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Ruling

Subject: Division 125 and section 45B

Question 1

Will any capital gain or capital loss to be made from the transfer by ABC Company (ABC) of its shares in a newly incorporated company, XYZ Company (XYZ) by way of an in-specie distribution (demerger distribution) to eligible shareholders in ABC (shareholders) be disregarded pursuant to Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the Commissioner make a determination under subsection 45C(3) of the Income Tax Assessment Act 1936 (ITAA 1936) that the whole, or any part, of the demerger allocation to be provided to ABC shareholders under the proposed demerger was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the demerger?

Answer

No.

This ruling applies for the following period:

1 July 2014 to 30 June 2015

The scheme commences on:

In the year ended 30 June 2015

Relevant facts and circumstances

Background

ABC

1. ABC is a public company not listed on the Australian Securities Exchange.

2. ABC is the head company of the ABC tax consolidated group.

3. ABC was established in the 19XX's and its business has diversified over time.

4. ABC has provided details of its dividend payment history indicating fully franked dividends were paid every year for the previous 6 years. ABC intends to continue to pay fully franked dividends in the future.

5. ABC started to undertake projects in a new business area. ABC's interests in this space have since grown significantly.

6. Prior to the proposed demerger, ABC conducted the new business through its wholly owned subsidiaries.

7. The new business has been funded using surplus funds of ABC. No capital raisings have been undertaken to raise funds for any of the new business interests.

Pre-demerger transactions

8. ABC incorporated XYZ, a new, wholly owned company to facilitate the demerger.

9. ABC and XYZ will enter into a sale agreement under which ABC agrees to transfer its new business interests to XYZ in consideration for the issue of shares in XYZ. The transfer of shares will be subject to receiving approval by ABC shareholders at a general meeting.

10. When shareholder approval is received the new business interests will be transferred from ABC to XYZ at book value.

11. Intercompany loans ABC made to XYZ and its subsidiaries will be forgiven prior to the demerger.

12. ABC and XYZ will enter into a shared services agreement whereby ABC will provide certain transitional services to XYZ for a period of 2 years after the demerger.

13. The management structure of both ABC and XYZ will remain the same and two employees will be transferred from to XYZ.

Valuation

14. The estimated total market value of ABC and the value of the assets which are to be transferred to XYZ at the time of the proposed demerger have been provided. The new business assets amount to less than 10% of the total value of ABC.

15. The final market values of the ABC assets will be determined at the time the demerger occurs (Implementation Date).

The demerger

16. On the Implementation Date of the proposed demerger of XYZ by ABC, ABC will:

• reduce its share capital by the capital reduction amount, which will be applied proportionately against the ABC shares on issue

• declare a special dividend to the ABC shareholders, and

• satisfy its obligation to pay the capital reduction amount and the special dividend to ABC shareholders by making an in specie distribution of all of its XYZ shares to ABC shareholders.

17. The capital reduction amount debited to the share capital account will be calculated by determining the relative market value of XYZ to the aggregate market value of the ABC group at the implementation date of the demerger.

18. The special dividend will be calculated by reducing the total market value of the in specie distribution by the capital reduction amount.

19. ABC shareholders will receive one share in XYZ for each ordinary share they hold in ABC.

20. ABC shareholders will retain their existing direct interest in ABC. ABC will not retain any shares in XYZ.

Accounting for the distribution to effect the demerger

21. ABC will account for the distribution of XYZ shares under the demerger by:

• debiting its share capital account by the capital reduction amount, and

• debiting retained earnings by the amount of the special dividend.

Reasons for the demerger

22. The commercial rationale for the transaction includes:

• ABC's existing businesses are not adequately benefiting from being part of the same group structure and there will be greater long term operational efficiency and growth opportunities if they are separated.

• The new business interests do not fit neatly with ABC's other activities as each have different risk and earnings profiles.

• The new business assets divert attention away from the quality of ABC's core business assets and are potentially undervalued.

• As a stand-alone company, XYZ will be able to develop a tailored strategy, with its own management, suitable to the industry.

• Both ABC and XYZ will have the flexibility to offer their own shares for potential corporate transactions and to independently access capital markets as required.

