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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1012800173822

Ruling

Subject: Consolidation and demerger

Question 1

Will Company A and Company B be a consolidatable group pursuant to section 703-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Can Company A choose to form a tax consolidated group pursuant to section 703-50 of the ITAA 1997, with Company B as its wholly owned subsidiary?

Answer

Yes.

Question 3

Will the transfer of the Properties from Company A to Company B, after the tax consolidated group has been formed, be disregarded as an intra-group transaction pursuant to the single entity rule (SER) in section 701-1 of the ITAA 1997?

Answer

Yes.

Question 4

Will the transfer of Company A's 100% shareholding in Company B to the Shareholders satisfy the requirements for demerger roll-over relief in Division 125 of the ITAA 1997 such that the Shareholders can choose to obtain a roll-over pursuant to section 125-55 of the ITAA 1997?

Answer

Yes.

Question 5

Will any dividends paid to the Shareholders under the proposed demerger be demerger dividends that are neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 6

Will the Commissioner make a determination that section 45B of the ITAA 1936 applies to the proposed demerger?

Answer

No.

Question 7

Will the Commissioner confirm that Division 7A of the ITAA 1936 will not apply to any of the distributions to be made under the proposed demerger?

Answer

Yes.

Question 8

Will the Commissioner apply the income tax general anti-avoidance provisions in Part IVA of the ITAA 1936 to any of the tax benefits obtained under the scheme?

Answer

No.

This ruling applies for the following periods:

The start date of the private ruling will be the incorporation of Company B, and the end date of the private ruling will be the demerger.

The scheme commences on:

The incorporation of Company B.

Relevant facts and circumstances

Company A is a resident private company, whose trading operations include the manufacture, installation and repair of products.

Company A's ordinary shares are:

• A% owned by Shareholder A (who is a resident), which are all pre-CGT assets

• B% owned by Shareholder B (who is a resident), of which two-thirds are pre-CGT assets, and

• C% owned by the Shareholder C (who is a resident), of which none are pre-CGT assets.

Company A owns the two properties ('Properties'), with:

• Property 1, being where Company A's trading operations are conducted from, and

• Property 2, being leased to various commercial tenants.

Company A has consistently paid fully franked dividends for every income year and up to 31 December 2014, and has a franking account balance to continue paying fully franked dividends in this manner.

As at 31 December 2014, the total equity disclosed in Company A's financial statements was split between Y% share capital and Z% retained profits.

Company A proposes to undertake a corporate restructure, which will involve the following:

• The establishment of a private company ('Company B'), to which Company A will subscribe to all of the ordinary shares, meaning that Company B will be a wholly-owned subsidiary of Company A.

• The formation of a tax consolidated group comprising of Company A and Company B.

• The transfer of the Properties from Company A to Company B at their respective market values.

• Company A demerging 100% of its ordinary shares in Company B to Shareholder A, Shareholder B and Shareholder C (collectively, the 'Shareholders').

Under the proposed demerger, the Shareholders will:

• receive an in-specie distribution of all the ordinary shares in Company B in the same proportion as the ordinary shares they hold in Company A, via Company A disposing its shareholding in Company B

• receive a return of share capital from Company A, which will be Y% of the total market value of the Properties multiplied by their respective shareholding percentage in Company A

• receive a demerger dividend from Company A, which will be Z% of the total market value of the Properties multiplied by their respective shareholding percentage in Company A

• each compulsorily apply the demerger allocation (i.e. return of share capital plus demerger dividend) to acquire the same proportion of new interests in Company B as they each held in Company A before the demerger, and

• maintain the same proportionate market value of ownership interests in Company A and Company B as they had each in Company A before the demerger.

Accounting for the proposed demerger will be completed in the following manner:

• The demerger dividends will be debited to the retained profits of Company A.

• The returns of share capital will be debited to the share capital account of Company b.

The corporate restructure is required for the following reasons:

• To maximise enterprise value by separating the Properties from Company A's trading operations

• For asset protection purposes, as the Shareholders wish to move the Properties from Company into a separate entity (being Company B).

Following the demerger, Company B will lease the Properties and collect rent. More specifically, Company B's activities in this regard will be as follows:

• Company A will pay Company B market value rent for the lease of Property 1 under a long term lease agreement.

