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Edited version of private advice

Authorisation Number: 1051915428324

Date of advice: 2 November 2021

Ruling

Subject: Proposed demerger

Question 1

Will the Resident Shareholders of Company A be entitled to choose demerger roll-over relief under section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will each of the Resident Shareholders of Company A who choose demerger roll-over relief in respect of their shares in Company A, disregard any capital gain made in respect of CGT event G1 happening to their shares pursuant to subsection 125-80(1) of the ITAA 1997?

Answer

Yes

Question 3

Will the first element of the cost base and the reduced cost base of the shares held by Company A Shareholders in Company A and Company B be subject to adjustment under subsection 125-80(2) of the ITAA 1997?

Answer

Yes

Question 4

Will the Resident Shareholders of Company A who choose demerger roll-over relief in respect of their shares be taken, for the purpose of Division 115 of the ITAA 1997, to have acquired their shares in Company B on the same date as their shares in Company A were acquired pursuant to item 2 of the table in subsection 115-30(1) of the ITAA 1997?

Answer

Yes

Question 5

If the value of the Company B shares distributed exceeds the amount debited to the share capital account and would otherwise be assessable as a dividend under subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936), will it be treated as a demerger dividend that is not paid out of profits and is not assessable or exempt income under subsections 44(3) and 44(4) of the ITAA 1936?

Answer

Yes

Question 6

Will section 45 or section 45A of the ITAA 1936 apply to the whole or any part of the proposed demerger scheme?

Answer

Question 7

Will the Commissioner make a determination in respect of the demerger or capital benefit provided to the shareholders of Company A under:

(a) Paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies in respect of the whole or any part of the demerger benefit; or

(b) Paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in respect of the whole or any part of the capital benefit.

Answer

Question 8

If the value of the Company B shares distributed exceeds the amount debited to the share capital account and, apart from subsections 44(3) and (4), would be treated as an assessable dividend under subsection 44(1) of the ITAA 1936, will it be treated as a dividend that may give rise to a liability to withholding tax pursuant to section 128B of the ITAA 1936 and withholding tax collection obligations under subdivision 12-F or 12A-C of Schedule 1 of the Taxation Administration Act 1953 (TAA)?

Answer

Question 9

As a consequence of section 125-155 of the ITAA 1997, will Company A disregard any capital gain under CGT event A1 upon the proposed transfer of its shares in Company B to its shareholders?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A

Company A is an Australian private company.

Company A and wholly owned subsidiaries previously acquired Company C and it's wholly owned subsidiaries (Company C Group).

Company A is the head entity of an income tax consolidated group, which consists of Company A and its wholly owned subsidiaries (Company A Group) and includes the acquired Company C Group.

Company A shareholding

Company A has only one class of shares on issue: ordinary shares.

One of the Company A shareholders has retired from the business and has been replaced by a new business partner.

It is proposed that the retired shareholder will sell their shares in Company A to a new business partner prior to the demerger at market value.

The shareholders of Company A (Company A Shareholders) immediately prior to the proposed demerger will include the new business partner. There are also individuals that currently hold options over ordinary shares in Company A under an employee share scheme.

The options are out of the money and are effectively worthless.

None of the options have been exercised since the commencement of the employee share scheme. The options will be cancelled prior to the proposed demerger.

There are no other equity interests (including shares, options or similar rights) on issue in Company A.

Company A shareholders tax attributes

For tax purposes, some of the shareholders of Company A are Attribution Managed Investment Trusts (AMITs).

Company A also has a shareholder that is a Venture Capital Limited Partnership (VCLP). The VCLP Shareholder is treated as a partnership for income tax purposes.

The Company A Shareholders are Australian residents for income tax purposes with the exception of non-resident partners of the VCLP. The shareholders that are Australian residents for tax purposes will be referred to as the Resident Shareholders.

None of the entities within the Company A Group hold real property interests of more than 50% of the total market value of assets held by them.

None of the shareholders of Company A have any capital losses.

The cost bases of the Company A Shareholder's ordinary shares in Company A are at least equal, if not greater than, the proposed return of capital amount (outlined further below).

Company C Group history

The Company C Group trades under various businesses and there are two main parts to the Company C Group, Business X and Business Y.

Business Y operates under Company D (an Australian subsidiary) and Company E (a foreign subsidiary) both acquired by the Company C Group prior to Company A's acquisition of the Company C Group.

The remaining entities form Business X.

Commercial drivers for the proposed demerger

Company A Shareholders propose to demerge the Business Y (comprising Company D and Company E) from the Company C Group.