Other matters

23. ABC's share capital account is not 'tainted', within the meaning of Division 197.

24. After the proposed demerger, at least 50% of the market value of CGT assets of XYZ and its subsidiaries will be used directly, or indirectly, in one or more businesses carried on by XYZ or any of its subsidiaries.

25. ABC will not make an election in writing under subsection 44(2) of the ITAA 1936 for subsection 44(3) and subsection 44(4) not to apply to the ABC shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10,

Income Tax Assessment Act 1997 subsection 104-10(1),

Income Tax Assessment Act 1997 section 104-230,

Income Tax Assessment Act 1997 Division 125,

Income Tax Assessment Act 1997 subsection 125-60(1),

Income Tax Assessment Act 1997 paragraph 125-60(1)(a),

Income Tax Assessment Act 1997 subsection 125-70(1),

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 paragraph 125-70(1)(c),

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 subsection 125-70(4),

Income Tax Assessment Act 1997 subsection 125-70(5),

Income Tax Assessment Act 1997 subsection 125-70(6),

Income Tax Assessment Act 1997 paragraph 125-70(6)(a),

Income Tax Assessment Act 1997 subsection 125-70(7),

Income Tax Assessment Act 1997 paragraph 125-70(7)(a),

Income Tax Assessment Act 1997 subsection 125-75(4),

Income Tax Assessment Act 1997 subsection 125-75(5),

Income Tax Assessment Act 1997 section 125-155,

Income Tax Assessment Act 1936 section 45B,

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 paragraph 45B(8)(k),

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

Income Tax Assessment Act 1936 subsection 45B(10),

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 45C(3) ,

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) and

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

Reasons for decision

Question 1

Summary

Any capital gain or capital loss made from the transfer by ABC of XYZ shares by way of a demerger distribution to ABC shareholders will be disregarded pursuant to Division 125 of the ITAA 1997.

Detailed reasoning

All legislative references in this section are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Division 125 - demerger relief

Division 125 contains relief from the possible CGT consequences of a demerger. In particular, it provides that certain capital gains or losses made by members of a demerger group under the demerger be disregarded.

Demerger group

Subsection 125-65(1) provides that a demerger group comprises the 'head entity' of the group and one or more demerger subsidiaries.

Subsection 125-65(3) provides that the head entity of a demerger group is the member of the group in which no other member of the demerger group owns ownership interests.

Subsection 125-65(6) states that a company is a demerger subsidiary of another company that is a member of a demerger group if the other company, either alone or together with other members of the group, owns, or has the right to acquire, ownership interests in the company that carry between them:

(a) the right to receive more than 20% of any distribution of income or capital by the company, or

(b) the right to exercise, or control the exercise of, more than 20% of the voting power of the company.

In the present case, ABC is the head entity of a demerger group (ABC demerger group) as no other member of the group holds ownership interests in ABC. The ABC demerger group comprises ABC as the head entity and all of the subsidiaries in which it has at least a 20% ownership interest including XYZ and its subsidiaries (XYZ group).

For the purpose of this ruling, the head entity and all of the entities that are part of the XYZ group just before the demerger will form part of the ABC demerger group.

Under the proposed scheme, ABC, as the head entity of the ABC demerger group, will dispose of 100% of its total ownership interests in XYZ to ABC shareholders. Therefore, CGT event A1 will happen when ABC disposes of its ownership interests in XYZ.

Section 125-155

Section 125-155 provides certain capital gains and losses of demerging entities are disregards as follows:

Any *capital gain or *capital loss a *demerging entity makes from *CGT event A1, *CGT event C2, *CGT event C3 or *CGT event K6 happening to its *ownership interests in a *demerged entity under a *demerger is disregarded.

