• Example 8- Scheme involving family arrangement and later disposal of ownership interests

    The facts

    SOC Pty Ltd (SOC) owns 100% of the issued capital in Mode Pty Ltd (Mode).

    SOC's business largely consists of investing activities and holding passive real estate investments. Mode Pty Ltd carries on an aquaculture business. All shares in Mode were acquired post 20 September 1985.

    Previously, SOC had carried on a manufacturing business. However it had received a damages claim against it in respect of one of its products that was later settled. As a result of the product liability claim it ceased its manufacturing business nine years ago.

    On 30 June 2004, SOC was owned by James and his wife Heidi. All shares were acquired prior to 20 September 1985. At this time SOC had a market value of approximately $6 million. James is sole director and manager of both SOC and Mode.

    For some years SOC has built up retained profits from dividend income received from Mode. At 30 June 2005, Mode had share capital of $20,000 and a market value of approximately $1.2 million.

    In September 2004 James decides to demerge Mode from SOC, with all Mode shares distributed to SOC shareholders in proportion to their holdings. James's accountants also advised that a demerger would facilitate any future sale of Mode.

    Both before and after demerger, James remained manager and director of both SOC and Mode. Both before and after the demerger Heidi continued in her role as bookkeeper of both SOC and Mode. The rest of the structure and management of both companies also remained the same.

    In September 2005, the business of Mode was sold to an unrelated third party.

    Applicant's stated reasons for demerger

    The stated reasons for the demerger were:

    • To separate Mode from the potential of future product liability claims being made against SOC in respect of its now ceased manufacturing activities;
    • Allow the management of Mode to focus not only on its existing customer base but also to expand this base;
    • Allow management to focus on Mode's trading activities and invest the necessary time to grow the business without hindrance from the potential for future claims to be made against SOC;
    • Allow SOC to focus on its real estate investment business; and
    • A demerger would facilitate any future sale of Mode.

    Commissioner's analysis and decision

    In examining the current demerger proposal in relation to the relevant circumstances stated in subsection 45B(8), the Commissioner took into account the following factors:

    • The facts indicated that the demerger was undertaken to dispose of Mode in a tax effective manner, rather than protect Mode from any potential liability claims made against SOC for its past manufacturing activities (particularly as the product liability claim against SOC occurred many years ago).
    • The management structure of both SOC and Mode has remained the same (with James acting as manager and director of both companies) both before and after demerger. The demerger did not bring about a separation of control in the decision making activities of either SOC or Mode;
    • With the management structure being the same both pre and post demerger, it is not apparent how a demerger allows management to focus more on the passive real estate business of SOC or assists the business activities of Mode;
    • The essential nature of the scheme allowed Mode shares to be received by SOC shareholders in a tax free form. In addition there has been a transformation of profits into a capital asset in the hands of SOC shareholders, who were then able to utilise the small business CGT concessions on the later disposal of the Mode business (paragraphs 43 to 45 and 84 to 95 of PS LA 2005/21);
    • The contemporaneous documentation suggests that the demerger was also done with a view to a future possible sale of the Mode business (paragraphs 73 to 78 of PS LA 2005/21).

    Based on the above, it is not apparent that the demerger was entered into for commercial reasons. Therefore the tax benefits to the relevant shareholders of SOC have greater significance (paragraphs 22 and 23 of PS LA 2005/21). Due to the above facts, the Commissioner would make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the demerger benefits provided under the scheme.

      Last modified: 03 Feb 2016QC 22770