Edited version of your written advice

Authorisation Number: 1051267728851

Date of advice: 11 August 2017

Ruling

Subject: Proposed Demerger

Question 1

Will the Commissioner confirm that the proposed demerger transaction constitutes a demerger for the purposes of Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997), and in particular that the capital gain that arises to the head entity on the transfer of shares to its shareholders will be disregarded?

Answer:

Yes

Question 2

Will the Commissioner confirm that the transfer of shares in the demerger subsidiary from the head entity to its shareholders would, to the extent that the transfer represents a distribution of profits of the head entity, be a demerger dividend which is not assessable income or exempt income pursuant to subsections 44(3) to 44(5) of ITAA 1936?

Answer:

Yes

Question 3

Will the Commisioner confirm that section 45B of the ITAA 1936 would not apply to treat the demerger dividend as assessable?

Answer:

Yes

This ruling applies for the following periods:

This ruling applies from 1 July 2017 to 30 June 2018.

The scheme commences on:

The year ended 30 June 2018.

Relevant facts and circumstances

ABC Holdings

ABC Holdings was incorporated in Australia. ABC Holdings has 20 shares on issue. 10 of these shares are held by the trustee for the XX Trust, and the remaining 10 shares are held by the trustee for the YY Trust.

XX Trust and YY Trust are Australian residents for tax purposes.

ABC Holdings is a holding company and is the head of the ABC Group.

The ABC Group is a group that comprises ABC Holdings and several subsidiaries.

ABC Holdings holds 20 of the 30 shares on issue of ABC V&V with a cost base of $20. The remaining 10 shares are held by the ZZ Trust.

ABC Holdings has ownership interests that carry the right to receive more than 20% of any distribution of income or capital by ABC V&V, and has the right to exercise or control the exercise of more than 20% of the voting power of ABC V&V.

The share capital account of ABC Holdings is not tainted within the meaning of section 197-50 of the ITAA 1997.

As at 30 June 2016, the franking balance account of ABC Holdings is in credit. Immediately prior to the proposed demerger it will be in credit.

As at 30 June 2016, the market value of the assets of ABC Holdings exceeds the total amount (as shown in its books of account) of its liabilities and share capital.

ABC V&V

ABC S&S is an Australian company and sole subsidiary of ABC V&V. For tax purposes, ABC V&V and ABC S&S together form a tax consolidated group.

The directors of ABC V&V are A, B and C.

As at 30 June 2016, the franking account balance of ABC V&V is in credit. Immediately prior to the proposed demerger it will be in credit.

The financial performance of ABC V&V during the last few years has been impacted by an industry downturn.

Demerger proposal

The proposed demerger will involve the following transactions:

● ABC Holdings will enter into agreements with ABC V&V setting out the respective rights and obligations of each entity with respect to the implementation of the demerger;

● ABC Holdings will restructure its current financing arrangements. In this regard:

● Any intercompany loans, receivables and payables between members of the ABC Group and ABC V&V will be settled or forgiven; and

● ABC Holdings and ABC V&V are parties to a deed of cross-guarantee in respect of their banking facilities (under which each party guarantees the debt/claims of the other parties). ABC Holdings and ABC V&V will undertake the necessary steps to revoke the cross-guarantees and establish stand-alone funding arrangements.

● ABC Holdings will restructure its shareholding in ABC V&V and effectively transfer all of its ABC V&V shares to its shareholders, XX Trust and YY Trust.

● A revaluation of ABC Holdings’ investment in ABC V&V to fair value will be undertaken. The gain on revaluation will be credited to retained earnings.

● ABC Holdings will declare a dividend to its shareholders, to be satisfied by the transfer of ownership interests in ABC V&V (ie. in specie payment of dividend).

● The total amount of the dividend (in-specie distribution) will be the market value of the ABC V&V shares at the time of the demerger.

● Post-demerger, it is proposed that:

● ABC V&V will operate independently of ABC Holdings;

● The XX Trust and the YY Trust will directly hold a new interest in ABC V&V in the same proportion as their shareholding in ABC Holdings (being 50/50); and

● The number of ABC Holdings shares held by XX Trust and YY Trust will remain the same.

