Demerger Relief: Eligibility and Cost Bases

Demerger relief can disregard specified capital gains or losses when a group separates a business into direct ownership by its existing owners. Test the transaction first, then assess each entity and owner separately. An owner’s rollover choice does not settle dividend treatment.

Demerger Eligibility for a Business Separation

A qualifying demerger gives the head entity’s owners direct interests in an entity leaving the demerger group. A commercial decision to separate businesses does not establish eligibility under Division 125 of the Income Tax Assessment Act 1997.

The demerger group consists of a head entity and one or more demerger subsidiaries. Subsidiary membership uses specified rights exceeding 20%, including company voting rights or rights to income or capital distributions. Trace indirect holdings through the group and check the special head-entity and listed-entity rules.

Trust membership requires CGT event E4 to be capable of applying to every unit or interest. A discretionary trust cannot be a group member. Neither can a complying superannuation entity or corporation sole. This restriction concerns group membership, separately from an owner holding shares in the head entity.

The demerged entity is the former group member in which owners receive direct interests. A demerging entity is a group member that carries out a qualifying disposal, cancellation or other separation step.

Before-and-After Ownership

This fictional diagram shows a complete distribution of a subsidiary’s shares. Both owners keep their relative holdings.

Before
Owner A (60%) + Owner B (40%)
                  |
             Head company
                  |
                100%
                  |
           Subsidiary company

After
Owner A (60%) + Owner B (40%)
       |                       |
  Head company          Demerged company

After the separation, Owner A owns 60% of each company and Owner B owns 40% of each. The head company no longer holds the demerged company. Add each share class and its rights to your client’s entity structure chart before applying the tax tests.

Test the Proposed Transaction

Test the whole restructuring against section 125-70, including steps before and after the distribution. Use the Division 125 requirements to record a conclusion for each condition.

1. Identify the separation mechanism. The permitted disposal, cancellation, issue or combined route must satisfy its 80% test. The denominator differs by route, so record the actual interests transferred, ended or issued.
2. Identify what owners acquire. They must receive new interests and nothing else under the restructuring, because they own or owned the original interests. Analyse cash payments and connected transactions within that requirement.
3. Match the entity types. A company head requires new company interests. A trust head requires new trust interests. Interests in a non-complying superannuation fund fail the separate exclusion.
4. Reconcile proportional ownership. Each owner must receive the same proportion, or as nearly as practicable the same proportion, of new interests as their original holding.
5. Reconcile proportionate market value. Immediately after the demerger, each owner must retain the same proportionate total value across the head and demerged entities. Equal share numbers alone do not establish this.
6. Check exclusions and special interests. An off-market share buy-back cannot qualify. Another available rollover covering all relevant original-interest CGT events also excludes a demerger. Apply statutory exceptions for employee interests or adjusting instruments only where their conditions are met.

A qualifying transfer of 80% does not make the retained balance eligible for another round of Division 125 relief. Section 125-100 restricts relief for remaining group-held interests after a partial separation.

Under the ATO’s restructuring determination, a single plan can include legally separate or conditional transactions. A prearranged sale or capital raising can change the ownership or value tests. Preparatory steps within the plan do not automatically cause failure. Keep the contracts and commercial reasons that establish the plan’s actual scope.

Separate Group and Shareholder Outcomes

The demerging entity’s CGT exemption and the owner’s rollover operate separately. Record the distribution treatment as a further conclusion.

Demerging Entity

Section 125-155 disregards specified gains or losses from CGT events A1, C2, C3 or K6 on interests in the demerged entity. It does not give every preparatory asset transfer the same treatment. Examine those transfers and other tax consequences on their own facts.

If an income-tax consolidated group is involved, retain separate membership and exit calculations. A demerger group is not interchangeable with a tax consolidation group.

Owner’s Rollover Choice

An owner can choose rollover where the eligible demerger causes a CGT event to their original interest and they acquire a new interest. The choice disregards the resulting capital gain or capital loss. Without the choice, calculate the event’s outcome under the applicable rules.

