Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 16 - Regulation impact statement - Demergers
Policy objective
16.1 The policy objective is to increase efficiency by allowing greater flexibility in structuring businesses, providing an overall benefit to the economy. The aim of the measure is also to enhance the competitiveness of Australias business sector.
Implementation options
16.2 The Review of Business Taxation originally recommended in A Tax System Redesigned a demerger roll-over (Recommendation 19.4). It was seen as a mirror of the scrip for scrip roll-over provided for takeovers.
16.3 The options for providing demerger relief that were considered are outlined in paragraphs 16.4 to 16.10.
Option 1: No tax consequences for members (Recommendation 19.4 of A Tax System Redesigned)
16.4 Recommendation 19.4 of A Tax System Redesigned provides for taxation relief for the members of the entity that reorganises its affairs. It proposed that relief was to be available for widely-held entities only, as it would be difficult to obtain valuations for entities that were not widely-held.
16.5 It should be noted that the recommendation was made in the context of an entities regime where most entities would be taxed as companies.
Option 2: Provide roll-over relief to members and an exemption at the entity level only
16.6 Given that the members of the demerging entity will hold interests in the same proportion in both entities after the demerger, it was seen as appropriate to provide roll-over relief at this level. This is consistent with the policy basis for other roll-overs in the tax law where there is a corporate restructure and ownership is maintained.
16.7 As the members of the entity will have their taxation liability deferred, it would seem inappropriate to tax the entity, which they own, on the same transaction. This could be said to amount to double taxation, as on realisation of their interest, or any other CGT event occurring in relation to those interests, the tax on the single transaction will be crystallised.
Option 3: Provide CGT relief at the member level and exempt tax on payments that amount to dividends
16.8 If the transfer of the interests in the new entity by the demerging entity were considered to be a dividend, it would seem appropriate to exempt taxation on the dividend when paid to the shareholders. This is on the same basis as in paragraph 16.7 - that the payment of tax by the company on the distribution of that dividend will amount to double taxation. This is because the tax is levied under income tax, as opposed to capital gains tax. On disposal of their interest in the demerged entities, and without some compensating factor (such as an increase in the cost base of their interests) the shareholders will be paying CGT on the increase in value of their shares in the original entity - such an increase is already captured as part of the value of the dividend paid on demerger.
Option 4: Provide CGT relief at the member and entity level and an exemption from the current dividend rules
16.9 This option is an expanded combination of options 1 and 2. It provides for a deferral of the CGT liability for the members, while providing a CGT exemption for the entity. This takes account of the CGT implications of a demerger and avoids double taxation of the gains made on the CGT asset as discussed in paragraph 16.7.
16.10 The CGT relief would not be sufficient on its own in situations where the entity transfers the replacement interests. In these circumstances, the distribution by an entity that is a company could constitute an assessable dividend, and would be taxed under the income tax law. The tax liability that could arise would restrict how a demerger would be structured and hence limit the flexibility that is intended to be provided by this measure.
Assessment of impacts
Members of companies and trusts
16.11 The proposed roll-over will affect investors in companies and trusts. Under a demerger the member will receive replacement interests in different entities. Depending on the method of restructure the member could acquire interests in the original entity and additional entities or interests in new entities. This may affect the value of their interests compared with the interest in the original entity.
16.12 This measure will affect those companies and fixed trusts that wish to restructure their affairs by splitting their operations.
Other entities wishing to restructure and members of these entities
16.13 The amendments will only apply to companies and fixed trusts. Therefore, other entities and their members, such as superannuation funds, will be at a commercial disadvantage. However, most of these entities are already concessionally taxed when compared with companies.
Analysis of costs and benefits associated with each implementation option
16.14 The level of compliance costs that may be incurred under a demerger restructure depends on the structure of the demerger group. The method used for the demerger will also have an impact on the compliance costs incurred by all entities involved. Further, any compliance costs are driven more by commercial decisions of the entity demerging rather than tax considerations. For example, if there was a single company (the head entity) that was spinning off one of its branches, it is anticipated that the compliance costs would be minimal given the simple structure of the business. However, if a demerger group involves several subsidiaries and it is planned that several of the subsidiaries will be spun off under the single demerger, the compliance costs may be high. In the second instance, the head entity may need to do extensive valuations in order to satisfy other regulatory requirements. Where possible the demerger legislation allows these valuations to be used in satisfying the tests for demerger relief. As the numbers of demerger scenarios are so varied, the compliance costs for this measure cannot be reliably quantified. Analysis of the possible qualitative costs that may be incurred is outlined in Table 16.1.