Following implementation of the above demerger, the 30 shares which ABC V&V have on issue will be held as follows:

● XX Trust – 10 shares

● YY Trust – 10 shares

● ZZ Trust– 10 shares.

The accounting entries in ABC Holdings’ accounts that will occur to give effect to the demerger are as follows, taking the unrealised gain of $1m for ABC Holdings’ investment in ABC V&V:

DR Investment in ABC V&V $1m

CR Asset revaluation reserve $1m

Revaluation of the ABC Holdings investment in ABC V&V to fair value

DR Asset revaluation reserve $1m

CR Retained earnings $1m

Recognition of revaluation to ABC Holdings to retained earnings

DR Retained earnings $1m

CR Dividend payable $1m

To recognise the dividend payable by ABC Holdings

DR Dividend payable $1m

CR Investment in ABC V&V $1m

To recognise transfer ABC Holdings’ shares in ABC V&V to XX Trust and YY Trust.

There is no amount debited to the share capital account of ABC Holdings.

Reasons for the demerger

The reasons for the proposed demerger are as follows:

Improving business efficiency

Conflict currently exists between the directors of ABC Holdings, A and B.

The demerger will result in each party effectively having a one-third control over the affairs of ABC V&V. As a result, business decisions and resolutions for ABC V&V will be able to be made more efficiently, as a vote of 2 out of 3 will be sufficient to reach a business decision.

A significant number of matters are not determined by the Board of ABC V&V itself but instead by the Board of ABC Holdings, including those which affect the operational and commercial directions of ABC V&V.

Asset protection and financial performance

The risk profile and recent financial performance of ABC V&V and the ABC Group differ greatly due to the nature of their operations and recent market conditions. The demerger will enable the assets of the lower risk business (the ABC Group) to be separated from the assets of the higher risk business (ABC V&V).

Separation of business with specialisation in different industries

ABC V&V is a specialised provider of equipment for its industry.

In recent years the business opportunities for ABC V&V, potential for work and profitability have been affected by the downturn in the industry across Australia. As a result, the directors of ABC V&V have reviewed and considered different alternatives for the future of ABC V&V.

Post demerger, it is proposed that ABC V&V will operate independently of the ABC Group and continue to downsize its operations in its commercial sector. The proposed course of action is the strategic sale of ABC V&V assets to a third party. This may take some time, and in the meanwhile ABC V&V will continue to trade. Upon the eventual sale of the underlying assets, both ABC V&V and ABC S&S will be placed into a members’ voluntary liquidation.

At least 50% the market value of CGT assets owned by ABC V&V will be used in carrying on its business just after the demerger.

Removal of cross guarantees

Cross guarantees exist between the entities in the ABC Group in favour of Big Bank.

Personal guarantees are imposed on C. In order for ABC V&V to obtain additional funding, Big Bank had required interlocking guarantees across all ABC entities and also for all directors to provide the same level of personal guarantees.

The demerger will result in the severance of C’s exposure to risk from the broader ABC Group, as they will no longer be required to provide personal guarantees in respect of any of the entities in the ABC Group. C will only be required to provide a personal guarantee in respect of ABC V&V.

Following the demerger:

● C will no longer provide a personal guarantee to Big Bank in respect of any of the entities in the ABC Group.

● All banking cross-guarantees between the ABC Group and ABC V&V will be removed.

● ABC V&V will operate independently of the ABC Group.

● The ABC Group and ABC V&V will each establish stand-alone funding arrangements.

Flexibility – broader ABC Group restructure

ABC Holdings holds 20 shares in ABC V&V. The directors of the ABC Group are currently considering a restructure to separate the ABC Group into discrete operations to achieve business separation and enhance business performance.

The two directors of ABC Holdings are A and B. However, the proposed restructure of the ABC Group intends to separate the ABC Group into two discrete business operations, with each director taking ownership of one each. Under the current structure, the wind-up of ABC Holdings will be limited by its shareholding in ABC V&V. Therefore, the demerger is proposed so that the underlying owners of ABC Holdings will hold a direct interest in ABC V&V (ie. as ABC Holdings will no longer hold an ownership interest in ABC V&V).