Demerging entity

Subsection 125-70(7) provides the meaning of demerging entity as follows:

An entity that is a member of a *demerger group just before the *CGT event referred to in section 125-155 happens is a demerging entity if, under a *demerger that happens to the group:

(a) the entity (either alone or together with other members of the demerger group) *dispose of at least 80% of their total *ownership interests in another member of the demerger group to owners of original interests in the *head entity of the demerger group; or

(b) at least 80% of the total ownership interests of that entity and of other members of the demerger group in another member of the demerger group end and new interests are issued to owners of original interests in the head entity; or

(c) the demerged entity issues sufficient new ownership interests in itself with the result that owners of original interests in the head entity own at least 80% of the total ownership interests in the demerged entity; or

(d) some combination of the processes referred to in paragraphs (a), (b) and (c) happens with the effect that members of the demerger group stop owning at least 80% of the total ownership interests owned by members of the demerger group in another member of the group.

An 'ownership interest' in a company is defined in paragraph 125-60(1)(a) as a share in the company or an option, right or similar interest issued by the company that gives the owner an entitlement to acquire a share in the company.

Under the proposed demerger, ABC will transfer all of its new business assets into XYZ, a newly incorporated subsidiary company. ABC will then transfer all of its ownership interests in XYZ to ABC shareholders on a proportionate basis.

Accordingly, ABC will be a 'demerging entity' as defined in paragraph 125-70(7)(a) as it will dispose of 100% of the total ownership interest in XYZ to owners of the original interests (ABC shareholders) in the head entity of the demerger group (ABC).

CGT event A1

Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset.

CGT event A1 will happen to ABC, a demerging entity, upon disposal of its ownership interests in XYZ to ABC shareholders by way of the in specie distribution.

Demerged entity

Under subsection 125-70(6) an entity that is a former member of a demerger group is a demerged entity if, under a demerger that happens to the group, ownership interests in the entity is acquired by:

(a) shareholders in the *head entity of the group; or

(b) unitholders or holders of interests in the head entity of the group.

Under the demerger, the ownership interests in XYZ will be acquired by ABC shareholders.

Pursuant to subsection 125-65(3), a company is the head entity of the demerger group if no other member of the group owns ownership interests in the company. In this instance, ABC will be the head entity of the demerger group and the shares in XYZ will be acquired by ABC shareholders.

Therefore, XYZ will be a 'demerged entity' as defined in paragraph 125-70(6)(a) as, under the proposed demerger, the ownership interests in the demerged entity will be acquired by the shareholders of the head entity of the demerger group.

Demerger

Under subsection 125-70(1), a demerger happens to a demerger group if:

(a) there is a restructuring of the demerger group, and

(b) under the restructuring:

i. members of the demerger group *dispose of at least 80% of their total *ownership interests in another member of the demerger group to owners of original interests in the *head entity of the demerger group, or

ii. at least 80% of the total ownership interests of members of the demerger group in another member of the demerger group end and new interests are issued to owners of original interests in the head entity, or

iii. the demerged entity issues sufficient new ownership interests in itself with the result that owners of original interests in the head entity own at least 80% of the total ownership interests in the demerged entity, or

iv. some combination of the processes referred to in subparagraphs (i), (ii) and (iii) happens with the effect that members of the demerger group stop owning at least 80% of the total ownership interests owned by members of the demerger group in another member of the group, and

(c) under the restructuring:

i. a *CGT event happens to an original interest owned by an entity in the head entity of the group and the entity *acquires a new interest and nothing else, or

ii. no CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires a new interest and nothing else, and

(d) the acquisition by entities of new interests happens only because those entities own or owned original interests, and

(e) the new interests acquired are:

i. if the head entity is a company - ownership interests in a company, or

ii. if the head entity is a trust - ownership interests in a trust, and

(g) neither the original interests nor the new interests are in a trust that is a *non- complying superannuation fund, and

(h) the requirements of subsection (2) are met.

In relation to the proposed demerger of XYZ by ABC, each of the elements constituting a demerger pursuant to paragraphs (a) to (h) of subsection 125-70(1) have been met as follows:

(a) Paragraph 125-70(1)(a) is satisfied because there will be a restructuring of the demerger group.

(b) Paragraph 125-70(1)(b) is satisfied because under the restructure, ABC will dispose of 100% of its ownership interests in XYZ to ABC shareholders.

