The ATO has changed its approach to what constitutes a restructuring for the purposes of the demerger rules. The change in ATO approach is likely to have an adverse impact on the ability of business to restructure with capital gains tax and demerger dividend relief.
Change in ATO approach
The object of the demerger rules is 'to facilitate the demerging of entities by ensuring that capital gains tax considerations are not an impediment to restructuring a business'. Prior to the release of the draft version of TD 2020/6 (i.e. TD 2019/1) in November 2018, the ATO approach in the application of the demerger rules was more closely aligned with those objects. It is clear from the publicly available class rulings (refer CR 2013/23 and CR 2008/74) that there has been a shift away from a more permissive view in 2013 with no public change in that view until 2018 where a more restrictive view was adopted (refer CR 2018/7 and CR 2018/31). The current ATO interpretation in TD 2020/6 indicates a significant departure from the objects of the demerger rules and is likely to be an impediment to restructuring a business.
The ATO has not set out the reasons for the change in approach, nor clarified what it is seeking to guard against. In our view it would be more appropriate to address the ATO's unidentified concerns through the denial of relief under the broad range of existing anti-avoidance measures.
Summary of the ATO position in TD 2020/6
The ATO considers that what constitutes a restructuring is a question of fact and all the steps that occur under a single plan of reorganisation constitute the restructuring. The ATO's position is that a restructuring is not necessarily confined to the steps or transactions that specifically deliver the ownership interests in the demerging entity to shareholders. However, it can include transactions that are previous transactions and / or subsequent transactions, regardless of whether those transactions are legally independent of one another, contingent on different events, or are transactions that may not occur at all (an 'expansion'). The ATO position can also be more restrictive. The suggestion that 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' (a 'contraction') is confusing and contradictory to other parts of the TD, not least because it fails to provide a clear practical delineation between what is and what is not to be included in a restructuring, and therefore permitting or refusing demerger rollover relief.
Key differences between the draft (TD 2019/D1) and the final (TD 2020/6)
There are some key differences between the draft Determination (TD 2019/D1) and the finalised position in TD 2020/6. TD 2019/D1 stated (perhaps unusually) that a transaction was not necessarily part of the restructuring because it was 'necessary for the restructuring to occur or was the occasion of the restructuring'. In TD 2020/6 this was replaced by 'enabled by the restructuring of the group or is a consequence of the restructuring of the group'. It is not clear whether this change has the effect of expanding or contracting the transactions that could form part of a restructure.
TD 2020/6 confirms that temporal proximity of the transaction steps is a relevant factor but is not decisive. In the ATO view, separation of transaction steps by several months does not automatically mean that those steps cannot form part of the same restructuring. This is helpful, but does not provide sufficient clarity. The ATO is encouraged to provide guidance regarding a 'safe harbour' period between transaction steps that would indicate a separation from the restructuring.
TD 2020/6 also confirms that the inclusion of preparatory steps for a restructure that do not affect the existence, proportionality or value of the ownership interests will not automatically mean that the conditions for demerger relief have been failed. In contrast, steps that affect the economic position of the owner's ownership interest (such as a variation of rights) may cause a failure of the requirements for demerger relief.
Examples in TD 2020/6
In broad terms TD 2020/6 has retained the same six examples from TD 2019/D1 and included a further example concerning preparatory steps prior to a restructure. Most of the 6 examples retained from TD 2019/D1 have been amended considerably but do not provide sufficient clarity on several issues, including:
- What is the time period at which a transaction that occurs either before or after the restructure will be disregarded or not be deemed to be part of the restructure?
- What is the threshold percentage for the quantum of capital raised and pre-separation return of capital or dividend compared to the value of the demerger subsidiary that will not impact the granting of demerger rollover relief?
- What is deemed to be 'sufficient operating profits' or 'adequate cash flow to fund a business' prior to a demerger?
- What is the nexus requirement between a third party acquisition of a demerger subsidiary and the provision and the demerger relief?
- Demerger related third party activity and unrelated third party are now distinguished based on an 'objective inference' in TD 2020/6 whereas this was previously distinguished based 'unlikely to occur except in preparation for' in TD 2019/D1? What is the legislative basis for this test?
- What is the policy rationale for not permitting demerger rollover relief for closely held corporate groups (refer Example 6)?
- Is the delineation for what is to be included as a preparatory step for a restructure based on what contributes to an entity to be a viable entity after the demerger occurs (refer Example 7)?
Impact of the change in ATO approach
The change in ATO approach is likely to have an adverse impact on the ability of business to restructure with capital gains tax and demerger dividend relief. The object of ATO guidance is to provide clarity, however this Determination seeks to provide the ATO with as much flexibility as it might need to either accept or deny the application of the demerger rules. Arguably, it provides the perfect (for the ATO) degree of uncertainty.
In order to be consistent with the objects of the demerger rules, the ATO should provide clear guidance on transactions that are able to obtain demerger relief and those that are not, together with safe harbour rules for transactions that will not form part of a restructure.
In a system of self-assessment with no requirement to obtain ATO approval for a demerger, it is possible that a consequence of the revised ATO approach will be that businesses instead consider that a narrower definition of 'restructuring' should apply, and as a result the nothing else and proportionality tests should be satisfied. On this basis, the Determination would have the effect of hindering the demerging of entities and creating an impediment to restructuring a business.
TD 2020/6 has a recurring theme that the mere inclusion of a step as part of a restructure will not of itself cause the denial of demerger relief. Even if correct, that approach has created significant uncertainty for business and clarification of the ATO view on what should be included as part of a restructure will greatly assist business activity.
Finally, the willingness of the ATO to issue a Determination which reads in requirements to the demerger relief provisions in Division 125 which some might argue do not appear in the legislation could have broader ramifications, such as for transactions involving a series of roll overs, particularly where the roll overs involved have a nothing else requirement. The ATO's willingness to depart from previously published Class Ruling positions on demergers may herald a change in position on these types of transactions.
Please contact a member of our Tax team if you would like to discuss any aspect of this article in further depth.