However, the above proposal is a long-term plan that is currently being considered. Immediately after the proposed demerger, it is envisaged that ABC Holdings will maintain its holding company status of the ABC Group with its subsidiaries whilst continuing its operations.

Further matters regarding the demerger

It is assumed that immediately after the distribution of property, the market value of the assets of ABC Holdings will exceed the total amount (as shown in its books of account) of its liabilities and share capital.

Following the demerger, the non-assessable, non-exempt dividend will be distributed to the respective trusts. The XX and YY trusts will not distribute the shares in ABC V&V to their respective beneficiaries.

There is no proposal for the sale of shares in ABC V&V by XX Trust and YY Trust following the demerger.

In the event of the winding-up of ABC V&V:

● all proceeds exceeding the original paid up capital will be fully assessable in the hands of the trustee/beneficiaries under section 47 of the ITAA 1997.

● The XX, YY and ZZ trusts will not treat the Liquidator’s dividend under section 47 as a return of capital; nor will they re-characterise such income received when it is distributed to their respective beneficiaries.

● Neither the XX and YY trusts nor their beneficiaries have carried forward tax losses at the date of this Ruling.

● No entity comprising the ABC Group, and the ABC V&V and ABC S&S group, will qualify for the small business tax concessions.

Relevant legislative provisions

Income Tax Assessment Act 1936 (ITAA 1936)

Subsection 6(1)

Section 44

Section 45B

Section 45C

Section 177D

Income Tax Assessment Act 1997 (ITAA 1997)

Section 104-25

Section 104-135

Section 125-55

Section 125-70

Section 125-75

Section 125-155

ATO view documents

Practice Statement PS LA 2005/21 Application of section 45B of the Income Tax Assessment Act 1936 to demergers

Taxation Ruling TR 2003/8 Income tax: distributions of property by companies to shareholders - amount to be included as an assessable dividend

Reasons for decision

Question 1

Will the Commissioner confirm that the proposed demerger transaction constitutes a demerger for the purposes of Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997), and in particular that the capital gain that arises to the head entity on the transfer of shares to its shareholders will be disregarded?

Summary

The Commissioner confirms that the proposed demerger transaction constitutes a demerger for the purposes of Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997), and in particular that the capital gain that arises to the head entity on the transfer of shares to its shareholders will be disregarded.

Detailed reasoning

Section 125-155 of the ITAA 1997 provides 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.

The various elements of this provision will be satisfied in this case, as discussed in further detail below.

CGT event A1 happens to ABC Holdings

CGT event A1 will happen to ABC Holdings when it makes an in-specie distribution to its shareholders, XX Trust and YY Trust (the shareholders) of its ordinary shares in ABC V&V, for the following reasons:

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

● The shares held by ABC Holdings in ABC V&V are a 'CGT asset’ given that they are a 'kind of property’ (paragraph 108-5(1)(a)).

● There will be a 'disposal’ given that there is a change of ownership from ABC Holdings to the shareholders by the in specie distribution of shares whereby both legal and beneficial ownership of the shares are transferred to the shareholders.

In this case the capital gain or loss under CGT event A1:

● is made by ABC Holdings as a 'demerging entity’ (as defined under subsection 125-70(7)); and

● is made by ABC Holdings from the event happening to its ownership interests in ABC V&V as the 'demerged entity’ (as defined in subsection 125-70(6).

None of CGT events C2, C3 and K6 will happen to ABC Holdings in relation to the distribution.

There is a demerger

Section 125-65 of the ITAA 1997 sets out the meaning of 'demerger group’, 'head entity’ and 'demerger subsidiary’.

In the facts provided, ABC Holdings and ABC V&V are part of a 'demerger group’ that consists of:

● ABC Holdings as the head entity as defined in subsection 125-65(3).

● ABC V&V as one of the demerger subsidiaries as defined in subsection 125-65(6). This is because ABC Holdings has ownership interests that carry the right to receive more than 20% of any distribution of income or capital in ABC V&V, and has the right to exercise or control the exercise of more than 20% of the voting power of ABC V&V.