• Company B will take over the long term lease agreements from Company A and collect the rent from the various commercial tenants who are leasing Property 2.

• Company B will collect the rents from the Properties on a regular and frequent basis, and they will exceed the expenses incurred.

• Property 2 will be managed by a commercial leasing agent, with approval required from the directors of Company B on any proposed lease agreements as well as any repairs or improvements.

• Property 1 will be managed by the directors of Company B using the systems the commercial leasing agent has in place for Property 2 as a guide.

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(3)

Income Tax Assessment Act 1936 Subsection 44(4)

Income Tax Assessment Act 1936 Subsection 44(5)

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(4)

Income Tax Assessment Act 1936 Paragraph 45B(4)(a)

Income Tax Assessment Act 1936 Subsection 45B(5)

Income Tax Assessment Act 1936 Paragraph 45B(5)(b)

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)(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 109C

Income Tax Assessment Act 1936 Subsection 109L(1)

Income Tax Assessment Act 1936 Subsection 109L(2)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Paragraph 177D(2)(a)

Income Tax Assessment Act 1936 Paragraph 177D(2)(b)

Income Tax Assessment Act 1936 Paragraph 177D(2)(c)

Income Tax Assessment Act 1936 Paragraph 177D(2)(d)

Income Tax Assessment Act 1936 Paragraph 177D(2)(e)

Income Tax Assessment Act 1936 Paragraph 177D(2)(f)

Income Tax Assessment Act 1936 Paragraph 177D(2)(g)

Income Tax Assessment Act 1936 Paragraph 177D(2)(h)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-135

Income Tax Assessment Act 1997 Division 125

Income Tax Assessment Act 1997 Section 125-1

Income Tax Assessment Act 1997 Subdivision 125-B

Income Tax Assessment Act 1997 Section 125-55

Income Tax Assessment Act 1997 Subsection 125-55(1)

Income Tax Assessment Act 1997 Subsection 125-60(1)

Income Tax Assessment Act 1997 Subsection 125-65(1)

Income Tax Assessment Act 1997 Subsection 125-65(3)

Income Tax Assessment Act 1997 Subsection 125-65(6)

Income Tax Assessment Act 1997 Subsection 125-70(1)

Income Tax Assessment Act 1997 Subsection 125-70(2)

Income Tax Assessment Act 1997 Subsection 125-70(6)

Income Tax Assessment Act 1997 Section 701-1

Income Tax Assessment Act 1997 Section 701-1(2)

Income Tax Assessment Act 1997 Section 701-1(3)

Income Tax Assessment Act 1997 Section 703-10

Income Tax Assessment Act 1997 Subsection 703-10(1)

Income Tax Assessment Act 1997 Subsection 703-15(2)

Income Tax Assessment Act 1997 Section 703-50

Income Tax Assessment Act 1997 Subsection 703-50(1)

Income Tax Assessment Act 1997 Section 960-135

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Question 1

Summary

Company A and Company B will be a consolidatable group pursuant to section 703-10 of the ITAA 1997.

Detailed reasoning

Subsection 703-10(1) of the ITAA 1997 states that a consolidatable group consists of a single head company and all of the subsidiary members of the group.

Company A will be the head company pursuant to item 1 of the table in subsection 703-15(2) of the ITAA 1997, because:

• it is a private company that has all of its taxable income taxed at the corporate tax rate of 30%

• it is a resident private company, and

• it is not a wholly-owned subsidiary of another entity pursuant to subsection 703-30(1), as not all of its ordinary shares (which will meet the membership interest definition in section 960-135 of the ITAA 1997) are held by the one entity.

Company B will be the subsidiary member pursuant to item 2 of the table in subsection 703-15(2) of the ITAA 1997, because:

• it will be a private company that has all of its taxable income taxed at the corporate tax rate of 30%, and will not be a non-profit company

• it will be a resident private company, and

• it will be a wholly-owned subsidiary of the head company Company A, as all of its ordinary shares (which will meet the membership interest definition in section 960-135 of the ITAA 1997) will be owned by Company A.

Question 2

Summary

Company a can choose to form a tax consolidated group pursuant to section 703-50 of the ITAA 1997, with Company B as its wholly owned subsidiary.

