By Enzo Coia, Partner, and James Gould, Analyst, Deloitte M&A Tax
On 21 March 2019, the ATO released Draft Tax Determination TD 2019/D1 concerning what constitutes a “restructuring” for the purposes of Div 125 demerger relief in the Income Tax Assessment Act 1997. As expected, the draft Determination attempts to explain the ATO’s new interpretation following guidance in the past 12 months.
Demerger restructures generally involve a group (the demerger group), whose shareholders acquire direct ownership over an entity (the demerged entity) that they previously owned indirectly.
Shareholders will not suffer the resulting CGT consequences if they qualify for Div 125 demerger relief, which broadly requires the satisfaction of the following tests:
- The demerged group must cease to hold at least 80% of the interests previously held in the demerging entity (the 80% test)
- The shareholders must acquire a new interest in the demerged entity and nothing else, eg cash (the nothing else test)
- The new interests (in the demerged entity) must be of the same kind of entity as the original interests (ie shares in the head entity and shares in the demerger subsidiary) (the same entity type test), and
- The proportion of new interests issued and their market value must correlate to the proportionate ownership and market value that each owner had in the original demerger group (the maintenance of ownership test).
Broadly, access to Div 125 demerger relief allows the owners of interests in the demerger group to disregard CGT events relating to the disposal, cancellation and creation of interests in relation to the scheme. Owners split their existing tax base across the remaining interests and the interests in the demerged entity. It also allows the corporate group undertaking the demerger to do so without a CGT impost.
Where were the flags?
Historically, the ATO has approved demergers that have been immediately preceded and/or proceeded by a pre-arranged transaction, with a narrow view of what constituted a “restructuring”. Perhaps the best example is the demerger of Progressive Enterprises Holding Limited (PEH) from Foodland Associated Limited (FAL) in Class Ruling CR 2005/74.
Immediately following the demerger, it was proposed that:
- PEH shares would be transferred to the Woolworths Group; and
- FAL shares would be transferred to the Metcash Group.
The transfer of PEH to the Woolworths Group and the transfer of FAL to the Metcash Group were to be implemented under one scheme of arrangement and the transfers to the Woolworths Group and the Metcash Group could not occur separately.
Similarly, CR 2013/23 involved the demerger of Talon Petroleum Limited (Talon) by Texon Petroleum Limited (Texon). A condition precedent to Texon’s merger with Sundance Energy Australia Limited was Texon’s demerger of assets held by Talon. Prior to the demerger, Texon transferred to Talon certain administrative assets that facilitated the demerger as well as inter-company loans that were converted into equity immediately prior to the demerger.
The ATO ruled that all Div 125 requirements were satisfied and Texon shareholders could choose Div 125 relief. Accordingly, the post-demerger acquisition of Texon by Sundance did not cause the ATO to take the view that shareholders were acquiring “something else” (ie shares in Sundance) as part of the demerger.
Where are the flags now?
The ATO favours the interpretation that the policy intention behind Div 125 demerger relief is to limit relief to restructures that do not result in changes to the economic position of the original owners. In doing so, a wider interpretation of what constitutes a “restructuring” has been taken, such that:
Parts of a plan, whether or not legally interdependent or dependent on different contingencies, should not be considered in isolation and one must look at the entirety of the plan, and its effect.
Further, TD 2019/D1 states than an interpretation akin to identifying “schemes” for the purposes of Pt IVA — ie whether the “restructuring” would “make sense” without a particular step — may also be appropriate.
The extension of what a “restructuring” means in Div 125, to include legally and commercially distinct transactions, is evidenced by the TD 2019/D1 examples that do not qualify (in the ATO’s view) for demerger relief — specifically, the following events occurring after a demerger:
- The subsequent sale of the demerging entity following demerger, whereby the transaction would not occur but for the precedent demerger — ie the transaction was conditional upon the demerger occurring. The demerger is in preparation for the subsequent sale, and the sale of the subsidiary “objectively forms part of the connected plan” to demerge then sell the remaining business, and as such the two legally distinct events are part of the same restructuring event. (Example 3)
- A capital raising, in which inter alia, the demerging entity has negotiated with a third party for the acquisition of shares in the demerged entity as part of the capital raising. The two events are part of the same “restructuring”. (Example 2)
- The demerged entity is listed and a subset of shareholders may use a sale facility for disposal of shares (at a premium) in the demerged entity. (Example 5)
The first instance (explained by example 3 in the draft Determination) is expected given recent ATO guidance (eg CR 2018/31 involving the Westfield demerger), although the draft Determination’s approach to conditionality is discussed below.