The conditions for a 'demerger’ specified in section 125-70 will be met for the following reasons:

● There is a restructuring of the demerger group under which a member of the group (ABC Holdings) will dispose of 100% of its ownership interests in another member of the demerger group (ABC V&V) to owners of the original interests in the head entity of the group (the shareholders): paragraph 125-70(1)(a) and subparagraph 125-70(1)(b)(i).

● Under the restructuring, no CGT event happens to the shares held by the shareholders in ABC Holdings (see below under question 3), and the shareholders acquire a new interest, being the interests in ABC V&V, and nothing else: subparagraph 125-70(1)(c)(ii).

● The acquisition of new interests by the shareholders under the proposal will happen only because they own shares in ABC Holdings. The in specie distribution of ABC Holdings’ shares in ABC V&V is made only to the shareholders. Consequently subparagraph 125-70(1)(d) will be satisfied.

● The new interests acquired will be the 'ownership interests in a company’ (paragraph 125-70(1)(e)(i)), being shares in ABC V&V.

● Neither the original interests (being the shareholders’ shares in ABC Holdings) nor the new interests (the shares they will acquire in ABC V&V) 'are in a trust that is a non-complying superannuation fund’: paragraph 125-70(1)(g).

● The requirements of subsection 125-70(2) will be met, thereby satisfying the requirement in paragraph 125-70(1)(h). This is because:

● each shareholder will acquire the same proportion of shares in ABC V&V (being the 'demerged entity’ under the terms of subsection 125-70(2) and subsection 120-70(6)) as it had in ABC Holdings just before the proposed demerger (50% each); and

● just after the demerger, each shareholder will have the same proportionate total market value of shareholding in ABC Holdings and ABC V&V as it had in ABC Holdings just before the demerger.

Section 125-155 applies

In light of the above, any capital gain or loss made from the application of CGT event A1 to the demerger in this case will be disregarded by operation of section 125-155.

Question 2:

Will the Commissioner confirm that the transfer of shares in the demerger subsidiary from the head entity to its shareholders would, to the extent that the transfer represents a distribution of profits of the head entity, be a demerger dividend which is not assessable income or exempt income pursuant to subsections 44(3) to 44(5) of ITAA 1936?

Summary

The Commissioner confirms that the transfer of shares in the demerger subsidiary from the head entity to its shareholders will, to the extent that the transfer represents a distribution of profits of the head entity, be a demerger dividend which is not assessable income or exempt income pursuant to subsections 44(3) to 44(5) of ITAA 1936.

Detailed reasoning

Subsection 44(1) provides that the assessable income of a shareholder includes dividends paid to it by a company out of profits derived by it from any source.

'Dividend’ is defined in subsection 6(1) of the ITAA 1936 to include 'any distribution made by a company to any of its shareholders, whether in money or other property’.

However, a demerger dividend is not assessable income or exempt income: subsection 44(4). Section 44 applies to the demerger dividend as if it had not been paid out of profits (subsection 44(3)).

'Demerger dividend’ is defined as '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)’: subsection 6(1). The distribution to shareholders of ABC Holdings’ shares in ABC V&V are 'demerger dividends’ given that:

● As noted above, the conditions of a 'demerger’ as specified in section 125-70 are satisfied in this case. The demerger is effected by the in specie distribution of shares in ABC V&V to the shareholders.

● Prima facie this distribution would be a 'dividend’ under subsection 6(1), being a distribution by a company of property. The distribution would also be assessable under subsection 44(1), given that the distribution is paid to the shareholders from retained earnings and the asset revaluation reserve.

In this regard, TR 2003/8 expresses the following view:

6. In the case of a resident shareholder the amount by which the money value of the property exceeds the amount debited to the share capital account will be included in the shareholder's assessable income to the extent that the dividend is paid (or taken to be paid) out of profits derived by the company.