Detailed reasoning

Subsection 703-50(1) of the ITAA 1997 states that a company may make a choice in writing that a consolidatable group is taken to be consolidated on and after a day that is specified in the choice and is after 30 June 2002, if the company was the head company of the group on the day specified.

All of the requirements of this provision will be met, because:

• there will be a consolidatable group, consisting of Company A and Company B

• Company A can make the choice, as it will be the head company of that consolidatable group, and

• the choice will be made after 30 June 2002.

Question 3

Summary

The transfer of the Properties from Company A to Company B, after the tax consolidated group has been formed, will be disregarded as an intra-group transaction pursuant to the single entity rule (SER) in section 701-1 of the ITAA 1997.

Detailed reasoning

The SER in section 701-1 of the ITAA 1997 operates for the core purposes set out in subsections 701-1(2) and 701-1(3) of the ITAA 1997, to work out the amount of the head company and subsidiary member's liability for income tax and the amount of a loss for a relevant period. They include all matters relevant and incidental to those calculations. The intended operation of the SER is to apply the income tax laws to consolidated group as if it were a single entity.

The Commissioner's view on the consequences of the SER are provided in paragraphs 7, 8 and 9 of Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997:

The transfer of each of the Properties from Company A to Company B will result in CGT event A1 under section 104-10 of the ITAA 1997 happening, and Company A will make capital gains from each of these CGT events.

However, as both Company A and Company B will be members of the consolidated group, the SER will operate to disregard both of these capital gains, as they arose from intra-group dealings between these two private companies.

Question 4

Summary

The transfer of Company A's 100% shareholding in Company B to the Shareholders will satisfy the requirements for demerger roll-over relief in Division 125 of the ITAA 1997 such that the Shareholders can choose to obtain a roll-over pursuant to section 125-55 of the ITAA 1997.

Detailed reasoning

Section 125-1 of the ITAA 1997 provides that the Shareholders can obtain a roll-over to defer CGT consequences for the CGT events that happen to their Company A shareholdings under a demerger, subject to the requirements of Subdivision 125-B of the ITAA 1997.

Subsection 125-55(1) of the ITAA 1997 states that the Shareholders can choose to obtain a roll-over if:

(a) they own an ownership interest in a company

(b) the company is the head entity of a demerger group

(c) a demerger happens to the demerger group, and

(d) under the demerger, a CGT event happens to their ownership interest and they acquire a new ownership interest in the demerged entity.

They own an ownership interest in a company

Subsection 125-60(1) of the ITAA 1997 states than an ownership interest in a company includes a share in the company.

As each of the Shareholders own ordinary shares in Company A, they therefore each own an ownership interest in Company B.

The company is the head entity of a demerger group

Subsection 125-65(1) of the ITAA 1997 states that a demerger group comprises the head entity of the group and one or more demerger subsidiaries.

Under subsection 125-65(3) of the ITAA 1997 Company A will be the head entity of the demerger group, as Company B will not own ordinary shares in Company A.

Under subsection 125-65(6) of the ITAA 1997 Company B will be a demerger subsidiary of Company A, as Company A will own 100% of the ordinary shares in Company B, which is more than the required 20%.

A demerger happens to the demerger group

Under subsection 125-70(1) of the ITAA 1997 a demerger will happen to the demerger group comprising of Company A and Company B, because:

(a) there will be a restructuring of the demerger group

(b) under the restructuring, Company A will dispose of its 100% ownership interest in Company B to the Shareholders

(c) under the restructuring, CGT event G1 under section 104-135 of the ITAA 1997 will happen due to Company A paying to the Shareholders returns of share capital, which along with the demerger dividends (making up the demerger allocations) will then be compulsorily applied by the Shareholders to acquire new ownership interests in Company B

(d) the acquisition by the Shareholders of the new ownership interests in Company B will happen only because they own the original ownership interests in Company A

(e) the new ownership interests in Company B acquired by the Shareholders will be ordinary shares

(g) neither the Shareholder's original ownership interests in Company A or new ownership interests in Company B will be in a trust that is a non-complying superannuation fund, and

(h) the requirements of subsection 125-70(2) of the ITAA 1997 will be met, because of the following:

Under the demerger, a CGT event happens to their ownership interest and they acquire a new ownership interest in the demerged entity

Company B will be a demerged entity under subsection 125-70(6) of the ITAA 1997, as it will be a former member of a demerger group (which also consisted of Company A as the head entity) resulting from a demerger in which its ownership interests will be acquired by the Shareholders.

