Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 9 Demutualisation of mutual entities other than insurance companies

Outline of chapter

9.1 Schedule 10 to this bill amends the income tax law to recognise a new demutualisation method for non-insurance mutual entities. Members of non-insurance mutual entities that demutualise using the new method will qualify for the concessions in Schedule 2H of the ITAA 1936.

Context of amendments

9.2 Schedule 2H provides a generic framework for the taxation consequences of non-insurance mutual entities that demutualise. Broadly, the Schedule:

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ensures that members of a mutual entity who receive shares as a result of the demutualisation of that entity are not subject to CGT until they dispose of those shares; and

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specifies the cost base for shares issued to members as a result of the demutualisation of a mutual entity.

9.3 Members of non-insurance mutual entities that demutualise get the benefit of the concessions in Schedule 2H only if the entity uses a demutualisation method specified in the Schedule. The Schedule currently recognises 3 different demutualisation methods for non-insurance mutual entities.

Summary of new law

9.4 The amendments recognise an additional demutualisation method - the combined direct and holding company method - for non-insurance mutual entities in Schedule 2H. Under the combined direct and holding company method of demutualisation, shares in the demutualising entity can be issued to members of the mutual entity and to a holding company. Shares in the holding company must then be issued to members of the demutualising entity.

9.5 Members of non-insurance mutual entities that demutualise using the combined direct and holding company method will qualify for the concessions in Schedule 2H.

Comparison of key features of new law and current law

Detailed explanation of new law

Combined direct and holding company method of demutualisation

9.6 Subdivision 326-B outlines the methods of demutualisation that can be used by a non-insurance mutual entity that demutualises. The amendments recognise an additional demutualisation method - the combined direct and holding company method - for non-insurance mutual entities in Schedule 2H. Members of non-insurance mutual entities that demutualise using the combined direct and holding company method will qualify for the concessions in Schedule 2H. [Schedule 10, item 4, section 326-40]

9.7 The combined direct and holding company method of demutualisation is a hybrid of the 2 existing demutualisation methods in Schedule 2H. Under the combined direct and holding company method of demutualisation:

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all membership rights in the mutual entity are extinguished;

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the demutualising entity becomes a company with share capital (the demutualised entity);

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shares of one class in the demutualised entity are issued within the limitation period (i.e. 2 years from the demutualisation resolution day or a longer period allowed by the Commissioner) to:

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existing members of the demutualising entity in exchange for the members giving up their membership rights in the mutual entity;

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a holding company; and

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new members of the demutualising entity (if any);

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shares of one class in the holding company are issued within the limitation period to:

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existing members in the demutualising entity as a result of the extinguishment of their membership rights in the mutual entity; and

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new members of the demutualising entity (if any);

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the total number of ordinary shares issued by the demutualised entity to the holding company must be equal to the total number of ordinary shares issued by the holding company to the existing and new members - this is to ensure that the adjusted market value of the ordinary shares issued by the demutualising entity is the same as the adjusted market value of the ordinary shares issued by the holding company to the members; and

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if a resolution is passed by members of the mutual entity to list the ordinary shares of the demutualised entity on the Australian Stock Exchange, the shares must be listed within the limitation period.

[Schedule 10, item 5, section 326-52]

9.8 Diagram 9.1 illustrates the combined direct and holding company method of demutualisation.

Application of Division 326

9.9 Division 326 applies to the demutualisation of a non-insurance mutual entity only if the conditions in section 326-5 are satisfied. Those conditions include, among other things:

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if the resolution by the members of a non-insurance mutual entity to demutualise is on or after 4 February 1999, a requirement that the members of the entity pass a resolution that the Division is to apply to the entity (paragraph 326-5(1)(a)); and

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a requirement that the demutualisation of the entity be completed on or after 12 May 1998 (paragraph 326-5(1)(e)) - subsection 326-5(2) specifies when the demutualisation of an entity is taken to be completed for these purposes.