7. In the case of a non-resident shareholder the amount by which the money value of the property exceeds the amount debited to the share capital account will be included in the shareholder's assessable income to the extent that the dividend is paid (or taken to be paid) out of profits derived by the company from an Australian source, unless a double tax treaty provides for a different result in the circumstances of the taxpayer. (Usually such treaties substitute a different test based on effective connection with a permanent establishment in Australia.)

8. For the purposes of paragraphs 6 and 7, the dividend is paid out of profits derived by the company if, immediately after the distribution of property, the market value of the assets of the company exceeds the total amount (as shown in the company's books of account) of its liabilities and share capital. In addition, if the dividend described in paragraphs 6 and 7 is a repayment by a company of an amount paid-up on the share, the dividend is taken to be paid out of profits derived by the company.

…..13. In most cases a company which distributes property to its shareholders and debits part of the value of that property to its share capital account would debit the remaining part to another account or reserve. Where that account or reserve does not represent share capital, it would, for subsection 44(1) purposes, represent profits derived by the company so that the amount debited to it would be included in the shareholder's assessable income under that subsection. This is so irrespective of whether or not the account or reserve is termed a 'profit and loss' account. It could, for example, be an asset revaluation reserve, a reserve to provide for the replacement of wasting assets or, in the context of a demerger, a 'demerger reserve': see QBE Insurance Group 10 ACLC 1490 at 1505.

It is assumed that immediately after the distribution of property, the market value of the assets of ABC Holdings will exceed the total amount (as shown in its books of account) of its liabilities and share capital; and consequently that the demerger benefit is paid out of the profits of the company.

● However subsection 44(3) deems the dividend not to be paid out of profits. Further subsection 44(4) deems it to be not assesseable or exempt income.

● Consequently the distribution is one that is 'assessable as a dividend under subsection 44(1)…apart from subsections 44(3) and (4)’. It follows that it is a 'demerger dividend’ under subsection 6(1) and section 44.

Subsection 44(5) provides that subsections 44(3) and 44(4) do not apply to a demerger dividend 'unless, just after the demerger, CGT assets owned by the demerged entity or a demerger subsidiary representing at least 50% by market value of all the CGT assets (or a reasonable approximation of market value) owned by the demerged entity and its demerger subsidiaries are used, directly or indirectly, in one or more businesses carried on by one or more of those entities.’

Paragraph 15.64 of the Explanatory Memorandum to New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Act 2002 provides that the rule 'ensures that the demerged entity is a viable, independent entity, capable of conducting business in its own right’.

It is proposed that ABC V&V will, following the demerger, operate independently of the ABC Group. While it is ultimately intended that ABC V&V’s assets will be sold to a third party, it is acknowledged that this may take some time, and in the meanwhile ABC V&V will continue to carry on its business in its own right.

At least 50% of the market value of CGT assets owned by ABC V&V (being the demerged entity) will continue to be used in its business just after the demerger.

As such, subsection 44(5) does not apply. It follows that the demerger dividend will not be assessable income or exempt income under subsection 44(4).

Question 3

Will the Commisioner confirm that section 45B of the ITAA 1936 would not apply to treat the demerger dividend as assessable?

Summary

The Commissioner confirms that he will not make a determination under section 45B of the ITAA 1936 to treat the demerger dividend as assessable.

Detailed reasoning

Paragraph 45B(3)(a) allows the Commissioner to make a determination in relation to a demerger benefit. However for this provision to apply, the relevant scheme must fall within the scope of section 45B.

Subsection 45B(2) outlines various conditions for the application of section 45B. It provides as follows:

45B(2)

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.

The application of the conditions in each of the above paragraphs is considered below.

Paragraph 45B(2)(a)

'Scheme’ is defined in section 995-1 of the Income Tax Assessment Act 1997 as 'any arrangement’ or 'any scheme, plan, proposal, action, course of action, or course of conduct, whether unilateral or otherwise’. Being a proposed plan or course of action contemplated by the ABC Group, the demerger will be considered a 'scheme’ under the terms of the prescribed definition.

The relevant scheme in this case to which section 45B applies is the business restructure that comprises principally of the demerger, with a longer term plan for the sale of the assets of ABC V&V and the winding up of the company.

