Alberto Colla, Partner

T:+61 3 8608 2754

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Demergers have been a prevalent feature of the Australian corporate landscape, with at least 37 demergers being completed by ASX listed companies in the last 12 years ⁽¹⁾.   A recent example is the 2007 demerger by Toll Holdings of its infrastructure business, now operated by Asciano Limited.

Demergers are typically undertaken to allow a company that operates diverse businesses to separate those businesses into discrete ASX listed entities. 

In this way, shareholders of the company undertaking the demerger will have their existing investment in one company divided between that company and a newly listed company that will operate the demerged business as a separate, new stand-alone ASX listed entity. 

The conventional approach

Demergers are conventionally accomplished by a capital reduction, undertaken either on a stand alone basis or more commonly combined with a scheme of arrangement between the company and its shareholders.

Under the capital reduction, the share capital of the company is reduced by an equal amount per share, representing in aggregate the value of the business being demerged. 

Under the scheme of arrangement, the cash sum referable to the capital reduction is then automatically applied by the terms of the scheme against the transfer by the company to each of its shareholders of a number of shares in the company to be demerged, in accordance with a pre-set ratio. The scheme ensures that the demerger is binding on all shareholders and allows flexibility to incorporate other restructuring features.  The demerged entity then applies for admission to ASX.

A capital reduction requires shareholder approval.  Demergers typically combine the capital reduction with a scheme.  The scheme component will require separate shareholder approval and court approval.  Accomplishing a demerger by capital reduction and scheme ordinarily takes about 10 weeks from the date of announcement.

A simpler approach?

It some cases, it may be possible to accomplish a demerger without a capital reduction and an inter-dependent scheme.  A simpler approach may be open to a company that has a shareholding in another company: declare a dividend in-specie whereby the first company distributes its shareholding in the other company in-specie to its shareholders. 

The only example to date of a demerger being accomplished by an in-specie distribution of shares is the July 2008 in-specie distribution by Toll Holdings of its shareholding in Virgin Blue.  Toll inherited its 63% shareholding in Virgin Blue on completion of Toll's takeover of Patrick Corporation in 2006⁽²⁾.  On completion of the takeover, Toll publicly stated that it did not intend to be a long-term shareholder of Virgin Blue and would consider various options to divest the Virgin Blue shares held by it newly acquired subsidiary Patrick⁽³⁾.

Accomplishing a demerger by declaring a dividend in-specie simply requires the directors to resolve to declare the dividend and to set a record date for the dividend, in accordance with the general requirements that apply to a conventional dividend (see Appendix 6A of the ASX Listing Rules).  Shareholder approval is not required. 

Although this sounds conceptually straightforward, effecting an in-specie distribution of shares by declaring a dividend is only available if relevant technical requirements are satisfied.

In particular, the company declaring the dividend in-specie must have profits that are equivalent to the market value of the shares proposed to be distributed in-specie.  This is because section 254T of the Corporations Act provides that, 'A dividend may only be paid out of profits of the company'.  This rule applies not just to cash dividends but also to dividends in-specie.

If this and other technical issues are satisfied, an in-specie distribution of shares can be a very effective and cost efficient way of effecting a demerger in a short period of time (certainly much faster than a scheme).

Even where the technical requirements for accomplishing a demerger by an in-specie distribution of share are satisfied, careful consideration needs to be given to the issues that arise in any demerger, in particular, ensuring that the demerger does not trigger adverse tax consequences for the company or its shareholders.  This usually entails applying to the Australian Tax Office for:

• a Private Ruling to the effect that the company will be eligible for demerger tax relief under Division 125 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), meaning that there should be no capital gains tax consequences arising to the company on the distribution of the relevant shares to its shareholders and
• a Class Ruling confirming that the company's shareholders will be eligible for demerger tax relief under Division 125 of the ITAA 1997.