| Option 1 | Option 2 | Option 3 | Option 4 | |
|---|---|---|---|---|
| Compliance costs | Initial costs | Initial costs | Initial costs | Initial costs |
| Interest owners [F6] |
There are a variety of ways that interest owners can familiarise themselves with the amendments including: going to see their tax agent; obtaining information from the ATO on the new provisions; and contacting the entity in which they own an interest for more information on the proposed demerger. The interest owner may require assistance in calculating the cost base adjustments required under the demerger provisions. The interest owner may choose to contact their tax agent to do this, or approach the ATO for assistance. |
As for option 1. | As for option 1. | As for option 1. |
| Ongoing costs | Ongoing costs | Ongoing costs | Ongoing costs | |
| The interest owner will need to keep a record of the cost bases of their original and new interests. This should add very little to the compliance costs of the interest owner because there should already be a record system in place to keep track of the cost base and events that may have happened to the original interests. | As for option 1. | As for option 1. | As for option 1. | |
| Initial costs | Initial costs | Initial costs | Initial costs | |
| Entity [F7] |
Seeking advice on the relief available. Preparing information documents for its interest holders. The amount of information that is required to be given to interest owners depends on whether the entities involved are listed on the Australian Stock Exchange or not. There are certain Corporations Act 2001 requirements that may need to be satisfied if the entity is a company. May need to value the assets being disposed of in order to calculate the capital gain or loss that may arise on demerger. |
As for option 1, except that the entity would not incur additional valuation costs for the assets disposed under the demerger because of the exemption from CGT on the disposal of assets, and because these valuations can be used in satisfying the demerger provisions. |
As for option 1. The entity may incur an additional cost in requesting advice from the Commissioner on the possible application of the demerger dividend integrity rules. |
As for option 2. The entity may incur an additional cost in requesting advice from the Commissioner on the possible application of the demerger dividend integrity rules |
| Ongoing costs | Ongoing costs | Ongoing costs | Ongoing | |
| There should be minimal ongoing costs for the entity that owned interests in the spun-off entity. | As for option 1. | As for option 1. | As for option 1. | |
| Administration costs | Initial costs | Initial costs | Initial costs | Initial costs |
|
Making changes to material prepared for taxpayers, tax practitioners and industry for education about the demerger rules. Costs will be minimal as the ATOs CGT booklets, return forms, schedules and guides are updated annually. Training staff on the new rules will be done internally as part of on-going ATO training. The additional costs would be minimal. Providing advice on the demerger rules. The costs will depend on the effectiveness of the ATOs and industrys education programs. |
As for option 1. | The costs in providing advice may be higher, given the integrity measures around the exemption of the dividend. The entity may request advice from the Commissioner on the possible application of the demerger dividend integrity rules that may not be required under options 1 and 2. | As for option 3. | |
| Ongoing costs | Ongoing costs | Ongoing costs | Ongoing costs | |
| Costs will continue to be incurred on providing advice on the concession but these costs should reduce over time. | As with option 1. |
As with option 1. The costs may not reduce as rapidly over time as under option 1 because of the possibility of needing advice from the Commissioner on the possible application of the demerger dividend integrity rules. |
As with option 3. | |
| Revenue costs | Unquantifiable but small, provided the shareholder CGT tax relief offsets the revenue gain from demergers that are in response to the Governments proposal. | Unquantifiable. In order to estimate the cost of this option requires data in relation to the cost base of the spun off entity which is not available. | Unquantifiable. The dividend exemption should not adversely affect revenue collections by decreasing assessable dividends, because of the integrity rule. | Unquantifiable. The reasons for this revenue estimate is a combination of the reasons given in options 1 to 3. |
| Benefits | The amendments will facilitate a structure of an entity, which should provide it with a more economically efficient structure. The flow-on effects from the economic efficiency include increased productivity and benefits to the community overall. | As with option 1. | As with option 1. | As with option 1. |
Consultation
16.15 Extensive consultation with industry and their representatives has taken place in relation to the amendments. There were a number of consultation sessions held in Melbourne and Sydney which focused on the draft legislation implementing option 4. Industry members and their representatives are supportive of this measure.
Conclusion and recommended option
16.16 The recommended option is option 4. After several consultation sessions with the relevant stakeholders, including industry and their representatives, it was determined that the recommendation for the demerger measure, as described in A Tax System Redesigned , would be too restrictive. It did not provide enough flexibility for entities to restructure their affairs to take advantage of the most efficient structures for their businesses.
16.17 Recommendation 19.4 A Tax System Redesigned was also expressed in terms of a consistent entities regime, where all but a handful of entities would be taxed as companies. That regime has not been implemented. The demerger rules in this measure had to take account of the current regimes.
16.18 By providing the concessions, taxation will not be an impediment to business reorganisation by way of demerger. Facilitating the demerger of entities in this way ensures that taxation does not unnecessarily drive the choice of structure in which a business should operate.
16.19 Options 1, 2 and 3 only deal partially with the possible tax impediments to a demerger.
16.20 Compliance costs while unquantifiable are not likely to be significantly higher because of a demerger.
16.21 Option 4 delivers the benefits in a manner that most satisfies industrys requirements and therefore is the preferred option.