In this respect, the following facts are noted:

● Following the demerger, it is proposed that ABC V&V will operate independently of the ABC Group and will attempt to downsize its operations in the relevant commercial sector.

● It is proposed that ABC V&V’s assets will eventually be sold to a third party. As this may take some time, in the meanwhile ABC V&V will continue to trade.

● Upon the eventual sale of the underlying assets, ABC V&V will be placed into a members’ voluntary liquidation.

The distribution of the ABC V&V shares to the shareholders will be considered a 'demerger benefit’ for the following reasons:

● A person is 'provided with a demerger benefit’ if 'a company provides the person with ownership interests in that or another company’: paragraph 45B(4)(a).

● Under the terms of the demerger, ABC Holdings will provide the shareholders with shares in ABC V&V, and they will thereby be considered to be provided with a demerger benefit as defined in paragraph 45B(4)(a).

Paragraph 45B(2)(b)

The meaning of 'obtains a tax benefit’ is prescribed in subsection 45B(9) as follows:

A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, 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 an assessable dividend.

As the distribution will be classed as a demerger dividend, it will fall within the scope of subsection 44(4), and will therefore not be assessable income or exempt income.

Given that this would result in a lesser amount payable by the relevant trustees or beneficiaries of the trusts than if the distribution had been an assessable dividend, a 'tax benefit’ will be obtained by the relevant trustee or beneficiary.

Paragraph 45B(2)(c)

The relevant circumstances which must be considered in the assessment of whether there exists a more-than-incidental purpose of enabling a taxpayer to obtain a tax benefit are outlined in subsection 45B(8).

They are considered in turn below.

Paragraph 45B(8)(a)

This paragraph prescribes the following 'relevant circumstance’:

'the extent to which the demerger benefit or capital benefit is attributable to capital or the extent to which the demerger benefit or capital benefit is attributable to profits (realised and unrealised) of the company or of an associate (within the meaning in section 318) of the company;..’

On the facts of this case:

● The in specie distribution of ABC V&V shares is debited against the retained earnings account and asset revaluation reserve of ABC Holdings.

● As discussed earlier, it is assumed that immediately after the distribution of property, the market value of the assets of ABC Holdings will exceed the total amount (as shown in its books of account) of its liabilities and share capital; and consequently that the demerger benefit is attributable to profits.

On the basis that the distribution can reasonably be regarded as being properly attributed to profit, the circumstance in paragraph 45B(8)(a) does not itself indicate a more than incidental purpose of obtaining a tax benefit (refer to paragraphs 51 and 52 in PS LA 2005/21).

Paragraph 45B(8)(b)

This paragraph provides:

'the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318) of the company;’

The pattern of distributions of dividends by ABC Holdings is noted but is not determinative of the issue, as it is recognised that the occasion for the distribution in a demerger is an extraordinary event: see paragraph 59 of PS LA 2005/21.

Paragraphs 45B(8)(c) to (f)

These paragraphs require an examination of the tax characteristics of the particular shareholder in question in determining the relevant circumstances of the scheme.

In this regard the various considerations taken into account, and the provisions to which they relate, are as follows:

● No capital benefit arises from the demerger: Paragraph 45B(8)(c). There is no proposal for the sale of shares in ABC V&V by XX Trust and YY Trust following the demerger.

● There are no pre-CGT ownership interests in this case. Specifically, shares held by the shareholders in ABC Holdings were acquired after 20 September 1985: paragraph 45B(8)(d).

● The shareholders of ABC Holdings are Australian residents: paragraph 45B(8)(e).

● The demerger rollover relief in section 125-55 of the ITAA 1997 does not apply in this case. In particular, CGT event G1 does not apply to the shareholders’ interests in ABC Holdings as a result of the demerger since the condition in subparagraph 104-135(1)(b) is not satisfied. This is because the payment made by the company is a 'dividend’, having been made from retained earnings. No amount is debited against the company’s share capital account for the payment. Consequently the factor prescribed in paragraph 45B(8)(f) has no relevance to this matter.