(c) Paragraph 125-70(1)(c) is satisfied because under the restructure, CGT event G1 will happen to an original interest owned by ABC shareholders in ABC and ABC shareholders will acquire a new interest, the XYZ shares, and nothing else.

(d) Paragraph 125-70(1)(d) is satisfied as the ABC Shareholders will receive shares in XYZ only because they are shareholders in ABC.

(e) Paragraph 125-70(1)(e) is satisfied because the XYZ shares will be ownership interests in a company.

(f) Paragraph 125-70(1)(f) has been repealed.

(g) Paragraph 125-70(1)(g) is satisfied as neither the original interests (ABC shares) nor the new interests (XYZ shares) are in a trust that is a non-complying superannuation fund.

(h) Paragraph 125-70(1)(h) is satisfied as the requirements of subsection 125-70(2) will also be met as discussed below.

Subsection 125-70(2) requires that:

Each owner (an original owner) of original interests in the *head entity of the *demerger group must:

(a) *acquire, under the *demerger, the same proportion, or as nearly as practicable the same proportion, of new interests in the *demerged entity as the original owner owned in the head entity just before the demerger; and

(b) just after the demerger, have the same proportionate total *market value of *ownership interests in the head entity and demerged entity as the original owner owned in the head entity just before the demerger.

Under the proposed demerger, ABC shareholders will acquire one XYZ share for each ABC share they own. Thus the requirements in paragraph 125-70(2)(a) are satisfied as ABC shareholders will acquire the same proportion of new interests in the demerged entity (XYZ) as they originally owned in the head entity (ABC) just before the demerger.

Certain ownership interests are disregarded as exceptions under section 125-75 for the purposes of the proportion test in subsection 125-70(2). However, none of the exceptions apply to the proposed demerger.

For the purposes of paragraph 125-70(1)(h), paragraphs 125-70(2) (a) and (b) are met in this instance, as ABC shareholders will have the same proportion of interest in XYZ as they do in ABC.

Since each of the elements outlined in paragraphs (a) to (h) of subsection 125-70(1) are met, and no relevant exceptions apply, a demerger will happen to the demerger group in this instance.

Conclusion

It is considered the requirements in section 125-155 are satisfied. Therefore, any of the capital gain that ABC may make from CGT event A1 happening on the disposal of the XYZ shares under the demerger, will disregarded under section 125-155.

Question 2

Summary

The Commissioner will not make a determination under subsection 45C(3) of the ITAA 1936 that the whole, or any part, of the demerger allocation provided to ABC shareholders under the demerger was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the demerger.

Detailed reasoning

All legislative references in this section are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise stated.

Subsection 45C(3)

Sub-section 45C(3) states that:

If the Commissioner has made a determination under section 45B in respect of the whole or a part of a capital benefit and the Commissioner makes a further written determination that the capital benefit, or the part of the capital benefit, was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the distribution from the company:

(a) on the day on which notice of the determination is served in writing on the company, a franking debit of the company arises in respect of the capital benefit; and

(b) the amount of the franking debit is the amount that, if the company had:

i. paid a dividend of an amount equal to the amount of the capital benefit, or the part of the capital benefit, at the time when it was provided; and

ii. fully franked the dividend;

would have been the amount of the franking credit of the company that would have arisen as a result of the dividend.

In order for the Commissioner to make a determination under 45C(3), a determination has to be made under 45B.

Section 45B

Subsection 45B(1) represents an integrity measure and is designed to ensure that relevant amounts are treated as assessable dividends for tax purposes if the capital and profit components of a demerger allocation do not reflect the circumstances of the demerger, or certain payments, allocations or distributions are made in substitution for dividends.

Section 45B would normally apply where the scheme of a demerger merely effects a group restructure without the essential object of enhancing efficiency of businesses run by the group. This enhancement of business efficiencies is the stated policy object of demerger tax relief.

In the context of a demerger, section 45B serves two objects:

1. Ensuring that the dividend exemption provided for in subsections 44(3) and (4) is only available in genuine demergers and that the components of a demerger allocation provided to head entity shareholders under a demerger as between capital and profit reflect the circumstances of the demerger.