A number of commercial reasons were provided as the reason for undertaking a demerger.

Company A Shareholders have no current plans in place to dispose of either business following the demerger or otherwise realise interests in either business, for example via an initial public offering (IPO).

Restructuring steps to implement the proposed demerger

Company A is proposing to undertake a number of transactions as part of its plan to ultimately demerge Business Y from the Company A Group. These transactions will be referred to collectively as the restructure steps.

The restructure steps

The restructure steps are outlined below in three parts. Part (a) is the proposed internal restructure of the Company A Group in preparation for the demerger of Business Y. This includes setup of a new holding and finance structure. Part (b) are additional movements of assets and liabilities within the Company A Group in preparation for the split of the businesses. Part (c) is the proposed demerger.

Part (a) Proposed internal restructure

Internal group restructure

(i) External financiers agree to the proposed restructure and new finance terms.

(ii) Company A establishes a new wholly owned subsidiary (Company B) with nominal capital.

The shares to be issued in Company B under the restructure steps will be ordinary shares.

(iii) Company B establishes a new wholly owned subsidiary New SubCo 1 with nominal capital.

(iv) New SubCo 1 establishes a new wholly owned subsidiary New SubCo 2 with nominal capital.

(v) New SubCo 2 establishes a new wholly owned subsidiary New SubCo 3 with nominal capital.

(vi) Company A subscribes for additional equity in Company B in consideration for promissory note 1 (PN1), which is equivalent to the market value of Business Y less the proposed amount of external debt to be raised by Business Y as part of the demerger.

The total number of Company B ordinary shares issued will be a proportionate number of shares to the number of issue in Company A to allow the shares to be split in the same proportions.

(vii) Company B subscribes for additional equity in New SubCo 1 in consideration for transferring PN1.

(viii) New SubCo 1 subscribes for additional equity in New SubCo 2 in consideration for transferring PN1.

(ix) New SubCo 2 subscribes for additional equity in New SubCo 3 in consideration for transferring PN1.

(x) SubCo 3 lends New SubCo 3 funds by way of promissory note 2 (PN2), equivalent to the external debt to be sought by Business Y.

The external debt to be sought by Business Y will be the business' proportionate share of the Company A Group's debt, calculated with reference to Business Y's market value relative to the total market value of the Company A Group.

(xi) Company C transfers the shares in Company E to Company D in consideration for Company D issuing further shares in itself to Company C. Thus, placing Company E underneath Company D.

(xii) Company C transfers all the shares in Company D to New SubCo 3 in exchange for New SubCo 3 transferring PN1 and PN2 to Company C. The transfer will also take with it Company E.

(xiii) Company C transfers PN1 and PN2 to SubCo 3 in exchange for a debt owed by SubCo 3 to Company C, cancelling PN2.

(xiv) New SubCo 3 repays money borrowed from SubCo 3 by raising external debt finance. SubCo 3 uses the money received from New SubCo 3 to partially retire its original acquisition debt. The effect of this step is to allocate (or bifurcate) the existing acquisition debt attributable to the Company C Group to both businesses to the commercially desired levels applicable to each business.

(xv) SubCo 3 transfers PN1 to Company A in exchange for a debt owed by Company A to SubCo 3. Company A cancels PN1.

Part (b) Movements of group assets and liabilities

Assets currently sitting in Business X, but which relate to Business Y, will be transferred to Business Y. This will enable Business Y to hold all assets inherently connected with the business immediately prior to the demerger.

At least X% of the market value of CGT assets owned by Company B and each of its subsidiaries, will be used directly or indirectly in the business.

In addition, remaining inter-entity loans between Business X and Business Y after the transfers of assets above will be dealt with as follows:

(i) Final cash sweeps from Business Y to Business X.

(ii) A forgiveness of any remaining inter-entity receivables held by Company D and Company E with the rest of the Company A Group.

The combination of the final cash sweeps and forgiveness of the remaining inter-entity receivables approximate Business Y's share of shared services costs since acquisition by Company C that had not been on-charged to Business Y since acquisition.

Following the demerger of Company B and it's subsidiaries, a transitional services agreement (estimated at roughly X months) will be put in place between Business Y and Business X to give time for Business Y to setup independent back office functions.

The forgiveness of any remaining inter-entity receivables will occur while the entities are in the same consolidated group.

Part (c) The demerger of Company B

(i) A capital reduction and a dividend will be declared by Company A to its shareholders in proportion to their respective shareholdings. The total distribution declared will be equal to the market value of the shares in Company B.

(ii) An in specie distribution of the shares in Company B by Company A to its shareholders will be made in consideration for the distribution owing to shareholders.

