Income tax: demerger of Members Equity Bank Pty Limited by Industry Super Holdings Pty Limited

This Ruling sets out the Commissioner's opinion on the way in which the relevant provision(s) identified apply to the defined class of entities, who take part in the scheme to which this Ruling relates.

The relevant provisions dealt with in this Ruling are: • subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936); • section 44 of the ITAA 1936; • section 45A of the ITAA 1936; • section 45B of the ITAA 1936; • section 45C of the ITAA 1936; • section 104-135 of the Income Tax Assessment Act 1997 (ITAA 1997); • section 115-30 of the ITAA 1997; and • Division 125 of the ITAA 1997. All subsequent legislative references in this Ruling are to the ITAA 1936 unless otherwise indicated.

The class of entities to which this Ruling applies consists of all ordinary shareholders of Industry Super Holdings Pty Limited (ISH) who: (a) were listed on the share register of ISH as at 7pm (EST) on 30 June 2011 (Record Date); (b) were residents of Australia as defined in subsection 6(1) on the Record Date; (c) held their ISH shares on capital account on that date; and (d) were not subject to taxation of financial arrangement rules in Division 230 of the ITAA 1997 in relation to gains and losses on their ISH shares. In this Ruling, a person belonging to this class of entities is referred to as an ISH shareholder.

The Commissioner makes this Ruling based on the precise scheme identified in this Ruling.

The class of entities defined in this Ruling may rely on its contents provided the scheme actually carried out is carried out in accordance with the scheme described in paragraphs 9 to 36 of this Ruling.

If the scheme actually carried out is materially different from the scheme that is described in this Ruling, then: • this Ruling has no binding effect on the Commissioner because the scheme entered into is not the scheme on which the Commissioner has ruled; and • this Ruling may be withdrawn or modified.

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This Ruling applies from 1 July 2011 to 30 June 2012. The Ruling continues to apply after 30 June 2012 to all entities within the specified class who entered into the specified scheme during the term of the Ruling. However, this Ruling will not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of this Ruling (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10).

The following description of the scheme is based on information provided by the applicant. Note : certain information has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation.

At a General Meeting on 8 April 2011, the ISH shareholders passed a resolution approving a reduction in ISH's share capital through an in specie distribution of the Members Equity Bank Pty Limited (MEB) shares to the ISH shareholders.

The shareholders of ISH are 33 industry complying superannuation funds who are all residents of Australia within the meaning of that term in subsection 6(1).

ISH is an Australian resident company and is the head company of a tax consolidated group of companies (ISH Group) for the purposes of Part 3-90 of the ITAA 1997.

On 1 January 2007, the ISH group was formed when the assets of the Industry Funds Banking Trust (IFBT) (a subsidiary MEB) was rolled into ISH and the unit holders in IFBT acquired shares in ISH. Roll-over relief was elected under Subdivision 124-N of the ITAA 1997.

ISH is a financial services institution. Before the demerger it had operations in: (a) banking via MEB and its subsidiaries; (b) funds management via IFM Holdings Pty Ltd (IFM) and its subsidiaries; and (c) funds services via Industry Funds Services Pty Ltd (IFS) and its subsidiaries.

Immediately before the demerger, the total issued share capital of ISH was $831,284,433 as follows: • $160,002 of share capital representing the value of ISH prior to the acquisition of MEB; • $536,000,000 of share capital issued on 1 January 2007 (in relation to the acquisition of MEB); • $57,000,000 of share capital issued on 2 January 2007 (in relation to the acquisition of IFS); and • $238,124,431 of share capital issued after 2 January 2007 to date.

All of the capital raised after 2 January 2007 was contributed to MEB.

There were no employee shares on issue just before the demerger.

There were no other ownership interests in ISH just before the demerger.

MEB is an Australian resident company and immediately prior to the demerger was a wholly-owned subsidiary of ISH and a member of the ISH group.

MEB is an authorised deposit-taking institution (ADI) for the purposes of the Banking Act 1959 . As a result of its ADI status, MEB is subject to regulatory compliance requirements as administered by the Australian Prudential Regulation Authority (APRA).

Immediately before the demerger, the issued share capital of MEB was $430,098,616.

There were no other ownership interests in MEB just before the demerger.

ISH consolidated all of its partly paid shares on a 2 for 1 basis, with the holding of partly paid shares of any individual member rounded up to the nearest whole number of shares on 29 June 2011.

On the Demerger Date, 1 July 2011, ISH distributed 100% of the shares it owned in MEB to the ISH shareholders such that for every 128.1467 ISH shares held, each ISH shareholder received 1 share in MEB.

As a result of the demerger, the ISH shareholders hold separate ownership interests in ISH and MEB.

The market value of the MEB shares was $636,800,000, based on the independent market valuation of MEB as at 30 June 2011.