2. Considering whether or not the demerger benefit or the capital benefit provided pursuant to the demerger is in substitution for a dividend.

Subsection 45B(2) sets out the conditions under which section 45B will apply to a demerger. It states:

This section applies if:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company, and

(b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the demerger benefit or the capital 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 a taxpayer (the relevant taxpayer) to obtain a tax benefit.

It can be seen that section 45B 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.

Scheme

Pursuant to subsection 45B(10), a 'scheme' in section 45B has the same meaning as provided in subsection 995-1(1) of the ITAA 1997. A scheme is defined as:

(a) any *arrangement, or

(b) any scheme, plan, proposal, action, course or action or course of conduct, whether unilateral or otherwise.

An arrangement is itself defined under subsection 995-1(1) as any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

This definition is very similar to the definition in subsection 177A(1), when read in conjunction with subsection 177A(3).

Pursuant to paragraph 28 of PS LA 2005/21:

That definition is widely drawn and includes any agreement, understanding, promise, undertaking, scheme, plan or proposal... It does not have to be a 'wide scheme' nor does it have to reach to include matters covering its overall commercial result or its 'practical meaning' (Commissioner of Taxation v. Hart). Although, it should be noted that however the 'scheme' is defined, it must be related to the tax benefit obtained.

This term is broadly defined, therefore a 'scheme' will be readily identifiable in most demergers. In that regard, paragraph 29 of PS LA 2005/21 states:

It is expected that a demerger, or part of a demerger, would constitute either a scheme or part of a scheme for the purpose of section 45B of the ITAA 1936. A demerger may be part of a wider scheme which includes a subsequent transaction such as a share buy-back, liquidation or proposed sale of either the demerged entity or the head entity to a third party. Similarly, the scheme may include a transaction precedent to the demerger, such as transfer of assets or addition of a new company to the group. Alternatively, the demerger itself or part of the demerger may constitute the scheme.

In the present circumstances, the features described in the facts are considered to constitute the relevant scheme for the purposes of section 45B of the ITAA 1936. In broad summary those features are the transfer of ABC's new business assets to XYZ and the subsequent transfer of the shares ABC holds in XYZ to its shareholders.

Accordingly, the proposed demerger of XYZ by ABC should be regarded as a 'scheme' for the purposes of section 45B.

Demerger benefit

Subsection 45B(4) states that a person is provided with a demerger benefit if in relation to a demerger:

(a) a company provides the person with ownership interests in that or another company, or

(b) 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.

Under the proposed demerger ABC will provide its shareholders with ownership interests (ordinary shares) in XYZ. Accordingly, the proposed demerger will result in the owners of ABC being provided with a demerger benefit for the purposes of section 45B.

Capital benefit

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) which provides that a person is provided with a capital benefit if they are either provided with an ownership interest in a company, distributed share capital or share premium, or something is done that increases the value of their ownership interest.

The proposed demerger will also result in the provision of a capital benefit as ABC will be transferring its ownership interests in XYZ to ABC shareholders and a capital benefit from the distribution of share capital, which will be debited against an untainted share capital account as a result of the demerger.

Subsection 45B(6) recognises the overlap in subsections 45B(4) and (5) as it stipulates that a person is not provided with a capital benefit to the extent that the provision of interests to them involves their receiving a demerger dividend.

A demerger dividend is defined in subsection 6(1) as 'that part of a demerger allocation that is assessable as a dividend under subsection 44(1) or that would be so assessable apart from subsections 44(3) and (4).' A 'demerger allocation' is also defined in subsection 6(1) and includes the total market value of the ownership interests provided to the head entity's owners under a demerger.

Consequently, to the extent that the provision of a demerger benefit is not a demerger dividend, the proposed demerger will also result in the provision of a capital benefit.

Tax benefit

A taxpayer 'obtains a tax benefit' as defined in subsection 45B(9) if an amount of tax payable, or any other amount payable under the ITAA 1936 or the ITAA 1997 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 or the capital benefit had been a dividend.