As stated earlier, CGT event G1 under section 104-135 will happen to the Shareholders' interests in Company A due to each being paid a return of share capital, and the Shareholders will each compulsorily apply both the return of share capital and the demerger dividend (i.e. the demerger allocation) to acquire a new ownership interest (i.e. ordinary shares) in Company B.

Question 5

Summary

Any dividends paid to the Shareholders under the proposed demerger will not be demerger dividends that are neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Detailed reasoning

Provided that the dividends paid to the Shareholders under the proposed demerger are demerger dividends as defined in subsection 6(1) of the ITAA 1936, and the Properties are used in a business carried on by Company B just after the demerger as required in subsection 44(5) of the ITAA 1936:

• subsection 44(3) of the ITAA 1936 will apply to treat the dividends as if they had not been paid out of Company A's retained profits, and

• subsection 44(4) of the ITAA 1936 will apply to treat the dividends as neither assessable income nor exempt income.

The dividends paid to the Shareholders will be demerger dividends as defined by subsection 6(1) of the ITAA 1936, because:

• they will be part of a demerger allocation under subsection 6(1) of the ITAA 1936, in that they will be part of the total market value of the allocation (i.e. the other part being the return of share capital) represented by the Company B shares disposed by Company A to the Shareholders, and

• they will be assessable income of the Shareholders under subsection 44(1) of the ITAA 1936 as they will be paid by Company A out of its retained profits.

Just after the demerger, Company B's activities will comprise the leasing of the Properties and the collection of rent.

Whilst the Commissioner acknowledges that generally the Australian courts have agreed that the presumption below discussed by Lord Diplock in American Leaf Blending Co Sdn Bhd v. Director-General of Inland Revenue [1978] 3 All ER 1185 (American Leaf Blending Co) applies in Australian cases, not everything a that a company does amounts to the carrying on of a business.

In other words, the fact that a taxpayer will be a company is not of itself determinative of there being a business carried on.

Therefore, in order for the Commissioner to gain an overall general impression, and be satisfied, that Company B will be carrying on a business (as defined in subsection 995-1(1) of the ITAA 1997) with respect to the rent it will collect for the Properties just after the demerger, each of the general indicators will need to be considered.

The general indicators that are favourable to Company B carrying on a business just after the demerger are as follows:

• Whether there is a purpose of profit as well as a prospect of profit from the activity - Company B will make significant profits from these activities from the outset.

• The size, scale and permanency of the activity - Both Properties will be subject to long term leases, and were owned by Company A prior to the demerger for a long period of time.

• Whether the activity is better described as a hobby, a form of recreation or a sporting activity - Company B's activities will in no way be described in this manner.

However, the Commissioner considers that Company B's planned use of a commercial leasing agent to manage Property 2 (and its various commercial tenants) results in the following remaining general indicators being unfavourable to Company B carrying on a business just after the demerger:

• Whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators.

• Whether there is more than just an intention to engage in business.

• Whether there is repetition and regularity of the activity.

• Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business.

• Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit.

Please note that the Commissioner is not saying that a taxpayer's use of an agent to undertake the activities on their behalf automatically means that they are not carrying a business.

In Ferguson v. Federal Commissioner of Taxation 79 ATC 4261; (1979) 9 ATR 873; (1979) 37 FLR 310 (Ferguson) and Federal Commissioner of Taxation v. JR Walker 85 ATC 4179; (1985) 16 ATR 331; (1985) 79 FLR 161 (Walker), the courts accepted that a person can still be carrying on a business notwithstanding that they used an expert manager to handle the day to day running of the business.

In contrast to Company B's activities of leasing the Properties, both Ferguson and Walker were concerned with primary production activities.

The following cases specific to the letting of properties indicate that the passive receipt of rent in itself is not sufficient for a business to be considered to be carried on, regardless of the number of properties let:

• In Federal Commissioner of Taxation v. McDonald 87 ATC 4541; (1987) 18 ATR 957, the taxpayer purchased several income producing properties with his wife, which were subsequently let through letting agents. Beaumont J indicated (quoting Wertman v. Minister of National Revenue 64 DTC 5158) that for a business to be carried on by owners of property, one would expect that they would be involved in providing services in addition to the process of letting property (as with a boarding house), not merely receiving payments for the tenants' occupation of the property.

