Disclaimer
This edited version has been archived due to the length of time since original publication.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: 1013041832552

Date of advice: 28 June 2016

Ruling

Subject: Demerger

Question 1

Can the Company X shareholders choose to obtain roll-over relief under Subdivision 125-B of the Income Tax Assessment Act 1997 (ITAA 1997) upon the demerger of Company Y by Company X?

Answer

Yes

Question 2

Can Company X disregard under section 125-155 of the ITAA 1997 any capital gain or capital loss arising from CGT event A1 happening to its ownership interests in Company Y upon the demerger of Company Y by Company X?

Answer

Yes

Question 3

Will the Commissioner confirm that all or any part of the distribution of Company Y shares to Company X shareholders that is a dividend will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 4

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or 45C of the ITAA 1936 applies to the whole, or a part, of any demerger benefit or capital benefit provided under the proposed demerger?

Answer

No

This ruling applies for the following period:

Income year ended 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

Background

Company X

Company X is an Australian private company.

Company X's combined business operations fall under two broad product offerings.

Company has fully paid ordinary shares on issue which are held by two Australian resident trusts.

There have been no previous distributions of share capital.

Company X is the head company of a tax consolidated group.

Company X does not have a formal dividend policy in place. However dividends are paid yearly on an ad-hoc basis, subject to available profits and working capital needs of the business.

Company Y

Company Y is an Australian private company. Company Y has fully paid ordinary shares on issue.

There have been no previous distributions of share capital.

Historically, dividends have been paid annually from operating profits of Company Y.

Reasons for the demerger

The restructure of the group, by a demerger is being undertaken for the following reasons:

Enhanced brand performance

If the businesses are demerged and proceed to standalone, it will allow Company Y to operate with authenticity within its own market. The separation of the Company Y brand from the Company X brand is crucial to achieving this core objective, and is fundamental to the long term viability of the business.

Business efficiencies

The separation of Company Y from Company X to result in a number of business efficiencies, including:

As part of improving in these areas Company Y has appointed an executive officer and full time sales staff. It is proposed to allocate staff and management to separate activities. It is considered that this should allow a more focused approach to each separate business and to reduce instances where management and staff have conflicting priorities.

Funding decisions

As it currently stands, Company Y is impacted by funding decisions made by Company X. For this reason it is beneficial to move Company Y outside the existing Company X group. Where Company Y looks to obtain financing for its operations, it can do so independently from Company X.

The demerger

Company X will demerge all its interest in Company Y to Company X shareholders in proportion to their current shareholding.

Other matters

There are no employee shares schemes in place or proposed to be in place as a result of the proposed demerger.

There is no intention that Company X shareholders will dispose of the shares in Company Y following the demerger taking place.

The share capital account of Company X is not tainted within the meaning of Division 197 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45BA

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 Division 125

Income Tax Assessment Act 1997 subdivision 125-B

Income Tax Assessment Act 1997 section 125-55

Income Tax Assessment Act 1997 section 125-65

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 section 125-155

Reasons for decision

Question 1

Summary

The Company X shareholders can choose to obtain roll-over relief under Subdivision 125-B of the ITAA 1997 upon the demerger of Company Y by Company X.

Detailed reasoning

In order for the demerger CGT outcomes contained in Division 125 of the ITAA 1997 to apply to a company or trust, a number of defined terms must be satisfied, including:

Demerger Group

A demerger group comprises one head entity and at least one demerger subsidiary (subsection 125-65(1) of the ITAA 1997). The demerger group in this case comprises Company X as the head entity and includes Company Y as a demerger subsidiary.

Company X will be the head entity because:

Company Y will be a demerger subsidiary of Company X because Company X owns ownership interests in Company Y that carry more than 20% of the rights to any distribution of income and capital, and the right to exercise more than 20% of the voting power of Company Y (subsection 125-65(6) of the ITAA 1997).

Demerger

Subsection 125-70(1) of the ITAA 1997 describes when a demerger happens. A demerger will happen to the Company X demerger group because:

Company Y is the demerged entity 

Relevantly, subsection 125-70(6) of the ITAA 1997 defines a demerged entity to be a former member of a demerger group in which ownership interests are acquired by shareholders of the head entity under a demerger.

In the present circumstances, Company Y is the demerged entity since the Company X shareholders receive shares in Company Y under a demerger.

Company X is the demerging entity

Relevantly, subsection 125-70(7) of the ITAA 1997 defines a demerging entity to be a member of a demerger group who disposes of at least 80% of its total ownership interests in another member of the demerger group to owners of original interests in the head entity under a demerger.

In the present circumstances, Company X is the demerging entity since it disposes of 100% of its shares in Company Y to the Company X shareholders under a demerger.

Can the Company X shareholders choose demerger rollover?