ISH accounted for the demerger as follows: DR Share capital - fair value at 30 June 2011 $636,800,000 CR Investment in MEB $636,800,000 DR Share capital $137,324,431 CR Equity reserve $137,324,431

The capital reduction amount reflects the share capital of ISH that was applied to the MEB investment.

ISH expected that a number of advantages would accrue to its shareholders as a result of the demerger of MEB, including: (a) the separation of businesses with fundamentally different characteristics, allowing ISH and MEB to focus on their respective core competencies, growth objectives and strategies; (b) giving legal effect to the separation of the business units within ISH. Each of the three business units within ISH had different management teams and individual Boards of Directors for a number of years prior to the demerger; (c) achieving compliance cost savings in terms of audit, statutory reporting etc; (d) improving the investment choice for ISH shareholders who have the choice to hold either or both ISH and MEB shares; (e) greater strategic freedom for MEB, including the ability to pursue growth opportunities without competing for capital with other ISH businesses; (f) releasing ISH from regulatory obligations imposed by APRA, subject to APRA approving revocation of its status as a non-operating holding company; and (g) allowing ISH to pursue alternative capital structures, including greater flexibility with debt and equity funding.

None of the ISH shareholders acquired their shares in ISH before 20 September 1985.

ISH confirmed that capital gains tax (CGT) assets representing more than 50% of the market value of all CGT assets of MEB and its subsidiaries would be used directly or indirectly in a business carried on by MEB or its subsidiaries just after the demerger.

ISH confirmed that its share capital account was not tainted within the meaning of Division 197 of the ITAA 1997 as at the Record Date.

No transactions in relation to the shares in MEB were contemplated to occur after the demerger.

No other consideration (other than the MEB shares) was paid to ISH shareholders on the demerger of MEB.

ISH has never paid a dividend to its shareholders.

ISH confirmed it did not make an election under subsection 44(2).

CGT event G1 happened in relation to each of the ISH ordinary shares owned by ISH shareholders at the time ISH made the payment of the capital reduction amount in the form of the MEB shares (section 104-135 of the ITAA 1997).

An ISH shareholder made a capital gain when CGT event G1 happened if the market value of the proportion of the capital reduction amount received for each ISH share exceeded the cost base of that share. The amount of the capital gain is equal to this excess (subsection 104-135(3) of the ITAA 1997). No capital loss can be made when CGT event G1 happens.

If an ISH shareholder acquired their shares at least 12 months before the payment of the capital reduction amount, any capital gain made when CGT event G1 happened may qualify as a discount capital gain under subsection 115-25(1) of the ITAA 1997 (provided the other conditions in Subdivision 115-A of the ITAA 1997 are satisfied).

ISH and MEB were part of a demerger group as described in subsection 125-65(1) of the ITAA 1997.

A demerger, as described under section 125-70 of the ITAA 1997 happened to this demerger group under the scheme.

ISH shareholders are eligible to choose demerger roll-over relief under subsection 125-55(1) of the ITAA 1997.

ISH shareholders who choose demerger roll-over relief can disregard any capital gains made when CGT event G1 happened to their ISH shares under the demerger (subsection 125-80(1) of the ITAA 1997).

An ISH shareholder who chooses demerger roll-over relief must recalculate the cost base and reduced cost base of their ISH and MEB shares.

The first element of the cost base and reduced cost base of each ISH share and corresponding MEB share received under the demerger is worked out as follows: • total the cost bases of the ISH shares (just before the demerger); and • apportion that sum over the ISH shares and corresponding new MEB shares received under the demerger.

The apportionment of this sum is done on a reasonable basis having regard to the market values (just before the demerger) of the ISH shares and MEB shares, or a reasonable approximation of those market values (subsections 125-80(2) and 125-80(3) of the ITAA 1997).

ISH shareholders who do not choose demerger roll-over relief: • are not entitled to disregard any capital gain made when CGT event G1 happened to their ISH shares; and • the first element of the cost base and reduced cost base of each ISH share and the corresponding MEB share is calculated in the same manner as if they had chosen demerger roll-over relief (see paragraph 45 of this Ruling) (subsections 125-85(1) and 125-85(2) of the ITAA 1997).

For the purpose of determining eligibility for a discount capital gain, a MEB share received by an ISH shareholder will be taken to have been acquired on the date the shareholder acquired, for CGT purposes, the corresponding ISH share (item 2 in the table in subsection 115-30(1) of the ITAA 1997). This will be the case whether or not the shareholder chooses demerger roll-over relief.

For the ISH shares that were subject to roll-over under Subdivision 124-N of the ITAA 1997 at the time the ISH group was formed, the acquisition date should be the date of acquisition of the ISH shareholders' original units in the Industry Funds Banking Trust.

For all other ISH shares, the acquisition date should be the date on which each respective ISH share was acquired by an ISH shareholder.

As the share capital reduction amount was debited to ISH's share capital account, it is not a dividend as defined in subsection 6(1).

No demerger dividend arose under the demerger.