(iii) There will be a demerger dividend being the difference between the market value of the shares in Company B and the capital reduction.

Market valuation of Business X and Business Y

An internal market valuation and supporting documentation has been prepared. The internal market valuation meets the ATO market valuation guidelines.

Distribution components

To determine how much share capital has been invested in Business Y, the relative market value of Company D and Company E to the Company A group has been used in accordance with ATO Practice Statement Law Administration 2005/21 (PS LA 2005/21).

The return of capital component will be debited to Company A's share capital account. The dividend component will be debited to Company A's retained earnings account.

Other Matters

Company A will not make an election under subsection 44(2) of the ITAA 1936 that subsections 44(3) and (4) of the ITAA 1936 do not apply to the demerger dividend.

Company A shareholders acquired interests in Company A during 20xx and none of the interests held in Company A or associates of Company A are pre CGT interests.

Company A does not have a formal dividend policy and has never paid any dividends to its shareholders.

There has been no transfer of any amount to Company A's share capital account that resulted in it becoming tainted under section 197-50 of the ITAA 1997.

When Company B leaves the income tax consolidated group, exit allocable cost amount calculations will need to be prepared, and where applicable, capital gains arising from CGT event L5 will be included in Company A's relevant income tax return.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 45

Income Tax Assessment Act 1936 section 45A

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 128B

Income Tax Assessment Act 1936 subsection 177D(2)

Taxation Administration Act 1953 Subdivision 12-F of Schedule 1

Taxation Administration Act 1953 Subdivision 12-A-C of Schedule 1

Income Tax Assessment Act 1997 subsection 104-70(1A)

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 section 112-115

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 subsection 115-30(1)

Income Tax Assessment Act 1997 Division 125

Income Tax Assessment Act 1997 section 125-55

Income Tax Assessment Act 1997 section 125-60

Income Tax Assessment Act 1997 section 125-65

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 section 125-80

Income Tax Assessment Act 1997 section 125-85

Income Tax Assessment Act 1997 section 125-155

Income Tax Assessment Act 1997 section 855-15

Income Tax Assessment Act 1997 section 855-25

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Will the Resident Shareholders of Company A be entitled to choose demerger roll-over relief under section 125-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

Yes. The Resident Shareholders will be eligible to elect to apply demerger relief under section 125-55 of the ITAA 1997.

Detailed reasoning

Division 125 of the ITAA 1997 provides demerger relief from the CGT consequences of a demerger.

The shareholders of Company A will be eligible to choose demerger relief for any CGT consequences of the demerger provided they meet all of the conditions of subsection 125-55(1) of the ITAA 1997 as follows:

(a) You own an ownership interest in a company (the original interest);

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

(d) Under the demerger, a CGT event happens to your original interest and you acquire a new or replacement interest in the demerged entity.

However, subsection 125-55(2) of the ITAA 1997 states that you cannot choose to obtain a roll-over for an original interest if:

(a) You are a foreign resident; and

(b) The new interest you acquire under the demerger in exchange for that original interest is not taxable Australian property just after you acquire it.

The VCLP has foreign resident partners. The new interests that will be acquired by the Company A Shareholders in Company B will not be taxable Australian property (TAP), as defined by section 855-15 of the ITAA 1997, on the basis that Business Y does not and will not hold real property interests of more than 50% of the total market value of assets held by each entity.

Accordingly, the non-residentVCLP partners are not eligible to choose to obtain a roll-over under section 125-55 of the ITAA 1997.

The remaining Resident Shareholders can choose to obtain a roll-over provided they satisfy the requirements of subsection 125-55(1) of the ITAA 1997. These requirements are considered below.

(a) You own an ownership interest in a company

An ownership interest in a company is defined by section 125-60 of the ITAA 1997 as a share or similar interest (including an option or right) issued by a company that gives the owner an entitlement to acquire a share in the company.

Each of the Company A Shareholders own ordinary shares in Company A. Company A is the company referred to in subsection 125-55(1)(a) of the ITAA 1997.

Other interests in Company A are the options over ordinary shares currently on issue. The options have not and will not be exercised as they will be cancelled prior to the demerger. There are no other rights or similar equity interests held in Company A.

Each of the ordinary shares in Company A is an ownership interest in a company (an original interest) pursuant to section 125-60 of the ITAA 1997.

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

Subsection 125-65(1) of the ITAA 1997 provides that a demerger group consists of the head entity of the group and at least one demerger subsidiary. The demerger group in this case comprises Company A as the head entity and will include Company B as a demerger subsidiary.