In the second instance listed above, the denial of demerger relief appears to contradict the ATO’s position in published class rulings. For example, Class Ruling CR 2008/31granted demerger relief to the demerger of a chemicals company that subsequently engaged in a capital raising (which was not considered part of the “corporate restructure”).
The third instance’s position in respect of past ATO guidance is unclear as the importance of the premium on the sale facility (in Example 5) is not made evident by the draft Determination. Class Ruling CR 2010/34 involved the demerger of DuluxGroup Limited by Orica Limited, in which eligible shareholders (granted demerger relief by the class ruling) had shares received under the demerger subsequently sold on the ASX via a sale facility. Although withdrawn in 2010 because it “does not contain an interpretative decision”, ATO ID 2003/1053 considered sale facilities for demerger shareholders following a demerger to be “ancillary” to the restructuring and did not prevent demerger relief. Finally, it is unclear whether the draft Determination’s interpretation could lead to outcomes whereby shareholders that do not use the sale facility cannot access demerger relief.
As mentioned, demergers that were conditional on a subsequent transaction (eg Westfield) were denied Div 125 demerger relief during 2018. At the time CR 2018/31was issued, it was unclear whether the conditionality triggered a failure of the “nothing else” requirement in s 125-70(1)(c).
A transaction is not necessarily part of the restructuring of the group merely because it is necessary for the restructuring of the group to occur, or was the occasion for the restructuring, or because it is enabled by the restructuring of the group or is a consequence of the restructuring of the group;
which indicates that:
- transactions “necessary for the restructuring of the group to occur” (ie the demerger is conditional on the transaction occurring?), and
- demergers that enable the transaction (ie the transaction is conditional on the demerger occurring?),
are not decisive for determining whether a restructuring includes the subsequent transaction.
However, in Example 3 (the only example regarding a sale subsequent to the demerger), the transaction is strictly conditional on the demerger, ie the transaction will not go ahead without the demerger occurring. Together with facts indicating that the demerger is undertaken with the intention of preparing the demerging entity for a subsequent sale, the conditionality appears to be a significant factor in characterising the sale as part of the connected plan to demerge, and thus part of the same restructuring.
Conversely, the demerger is not considered conditional on the transaction because “in theory, [the demerger] could be approved, and [the subsequent transaction] could be rejected by shareholders”. The only material change between Examples 3 and 4 (where demerger relief is available) seems to be the fact that the demerger would occur regardless of the transaction, ie the two events are not “planned to occur in sequence”. Although the ATO’s interpretation could indicate a black letter interpretation of conditionality and the importance of documentation, it is a non-commercial view of conditionality, especially given Example 3 states that the demerger is unlikely to occur commercially without the subsequent transaction.
Is it safe?
We are still confused by two key issues that remain unanswered by TD 2019/D1. Firstly, in many demergers, there is an “enabling” distribution (common in many demergers) which is applied by the shareholders to acquire the shares in the demerged entity. This transaction structure, and the fact that demerger relief is available, are made clearly evident within the example accompanying s 125-70(1). Given the breadth of a “restructuring” in TD 2019/D1, how is one supposed to reconcile that such a cash distribution could be part of a restructure and demerger relief not be available? That is, will this now or in future be captured as part of the restructuring, and potentially fail the “nothing else” test?
Secondly, it is difficult to reconcile an interpretation of “restructuring” that is significantly wider than what is necessary to satisfy the provisions in Div 125. If the dimensions of a restructuring are not tethered to what is contemplated by Div 125, it is difficult to know when to stop pulling out the ruler. We would have thought an interpretation could be sensibly made that a “restructure” could be broad but a demerger that happens “under” it could be limited to something less than all of the restructure steps but still quality for relief because the other elements in s 125-70 are met.
It has been speculated that the ATO’s more liberal interpretation of a restructuring’s breadth will be applied to other tax provisions that provide CGT relief. This speculation will continue following the issuance of TD 2019/D1, given the ATO’s statement that “many provisions providing relief from CGT” have the same policy rationale as Div 125 — that restructures should be capable of demerger relief where they leave relevant shareholders/unitholders in the same economic position as they were in prior to the “restructuring”.
For example, Subdiv 122-A and 122-B contain requirements that the consideration received for the “trigger event” must be only shares in the new company. Similar provisions are contained in Subdiv 124-E, 124-F, 124-I, and 124-Q, and Div 615(among others). It is difficult to envisage how the ATO’s view on what constitutes a “restructuring” will not eventually be applied to other provisions. The first manifestation of this application may be the ATO’s planned guidance on back-to-back CGT rollovers, which is expected to be released in May 2019.