The Commissioner will not make a determination under subsection 45A(2) in respect of the demerger.

The Commissioner will not make a determination under paragraph 45B(3)(a) that section 45BA applies to the whole or any part of the demerger benefit provided to an ISH shareholder under the demerger.

The Commissioner will not make a determination under paragraph 45B(3)(b) that section 45C applies to the whole or any part of the capital benefit provided to an ISH shareholder under the demerger.

A significant tax consequence of the scheme is the availability of demerger roll-over under Division 125 of the ITAA 1997. Broadly, ISH shareholders can choose roll-over relief to disregard a capital gain made under the demerger. There are special rules for calculating the cost base and reduced cost base of the ISH and MEB shares for ISH shareholders, whether or not they choose roll-over.

Subsection 125-55(1) of the ITAA 1997 provides that roll-over can be chosen if, at the time of the scheme: (a) a person owns a share in a company; (b) the company is the head entity of a demerger group; (c) a demerger happens to the demerger group; and (d) under the demerger, a CGT event happens to the original interest and a new or replacement interest is acquired in the demerged entity and nothing else.

Under the scheme, the conditions for choosing demerger roll-over under Division 125 of the ITAA 1997 were satisfied in respect of the demerger of MEB. Consequently, demerger roll-over relief in Division 125 is available to the ISH shareholders in respect of the demerger of MEB. The Ruling section provides a detailed explanation of the Commissioner's decision. Therefore, no further explanation is warranted.

Subsection 44(1) includes in a shareholder's assessable income any dividends, as defined in subsection 6(1), paid to shareholders out of profits derived by the company from any source if the shareholder is a resident of Australia.

Paragraph (d) of the definition of dividend in subsection 6(1) provides that a dividend excludes amounts debited against an amount standing to the credit of the share capital account of the company.

The term 'share capital account' is defined in section 975-300 of the ITAA 1997 as an account which the company keeps of its share capital, or any other account created on or after 1 July 1998, where the first amount credited to the account was an amount of share capital.

Subsection 975-300(3) of the ITAA 1997 states that an account is not a share capital account if it is tainted.

The in specie distribution of the MEB shares to ISH shareholders was recorded as a debit to ISH's share capital account. As the share capital account of ISH was not tainted within the meaning of Division 197 of the ITAA 1997, paragraph (d) of the definition of dividend in subsection 6(1) of the ITAA 1936 applies. Accordingly, the in specie distribution to ISH shareholders of MEB shares is not a dividend as defined in subsection 6(1) of the ITAA 1936.

Section 45A is an anti-avoidance provision that applies where capital benefits are streamed to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholders), and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

Where the Commissioner makes a written determination under subsection 45A(2) that section 45C applies in relation to the whole or part of the capital benefits, the capital benefits will be treated as unfranked dividends paid out of the company's profits.

Although ISH provided its shareholders with a 'capital benefit' as defined in paragraph 45A(3)(b) in the form of MEB shares, the capital benefit was provided to all ISH shareholders in the same proportion as their shareholdings in ISH. Consequently, there are no advantaged or disadvantaged shareholders as contemplated by subsection 45A(1).

Section 45B is an anti-avoidance provision that applies to ensure that relevant amounts are treated as dividends for taxation purposes if: • components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger; or • certain payments, allocations and distributions are made in substitution for dividends (subsection 45B(1)).

Where the requirements of subsection 45B(2) are met, subsection 45B(3) empowers the Commissioner to make a determination that either section 45BA applies in relation to a demerger benefit or section 45C applies in relation to a capital benefit.

While the conditions of paragraphs 45B(2)(a) and 45B(2)(b) are met, the requisite purpose of enabling the ISH shareholders to obtain a tax benefit (by way of a demerger benefit or a capital benefit) is not present.

Accordingly, the Commissioner will not make a determination under paragraphs 45B(3)(a) or (b) that either sections 45BA or 45C apply to the scheme to which this Ruling relates.

The following is a detailed contents list for this Ruling: Paragraph What this Ruling is about 1 Relevant provision(s) 2 Class of entities 3 Qualifications 4 Date of effect 8 Scheme 9 Background 10 ISH shareholders 11 ISH 12 MEB 19 The demerger of MEB 23 Accounting for the demerger 27 Reasons for the demerger 29 Other matters 30 Ruling 37 The demerger of MEB 37 CGT event G1 37 Capital gain 38 Demerger roll-over 40 CGT consequences of choosing demerger roll-over 43 Other consequences of choosing demerger roll-over 44 ISH shareholders who do not choose demerger roll-over 47 Acquisition date of MEB shares 48 Dividend consequences 51 Application of sections 45A, 45BA, 45B, 45C 53 Appendix 1 - Explanation 56 The demerger of MEB 56 Demerger dividend 59 The application of sections 45A, 45BA, 45B, 45C 64 Section 45A 64 Section 45B 67 Appendix 2 - Detailed contents list 71