None of the Company A Shareholders can be the head entity of the demerger group because:

• The VCLP is treated as a partnership for income tax purposes. A partnership is not capable of being the head entity of a demerger group (subsection 125-65(3) of the ITAA 1997).

• Members of a demerger group cannot include trusts unless CGT event E4 is capable of applying to all of the units and interests in the trust (subsection 125-65(2) of the ITAA 1997). This excludes discretionary trusts. AMITs are also excluded by virtue of subsection 104-70(1A) of the ITAA 1997 which states that CGT event E4 does not occur in respect of interests in an AMIT.

• The demerger group must have a head entity that has at least one demerger subsidiary, being a subsidiary that it holds a minimum 20% interest.

• The remaining Company A Shareholders are individuals or trusts that do not qualify as demerger group members and/or do not hold a minimum 20% interest in Company A.

Company A will be the head entity because:

• No other member of the demerger group holds ownership interests in Company A (subsection 125-65(3) of the ITAA 1997), and

• There will be no other company or trust capable of being a head entity of a demerger group of which Company A could be a demerger subsidiary (subsection 125-65(4) of the ITAA 1997).

Company B will be a demerger subsidiary of Company A because Company A will own ownership interests in Company B 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 B (subsection 125-65(6) of the ITAA 1997).

(c) A demerger happens to the demerger group

The meaning of demerger is set out in section 125-70 of the ITAA 1997. Subsection 125-70(1) states that a demerger happens to a demerger group if:

(a) There is a restructuring of the demerger group; and

(b) Under the restructuring:

(i) Members of the demerger group dispose of at least 80% of their total ownership interests in another member of the demerger group to owners of original interests in the head entity of the demerger group;... and

(i) A CGT event happens to an original interest owned by an entity in the head entity of the group and the entity acquires a new interest and nothing else;...and

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

(e) The new interests acquired are:

(i) If the head entity is a company - ownership interests in a company:... and

(f) [repealed]

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

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

Restructuring of the demerger group

Taxation Determination Income tax: what is a 'restructuring' for the purposes of subsection 125-70(1) of the Income Tax Assessment Act 1997? (TD 2020/6) sets out the Commissioner's views of what is 'restructuring' for the purposes of subsection 125-70(1) of the ITAA 1997. A restructuring of a demerger group takes on its ordinary business meaning, referring to the reorganisation of a group of companies or trusts. As to which steps will form part of the restructuring is a question of fact. However, all the steps which occur under a single plan of reorganisation will usually constitute the restructuring.

The commercial understanding and objectively inferred plan for reorganisation will determine which steps or transactions will form part of the restructuring of the demerger group. The objectively inferred purpose of the restructuring is to separate Business Y from the rest of the Company A group so that each can operate as an individual standalone corporate group.

The proposed transactions (the restructure steps) are part of a single plan to give effect to the separation of the Business Y entities from the rest of the Company A group. Part (a) of the restructure steps are designed to facilitate the separation through the creation of a new holding and funding structure, including a separation of the external bank debt between the businesses. Part (b) moves assets currently sitting in Business X to Business Y enabling Business Y to hold all assets inherently connected with the business immediately prior to the demerger. Part (c) will then give effect to the separation of the entities, demerging Business Y from the rest of the group.

Based on our understanding of the commercial drivers for the restructure and the objectively inferred plan of the reorganisation steps outlined for the demerger, all of the restructure steps would form part of the 'restructuring' for the purposes of subsection 125-70(1) of the ITAA 1997.

The options over ordinary shares will be cancelled prior to the restructure steps. The cancellation is to occur, whether or not the restructuring goes ahead on the basis that the options are out of the money and are effectively worthless and so a cancellation is commercially sensible for the option holders and the Company A group.

Based on these factors, the decision to cancel the options is independent from the restructure of the Demerger Group. We accept that the cancellation of the options over ordinary shares does not form part of the restructuring referred to in subsection 125-70(1) of the ITAA 1997.

The transfer of shares from the retired shareholder to the new business partner, at market value, will also occur prior to the restructuring steps. The share transfer is independent from the restructure of the demerger group and is driven by the retirement of the shareholder and replacement business partner. We accept that the share transfer does not form part of the restructuring referred to in subsection 125-70(1) of the ITAA 1997.

Disposal of interests to owners

Under subparagraph 125-70(1)(b)(i) of the ITAA 1997, a restructure can be achieved by members of the demerger group disposing of at least 80% of their total ownership interests in another member of the demerger group to owners of original interests in the head entity of the demerger group.

Company A will transfer X% of the shares that it will own in Company B to the Company A shareholders on implementation of the demerger, therefore the requirements in subparagraph 125-70(1)(b)(i) of the ITAA 1997 will be satisfied.