A foreign resident cannot choose this rollover where the new interest is not taxable Australian property immediately after acquisition. If an owner uses a nominee sale facility, trace the entitlement and subsequent sale separately. Receiving sale proceeds does not remove the need to analyse the facility’s terms.

Identify whether the owner holds interests on capital account or under another tax regime. A company shareholder, individual, trustee and complying superannuation fund can have different later-return outcomes, including different discount treatment. The group-member exclusion for superannuation entities does not itself exclude a fund shareholder from owner relief.

Distribution and Anti-Avoidance

Separate the capital component from any demerger dividend. Under sections 44 and 45B, dividend relief has its own conditions.

The demerger dividend can be neither assessable nor exempt income under section 44. This depends on the head entity’s election position and the business-use condition. Immediately after separation, at least 50% by market value of the relevant demerged group’s CGT assets must be used in its businesses. Apply the statutory asset exclusions when calculating that percentage.

An owner’s rollover choice does not decide that dividend result. Assess section 45B separately, including whether capital and profit allocations reflect the transaction and whether the scheme substitutes benefits for dividends. A determination can produce dividend treatment despite an otherwise qualifying demerger.

Allocate the Cost Base After the Demerger

Allocate the existing post-CGT cost bases between the continuing original interests and the new interests using reasonable relative market values immediately after the demerger. The head entity’s allocation advice can support the percentages. Keep the valuation evidence behind that advice.

Fictional Cost-Base Reconciliation

Assume an Australian-resident individual owns 1,000 post-CGT shares in the head company, with a total cost base of $20,000. The owner receives 500 demerged-company shares, retains the 1,000 original shares and chooses available rollover. Assume one original parcel and no separate costs or pre-CGT interests.

Immediately after the demerger, the owner’s head-company shares are worth $24,000 and the new shares are worth $6,000. Their combined market value is $30,000. The relative values allocate 80% of the original cost base to the head company and 20% to the demerged company.

Holding	Shares	Relative market value	Allocated cost base	Cost base per share
Continuing head-company shares	1,000	80%	$16,000	$16
New demerged-company shares	500	20%	$4,000	$8
Combined	1,500	100%	$20,000	Not applicable

The combined cost base remains $20,000: $16,000 plus $4,000. The new shares’ $6,000 market value does not become their cost base. Do not first subtract a capital return from the original total and then apportion it again.

The ATO’s demerger calculation guidance explains the relative market value method. Cost-base adjustments remain required when an eligible demerger occurs without a rollover choice, or without a CGT event on original interests.

Acquisition History and Later Disposals

Keep original acquisition records even when no immediate gain is recognised. New post-CGT interests are acquired at the demerger, while separate discount rules can refer back to the corresponding original interests. Do not replace both dates with one date in the investment register.

The ATO guidance identifies cases where the discount holding period starts at the demerger, including where no CGT event happens to original interests. Pre-CGT interests also require separate treatment. Choosing rollover can preserve pre-CGT status for corresponding new interests. Without that choice, new interests attributable to pre-CGT originals generally use ordinary cost-base rules.

Keep the allocation method and corresponding original parcels with both holdings. For a later disposal, use the capital gains tax calculator only after establishing the relevant cost base and applicable relief.

Assemble the Client’s Demerger File

Prepare a separate tax conclusion for every demerging entity and owner. The signed file must support the transaction that actually occurs, including any change from the proposed steps.

Collect the executed transaction documents and resolutions, with before-and-after ownership registers for every class. Retain the valuations and allocation advice, capital accounts and distribution calculations. Include residency evidence and the owner’s rollover choice alongside the relevant CGT calculations.

Attach any applicable class ruling or private ruling and identify its covered taxpayers and scheme. A ruling for another transaction does not settle your client’s result. A ruling covering this transaction can determine how the ATO applies the covered provisions when the taxpayer and implemented facts match its terms.

Before completing the returns, reconcile the final interests issued or transferred against the ownership tests. Reconcile each owner’s continuing and new cost bases to the supported allocation. Transfer acquisition history and the ruling’s applicable conditions into future-return records, alongside the separate current-year entity, owner and dividend conclusions.