Edited version of private ruling

Authorisation Number: 1011495035563

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Ruling

Subject: Proposed demerger

Question

Will the Commissioner make a determination under paragraph 45B(3)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45BA of the ITAA 1936 applies to the whole, or any part, of any demerger benefit provided to the shareholders of company A under the demerger?

Answer

Yes. The Commissioner will make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the whole of any demerger dividend provided to the shareholders of company A under the proposed demerger.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

During the income year ended 30 June 2011

Relevant facts and circumstances

The Company A group

The company A group consists of company A, company B, company C, company D, company E and trust F. Company A was established prior to 20 September 1985 and is the holding company of the group

Along with the investments in company B, company C, company D, company E and trust F, company A holds a number of miscellaneous assets.

Company B was established prior to 20 September 1985 and is wholly owned by company A. All of company A's ownership interests are ordinary shares, carrying dividend and capital entitlements, the right to vote and to attend meetings. These shares have a pre-CGT character.

Company C was established after 20 September 1985 and is also wholly owned by company A. All of company A's ownership interests are ordinary shares, carrying dividend and capital entitlements, the right to vote and to attend meetings. These shares have a post-CGT character

The X family trust holds majority ownership interests in company A while the members of the X family hold the remaining interest. All these ownership interests are ordinary shares, carrying standard rights to voting, dividends, returns on capital and the right to attend meetings of the company. The majority of these shares have a pre-CGT character. The primary beneficiaries of the X family trust are members of the X family.

All the directors of company A, company B and company C are members of the X family.

Dividend distribution

In the past five years inclusive, company A paid dividends every year; company B paid dividends four out of the five years; while company C paid dividends two out of the five years. All the dividends paid were fully franked.

Franking account balance

The franking account balances of company A, company, B and company C at the anticipated time immediately prior to the demerger will be in credit.

Proposed demergers of company B and company C

Company A proposes to demerge company B and company C. To ensure the percentage of ownership in company C by each shareholder post demerger will be equal to their percentage ownership immediately prior to the demerger, company C will undertake a share split, before the proposed demergers.

The proposed demergers of company B and company C by company A will involve the following:

· Company A will revalue upwards its investments in company B and company C by approximately $Y and $Z to their market values respectively.

· Company A will undertake a reduction of capital and pay out a dividend. The reduction of capital is to be approved by shareholders pursuant to an ordinary resolution at a meeting of shareholders.

· Company A will make an in-specie distribution of the shares it holds in company B and company C.

Reasons for the proposed demergers of company A and company B

The primary objectives and rationale advanced by company A for demerging company B and company C fall under the following:

· finance and capital raising

· separate operations

· increased growth opportunities, and

· management.

Other matters

For the purposes of section 125-65 of the Income Tax Assessment Act 1997 (ITAA 1997), the demerger group consists of company A, company B, company C, company D and company E.

Company A will not elect under subsection 44(2) of the ITAA 1936 to have subsections 44(3) and 44(4) of the ITAA 1936 not to apply to any demerger dividend.

At least 50% of the market value of the CGT assets owned by company B and company C will be used in carrying on their businesses immediately after the proposed demerger of the entities.

Each shareholder in company A will, just after the proposed demergers of company B and company C, have the same proportionate total market value of ownership interests in company A, company B and company C as they originally do in company A just before the proposed demerger.

There is no intention for any of the shares in company B and company C to be disposed of immediately after the proposed demerger.

All the shareholders of company A are Australian residents for tax purposes.

Neither company A nor any of its subsidiaries are superannuation funds.

None of the shareholders in company A have capital tax losses.

The share capital of company A is not tainted within the meaning of section 197-50 of the ITAA 1997.

The acquisition of the shares in company B and company C by company A were all funded from internal cash flow.

An 'alternative transaction' was considered to achieve the same commercial outcomes as the proposed demerger of company B. This 'alternative transaction' involved the disposal of all other assets of company A to a newly incorporated subsidiary company of company A, 'New Co', for nominal consideration. Subsequently New Co would be demerged from company A. The shares in company B and company C would be the only assets left in company A at that point.

This 'alternative transaction' was not preferred as there would be potential stamp duty liability on the transfer of assets to New Co.

The estimated incidental costs for undertaking the proposed demerger and the carrying out the alternative transaction would be the same.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1).

Income Tax Assessment Act 1936 subsection 44(1).

Income Tax Assessment Act 1936 subsection 44(2).

Income Tax Assessment Act 1936 subsection 44(3).