Subsection 125-55(1) of the ITAA 1997 relevantly provides that demerger rollover may be chosen if:

Therefore Company X shareholders will be eligible to choose rollover under subsection 125-55(1) of the ITAA 1997.

Question 2

Summary

Company X can disregard under section 125-155 of the ITAA 1997 any capital gain or capital loss arising from CGT event A1 happening to its ownership interests in Company Y upon the demerger of Company Y by Company X.

Detailed reasoning

Section 125-155 of the ITAA 1997 provides that a demerging entity may ignore capital gains or capital losses arising from certain CGT events (including CGT event A1) happening to its ownership interests in a demerged entity under a demerger.

In the present case:

Therefore, any capital gain or loss under CGT event A1 made by Company X on the disposal of its Company Y shares under the demerger will be disregarded (section 125-155 of the ITAA 1997).

Question 3

Summary

All or any part of the distribution of Company Y shares to Company X shareholders that is a dividend will constitute a demerger dividend, and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Detailed reasoning

Is a dividend paid under the demerger?

Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income a dividend, as defined in subsection 6(1) of the ITAA 1936, paid to a shareholder out of company profits.

Capital reduction amount

The definition of a dividend in subsection 6(1) of the ITAA 1936 excludes amounts debited against an amount standing to the credit of the share capital account of the company (paragraph (d) of the subsection 6(1) of the ITAA 1936 definition of a dividend).

As the capital reduction amount will be debited against an amount standing to the credit of the share capital account (as that term is defined in subsection 6(1) of the ITAA 1936) of Company X it will not be a dividend, as defined in subsection 6(1).

Therefore, the capital reduction amount will not be assessable income of the shareholders of Company X for the purposes of subsection 44(1) of the ITAA 1936.

Dividend

The definition of a dividend includes any amount distributed or credited by a company to any of its shareholders. Therefore, the distribution of the Company Y shares will, in part, constitute a dividend of the Company X shareholders. The total amount of the dividend will be the market value of the Company Y shares at the time of the demerger excluding the amount debited to the share capital account of Company X.

In general, a dividend satisfied by a distribution of property (such as shares in a subsidiary) will be a dividend paid out of profits derived if, immediately after the distribution of that property, the market value of the assets of the company exceed the total amount (as shown in the company's books of account) of its liabilities and share capital (see paragraph 8 of Taxation Ruling TR 2003/8).

However, a demerger dividend is taken not to have been paid out of profits and is neither an assessable income nor an exempt income amount (subsections 44(3) and (4) of the ITAA 1936) where:

In the present circumstances, the dividend paid to the Company X shareholders under the demerger would satisfy the conditions necessary to be a demerger dividend and would therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Question 4

Summary

The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C will apply to the whole, or any part, of any benefit provided to the Company X shareholders under the proposed arrangement.

Detailed reasoning

Subsection 45B(1) of the ITAA 1936 provides that the purpose of section 45B is to ensure that relevant amounts are treated as 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.

Subsection 45B(2) of the ITAA 1936 sets out the conditions that must be met in order for section 45B to apply. Relevantly, this section applies if:

Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) empowers the Commissioner to make a determination under either or both of section 45BA in relation to a demerger benefit and section 45C in relation to a capital benefit.

The effect of a determination made under paragraph 45B(3)(a) of the ITAA 1936 is that part or all of a demerger benefit will be treated as not being a demerger dividend (subsection 45BA(1) of the ITAA 1936).

The effect of a determination made under paragraph 45B(3)(b) of the ITAA 1936 is that part or all of a capital benefit will be an unfranked dividend paid to the relevant taxpayer out of profits (subsections 45C(1) and (2) of the ITAA 1936).

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.

In the present circumstances, the transfer of shares in Company Y to the Company X shareholders under the demerger constitutes the relevant scheme for the purposes of section 45B of the ITAA 1936.

Demerger benefit and capital benefit

The provision of ownership interests to a shareholder under a demerger constitutes the shareholder being provided with a demerger benefit (subsection 45B(4) of the ITAA 1936). Therefore, under the proposed scheme, the market value of the Company Y shares provided to the Company X shareholders constitutes a demerger benefit.

The provision of those Company Y shares also constitutes a capital benefit to the extent it is not a demerger dividend (paragraph 45B(5)(a) and subsection 45B(6) of the ITAA 1936). As such, the market value of the Company Y shares distributed under the demerger less the demerger dividend is a capital benefit provided to the Company X shareholders.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides, inter alia, that a relevant taxpayer 'obtains a tax benefit' if an amount of tax payable by that taxpayer would, apart from the operation of section 45B, be less than the amount that would have been payable if the 'demerger benefit' had been an assessable dividend or the capital benefit had been a dividend.