Paragraph 45B(8)(h)

This paragraph requires consideration of schemes that involve the distribution of share capital or share premium. The demerger does not involve the distribution of share capital or share premium.

Paragraph 45B(8)(i)

This paragraph requires a consideration of any later disposal of interests in ABC V&V acquired by the shareholders of ABC Holdings. Regard is to be had to the length of time the ownership interests are intended to be held, in order to ascertain whether there exists any prearranged disposal of the demerged interests by the head entity’s owners to enable a realisation of those interests in a tax effective way.

In this case there is no proposal for the sale of shares in ABC V&V by XX Trust and YY Trust following the demerger. The XX Trust and YY Trust will retain their ownership interests in ABC V&V for the period in which ABC V&V continues to trade, throughout the period in which it intends to downsize its business operations and sell its assets, and until the point in time at which it is liquidated.

Paragraph 45B(8)(j)

Regard must be had to whether the profits of the demerging entity and demerged entity are attributable to, and acquired under, transactions between the entity and an associate of the entity.

Paragraph 81 in PS LA 2005/21 states that:

81. This relevant circumstance elaborates on paragraph 45B(8)(a) of the ITAA 1936, and looks for the concentration of assets or profits of the corporate group in the demerging entity beyond that which would be explicable by a business restructure; 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. The implication here is that the purpose for the demerger must be more than a mere transfer of property from the corporate group to the head entity's shareholders.

82. For example, this relevant circumstance exposes whether the demerger relief is being used as a device for distributing corporate earnings to owners of the head entity. If it is established that part of the profits or assets of the demerging entity are referable to those of an associate and are not explainable by the demerging entity's need to be a viable, stand-alone entity, this is suggestive of a purpose of enabling a taxpayer to obtain a tax benefit by way of non-assessable dividend.

The profits and assets of ABC Holdings and ABC V&V are not referable to those of an associate and are instead acquired through genuine commercial transactions.

There has been a steady decline in the financial performance of ABC V&V in the last few years, and this is a reflection of the industry downturn. This is consistent with the view that ABC V&V is considered to be a higher risk business, forming the reason for the stated purpose of enabling the assets of to be separated from those of the lower risk businesses in the ABC Group. These factors are inconsistent with any finding that the demerger is a method of distributing broader ABC Group earnings to the shareholders.

Paragraph 45B(8)(k)

This paragraph requires that regard be had to 'any of the matters referred to in subsection 177D(2)’, which are matters prescribed for the purposes of determining the 'dominant purpose’ test in Part IVA. In the context of section 45B, however, they are to be applied in determining the 'more than incidental’ test specific to the provision.

The factors prescribed in subsection 177D(2) focus on indicia that may reveal the true objectives of the relevant scheme. It is recognised that many of the considerations taken into account under this provision may overlap with those already mentioned above.

The circumstances which the Commissioner considers relevant to the assessment of the scheme in this case, and the corresponding paragraphs in subsection 177D(2) to which they relate, are as follows:

● The manner in which the scheme is carried out (paragraph 177D(2)(a)) is the arrangement that consists primarily of the demerger.

An inquiry into the manner of the scheme is an objective inquiry into the reasons a taxpayer had for entering into it (see paragraph 86 in PS LA 2005/21).

In this regard, the demerger would achieve various commercial advantages:

● Improving business efficiency

The demerger will improve business efficiency. The board of ABC Holdings currently holds considerable power over the determination of a large number of important commercial matters for ABC V&V. However, the existing conflicts in the relationship between the directors of ABC Holdings - A and B - impact the ability of ABC Holdings to make commercial decisions quickly and efficiently, including those involving ABC V&V.

By removing ABC Holdings as a shareholder, it would allow resolutions in respect of the commercial or business direction of the company to be made by majority vote between the 3 shareholders.

● Asset protection and financial performance

The risk profile and recent financial performance of ABC V&V and the ABC Group differ greatly due to the nature of their operations and recent market conditions. The demerger will enable the assets of the lower risk business (the ABC Group) to be separated from the assets of the higher risk business (ABC V&V).