Income Tax Assessment Act 1936 subsection 44(4).

Income Tax Assessment Act 1936 section 45B.

Income Tax Assessment Act 1936 subsection 45B(1).

Income Tax Assessment Act 1936 subsection 45B(2).

Income Tax Assessment Act 1936 paragraph 45B(2)(a).

Income Tax Assessment Act 1936 paragraph 45B(2)(b).

Income Tax Assessment Act 1936 paragraph 45B(2)(c).

Income Tax Assessment Act 1936 subsection 45B(3).

Income Tax Assessment Act 1936 paragraph 45B(3)(a).

Income Tax Assessment Act 1936 subsection 45B(4).

Income Tax Assessment Act 1936 subsection 45B(8).

Income Tax Assessment Act 1936 paragraph 45B(8)(a).

Income Tax Assessment Act 1936 paragraph 45B(8)(b).

Income Tax Assessment Act 1936 paragraph 45B(8)(c).

Income Tax Assessment Act 1936 paragraph 45B(8)(d).

Income Tax Assessment Act 1936 paragraph 45B(8)(e).

Income Tax Assessment Act 1936 paragraph 45B(8)(f).

Income Tax Assessment Act 1936 paragraph 45B(8)(g).

Income Tax Assessment Act 1936 paragraph 45B(8)(h).

Income Tax Assessment Act 1936 paragraph 45B(8)(i).

Income Tax Assessment Act 1936 paragraph 45B(8)(j).

Income Tax Assessment Act 1936 subparagraph 45B(8)(j)(i).

Income Tax Assessment Act 1936 subparagraph 45B(8)(j)(ii).

Income Tax Assessment Act 1936 paragraph 45B(8)(k).

Income Tax Assessment Act 1936 subsection 45B(9).

Income Tax Assessment Act 1936 section 45BA.

Income Tax Assessment Act 1936 subsection 45BA(1).

Income Tax Assessment Act 1936 subsection 45BA(2).

Income Tax Assessment Act 1936 subsection 45C.

Income Tax Assessment Act 1936 subsection 177A(1).

Income Tax Assessment Act 1936 paragraph 177D(b).

Income Tax Assessment Act 1936 subparagraph 177D(b)(i).

Income Tax Assessment Act 1936 subparagraph 177D(b)(ii).

Income Tax Assessment Act 1936 subparagraph 177D(b)(iii).

Income Tax Assessment Act 1936 subparagraph 177D(b)(iv).

Income Tax Assessment Act 1936 subparagraph 177D(b)(v).

Income Tax Assessment Act 1936 subparagraph 177D(b)(vi).

Income Tax Assessment Act 1936 subparagraph 177D(b)(vii).

Income Tax Assessment Act 1936 subparagraph 177D(b)(viii).

Income Tax Assessment Act 1936 section 318.

Income Tax Assessment Act 1997 section 104-230.

Income Tax Assessment Act 1997 subsection 104-135(5).

Income Tax Assessment Act 1997 Division 125.

Income Tax Assessment Act 1997 section 125-65.

Income Tax Assessment Act 1997 section 125-70.

Income Tax Assessment Act 1997 paragraph 125-70(1)(a).

Income Tax Assessment Act 1997 subparagraph 125-70(1)(b)(i).

Income Tax Assessment Act 1997 subparagraph 125-70(1)(c)(i).

Income Tax Assessment Act 1997 paragraph 125-70(1)(d).

Income Tax Assessment Act 1997 paragraph 125-70(1)(e).

Income Tax Assessment Act 1997 paragraph 125-70(1)(g).

Income Tax Assessment Act 1997 paragraph 125-70(1)(h).

Income Tax Assessment Act 1997 subsection 125-70(2).

Income Tax Assessment Act 1997 section 125-80.

Income Tax Assessment Act 1997 subsection 125-80(1).

Income Tax Assessment Act 1997 subsection 125-80(2).

Income Tax Assessment Act 1997 subsection 125-80(5).

Income Tax Assessment Act 1997 subsection 125-80(6).

Income Tax Assessment Act 1997 subsection 995-1(1).

Reasons for decision

Paragraph 45B(3)(a) of the ITAA 1936 provides:

Commissioner to make a determination that section 45BA or 45C applies

The Commissioner may make, in writing, a determination that:

(a) section 45BA applies in relation to the whole, or part, of the demerger benefits.