Under the proposed demerger, ABC shareholders will obtain a tax benefit as:

(a) a capital gain that may arise under CGT event G1 as a result of the payment of the capital allocation amount as part of the in specie distribution will be disregarded where a rollover is chosen under section 125-55 of the ITAA 1997, and

(b) the demerger dividend that would otherwise be assessable income under subsection 44(1) will be treated as non-assessable non-exempt income as a result of subsections 44(4) and (5) and section 125-80 of the ITAA 1997.

Therefore, ABC shareholders will obtain a tax benefit from receiving demerger distribution when compared to the tax consequences of receiving the demerger benefit or capital benefit as an assessable dividend.

Purpose

Subsection 45B(2)(c) provides that 45B only applies if, having regard to the relevant circumstances of the scheme, it would be concluded the scheme was entered into for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a tax payer to obtain a tax benefit. The relevant circumstances to be considered are listed in subsection 45B(8).

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) 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) include the tax and non-tax (i.e. business and other financial) implications of the scheme, the latter covered largely by the matters in paragraph 177D(b), which are included in subsection 45B(8) by virtue of paragraph 45B(8)(k).

Genuine demerger

PS LA 2005/21 provides guidance on the application of section 45B to the demerger of an entity. PS LA 2005/21 makes reference to paragraph 15.74 of the Revised Explanatory Memorandum which refers to 'genuine demergers' in contradistinction to 'demergers directed at obtaining the dividend exemption pursuant to applying section 45B'. In addition the second reading speech makes plain that genuine demergers are those directed at restructuring a business in the interest of business efficiency. An absence of substantive business reasons for the demerger may point to the demerger being a tax driven scheme.

For the purposes of section 45B, it is evident that the purpose for undertaking the demerger is to improve the performance of both the new and original businesses. This is reflected in the structural, financial and personnel changes that will be made with a view to improvement in profitability of the discrete operations.

This restructure has, as its essential object, the improved business operations of the two companies. The legal separation of those companies will allow both companies to independently focus on maximising their return on capital by addressing their individual business needs and pursuing different growth opportunities. Improved management of each company is also reasonably expected to result from the restructure. It is considered that the applicant has established that the proposed restructure will result in significant business efficiencies.

The application provides commercial reasons for the proposed demerger that support the premise that the proposed demerger of XYZ by ABC is a genuine demerger.

The relevant circumstances

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

Paragraph 45B(8)(a)

Paragraph 45B(8)(a) directs attention to the composition, as between share capital and profits (realised and unrealised) of the demerger benefit 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 is inconsistent with the substance (that is, the capital and profit it is attributable to) this would tend to a conclusion that the requisite purpose exists (paragraph 50 of PS LA 2005/21).

If the dividend element of a demerger benefit is not attributable to an amount that could reasonably be regarded as the profit made on or applied to the assets being demerged, this would suggest a purpose of obtaining a non-assessable dividend under the demerger relief.

It is considered the components of the demerger benefit as between paid in capital and profits have been properly attributed to each based on applying the relative market value method and in that regard this matter does not incline towards the requisite purpose.

Paragraph 45B(8)(b)

Paragraph 45B(8)(b) directs attention to the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or an associate (within the meaning in section 318) of the company. The inference here is that an interruption to the normal pattern of profit distribution and its replacement with a distribution under a demerger would suggest dividend substitution.

During the relevant periods ABC consistently paid fully franked dividends. ABC has advised that it intends to continue to pay dividends to its shareholders in the future.

It is considered that the distribution of the dividend that will result from the proposed demerger of XYZ from ABC is extraordinary when compared with the pattern of dividend distributions made prior to the proposed demerger and it is unlikely to be used to replace standard profit distributions.

This factor inclines away from the requisite purpose.

Paragraph 45B(8)(c)

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

There is nothing to indicate that the proposed demerger is structured to provide tax benefits to ABC shareholders.

This factor does not incline for or against the requisite purpose.

Paragraph 45B(8)(d)

Paragraph 45B(8)(d) considers whether some or all of the ownership interests in the company, or in an associate of the company, held by the relevant taxpayer were acquired, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985.

In this case, all of the relevant taxpayers' original shares in ABC are post CGT shares; therefore, this factor is not relevant.

