Demerger: original post-CGT interests - consequences for shareholders under Division 725 if new interests in demerged entity are issued at a discount

If a direct value shift happens under a demerger because new interests in a demerged entity are issued at a discount, can the cost bases and reduced cost bases of those interests be increased under section 725-250 of the Income Tax Assessment Act 1997 (ITAA 1997) if they were issued in respect of post-CGT original interests?

No. The cost bases and reduced cost bases of the new interests in the demerged entity are not increased under section 725-250 of the ITAA 1997. As the original interests are post-CGT interests, adjustments are made to the cost base and reduced cost base of both the new interests and the original interests under Division 125 of the ITAA 1997.

There are three Australian resident shareholders (original interest holders) in Company A, an Australian resident company. Each shareholder is an associate of the other shareholders. All of the shares were acquired after 19 September 1985.

Company A is the owner of the only share (a post-CGT share) on issue in subsidiary Company B. Company A has not made a choice to form a consolidated group.

Under an arrangement, Company B (the demerged entity) issues shares to the shareholders in Company A, in the same proportions as their Company A shareholdings. No consideration is to be provided to Company B for the shares. The arrangement satisfies the definition of a demerger in section 125-70 of the ITAA 1997.

As a result of the issue of shares at a discount by Company B, there is a reduction in the market value of the share that Company A holds in Company B, resulting in a direct value shift. The conditions set out in section 725-50 of the ITAA 1997 for there to be consequences under Division 725 of the ITAA 1997 as a result of the direct value shift are satisfied.

Division 725 of the ITAA 1997 does not apply to the original interest holders because of the more specific application of section 125-95 of the ITAA 1997. That section provides that where cost base and reduced cost base adjustments are required under sections 125-80, 125-85 or 125-90 of the ITAA 1997, no further cost base and reduced cost base adjustments are required to be made under the Act as a result of something that happens under the demerger. Cost base and reduced cost base adjustments are required under sections 125-80, 125-85 or 125-90 of the ITAA 1997 where the original interests were acquired on or after 20 September 1985.

Accordingly, as the new interests are issued in respect of the three shareholders' original post-CGT interests, no further cost base and reduced cost base increases are made under Division 725 of the ITAA 1997 as a result of the direct value shift.