(b) …

Section 45BA of the ITAA 1936 provides:

Effect of Determination under section 45B for Demerger benefits

45BA(1) [Demerger benefit when provided] If the Commissioner makes a determination under subsection 45B(3), the amount of the demerger benefit, or the part of the benefit, is taken not to be a demerger dividend for the purposes of this Act for the owner of the ownership interest or the relevant taxpayer at the time when the owner or relevant taxpayer is provided with the demerger benefit.

45BA(2) [Amount of benefit] The amount of the demerger benefit is:

(a) if the benefit is the provision of an ownership interest - the market value of the interest at the time that it is provided; or

(b) if the benefit is an increase in the value of an ownership interest - the increase in the market value of the interest as a result of the change; or

(c) if the benefit is a distribution to the shareholder of share capital or share premium - the amount debited to the share capital account or share premium account of the company in connection with the provisions of the benefit.

The application of paragraph 45B(3)(a) of the ITAA 1936 requires a broader consideration of section 45B of the ITAA 1936.

Section 45B of the ITAA 1936

The policy objective of section 45B, which is set out in subsection 45B(1) of the ITAA 1936, concerns the relationship between a company and its shareholders. In regard to demerger, section 45B of the ITAA 1936 guards against the use of a demerger for a substantial purpose of delivering a tax benefit to a relevant taxpayer (normally the shareholder of the head entity of the demerger group) rather than for a genuine commercial purpose, or manipulating the mix of capital and profit in the demerger allocation to deliver the relevant taxpayer a tax benefit.

Subsection 45B(2) of the ITAA 1936 sets out the conditions under which section 45B of the ITAA 1936 will apply to a demerger. Relevantly, the subsection provides that:

(a) there is a scheme under which a person is provided with a demerger benefit by a company

(b) under the scheme, a taxpayer (the relevant taxpayer) who may or may not be the person provided with the demerger benefit, obtains a tax benefit, and

(c) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain a tax benefit.

It can be seen that section 45B of the ITAA 1936 turns on a test of whether there is a more than incidental purpose (rather than 'dominant' purpose), on the part of anyone who entered into or carried out the scheme, of enabling the relevant taxpayer to obtain a tax benefit.

Each of the key terms referred to in subsection 45B(2) of the ITAA 1936 is considered below.

The scheme

A 'scheme' for the purposes of section 45B of the ITAA 1936 is taken to have the same meaning as provided in subsection 177A(1) of Part IVA of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan, or proposal. In particular, a scheme is anything that satisfies any of the terms in the statutory definition.

The scheme in this instance is a statutory demerger pursuant to section 125-70 of the ITAA 1997.

· There is a restructuring and, under the restructuring, company A disposes 100% of its shareholding in company B and company C to its shareholders (paragraph 125-70(1)(a) and subparagraph 125-70(1)(b)(i)) of the ITAA 1997)

· Under the restructuring, CGT event G1 will happen to each share owned by company A's shareholders and the shareholders will acquire new shares in company B and company C only and nothing else (subparagraph 125-70(1)(c)(i) of the ITAA 1997)

· The company A shareholders acquire the new shares only because they own shares in company A (paragraph 125-70(1)(d) of the ITAA 1997)

· company A being a company, the new interests are shares in company B and company C (paragraph 125-70(1)(e) of the ITAA 1997)

· Neither the original shares nor the new shares are in a trust that is a superannuation fund (paragraph 125-70(1)(g) of the ITAA 1997), and

· Each company A shareholder, under the demerger, acquires as nearly as practicable the same proportion of new shares in company B and company C as their original shareholding in company A before the demerger; and just after the demerger, has the same proportionate total market value of shareholding in company A, company B and company C as they did in company A just before the demerger (paragraph 125-70(1)(h) and subsection 125-70(2) of the ITAA 1997).

A person is provided with a demerger benefit by a company

Person

Paragraph 45B(2)(a) of the ITAA 1936 refers to a person being provided with a demerger benefit (or capital benefit) by a company. Subsection 995-1(1) of the ITAA 1997 defines 'person' to include a company. The six individual shareholders and the corporate trustee, company G, are all persons for the purposes of section 45B.

The demerger benefit

The phrase 'provided with a demerger benefit' is defined in subsection 45B(4) of the ITAA 1936 to include the circumstances where a company provides the person with ownership interests in that or another company or something is done in relation to an ownership interest owned by the person that has the effect of increasing the value of an ownership interest (which may or may not be the same ownership interest) owned by the person.

In the present circumstances, the shareholders of company A will be provided with a demerger benefit, being an ownership interest, when company A makes an in-specie distribution of its shares in company B and company C.

