treated as either assessable income or exempt income if the dividend constitutes a “demerger dividend” and certain other requirements are satisfied (section 44 ITAA 1936).
For demerger relief to be available, there must be a ‘demerger’ as defined in section 125-70(1) ITAA 1997 – this requires that there be a “restructuring” of the demerger group under which (in the most common scenarios) members of the group dispose of at least 80% of their total ownership interests in another member of the group 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 group in another member of the group end and new interests are issued to owners of original interests in the head entity (section 125-70(1)(b)). Under the restructuring, a CGT event must happen to an original interest owned by a taxpayer in the head entity of the group and the taxpayer must acquire a new interest and “nothing else” (section 125-70(1)(c)).
The position adopted by the ATO is to narrow the scope of demergers where, in the context of a “restructure” of a group, what happens before or after the demerger can be critical to the tax outcome, and demerger relief is unlikely to be available except in the most “vanilla” internal group restructure.
In a cross-border context, a common situation that could arise is where a post-demerger sale of an Australian entity may not be seen to not be legally and commercially independent of the demerger. The demerger may be perceived to occur in preparation for, or as a condition of, a subsequent sale of that entity to a third party purchaser, especially if negotiations were undertaken prior to the demerger (see Example 3 in TD 2002/6). If however, the sale of the entity post-demerger was unplanned, and legally and commercially independent of the demerger, there may be scope for the restructure to qualify for demerger relief (see Example 4 in TD 2002/6)
The ATO states in TD 2020/6 that:
- ….. What constitutes a particular restructuring is essentially a question of fact. However, all the steps which occur under a single plan of reorganisation will usually constitute the restructuring. The restructuring of a demerger group is not necessarily confined to the steps or transactions under paragraph 125-70(1)(b) that deliver the ownership interests in an entity to the owners of the head entity of the demerger group, but may include previous and/or subsequent transactions in a sequence of transactions.
- Transactions that are to occur under a plan for the reorganisation of the demerger group may constitute parts of the restructuring of the demerger group even though those transactions are legally independent of each other, contingent on different events, or may not all occur. For example, if a transaction or step is subject to a separate decision-making process (such as separate votes by shareholders of the company that is the head entity of the demerger group) from the steps taken to separate an entity, it may still be part of the restructuring. Thus the planned transfer of interests in the separated entity by all the owners of those interests to a particular acquiring entity would generally be considered to form part of the restructuring where commercially the transfer of the interests would be understood to be a step in a plan for the owners to transfer their interests in the separated entity to the acquiring entity. ………………..
- In determining the scope of the plan (and hence the restructuring), the Commissioner will look at all the facts and circumstances, including contracts and deeds executed by or affecting the relevant entities …. statements in documents filed with regulators, commercial factors, internal deliberations by a company’s directors or the directors of a trustee company, statements by directors or influential owners and announcements to any relevant securities exchange. ….
- …. the scope of the restructuring (including when it begins and ends) is also relevant to the ‘nothing else’ condition…. and the proportionate ownership test and proportionate market value test in subsection 125-70(2).
- The purpose or object of the conditions in subsections 125-70(1) and (2) is to determine whether the identified restructuring has resulted in a change to the economic position of the owners of original interests in the head entity of the relevant demerger group.
- The fact that transactions or steps are separated by several months does not automatically mean that they cannot form part of the same restructuring. Temporal proximity is a relevant factor, but is not decisive on its own when establishing the objectively inferred plan for the reorganisation of a demerger group….
If you are looking to restructure your ownership in an Australian corporate group and you are considering the demerger rules contact us today to discuss whether such an approach is sensible.
For more information, please reach out to:
Head, US-Australia Tax Desk