As reported in our previous alert, the Australian Taxation Office (ATO) has been working towards setting the goal posts on the meaning of “restructuring” for the purpose of the demerger rules in Division 125 of the Income Tax Assessment Act 1997 (Cth).

In its recently finalised taxation determination TD 2020/6 (determination), released on 22 July 2020, the ATO has shifted (some would say widened) the goal posts from its draft guidance.  Even so, taxpayers still need to play the percentages to be able to score a successful demerger.  Some commentators are already calling for a legislative fix to overturn the ATO’s narrowing views on what is eligible for demerger relief.

What has happened to the goal posts

There are some important, sometimes subtle, shifts in the ATO’s thinking on demergers since its draft guidance (you should read our previous alert together with this update).  These can be seen through its commentary and description of the examples.

• Demerger followed by a capital raising – The ATO has broadened the circumstances in which a capital raising can be conducted and still satisfy the conditions for demerger.  Important changes include:
  • Not limiting the possible capital raises to just minor ones.
  • Permitting the capital raising to be put to shareholders as part of the demerger, including allowing the demerger to be conditional on the capital raising.
  • Requiring the capital raising to either be open to any willing investor or be conducted by way of a rights issue to existing shareholders (subject to certain conditions).
    
    This is an important and eminently sensible change in approach by the ATO, and it is commendable that the ATO has heeded the feedback from consultation.
• Demerger followed by issue of shares to a new shareholder – On the other hand, the ATO has toughened its stance on the dilution of existing shareholders by issuing shares in the demerged entity to a new shareholder.  In its revised example, it seems to suggest that such a transaction would not qualify for demerger rollover relief if:
  • A substantial (as opposed to 50%) stake is acquired by the new shareholder, where the discussions with the new shareholder are had before the demerger (query whether the extent of those discussions is relevant).
  • The capital injection occurs without also involving a return of the same value to the other shareholders (this was a feature of the original example in the draft guidance and clearly demonstrated there was a contrived arrangement to effect a change of ownership).
  • Other shareholders are excluded from the capital raise (the example suggests this could even be shareholders with small parcels).
    
    It is unfortunate that the ATO has not provided more useful guidance on where the threshold now sits – substantial and significant are imprecise concepts.
• Sale facilities – The ATO has sensibly accepted that broadly available voluntary sale facilities that contain no incentives (other than not having to pay brokerage fees) will not prevent demerger rollover relief applying.
• Pre-demerger restructuring – In a new example, the ATO confirms that pre-demerger structuring to effect a separation of the respective businesses and ready them to operate independently will not prevent demerger rollover relief applying, but they are part of the restructuring for testing whether demerger relief is in fact available.  Such structuring includes things like transferring assets, novation of contracts, transfer of employees and setting up a new company to be the demerged entity.  This example describes things which would clearly have been in the minds of the legislature when originally setting the policy on demergers – a demerger simply could not be effected in most corporate groups without undertaking the steps in this example.  The fact that the ATO found the need to insert this example into the final determination shows the uncertainty created by the ATO’s shifting positions on demergers, but also shows how early a restructuring can commence (with the result that it is possible that the other demerger conditions may not be satisfied).

The above guidance is drawn from the ATO’s examples and changes between its draft and final guidance.  Taxpayers should carefully consider the similarity of a particular example to their circumstances and engage appropriately with the ATO.

Let’s recap.  What is a demerger?

A demerger broadly involves a restructuring of a corporate group by splitting it into two corporate groups.  Both the demerger group (the original group) and the demerged entity or group (the entity or group that has been demerged out of the original group) will be owned directly and in the same proportions by the existing shareholders of the demerger group.

If the demerger rules apply:

• The demerger group is not subject to capital gains tax (CGT) on the disposal of the demerged group; and
• Shareholders are not subject to tax on receiving shares in the demerged group (this may otherwise be subject to tax as a capital return subject to CGT or a dividend subject to ordinary income tax or, in the case of non-resident shareholders, dividend withholding tax).

In order for demerger relief to apply, a “demerger” must happen, which requires the following:

• Importantly for this discussion, there must be a “restructuring” of the demerger group;
• Under the restructuring, the demerger group must dispose of at least 80% of the shares in the demerged group to the shareholders;
• The shareholders must acquire shares in the demerged group, and nothing else (nothing else requirement); and
• The shareholders must acquire the same proportion of demerged shares and proportionate market value in the demerged group as it had in the demerger group (the proportionality requirement).

What does “restructuring” mean?

The scope of the restructuring is critical in determining whether the conditions to qualify as a demerger, including the nothing else requirement and the proportionality requirement, are met.  Hence, identifying the restructuring is an important exercise.

According to the ATO, what constitutes “restructuring” is a question of fact.  The fundamental point of difference between taxpayers and advisers on the one hand and the ATO on the other is seen in the ATO’s view that all steps which occur under a single plan of reorganisation will usually constitute the restructuring, and not just the steps that effect the demerger.  Instead, previous and/or subsequent transactions to the demerger may form part of the restructuring of the demerger group, which may cause the demerger to fail the requirements for relief.

A key factor for the ATO is the proposal that is presented to the original shareholders in the demerger group.  This may be in any communications with shareholders.  The ATO has said that it will look at all the facts and circumstances in determining the restructure.  This includes contracts and deeds executed by or affecting the relevant entities (including contracts and deeds that are given legal effect by a court decision, such as a scheme of arrangement), statements in documents filed with regulators, commercial factors, internal deliberations by a company’s directors, statements by directors or influential owners and announcements to any relevant securities exchange.

This means that taxpayers will need to ensure their tax advisers have full visibility on all matters, documents and communications associated with the transactions in assessing whether demerger relief will be available.  Also, protections for the confidentiality of board discussions and competitive commercial information will need to be carefully considered.

Demerger plays

Let us look at some common demerger plays and see what the ATO thinks of them:

Timing and actions

The principles in the determination apply to income years commencing both before and after 22 July 2020 (noting that this will mean that the determination will apply even to years where the ATO took contrary positions in public rulings). 

However, the ATO states that it does not intend to devote compliance resources to whether demerger rollover relief was available for CGT events occurring before 20 March 2019 (when its draft determination was released) unless the issue arises as part of usual compliance activity, a ruling request, a request to amend an assessment, an objection to an assessment or in submissions by the ATO in litigation.

Taxpayers should review demergers that happened on or after 20 March 2019 for compliance with the determination.  We also recommend that taxpayers revisit transactions that happened before that date, even if it is only at a high level, so as to be prepared to address any issues should it arise in the context of ordinary ATO activity.