• Furthermore, in Cripps v. Federal Commissioner of Taxation 99 ATC 2428; (1999) 43 ATR 1202, the taxpayers (being a husband and wife) were held not to be carrying on a business despite the fact that they jointly owned 14 double storey townhouses and periodically rented out two houses. The Administrative Appeals Tribunal noted that, due to the 14 townhouses being managed by an agent, the activity involved little, if any, active participation from the taxpayers and concluded that they were unlikely to have been any more involved that a concerned and interested absentee landlord.

• Whereas, in Case G10 75 ATC 33; (1974) 19 CTBR (NS) Case 103, the taxpayer, who was letting out several holiday flats for short term rental, was held to be carrying on a business as he was actively engaged personally from day to day in multifarious activities directed to the profitable operation of his income producing holiday flats, as opposed to simply owning the flats to bring him income vicariously through a letting agent.

Whilst it is acknowledged that the above taxpayers in these cases were individuals and not companies, Lord Diplock did observe that the taxpayer in American Leaf Blending Co had negotiated with different tenants (and not an agent on its behalf) and that there had been three successive tenants in the five years in question.

Finally, it must be highlighted that the above unfavourable analysis of Company B's prospective activities is no way an attempt to dictate how it should engage in those activities as referred to in the High Court decision in Tweddle v. Federal Commissioner of Taxation (1942) 180 CLR 1; (1942) 7 ATD 186; 2 AITR 360, but is instead a concerted effort to form the required objective view of those activities.

Based on the above unfavourable analysis of Company B's prospective activities, the Commissioner is therefore of the view that Company B will not be carrying on a business just after the demerger, meaning that the qualification in subsection 44(5) of the ITAA 1936 will apply so that the demerger dividends paid to the Shareholders will be included in their assessable incomes under subsection 44(1) of the ITAA 1936.

Question 6

Summary

The Commissioner will not make a determination that section 45B of the ITAA 1936 applies to the proposed demerger.

Detailed reasoning

With respect to demergers, subsection 45B(1) of the ITAA 1936 there are two purposes of section 45B of the ITAA 1936.

(a) The first purpose is concerned with ensuring that the dividend exemption provided for in subsections 44(3) and 44(4) of the ITAA 1936 is available only in genuine demergers, and that the components of a demerger allocation provided to the head entity shareholders under a demerger - as between capital and profit - reflect the circumstances of the demerger.

(b) The second purpose is to ensure relevant amounts are treated as dividends for taxation purposes where certain capital distributions are made to shareholders in substitution of dividends.

However, since the qualification in subsection 44(5) of the ITAA 1936 will apply so that the demerger dividends paid to the Shareholders will be included in their assessable incomes under subsection 44(1) of the ITAA 1936, only the second purpose of section 45B of the ITAA 1936 will need to be considered.

Subsection 45B(2) of the ITAA 1936 sets out the requirements for section 45B of the ITAA 1936 to apply. These requirements are that:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936)

(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 (paragraph 45B(2)(b) of the ITAA 1936), 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 (paragraph 45B(2)(c) of the ITAA 1936).

Each of these requirements is considered below.

A scheme

Subsection 45B(10) of the ITAA 1936 states that for the purposes of section 45B of the ITAA 1936, 'scheme' has the meaning given by subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997), which defines it to mean any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The arrangement involving Company A and Company B forming a tax consolidated group, the transfer of the Properties from Company A to Company B and then Company A demerging 100% of its ordinary shares in Company B to the Shareholders, is a scheme for the purposes of section 45B of the ITAA 1936.

Demerger benefit and capital benefit

The phrase 'provided with a demerger benefit' is defined in subsection 45B(4) of the ITAA 1936 to include, at paragraph (a), the provision of an ownership interest in a company.

With Company A disposing of its 100% ownership interest in Company B to the Shareholders, this means that the Shareholders will each be provided with a demerger benefit under paragraph 45B(4)(a) of the ITAA 1936.

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the 1936, and paragraph (b) includes a distribution by a company to a person of share capital.

With each of the Shareholders receiving a return of share capital from Company A, this means that each of the Shareholders will also be provided with a capital benefit under paragraph 45B(5)(b) of the ITAA 1936.