As a result of the demerger, the Company X shareholders would, apart from the operation of section 45B of the ITAA 1936, receive a demerger dividend equal to the market value of the shares in Company Y at the time of the demerger less the amount debited to share capital that is neither assessable income nor exempt income. The tax payable by Company X shareholders on the demerger would be higher if the demerger benefit was an assessable dividend. Accordingly, Company X shareholders will obtain a tax benefit for the purposes of section 45B.

More than incidental purpose

Given that the proposed demerger is a scheme that provides a tax benefit to the Company X shareholders, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c). This paragraph provides that the section will apply if enabling the shareholder to obtain the tax benefit is a more than incidental purpose of the scheme.

The requisite purpose is to be determined having regard to the relevant circumstances of the scheme which are listed inclusively in subsection 45B(8) of the ITAA 1936. Each of the circumstances must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose.

Relevant circumstances

The relevant circumstances include the tax and non-tax (i.e. business and other financial) implications of the scheme, the latter covered largely by the matters in subsection 177D(2) of the ITAA 1936, which are included in subsection 45B(8) by virtue of paragraph (k).

In this case, the nature of the scheme indicates that the more pertinent circumstances are those covered by paragraphs (a), (b), (i), (j) and (k) of subsection 45B(8) of the ITAA 1936.

Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or an associate (within the meaning of section 318 of the ITAA 1936) of the company. In the circumstances of the capital benefits provided under this scheme, it is considered that they appropriately reflect a return of share capital to the Company X shareholders.

In the present case, the proposed demerger will result in a return of capital of and a demerger dividend sourced from realised and unrealised profits which is considered to be attributable to share capital and profits in accordance with PSLA 2005/21. This factor does not incline for a conclusion as to the requisite purpose.

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions made by a company or an associate of the company. In this case, Company X does not have a formal dividend policy in place. However dividends are paid yearly on an ad-hoc basis, subject to available profits and working capital needs of the business. This factor does not incline for a conclusion as to the requisite purpose.

Paragraph 45B(8)(i) of the ITAA 1936 directs attention to those cases where the scheme of demerger involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests. The demerger arrangement does not involve the later disposal of ownership interests and there is no intention that Company X shareholders will dispose of the shares in Company Y following the demerger.

Paragraph 45B(8)(j) of the ITAA 1936 applies to circumstances where the profits and assets of the demerging entity are attributable to or acquired under transactions with associated entities. This relevant circumstance aims to expose instances where demerger relief is being used as a vehicle for distributing corporate earnings by way of non-assessable dividend. In this case, there are no profits derived by Company X or assets held by Company X that are attributable to transactions with Company Y or other related parties.

45B(8)(k) Part IVA matters

This circumstance requires regard to be had to any of the matters referred to in paragraphs 177D(2)(a) to (h) of the ITAA 1936.

The incorporation of the Part IVA factors into section 45B of the ITAA 1936 does not introduce a different (dominant) purpose test into section 45B. The matters are applied in the context of the 'more than incidental purpose test' in section 45B.

The eight matters in subsection 177D(2) of the ITAA 1936 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.

If, on the one hand, reference to the matters in subsection 177D(2) of the ITAA 1936 reveal that the essential object of a demerger is to produce changes and improvements to the business structures of the corporate group, the tax free aspect of the transfer of ownership interests to the head entity's owners is more likely to be an incidental object of the demerger.

If on the other hand reference to those matters reveals that the transfer of ownership interests from the corporate group to the head entity's shareholders is an essential object of the scheme, the tax-free aspect of the transfer would ordinarily be a substantial object of the demerger.

Paragraph 177D(2)(a) of the ITAA 1936 requires an inquiry into the manner in which the scheme was entered into or carried out

Given the commercial reasons for the demerger, it is considered that the essential object of the proposed demerger is to achieve the separation of each business in order for both Company X and Company Y to become viable, stand-alone entities. Therefore, the tax benefit that Company X shareholders would receive is an incidental object of the demerger. As a result, it is considered that the 'manner' of the scheme does not point toward there being a more than incidental purpose of obtaining the tax benefit.

Paragraph 177D(2)(b) 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.

Based on a review of the benefits outlined in the ruling application that both businesses expect to achieve, it is considered that this factor does not point toward there being a more than incidental purpose of obtaining the tax benefit.

It is considered that none of the matters in paragraphs 177D(2)(c) to (h) incline towards a requisite purpose.

Conclusion

Having regard to the relevant circumstances of the proposed scheme, as set out in subsection 45B(8) of the ITAA 1936, it is considered that the proposed demerger is not being undertaken for the more than incidental purpose of obtaining a tax benefit. Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C will apply to the whole, or any part, of any benefit provided to the Company X shareholders under the proposed arrangement.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).