Paragraph 45B(8)(e)

Paragraph 45B(8)(e) requires consideration of whether the shareholders of the head entity are non-residents.

In the present case, all of the ABC shareholders are residents of Australia for tax purposes (as defined in section 6(1)), hence, this factor is not relevant.

Paragraph 45B(8)(f)

Paragraph 45B(8)(f) considers 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 capital benefit.

Nothing is known of the circumstances of ABC shareholders by ABC that indicates the proposed demerger is structured to provide tax benefits to them.

This factor does not incline for or against the requisite purpose.

Paragraph 45B(8)(g)

Paragraph 45B(8)(g) has been repealed.

Paragraph 45B(8)(h)

Paragraph 45B(8)(h) requires that consideration be given to whether the interest held by the relevant shareholders after the share capital reduction is the same as the interest that would have been held if an equivalent dividend had been paid.

As determined in the response to question 1, the proposed demerger would not disturb the head entity shareholder's existing ownership interest in the way described in paragraph 45B(8)(h), as it would meet the requirements of the proportionate interest test in subsection 125-70(2) of the ITAA 1997.

Therefore, this factor does not incline towards the requisite purpose.

Paragraph 45B(8)(i)

Paragraph 45B(8)(i)  directs attention to situations where a demerger involves the provision of owner interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests, recognising that the proceeds on disposal of such ownership interests provide the equivalent of a cash dividend in a more tax effective form.

The proposed scheme does not involve a later disposal of the XYZ shares. This factor inclines away from the requisite purpose.

Paragraph 45B(8)(j) 

Paragraph 45B(8)(j) applies only to demergers and considers whether the profits and assets of the demerging entity are attributable to or acquired under transactions with associated entities (within the meaning of section 318). The demerging entity is the entity that provides the ownership interests in the demerged entity to the head entity's owners

The respective assets and expected profits of ABC and XYZ following the proposed demerger will be explicable to the businesses to be carried on by the two entities. There will be no concentration of assets in the demerged entities that do not relate to or concern the businesses in those entities.

Therefore, this factor does not indicate that the requisite purpose is present.

Paragraph 45B(8)(k)

The incorporation of the Part IVA factors into section 45B does not introduce a different purpose test into section 45B. The tests are applied in the context of the 'not incidental purpose test' in section 45B.

The eight matters in paragraph 177D(2) constitute the essential facts and circumstances of a scheme, including the outcomes for the parties to the scheme, by reference to which the tax and non-tax objects of the scheme can be identified and contrasted from an objective point of view.

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.

The matters in subparagraphs 177D(2)(a) to (h) should reveal whether or not the business objects of the demerger are, relatively speaking, such as to render the provision of the tax benefit, i.e. the delivery of the demerger dividend, a mere incident of the demerger.

An analysis of subsection 177D(2) is set out below.

Paragraph 177D(2)(a)

Paragraph 177D(2)(a) refers to the manner of scheme was entered into or is being carried out. An enquiry into the manner of a scheme is an objective inquiry into the reasons a taxpayer had for entering into it or carrying it out. It involves a consideration of the decisions, steps and events that combine to make up the scheme.

In this case, the scheme takes the form of a demerger scheme which accords with that set out in the statutory demerger provisions in Division 125 of the ITAA 1997 which provide demerger tax concessions.

The scheme involves the following steps:

1. The creation of XYZ by ABC

2. The transfer of the new business assets from ABC to XYZ

3. The transfer of shares in XYZ to ABC shareholders

The application provides commercial reasons for the proposed demerger that support the premise that the proposed demerger of XYZ by ABC is a genuine demerger.

This factor inclines away from the requisite purpose.

Paragraph 177D(2)(b):

Paragraph 177D(2)(b) refers to the form and substance of the scheme. The substance of the scheme is a reference to its essential nature, which would normally be determined from the effects of the scheme on the commercial and economic circumstances of all the parties involved in the demerger.

The information provided details a number of reasons why the demerger will be beneficial to the ABC group and how the business efficiencies of both ABC and XYZ will be enhanced.