Tax benefit

Each of the Shareholders 'obtains a tax benefit', as defined in subsection 45B(9) of the ITAA 1936, if:

• the amount of tax payable, or

• any other amount payable under the ITAA 1936 or the ITAA 1997,

• be less than the amount that would have been payable, or

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

if the demerger benefit and capital benefit had been an assessable dividend.

But for section 45B of the ITAA 1936, the amount of tax payable by each of the Shareholders from the proposed demerger will be less than the amounts that would have been payable if the demerger benefits and capital benefits had been assessable fully franked dividends.

More specifically, due to a return of share capital being excluded from being defined as a dividend via paragraph (d) of the definition of that term in subsection 6(1) of the ITAA 1936, the Shareholders are not subject to tax on their capital benefits.

Therefore, the Shareholders will obtain a tax benefit under subsection 45(9) of the ITAA 1936.

A more than incidental purpose of enabling a taxpayer to obtain a tax benefit

Under paragraph 45B(2)(c) of the ITAA 1936, the purpose of the person, or one of the persons, who entered into or carried out the scheme, or any part of the scheme, is determined having regard to the 'relevant circumstances of the scheme'. Subsection 45B(8) of the ITAA 1936 provides a (non-exhaustive) list of the relevant circumstances.

In this case the persons will be the Shareholders and Company A's directors.

The test of purpose is an objective one. The question is whether 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 the purpose of enabling a taxpayer to obtain a tax benefit. The requisite purpose need not be the dominant purpose, but it must be more than an incidental purpose.

The relevant circumstances of the scheme in the present case are discussed below (insofar as they are relevant).

Paragraph 45B(8)(a) of the ITAA 1936

Paragraph 45B(8)(a) of the ITAA 1936 directs attention to the composition, as between share capital and profits (realised and unrealised), of the demerger benefit provided to the head entity's owners.

As at 31 December 2014, the total equity disclosed in Company A's financial statements was split between Y% share capital and Z% retained profits.

Upon the transfer of the Properties from Company A to Company B, the composition of the demerger benefits provided to each of the Shareholders will be in accordance with this split between share capital and profits.

This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(b) of the ITAA 1936

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distribution of dividends, bonus shares and returns of capital or share premium. The inference here is that an interruption to the normal pattern of profit distribution and its replacement with a demerger benefit and capital benefit would suggest dividend substitution.

Company A has consistently paid fully franked dividends for every income year and up to 31 December 2014.

Furthermore, after the demerger, Company A will have sufficient retained profits and a sufficient franking account balance to enable fully franked dividends to be paid to the Shareholders in future income years.

This circumstance points away from the requisite purpose in paragraph 45(2)(c) of the ITAA 1936.

Paragraph 45B(8)(c) of the ITAA 1936

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

This indicator will be of no relevance as no capital gains will be produced as a result of the demerger due to CGT rollovers in Division 125 of the ITAA 1997.

This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(d) of the ITAA 1936

Paragraph 45B(8)(d) of the ITAA 1936 refers to whether some or all of the ownership interests in the company held by the relevant taxpayer were acquired, or taken to have been acquired, by the relevant taxpayer before 20 September 1985.

The decision to deliver ownership interests under a demerger could be influenced by owners to the head entity receiving new pre-CGT interests in the demerged entity, and

Of the Shareholders:

• all of Shareholder A's ownership interest in Company A is a pre-CGT ownership interest

• two-thirds of Shareholder B's ownership interest in Company A is a pre-CGT ownership interest.

• none of Shareholder C's ownership interest in Company A is a pre-CGT ownership interest.

This circumstance neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(e) of the ITAA 1936

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

Each of the Shareholders are resident taxpayers.

This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(f) of the ITAA 1936

Paragraph 45B(8)(f) of the ITAA 1936 refers to whether the cost base of the relevant ownership interest is not substantially less than the value of the applicable capital component of the demerger benefit or the capital benefit.

Where the cost base of the relevant ownership interest is less than the applicable capital component of the demerger benefit, there is an opportunity to obtain a distribution under a demerger that is subject to the CGT rollover in Division 125 of the ITAA 1997, which, but for the concession, would result in a capital gain under CGT event G1 in section 104-135 of the ITAA 1997

Upon the transfer of the Properties from Company A to Company B, each of the Shareholders' cost bases of their Company A ownership interests will be less than the returns of share capital paid to them under the demerger.