● Removal of cross guarantees

The demerger will result in the severance of C’s exposure to risk from the broader ABC Group, as he will no longer be required to provide a personal guarantee in respect of any of the entities in the ABC Group, and will only be required to provide a personal guarantee in respect of ABC V&V.

● Flexibility – broader ABC Group restructure

A restructure to separate the ABC Group into discrete operations is currently being considered as a long-term plan.

Under the broader ABC Group restructure, it is proposed that:

● The shareholders of ABC Holdings (XX Trust and YY Trust) will each acquire direct ownership in the underlying business in which they specialise.

● Under direct ownership, the discrete business units will operate as independent and separate businesses with separate management, with the ability to focus on their core markets.

● ABC Holdings will realise any remaining assets, distribute any retained profits and be wound-up.

● As a result of the ABC Group restructure, the current shareholders (XX Trust and YY Trust) will cease to be in business together.

This plan is not likely to be implemented immediately after the proposed demerger, but it exists as a long-term objective for the ABC Group.

The effect of the proposed demerger is consistent with this objective in its removal of ABC Holdings from ownership and management of the ABC V&V business.

● The substance of the scheme (paragraph 177D(2)(b)) can be discerned from its effects: paragraph 87 in PS LA 2005/21. In this respect, this consideration overlaps to some extent with that in paragraph 177D(2)(d), under which regard must be had to the result in relation to the operation of the tax acts that, but for this Part (or section 45B, in this context), would be achieved by the scheme.

The effects of the scheme on the parties to the demerger are primarily the (anticipated) commercial circumstances of all relevant parties following the demerger, as well as the capital benefit or demerger benefit afforded to these parties.

The question as to whether the capital and demerger benefits are sufficiently outweighed by the commercial objectives of the proposal such that they may be regarded as merely an incidental purpose of the scheme is determined by taking into account the previous and following other considerations.

● The time at which the scheme was entered into is also a relevant consideration under paragraph 177D(2)(c). In respect of the timing of the scheme, several reasons have been given as to why the restructure is presently contemplated:

● The steady deterioration in the working relationship between A and B has had a negative impact on the business operations of ABC V&V, necessitating the proposed restructure under which commercial decisions will be able to be made and implemented efficiently, with the view to effecting the longer-term proposal for the company’s assets to be sold and for its ultimate winding-up.

● The downturn in the industry over the last few years has had a negative impact on ABC V&V; the proposed demerger will enable the assets of the lower risk business (the ABC Group) to be separated from the assets of the higher risk business (ABC V&V). Again this is consistent with the longer-term proposal for the company’s assets to be sold and for its ultimate winding-up.

These factors support the view that the timing of the scheme is largely or primarily based on commercial considerations.

● Paragraphs 177D(2)(e) to (h) require a consideration of the change in the financial position of, or other consequences to, relevant taxpayers or any person who has a connection with such taxpayers, as a result of the scheme. They also require a consideration of the nature of the relationship between the relevant taxpayer and such a person.

In the present case, the demerger results in the acquisition by the shareholders of shares in ABC V&V; that is, an asset owned previously by ABC Holdings is now directly owned by the shareholders, which as stated in paragraph 94 of PS LA 2005/21 'delivers to the head entity's shareholders an asset which they can liquidate, exchange or use as financial security’, being a commercial benefit separate to the tax advantage derived from the scheme.

Upon taking into account the abovementioned circumstances, it is the Commissioner’s view that the scheme was not carried out for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit under paragraph 45B(2)(c).

The matters which the Commissioner has considered persuasive in reaching this conclusion are as follows:

● The scheme is driven largely by the various commercial objectives articulated in ABC Holdings’ Private Ruling Application and mentioned above.

● In particular, the various reasons provided for the demerger and for the timing of the demerger are accepted as business objectives that form the essential purpose of the scheme.

● The tax benefit obtained by a taxpayer is, on the basis of the submissions provided, merely incidental to the primary purposes of the demerger.

For these reasons the Commissioner confirms that he will not make a determination under section 45B of the ITAA 1936 to treat the demerger dividend as assessable.

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