When a company you hold spins off a business: demergers and CGT relief for retiree shareholders

If you hold shares directly, a recurring corporate event is the demerger — when a listed company splits part of its business into a separate, separately listed entity and hands shares in that new company to its existing shareholders. Australian retiree portfolios have lived through plenty of these: BHP spinning off South32, BHP distributing Woodside shares, Wesfarmers demerging Coles, and Tabcorp demerging The Lottery Corporation, among others. After a demerger you held one company and now hold two — the (smaller) original "head" company and the new "demerged" entity — having received the new shares without paying for them. That raises two capital gains tax (CGT) questions: is receiving the new shares taxable now, and how is your original cost base split between the two holdings? For qualifying demergers, demerger relief under Division 125 of the income tax law generally lets you choose a CGT rollover so no gain or loss arises on the receipt, treats any demerger dividend as not assessable, and splits your cost base across the two holdings. The exact figures for any particular demerger are set out in the company's demerger booklet and the matching ATO class ruling — and the single most important thing to get right is not treating the new shares as having a nil cost base when you eventually sell them.

What actually happens in a demerger?

A corporate group splits off part of its business into a separate entity, and shares in that entity are distributed "in specie" — as shares, not cash — to the existing shareholders of the head company, usually at a set ratio such as one new share for every so many head-company shares. Before the demerger you held only the head company; afterwards you hold both the head company (now smaller, having shed the demerged business) and the new entity. Total value is broadly preserved across the two holdings — a demerger reorganises value rather than creating or destroying it, market reaction aside. The practical change for you is that one line in your portfolio becomes two, each needing its own cost base record.

How does the Division 125 CGT rollover work?

For a qualifying demerger you can choose to roll over — that is, defer — the capital gain or loss you make as a shareholder, so receiving the new shares isn't taxed at the time. Qualifying demergers also generally treat the demerger dividend component as not assessable, as the class ruling for the specific deal confirms. The rollover is a genuine choice, and usually the head company tells shareholders whether it is available; for any significant restructure the ATO publishes a class ruling setting out the consequences. One point catches people: whether or not you choose the rollover, you must recalculate the cost base of both your remaining head-company shares and your new demerged-entity shares — the recalculation isn't optional even if the rollover is.

How is the cost base split between the two holdings?

The original cost base is apportioned between the head-company shares and the new shares using the relative market value method — each post-demerger holding takes a share of the cost base in proportion to its market value just after the demerger. The company's demerger documentation and the ATO class ruling give you the percentages, for instance "X% stays with the head company, Y% moves to the new shares." If your original cost base was $10,000 and the split is 90% head company and 10% new entity, then $9,000 stays with the head-company shares and $1,000 becomes the cost base of the new shares. The apportionment applies to each parcel you bought, preserving the parcel-by-parcel history where you accumulated the original holding over time at different prices.

What date matters for the acquisition date and 50% discount?

This is where the draft instinct — "the new shares inherit the original purchase date" — needs a little precision. Strictly, your new interests in the demerged entity are acquired on the date of the demerger. But for the 50% CGT discount, what matters is how long you held the corresponding original shares: if you sell the new shares, you qualify for the discount provided you owned the original head-entity shares for at least 12 months. The ATO's own example makes it concrete: new shares received in a 2002 demerger that related to head-company shares bought in August 2001 meet the 12-month test once sold after August 2002 — measured from the original purchase, not the demerger. There is also a valuable carry-over for very long-term holders: if a proportion of your original shares were pre-CGT (acquired before 20 September 1985), the same proportion of your new shares is treated as pre-CGT assets under the rollover. So the long history of an old blue-chip holding is largely preserved rather than reset.

When does demerger relief not apply?

Not every distribution that looks like a demerger qualifies. Where relief doesn't apply, part of the value can be an assessable (often unfranked) dividend, or a capital gain can arise on receipt. Foreign demergers are the most common trap: a foreign resident — and, in practice, the treatment of foreign-company demergers generally — can only access the Australian rollover in limited circumstances, since a foreign resident can choose the rollover only where the new interest is taxable Australian property. The upshot is that a retiree holding shares in a foreign-listed company that demerges should not assume the favourable Australian treatment; the outcome is often taxable and more complex to report, and specific cross-border tax advice is the right course. For any demerger, the ATO class ruling (or, for a foreign one, tailored advice) is the authority on whether relief applies and how to report it.

What's the most costly mistake retirees make later on?

The costliest and most common error comes years later, on sale. When you eventually sell the new demerged shares, the gain is worked out against their apportioned cost base — not zero. Treating the shares as having a nil cost base because they arrived "for free" overstates the gain, and the tax, sometimes badly. The apportioned figure from the demerger booklet and class ruling is the one to use, and the discount is judged on the original holding period as above. So the follow-through is simple but real: record both holdings with their apportioned cost bases, keep the demerger booklet and class ruling for the years until you sell, and tell Centrelink about the change of holdings (the new entity is a new line to record). The assets-test effect is broadly neutral since total value is preserved, and where relief applies there is no income spike to disturb the Commonwealth Seniors Health Card income test.

Worked examples

These two cases show a demerger handled well, and a trap to avoid. They are illustrative only and not personal advice.

Edward, 73, has held 2,000 BHP shares since 2001 at a $9 cost base ($18,000 in total). BHP demerges, distributing shares in a new entity, and the ATO class ruling confirms demerger relief with a cost base split of, say, 95% BHP and 5% new entity. On these facts it is generally rational for Edward to choose the rollover: no capital gain on receiving the new shares, and the demerger dividend is not assessable. His $18,000 cost base splits to $17,100 with the BHP shares and $900 with the new-entity shares. When he later sells either parcel, he tests the 50% discount against his 2001 purchase of the original BHP shares, so the discount is comfortably available. The discipline is to record the two holdings at $17,100 and $900, keep the class ruling, report the new holding to Centrelink — and, crucially, when he sells the new-entity shares, to use the $900 cost base rather than zero.

Patricia, 70, inherited shares in a foreign-listed company from her late husband, and that company now demerges, distributing shares in a spun-off overseas entity. On these facts she should not assume Australian demerger relief applies — foreign demergers frequently fall outside it. The distribution may be an assessable unfranked foreign dividend, taxable in the year of the demerger, and the cost base of the new foreign shares may be set differently from the Australian rollover position. On these facts the rational step is to get specific cross-border tax advice rather than relying on the favourable domestic treatment, report any assessable dividend, and establish the new shares' cost base correctly. The foreign element makes this materially more complex than a domestic demerger.

For retiree share investors, a demerger is a recurring event whose CGT treatment is favourable when relief applies — but only if it is reported correctly and the cost base is tracked. The work is to obtain the demerger booklet and ATO class ruling, confirm the rollover is available, apply the relative-market-value split to each parcel, record the two holdings at their apportioned cost bases, keep the original holding period in view for the discount and any pre-CGT proportion, report the change to Centrelink, and — above all — flag the apportioned cost base for the eventual sale of the new shares so they are never treated as nil cost base. A qualifying domestic demerger generally costs no tax at the time and preserves your long-term holding benefits; the only way it goes wrong is sloppy record-keeping that overstates a gain years later, or assuming a foreign demerger gets the same treatment when it may not.

Sources

• ATO — Demergers: CGT rollover for shareholders and unit holders
• ATO — CGT discount