This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(h) of the ITAA 1936

Paragraph 45B(8)(h) of the ITAA 1936 refers to 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.

Upon the transfer of the Properties from Company A to Company B, the demerger benefits paid to the Shareholders will be comprised of Y% returns of share capital and Z% demerger dividends.

Whilst the Shareholders will each still retain their respective ownership interests in Company A, it will be immaterial if the demerger benefits were paid entirely from Company A's profits as fully franked dividends, due to the demerger dividends being included in their assessable incomes under subsection 44(1) of the ITAA 1936 and the returns of share capital being of such small amounts.

This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(i) of the ITAA 1936

Paragraph 45B(8)(i) of the ITAA 1936 directs attention to those cases where the demerger involves the provision 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.

From the facts provided, no indication has been given that the Shareholders will look to dispose of their ownership interests in Company B in the near future.

This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(j) of the ITAA 1936

Paragraph 45B(8)(j) of the ITAA 1936 requires that regard be had to whether the profits and assets of the demerging entity (which under subsection 125-70(7) of the ITAA 1997 will be the head entity where the demerger group contains only a head entity and a demerger subsidiary) are attributable to or acquired under transactions with associated entities (within the meaning of section 318 of the ITAA 1936). The premise being that the demerger is being used to deliver assets or profits tax free to the head entity's owners in the form of an ownership interest.

Whilst some of the ordinary shares in Company A are held by its associates, the demerger dividends (which are the majority of the demerger allocations) paid to the Shareholders will be included in their assessable incomes under subsection 44(1) of the ITAA 1936.

This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(k) of the ITAA 1936

Paragraph 45B(8)(k) of the ITAA 1936 refers to the Part IVA matters in paragraphs 177D(2)(a) to 177D(2)(h) of the ITAA 1936 (formerly subparagraphs 177D(b)(i) to 177D(b)(viii) of the ITAA 1936).

Paragraph 177D(2)(a) of the ITAA 1936

This matter refers to the manner in which the scheme was entered into and carried out. In effect, an inquiry into the manner of a scheme is an objective inquiry into the reasons a taxpayer had for entering into it.

The reasons for the demerger being entered into, which will result in the demerger benefits and capital benefits being provided to the Shareholders, is for the proposed restructure that will result:

• enterprise value being maximised, and

• asset protection for the Properties from any potential risk from Company A's trading operations.

This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 177D(2)(b) of the ITAA 1936

This matter looks to the form and substance of the scheme.

The legal form of the scheme will be a demerger, which will result in the Shareholders receiving ownership interests in Company B that are in the same proportion to their ownership interests in Company A, as well as demerger and capital benefits being provided to them.

Whilst the Shareholders will obtain tax benefits as a result of the demerger, in the form of returns of share capital and the CGT rollovers Division 125 of the ITAA 1997, these tax benefits are legislative outcomes of the proposed restructure for whose purpose the demerger was entered into (i.e. the substance of the scheme).

This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 177D(2)(c) of the ITAA 1936

This matter refers to the time at which the scheme was entered into and the length of the period during which the scheme was carried out. In particular, it enables consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or is related to commercial opportunities or requirements.

Unless the relevant laws change, then the timing and duration of the scheme will have no influence on the demerger achieving the proposed restructure and providing the tax benefits to the Shareholders.

This matter points neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 177D(2)(d) of the ITAA 1936

This matter refers to the result the scheme would achieve under the ITAA 1936 and the ITAA 1997 but for the application of section 45B of the ITAA 1936.

But for section 45B of the ITAA 1936 the returns of share capital will not be dividends as defined in subsection 6(1) of the ITAA 1936, and therefore will not be assessable income for the Shareholders under subsection 44(1) of the ITAA 1936.

In other words, but for section 45B of the ITAA 1936, the demerger benefits and capital benefits will be preferable to a fully franked dividend (i.e. less tax payable) for the Shareholders.

This matter points toward the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 177D(2)(e) of the ITAA 1936

This matter refers to any change in the financial position of the relevant taxpayer.

Whilst the Shareholders will be provided with ownership interests in Company B as a result of the demerger, there will in effect be no change in respective financial positions due to each of them having an indirect ownership interest in Company B before the demerger via their ownership interests in Company A.