9.10 Any non-insurance mutual entity that has demutualised on the basis of the announcement of these measures would have been unable to comply with the requirement that the members of the entity pass a resolution that the Division is to apply to the entity. Therefore, that requirement will need to be satisfied where a non-insurance mutual entity has demutualised using the combined direct and holding company method of demutualisation only if the demutualisation resolution day was on or after 14 March 2002. [Schedule 10, item 1, paragraph 326-5(1)(a)]

9.11 In addition, the demutualisation of a mutual entity that is implemented using the combined direct and holding company method of demutualisation is taken to have been completed on the later of:

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the day when all the shares in the demutualised entity that are to be issued in connection with the demutualisation have been issued; and

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the day when all the shares in the holding company that are to be issued in connection with the demutualisation have been issued.

[Schedule 10, item 2, paragraph 326-5(2)(c)]

Demutualisation shares

9.12 Section 326-25 defines the demutualisation shares in relation to a demutualised entity. The demutualisation shares in relation to a demutualised entity that uses the combined direct and holding company method of demutualisation are the ordinary shares issued by the demutualising entity and the holding company within the limitation period to:

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existing members in exchange for the members giving up their membership rights in the mutual entity; and

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new members.

[Schedule 10, item 3, paragraphs 326-25(ba) and 326-25(bb)]

Continuity of beneficial interest test

9.13 The concessions in Schedule 2H are available to members of a non-insurance mutual entity that demutualises only if the continuity of beneficial interest test in section 320-60 is satisfied. The continuity of beneficial interest test will be satisfied under the combined direct and holding company method of demutualisation if:

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90% or more of the total number of ordinary shares issued by the demutualised entity to members other than the holding company are issued to existing members; and

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90% or more of the total number of ordinary shares issued by the holding company are issued to existing members.

[Schedule 10, item 6, paragraph 326-60(2)(ba)]

Example 9.1

Members of a mutual entity (Victor Harbour Cooperative) passes a resolution to demutualise under the combined direct and holding company method of demutualisation. 100 shares are issued in the demutualised entity (Victor Harbour Limited). Victor Harbour Limited issues 40% (40 shares) of its shares to members and 60% (60 shares) to a holding company (Victor Harbour Holdings Limited). The continuity of beneficial interest test will be satisfied if:

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at least 36 of the shares in Victor Harbour Limited that are issued directly to members (other than Victor Harbour Holdings Limited) are issued to existing members; and

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at least 54 of the shares in Victor Harbour Holdings Limited are issued to existing members.

CGT consequences of demutualisation

Extinguishment of membership rights

9.14 Section 326-65 ensures that any capital gain or capital loss that arises as a result of the extinguishment of membership rights of a member of a non-insurance mutual entity that demutualises using a specified method of demutualisation is disregarded. The amendments ensure that section 326-65 applies to the extinguishment of membership rights of a member of a non-insurance mutual entity that demutualises using the combined direct and holding company method of demutualisation. [Schedule 10, item 7, subsection 326-65(1)]

Disposal of demutualisation shares

9.15 The CGT consequences on the disposal of demutualisation shares by a member of a mutual entity depends on whether:

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the entity or a holding company becomes a listed public company (Subdivision 326-D); or

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the entity or a holding company becomes a company that is not a listed public company (Subdivision 326-E).

9.16 The amendments ensure that Subdivisions 326-D and 326-E apply appropriately where a non-insurance mutual entity demutualises using the combined direct and holding company method of demutualisation. [Schedule 10, items 8 and 9, paragraphs 326-70(1)(a) and 326-135(1)(a)]

Disposal or extinguishment of rights to receive shares

9.17 Subdivision 326-G outlines the CGT consequences from the disposal or extinguishment of rights to receive shares in the demutualised entity or a holding company. The amendments ensure that Subdivision 326-G applies appropriately where a non-insurance mutual entity demutualises using the combined direct and holding company method of demutualisation. [Schedule 10, items 10 to 12, paragraph 326-185(1)(a), subsection 326-190(2) and paragraph 326-195(1)(a)]

Application and transitional provisions

9.18 The amendments apply from 17 November 1999. A non-insurance mutual entity has demutualised on the basis of the announcement of these measures.