The tax benefit and the relevant taxpayers who obtain the tax benefit

Subsection 45B(9) of the ITAA 1936states that a relevant taxpayer obtains a tax benefit if :

· an amount of tax payable; or

· any other amount payable under the Act,

by the relevant taxpayer would, apart from the operation of section 45B,

· be less than the amount that would have been payable;

· or would be payable at a later time than it would have been payable,

if the demerger benefit had been an assessable dividend.

In the context of section 45B of the ITAA 1936, the 'relevant taxpayer' who obtains the tax benefit does not have to be the person that has been provided with the demerger benefit.

In determining whether a tax benefit has been obtained from the scheme, the meaning of 'tax benefit' as posed in subsection 45B(9) of the ITAA 1936 seeks to compare the tax payable, or other amount payable under the Act, from the provision of the demerger benefit to a person against the tax payable, or other amount payable under the Act, if the demerger benefit had been instead an assessable dividend. An assessable dividend is a dividend, as defined in subsection 6(1) of the ITAA 1936, that is paid out of profits and included in a shareholder's assessable income pursuant to subsection 44(1) of the ITAA 1936.

Subsection 6(1) of the ITAA 1936 provides that a dividend includes any distribution made by a company to any of its shareholders, whether in money or other property, and any amount credited by a company to any of its shareholders as shareholders unless it is debited against share capital. Subsection 44(1) of the ITAA 1936 provides that the assessable income of a shareholder in a company includes (where a resident) dividends that are paid to the shareholder by the company out of profits derived by it from any source.

A distinction is made between a dividend and a demerger dividend in subsection 6(1) of the ITAA 1936 where the latter is that part of a demerger allocation that is assessable as a dividend under subsection 44(1) of the ITAA 1936 or that would be so assessable apart from subsections 44(3) and 44(4) of the ITAA 1936 which apply to the demerger dividend as if it had not been paid out of profits and is not assessable income or exempt income. A demerger allocation is also defined in subsection 6(1) and in this ruling refers to the total market value of the allocation of ownership interests in the demerged entities distributed under the demerger by the head entity of the demerger group to the owners of its issued shares.

Under the proposed demerger, company A will make a demerger allocation which is the market value of its investments in company B and company C. The allocation is to be debited against the share capital account, the retained profits and the demerger reserve (an account created from the revaluation of the entities to be demerged). The demerger dividend will thus be the sum of the amounts debited to the retained profits and the demerger reserve.

Subsection 44(2) of the ITAA 1936 offers an election to the head entity, in this case company A, to have subsections 44(3) and 44(4) of the ITAA 1936 not apply to the total demerger dividend for all shareholders receiving ownership interests in the demerged entity or entities under the demerger. There is no proposal to exercise the election.

Pursuant to subsections 44(3) and 44(4) of the ITAA 1936 the demerger dividend is deemed not to have been paid out of profits and is to be characterised as neither assessable income nor exempt income, making it 'non-assessable and non-exempt income' and effectively not taxable.

Accordingly, company A's shareholders would be 'relevant taxpayers' who will obtain a tax benefit, within the meaning of subsection 45B(9) of the ITAA 1936, from the provision of the demerger benefit, in particular that part of it which is the demerger dividend.

The relevant circumstances of the scheme and their part in the conclusion as to the requisite purpose for the application of section 45B of the ITAA 1936

Pursuant to paragraph 45B(2)(c) of the ITAA 1936 the application of section 45B of the ITAA 1936 requires consideration of the 'relevant circumstances' set out in subsection 45B(8) of the ITAA 1936 to determine whether it would be concluded that one or more of the persons who entered into or carried out the scheme or any part of it did so for a purpose, other than an incidental purpose, of enabling a relevant taxpayer to obtain a tax benefit from the provision of the demerger benefit.

The test of purpose is an objective test. As indicated above, the requisite purpose need not be the most influential or prevailing purpose but it must be more than an incidental purpose and it may be the purpose of any party to the scheme.

The list of relevant circumstances in subsection 45B(8) of the ITAA 1936 is not exhaustive and regard may be had to other circumstances on the basis of their relevance. Nevertheless, all of the circumstances listed in subsection 45B(8) must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose.

Broadly, the relevant circumstances listed in subsection 45B(8) of the ITAA 1936 include the tax and non-tax (that is, business and other financial) implications of the scheme, the latter covered largely by the matters in paragraph 177D(b) of the ITAA 1936, which are included in subsection 45B(8) of the ITAA 1936 by virtue of paragraph 45B(8)(k) of the ITAA 1936.