This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 177D(2)(f) of the ITAA 1936

This matter refers to the change in the financial position of any person connected with the relevant taxpayer.

There will be no change in the financial position of any person connected with the Shareholders, because the demerger group only consisted of Company A and Company B, meaning that there were no other entities of which persons (outside of the Shareholders) could have effected ownership interests.

This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 177D(2)(g) of the ITAA 1936

This matter requires consideration of any other consequences of the scheme for the relevant taxpayer or any person connected with the relevant taxpayer. The other consequences of the scheme would be consequences of the demerger and not of something that has occurred post-demerger, and generally will include the sorts of changes of a non-financial nature that might occur in, and be consistent with, a business restructure.

The other consequence of the demerger for the Shareholders will be:

• enterprise value being maximised, and

• asset protection for the Properties from any potential risk from Company A's trading operations.

This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 177D(2)(h) of the ITAA 1936

This matter looks to the nature of any connection between the relevant taxpayer and any other person connected with the relevant taxpayer referred to in paragraph 177D(2)(f) of the ITAA 1936.

Whilst the demerger and capital benefits provided by the demerger will result in the tax benefits being obtained by the Shareholders (i.e. the returns of share capital that will not be included in their assessable incomes under subsection 44(1) of the ITAA 1936), the demerger is influenced by the need to achieve the proposed restructure, not because of any family, business or other connection.

This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936.

Conclusion on purpose under paragraph 45B(2)(c) of the ITAA 1936

Having regard to the relevant circumstances of the demerger, it is concluded that the Shareholders and Company a's directors:

• will be entering into or carrying out the demerger, or any part of the demerger, for the primary purpose of implementing the proposed restructure, and

• will not be entering into or carrying out the demerger, or any part of the demerger, for a more than incidental purpose of enabling the Shareholders to obtain a tax benefit.

Question 7

Summary

Division 7A of the ITAA 1936 will not apply to any of the distributions to be made under the proposed demerger.

Detailed reasoning

In accordance with subsection 109L(1) of the ITAA 1936, Company A will not be taken under section 109C of the ITAA 1936 to pay dividends to the Shareholders with respect to the demerger dividends, as they will be included in the Shareholders' assessable incomes under subsection 44(1) of the ITAA 1936, due to the exemptions in subsections 44(3) and 44(4) of the ITAA 1936 not applying.

In accordance with subsection 109L(2) of the ITAA 1936, Company A will not be taken under section 109C of the ITAA 1936 to pay dividends to the Shareholders with respect to the returns of share capital, as they will not be included in the Shareholders' assessable incomes under subsection 44(1) as they are excluded from being defined as a dividend via paragraph (d) of the definition of that term in subsection 6(1) of the ITAA 1936.

Question 8

Summary

The Commissioner will not apply the income tax general anti-avoidance provisions in Part IVA of the ITAA 1936 to the tax benefits obtained by Company A from the disregarded capital gains from the transfer of the Properties to Company B.

Detailed reasoning

As the Commissioner has already considered the eight matters in subsection 177D(2) of the ITAA 1936 to determine that each of the Shareholders will not have a more than incidental purpose to obtain the tax benefits from the capital benefits provided by the demerger for the purposes of section 45B of the ITAA 1936, he is satisfied that each of the Shareholders will not have a dominant purpose to obtain those tax benefits for purposes of the general anti-avoidance provisions of Part IVA of the ITAA 1936.

With respect to the tax benefits obtained by Company A from the disregarded capital gains from the transfer of the Properties to Company B, the Commissioner does accept the practice of a head company forming a tax consolidated group just before a demerger in the course of restructuring a corporate group. This is because prior to the introduction of the income tax consolidation rules, this same outcome (i.e. the disregarding of the capital gains) could have been achieved by claiming roll-over relief under section 160ZZO of the ITAA 1936 (which was repealed on 1 July 1998) or Subdivision 126-B of the ITAA 1997 (which was amended on 24 October 2002 so that the recipient company could only be a foreign resident).

In other words, the Commissioner accepts that Company A will not have a dominant purpose of forming a tax consolidated group with Company B prior to the demerger to obtain those tax benefits, as required by section 177D of the ITAA 1936.

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