The practical implications of the scheme for ABC and its shareholders are consistent with its being, in form and in substance, a genuine demerger of XYZ from its parent, ABC. In this case, the form of the scheme is consistent with its substance.

There are clearly identifiable gains and enhancement of business efficiency achieved by the demerger in contrast to the tax benefits secured by the demerger dividend.

Therefore, this factor does not incline towards the requisite purpose.

Paragraph 177D(2)(c)

Paragraph 177D(2)(c) refers to the timing of the scheme. The in specie distribution of XYZ is proposed to be completed during the year.

There is nothing in the timing of this transaction that would indicate a requisite purpose exists.

Paragraph 177D(2)(d)

This factor requires identifying the tax results of the scheme if section 45B were not to apply (PS LA 2005/21 paragraph 92).

The tax outcomes produced by the proposed demerger, assuming the non-application of section 45B, will be as follows:

• the ABC shareholders will receive a demerger dividend, which will be non-assessable non-exempt income by virtue of subsection 44(4), and

• the ABC shareholders will be eligible for CGT roll-over relief in respect of the capital gain that arises from CGT event G1 happening when they receive the shares in XYZ.

Although the tax outcome of the demerger is a circumstance that inclines slightly towards the requisite purpose being present, the tax outcome is merely the result of a genuine business demerger.

Hence, this factor is not by itself sufficient to conclude that the requisite purpose exists.

Paragraph 177D(2)(e)

Paragraph 177D(2)(e) directs attention to any change in financial position of the head entity's owners that will result or is likely to result from their participation in the scheme.

The financial position of the ABC shareholders will change because the shareholders will receive assets being ownership interests in XYZ where previously they had only an economic interest as a shareholder in ABC. Accordingly, there is a beneficial change in the financial position of the shareholders of the head entity and this change would incline toward the requisite purpose of obtaining a tax benefit.

However, this is not sufficient on its own to justify a conclusion that the requisite purpose exists, especially in light of the reasons for the demerger which suggest that the tax benefits to be obtained are merely incidental to the purpose for entering into the scheme.

Paragraph 177D(2)(f)

Paragraph 177D(2)(f) refers to the change in financial position of any person who has a connection with the relevant taxpayer. With the exception of the shareholders, there are no parties related to ABC that stand to benefit from the scheme of making the in specie distribution of XYZ shares.

It could not be said that ABC has entered this scheme for the purpose of obtaining a tax benefit in the interests of other parties.

Paragraph 177D(2)(g)

Paragraph 177D(2)(g) refers to any other consequence for the taxpayer as a result of the scheme. After considering the facts of the in specie distribution of XYZ shares, there are no other apparent consequences that would indicate that the shareholders or directors of ABC have entered the scheme for the purpose of obtaining a tax benefit.

Paragraph 177D(2)(h)

Paragraph 177D(2)(h) refers to connection between the taxpayer and any other person referred to in paragraph 177D(2)(f). This subparagraph has no relevance as there is no other entity connected to ABC that stands to obtain a tax benefit as a result of the scheme.

It is concluded, therefore, that the results achieved by the scheme, unaffected by section 45B, were not tax driven results and the requisite purpose of enabling the shareholders of ABC to 'obtain a tax benefit' is in this instance not present.

Conclusion

The question section 45B poses is not whether the demerger enables the shareholder to obtain a tax benefit but whether the demerger was entered into or carried out for a 'more than incidental purpose' of enabling the shareholder to obtain the tax benefit.

Where the demerger is a genuine business demerger, the issue for section 45B generally is whether the components of the demerger allocation as between profit and capital reflect the circumstances of the demerger.

The information provided with the application indicates that the demerger is directed at restructuring the business in the interests of business efficiency. As such, the concessionary tax treatment for the ABC shareholders is regarded as merely a natural incident of a business restructure.

Therefore, the Commissioner concludes that, in this case, enabling the shareholders to obtain a tax benefit was not a more than incidental purpose for the demerger.

Consequently, the Commissioner will not make a determination under section 45B, and therefore it follows that the Commissioner will not make a determination under subsection 45C(3) that the whole, or any part, of the demerger allocation provided to ABC shareholders under the demerger was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the demerger.

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