Paragraph 45B(8)(a) of the ITAA 1936 - the extent to which the demerger benefit or capital benefit is attributable to capital and profits (realised or unrealised) of the company or of an associate (within the meaning in section 318 of the ITAA 1936) of the company

Paragraph 45B(8)(a) of the ITAA 1936 directs attention to the composition of the demerger benefit, as between share capital and profits (realised or unrealised), provided to the head entity's shareholders from the points of view of both their relative size generally and their potential for unnatural bias.

If the composition of the demerger benefit involves an inordinately large profit element or a bias towards profit which is inconsistent with the natural profit element of the assets being demerged, a purpose of accessing demerger relief to obtain a non-assessable dividend could be inferred.

Under the proposed demerger, company A will make a demerger allocation, a major component of which is the demerger dividend. A substantial amount of the demerger dividend will be debited to an asset revaluation reserve, styled the 'demerger reserve'.

The components of the demerger benefit as between paid in capital and profits have been properly attributed to each and in that regard this matter does not incline towards the requisite purpose. However the size of the profit component relative to the size of the capital component does highlight the significance of the tax benefit the relevant taxpayers will obtain from the proposed demerger.

Paragraph 45B(8)(b) of the ITAA 1936 - the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318 of the ITAA 1936) of the company

The inference here is that an interruption to the normal pattern of profit distribution and its replacement with a capital benefit or a non-assessable, non-exempt demerger dividend would suggest dividend substitution. It is also a matter which invites consideration of the franking aspect of the distributions.

The demerging entity has paid a dividend in each financial year from 30 June 2003 to the latest financial year 30 June 2009. Moreover all the dividends were distributed fully franked.

As the applicant indicates, the proposed demerger dividend would not represent a substitution for a normal assessable dividend in this case. Also, as the applicant has pointed out, the demerged entities, as associates of company A will retain their profits for future distribution to their new shareholders, the relevant taxpayers, in the normal course.

However, whereas a demerger is an extraordinary event that is unlikely to be a replacement for a standard profit distribution, it nevertheless provides the demerging company with the opportunity to distribute profit, realised or unrealised, to its shareholders tax-free. This attractive feature of the demerger concession is made more so where the profits are untaxed and the available franking credit modest.

In this instance, not only is the proposed profit distribution relative to the capital element of the demerger benefit significant, the available franking credit is adequate to only partially frank the dividend were the profit to be distributed otherwise than under the shelter of the demerger concession.

The unlikelihood of characterising the proposed demerger dividend as a substitute for an assessable dividend paid in the normal course of the company's annual fully franked distributions would incline away from the requisite purpose. However, its tax-free nature in the relative absence of franking credit is a feature that would incline towards the requisite purpose.

Paragraph 45B(8)(c) of the ITAA 1936 - whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income

No capital losses are involved in this case. Accordingly, this matter does not incline towards the requisite purpose.

Paragraph 45B(8)(d) of the ITAA 1936 - whether some or all of the ownership interests in the company or in an associate (within the meaning of section 318 of the ITAA 1936) of the company held by the relevant taxpayer were required, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985

This circumstance distinguishes between pre and post-CGT assets, a characteristic of the original ownership interests in the head entity which, by the operation of Division 125 of the ITAA 1997, is normally transmitted to the new ownership interests in the demerged entity or entities (subsection 125-80(5)of the ITAA 1997).

In other words, the decision to deliver ownership interests under a demerger could be influenced by the advantage of the shareholders in the head entity receiving them as pre-CGT interests, with the attendant tax advantages that entails. Not only would the relevant taxpayers receive the shares in the demerged entities as a tax-free, in-specie demerger dividend, they would also be pre-CGT capital assets in their hands; in which case, their dealing with them as such would compound the immediate tax benefit bestowed by the demerger.

It will be recalled that section 125-80 of the ITAA 1997 enables the head entity's shareholders to choose roll-over which involves three main advantages accruing to them in relation to the demerger. First, any capital gain or capital loss they might make from a CGT event happening to their original share in the head entity is disregarded (subsection 125-80(1) of the ITAA 1997). Secondly, the cost base of their original shares is divided between the original share and the new demerged shares, based on the respective market valuations of the shares (subsection 125-80(2) of the ITAA 1997). Thirdly, if the original shares are pre-CGT shares the demerged shares also take on that characteristic (subsection 125-80(5) of the ITAA 1997).

