In Australia, the tax consequences of a partial demerger (where...

In Australia, the tax consequences of a partial demerger (where only a portion of the assets or business is demerged, and the remaining portion is retained by the original company) can differ somewhat from a full demerger. The scenario you describe involves a 80% demerger, where 80% of the value of the business or assets (worth $428 million) is transferred to the demerged company, and 20% is retained by the original company as shares. Here's an outline of the key Australian tax consequences in this case, under the assumption that the demerger qualifies for tax relief under Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997):

1. Eligibility for Tax-Free Treatment (Division 125)

• As with a full demerger, the partial demerger may qualify for tax-free treatment under Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997), provided specific conditions are met. These conditions include:

  • Control and ownership: The demerger must involve a genuine separation of the business, with shareholders in the original company receiving shares in the demerged company (the new entity).

  • The transaction must not be carried out solely for tax avoidance purposes.

  • The shareholder must receive new shares in the demerged company in exchange for their shares in the original company, and those shares must reflect their proportionate interest in both companies after the demerger (e.g., receiving 80% of shares in the new company, with the remaining 20% retained by the original company).

2. Tax-Free Treatment for the Dividing Company (Demerger Entity)

• For the demerging company, if the demerger qualifies for tax relief, there is no capital gains tax (CGT) triggered on the transfer of assets to the demerged company.

• The demerging company will not recognize a gain or loss on the transfer of its business or assets (worth $428 million in this case) to the new company.

• Tax-free transfer of assets: The original company does not incur immediate tax liability when transferring the business/assets to the demerged company, provided the demerger meets the necessary requirements.

3. Tax Consequences for Shareholders

• CGT Rollover Relief: Shareholders in the original company (the "demerging company") are typically eligible for CGT rollover relief on the shares they hold. This means shareholders will not pay CGT at the time of the demerger.

  • The shareholders will continue to hold their original shares in the demerged company and will receive new shares in the demerged entity in proportion to their holdings.

  • The cost base of the shares in the original company will be allocated between the shares in the original company (retained portion, 20%) and the shares in the demerged company (80% of the value), based on their relative market values at the time of the demerger.

• Adjusting the cost base: For CGT purposes, the cost base of the original shares will be split between the shares in the original company (20% retained) and the shares in the new company (80% demerged). This adjustment will affect the future CGT calculation when the shares are eventually sold or disposed of.

  • Example: If the original shares had a cost base of $100,000 and the 80% demerged business is valued at $428 million, the adjusted cost base for the 20% retained shares and the 80% demerged shares will reflect their proportionate value based on the total value of the transaction.

4. Shares in the Demerged Company (80% Transfer)

• For the demerged company, shareholders will receive new shares in proportion to their existing holdings in the original company (80% of the business is being transferred).

• The demerged company’s shares will be valued based on the market value of the assets or business being transferred, which in this case is $428 million.

• Shareholders do not pay tax on the receipt of the new shares in the demerged company at the time of the demerger (CGT rollover relief applies).

5. Stamp Duty

• Stamp duty: Generally, no stamp duty will be payable on the transfer of assets between the demerging company and the demerged company if the demerger qualifies under Division 125. This tax relief is designed to avoid double taxation and make the transaction easier to execute.

• If the demerger does not qualify for tax-free treatment (e.g., if it's viewed as a sale rather than a genuine demerger), stamp duty may apply on the transfer of assets, but this is rare in the case of tax-free demergers.

6. Future Tax Consequences

• CGT on Sale of Shares: Once the shares in the original company and the demerged company are sold or disposed of, CGT will apply based on the adjusted cost base of those shares. This means that shareholders will only incur CGT when they sell or dispose of the shares.

• Future Dividends: Any dividends paid by the new demerged company will be subject to income tax in the hands of the shareholders, but there is no immediate tax at the time of the demerger on the receipt of shares in the new company.

7. Losses and Deductions

• The demerged company (new company) may be able to carry forward certain tax losses and deductions related to the transferred assets, subject to meeting the tax consolidation and loss utilization rules.

• The original company may retain losses that are not transferred to the new company, unless they are absorbed in the overall transaction.

8. Anti-Avoidance Rules

• The Australian Taxation Office (ATO) closely scrutinizes demergers to ensure that they are not structured solely for tax avoidance purposes. A demerger must involve a genuine separation of business operations and assets, not just an attempt to reduce taxes or shift assets.

• If the ATO believes the demerger is part of a tax avoidance scheme, it could disallow the tax relief and impose penalties or interest.

Summary of the Key Tax Consequences:

1. Demerger is generally tax-free under Division 125, provided the conditions are met.

2. The demerging company does not incur CGT on transferring assets to the new company.

3. Shareholders receive rollover relief and do not pay CGT at the time of the demerger. The cost base of their shares is allocated between the shares in the original company (20% retained) and the new company (80% transferred).

4. No stamp duty is payable if the demerger qualifies under Division 125.

5. Future CGT is payable when shares in the original or demerged company are sold or disposed of.

6. The demerger must be genuine, or the ATO may disallow the tax treatment.