In this case, all but one of the relevant taxpayers' original shares in company A are pre-CGT shares, so the demerged shares in company C and company B distributed in relation to those original shares will also be pre-CGT shares in their hands (subsections 125-80 (5) and (6) of the ITAA 1997).

Furthermore, subject to the terms of section 104-230 of the ITAA 1997 (CGT event K6), the pre-CGT characteristic of the shares in the demerged entities will normally determine that CGT events that happen in relation to the shares will result in capital gains being derived there from being disregarded.

This matter would incline towards the requisite purpose

Paragraph 45B(8)(e) of the ITAA 1936 - whether the relevant taxpayer is a non-resident

Depending on the circumstances of their shareholding, the characteristic of non-residency could influence a preference on the part of the relevant taxpayer for capital or profit in the demerger allocation or, indeed, influence the fact of the demerger itself, given that the non-resident taxpayer would not be exposed to dividend withholding tax on a demerger dividend.

In this instance, all the relevant shareholders are residents for income tax purposes, so this is not a circumstance that would incline towards the requisite purpose.

Paragraph 45B(8)(f) of the ITAA 1936 - whether the cost base(for the purposes of the ITAA 1997) of the relevant ownership interest is not substantially less than the value of the applicable demerger benefit or capital benefit

The point of this circumstance is to consider whether, but for the demerger rollover treatment, the capital element of the demerger benefit would result in a CGT Event G1 that produces an assessable capital gain.

In this case, the relevant ownership interests are the shares in company A which are pre-CGT assets for which a capital gain under CGT event G1 is disregarded pursuant to subsection 104-135(5) of the ITAA 1997. (Of the issued shares in company A only one share is post CGT in character. The cost base of the post CGT share is $1.00).

Furthermore, the demerger benefit comprises for the most part a demerger dividend which has no bearing on the cost base of the relevant ownership interests.

This is not a matter that points to the requisite purpose.

Paragraph 45B(8)(g) of the ITAA 1936 - is repealed.

Paragraph 45B(8)(h) of the ITAA 1936 - if the scheme involves the distribution of share capital or share premium - whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital or share premium

Ordinarily, this circumstance would not have significant relevance for demergers as, owing to the requirements of the proportion test in subsection 125-70(2) of the ITAA 1997, demerger would not disturb the relevant taxpayers' proportionate interests in the head entity.

The circumstance appears to be more concerned with the provision of capital benefits per se, rather than capital benefits provided in the context of a demerger allocation.

This is not a matter which would suggest the requisite purpose.

Paragraph 45B(8)(i) of the ITAA 1936 - if the scheme involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interest and the later disposal of those interests:

(i) the period for which the ownership interests are held by the holder of the interests; and

(ii) when the arrangement for the disposal of the ownership interests was entered into

The premise here is that a pre-arranged disposal of the demerged interest or the interest in the head entity by the head entity's owners may suggest the demerger was undertaken to transfer corporate assets to the shareholder and not to restructure the business in the interest of enhancing its performance.

In this instance, the applicant has advised that 'there is no intention for any of the shares in the entities to be disposed of subsequent to the demerger'; it is presumed that the entities referred to are company B and company C.

On the basis that disposal of the demerged interest is not in contemplation under the scheme, this matter does not incline towards the requisite purpose.

Paragraph 45B(8)(j) of the ITAA 1936 - for a demerger only:

(i) whether the profits of the demerging entity are attributable to transactions between the entity and an associate (within the meaning of section 318 of the ITAA 1936) of the entity;

(ii) whether the assets of the demerging entity were acquired under transactions between the entity and an associate (within the meaning in section 318 of the ITAA 1936) of the entity

The essential inquiry in these subparagraphs is whether there is a concentration of assets or profits of the corporate group in the demerging entities beyond that which is explicable in terms of the businesses they carry on and the organic growth thereof. The premise here is that the demerger would be used to deliver such assets or profits in a tax advantaged manner to the head entity's owners in the form of a demerger benefit.

As there has been no concentration of assets in the demerged entities that do not relate to or concern the businesses in those entities, this matter does not suggest the requisite purpose.

Paragraph 45B(8)(k) of the ITAA 1936 - any of the matters referred to in subparagraphs 177D(b)(i) to 177D(b)(viii) of the ITAA 1936

The matters in subparagraphs 177D(b)(i) to 177D(b)(viii) of the ITAA 1936 are matters which require a scheme to be examined from a practical perspective in order to identify and compare its tax and non-tax (ordinarily business) objectives.

For the provision of tax benefits to be no more than an incident of the demerger scheme the business objects of the scheme should be, by way of contrast, objectively and demonstrably significant.

In this regard, it will be recalled that The Revised Explanatory Memorandum (Senate) to New Business Tax System (Consolidations, Value Shifting, Demergers and Other measures) Bill 2002 at paragraph 15.5 provided that 'The object of the CGT relief and dividend exemption will facilitate the demerging of entities by ensuring that tax considerations are not an impediment to restructuring a business.' When the Bill was introduced the relevant Minister stated that the policy objective was that 'the tax relief will apply only to genuine demergers … Providing tax relief for demergers will increase business efficiency by allowing greater flexibility in restructuring a business and ensuring that tax considerations are not an impediment to such restructures'.

The matters in subparagraphs 177D(b)(i) to 177D(b)(viii) of the ITAA 1936 should reveal whether or not the business objects of the demerger are, relatively speaking, such as to render the provision of the tax benefit, that is, the delivery of the demerger dividend, a mere incident of the demerger.

These matters include the manner in which the scheme is to be carried out, its form and substance, its timing and the financial and other implications of the scheme for the parties involved. Consideration of each matter individually follows.

Subparagraph 177D(b)(i) of the ITAA 1936 - The manner in which the scheme was entered into or carried out

An enquiry into the manner of a scheme is an objective inquiry into the reasons the parties had for entering into or carrying out the scheme. This involves consideration of the decisions, steps and events that combine to make up the scheme.

The applicant has indicated in the ruling application that asset protection, the creation of stand alone businesses, the true representation of trading operations, the development of commercial strategies and the separation of financial arrangements to reflect corporate risk profile are the things that explain the reasons for the proposed demerger.

Asset protection is a matter which, generally speaking, concerns the protection of shareholders' wider assets from the risk of exposure to liabilities incurred by the corporation in which they hold shares. In this regard, all shareholders enjoy the protection of the corporate veil and the principle of limited liability which provides that their exposure to the company's debts is limited to their share of the company's issued capital. This is not an issue which should concern demerger.

Apart from the steps proposed to give effect to a demerger which accords with the requirements of Division 125 of the ITAA 1997, the proposed scheme does not advert to steps that normally might be expected to be taken to restructure the demerged entities as discrete, independent businesses.

The present application indicates, in effect, that the demerged entities intend to take steps to become independent from the company A group after the demerger; in short, that the restructure of their operations to turn them into discrete, independent businesses will occur post demerger. However, the demerger will not change the demerged entities' dependence on company A for access to premises and for the interlocking guarantees and indemnities which secure their financial facilities.

Turning the demerged entities into discrete independent businesses should be an integral part of the business restructure for which the demerger concession is made available. The act of transferring the ownership of the demerged businesses to the owners of the demerging entity is meant to be the final step of the restructure not the first step.

In effect, the approach proposed in the application would elevate the common ownership of the demerged and demerging entities to being the focus of the demerger and not a mere incident of the business restructures. The demerger concessions were enacted to remove the tax burden that common ownership of the restructured businesses imposed on shareholders. The tax consequences of common ownership were acknowledged as an impediment to business restructures which would otherwise be undertaken to improve performance at the levels of both the individual businesses and the economy generally.

In a case such as this, where essential steps of the business restructure are proposed to be taken after company B and company C have been demerged to the company A shareholders, the manner in which the scheme is entered into and carried out points objectively to the provision of the tax benefit being more than a mere incident of the demerger.

Subparagraph 177D(b)(ii) of the ITAA 1936 - The form and substance of the scheme

Subparagraph 177D(b)(ii) of the ITAA 1936 refers to the form and substance of the scheme. The form of a scheme is the way it presents and the substance of a scheme is a reference to its essential nature which normally would be determined from the effects of the scheme on the commercial and economic circumstances of the parties involved in the scheme.

The proposed scheme takes the form of a demerger in that it would accord with the steps that satisfy the definition of demerger in section 125-70 of the ITAA 1997. The substance of the scheme, however, does not conform to a business restructure which creates discrete, independent businesses such that their common ownership can be regarded as but an incident of the restructure.

Post the proposed demerger, the transformation of the demerged and demerging entities into independent businesses will still only be inchoate. Objectively, this would indicate that the substance of the proposed scheme is no more than the transfer of assets in specie by company A to its shareholders by way of a reduction of capital and a distribution of profit, i.e. a dividend.

The substance of the proposed scheme would therefore point to a substantial purpose of enabling the relevant taxpayers to obtain a tax benefit.

Subparagraph 177D(b)(iii) of the ITAA 1936 - The time at which the scheme was entered into and the length of the period during which the scheme was carried out

This matter is not limited to time measurement. It also includes a reference to the timing of the scheme from the point of view of the scheme's coincidence with events or circumstances beyond the scheme itself; in particular, whether the scheme was designed to take advantage of events or changes of a tax or non-tax nature that were taking place or were available at the time.

The application represents the proposed demerger as the first step in what at this time is no more than a possible business restructure. In other words, the proposed scheme will take advantage of the tax concession in advance of any substantive changes to the businesses of the demerged entities.

In this regard, the timing of the scheme would point objectively to the requisite tax purpose.

Subparagraph 177D(b)(iv) of the ITAA 1936 - The result in relation to the operation of this Act that, but for this Part (section 45B of the ITAA 1936), would be achieved by the scheme

But for the application of section 45B of the ITAA 1936 the proposed scheme would result in the shareholders of company A receiving dividends of $W tax free. This is an immediate consequence that prima facie would point objectively to the requisite purpose of enabling the shareholders to obtain a tax benefit.

Thereafter, there is also the potential for the tax benefit to be compounded by the fact that the shareholders of company A will hold the in specie dividend, that is, the shares in the demerged entities, as pre-CGT assets with the advantages that entails.

Subparagraph 177D(b)(v) of the ITAA 1936 - Any change in financial position of the relevant taxpayer(s) that has resulted, will result, or may reasonably be expected to result, from the scheme

The essential benefit to the taxpayers' financial position from the proposed scheme is that they would own the shares in the demerged entities previously owned by company A, having received them free of tax. As the owners of the shares they can realise, exchange or use them as financial security for a loan. Given the substantial market value of the shares, their acquisition by way of direct ownership free of tax represents a significant change for the better in the financial position of the relevant taxpayers.

This matter inclines objectively towards the requisite purpose.

Subparagraph 177D(b)(vi) of the ITAA 1936 - Any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme

Relevantly, this matter would cover consideration of the financial changes for the corporate entities involved in the scheme that ordinarily would pertain to or are consistent with a business restructure. For example, establishing the business independence of the demerged entities would involve the severing of business and financial ties with other members of the company A group and revising relations with creditors to disentangle group security arrangements.

The absence of these changes in the present scheme would point objectively to the tax purpose for the demerger being more than incidental.

Subparagraph 177D(b)(vii) of the ITAA 1936 - Any other consequence for the relevant taxpayer(s), or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out

Ordinarily, the features of a business restructure of entities of the size of the present demerged and demerging entities would be expected to include changes to the decision-making structure. In this instance, the decentralisation of the entities' decision-making structure, though mentioned in the ruling application as a future consideration, is absent from the present scheme.

The absence of such changes would point objectively to the tax purpose for the demerger being more than incidental.

Subparagraph 177D(b)(viii) of the ITAA 1936- The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer(s) and any person referred to in subparagraph 177D(b)(vi) of the ITAA 1936

The pertinent connection for the purposes of the scheme between the relevant taxpayers and the group entities referred to in subparagraph 177D(b)(vi) of the ITAA 1936 is that of shareholder and company, the significance of which is the assessability of dividends, but for the demerger concession.

However, the availability of the concession is subject to the connection being relatively incidental to the business restructure. In the present case, the transfer of profit from company A to the relevant taxpayers pursuant to the relationship of company A and shareholder is the focus of the scheme which involves little else in the way of a business restructure.

In this instance the connection between the relevant taxpayers and company A, in the context of the proposed scheme would point objectively to the requisite tax purpose.

Conclusion

In the view of the Commissioner it would be concluded objectively, having regard to the 'relevant circumstances' of the proposed scheme, as set out in subsection 45B(8) of the ITAA 1936, that most if not all of the participants in the proposed scheme, including the shareholders of company A, would have entered into and carried out the proposed scheme for a more than incidental purpose of enabling the shareholders of the demerging entity, company A, that is, the relevant taxpayers, to obtain a tax benefit in the amount of their demerger dividend.

Accordingly, if the scheme were to go ahead as proposed, 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 whole of the 'demerger benefit'.

Section 45BA of the ITAA 1936 provides that if the Commissioner makes such a determination the amount of the demerger benefit that is attributable to the profit of company A and would otherwise be received by the relevant taxpayers, the shareholders of company A, as a demerger dividend would be taken not to be a demerger dividend for the purposes of the Act. In other words, it would be taken to be received by them as an assessable dividend.

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