Acquisition of new interests and nothing else

Paragraph 125-70(1)(c) of the ITAA 1997 requires that under the restructuring, a CGT event happens to an entity's original interest in Company A and the Company A shareholders acquire a new interest and nothing else.

To give effect to the demerger, Company A will declare a capital reduction and demerger dividend to its shareholders in proportion to their respective holdings. Company A will make an in specie distribution of the shares it holds in Company B to Company A's shareholders. The in specie distribution will trigger CGT event G1 for the Company A Shareholders to the extent of the return of capital on their interests held in Company A (section 104-135 of the ITAA 1997).

Under the restructuring, Company A shareholders will acquire new ownership interests in the demerged entity, Company B, and will not receive anything else.

New interests a consequence of owning original interests

Paragraph 125-70(1)(d) of the ITAA 1997 requires the new interests to be acquired by the Company A shareholders only because those shareholders own or owned original interests.

This requirement is satisfied on the basis that the new interests will be acquired as payment of the capital reduction for the Company A Shareholder's original interests.

Type of new interests acquired

The interests which will be provided to the shareholders will be shares in Company B which are ownership interests in a company.

These shares will be ordinary class shares.

The requirement in paragraph 125-70(1)(e) of the ITAA 1997, that the new interest is an ownership interest in a company where the head entity is a company, is satisfied.

Non complying superannuation fund

Company A and Company B are companies and the ownership interests in the companies are ordinary shares. The original and new interests are not interests in a trust that is a non-complying superannuation fund.

The requirement in paragraph 125-70(1)(g) of the ITAA 1997 is satisfied.

Continuity of proportionate interests

Subsection 125-70(2) of the ITAA 1997 provides that each owner of original interests in the head entity of the demerger group must:

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

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

The disposal of the shares in Company B to the existing Company A shareholders will be distributed based on each owner's proportionate shareholding in Company A.

Each Company A Shareholder will have the same proportionate interest in the combined total market value of Company A and Company B as they had in Company A before the demerger.

The requirements of subsection 125-70(2) will be satisfied.

CGT event happens to original interest and new interest acquired in the demerged entity

CGT event G1 will happen in relation to the shares held by Company A Shareholders in Company A to the extent that Company A makes a return of capital to its shareholders. Under the demerger steps, the Company A Shareholders will acquire shares in Company B (the demerged entity) via an in specie distribution.

Subsection 125-55(1)(d) of the ITAA 1997 will be satisfied.

Conclusion

All of the requirements of subsection 125-55(1) of the ITAA 1997 will be satisfied for each of the Company A Shareholders because:

• Each Company A Shareholder owns an ownership interest in Company A (the original interest)

• Company A is the head entity of a demerger group

• A demerger will happen to the demerger group, and

• Under the demerger, a CGT event (CGT event G1) will happen to each shareholder's original interest and the shareholders will acquire shares in the demerged entity, being Company B.

The non-resident partners of the VCLP are excluded from choosing demerger roll-over relief under subsection 125-55(2).

Therefore, only the Resident Shareholders will be entitled to choose demerger roll-over under section 125-55 of the ITAA 1997.

Question 2

Summary

Yes. The Resident Shareholders that choose to apply demerger roll-over relief will disregard any capital gain resulting from CGT event G1 pursuant to subsection 125-80(1) of the ITAA 1997.

Detailed reasoning

The Resident Shareholders are eligible to choose demerger roll-over relief as they will satisfy the requirements of section 125-55 of the ITAA 1997.

Pursuant to subsection 125-80(1) of the ITAA 1997, the choice will have the effect of disregarding any capital gain made on an original interest under the demerger. Any capital gain resulting from CGT event G1 in respect of the Resident Shareholders interests in Company A can be disregarded.

Question 3

Summary

Yes. All of the Company A Shareholders will be subject to first element cost base adjustments and reduced cost base adjustments under subsection 125-80(2) of the ITAA 1997. Subsection 125-80(2) of the ITAA 1997 apportions each of the Company A Shareholders cost bases in Company A ordinary shares (original interests) across their original interests and their new interests in Company B.

Detailed reasoning

The first element of the cost base and reduced cost base of the Company A shares and the corresponding Company B shares acquired under the demerger, will be the sum of its original cost bases (just before the demerger) of the Company A shares, apportioned over those Company A and Company B shares on a reasonable basis (subsection 125-80(2) of the ITAA 1997). The proportion must have regard to the market value of the Company A and Company B shares just after the demerger is affected, or an anticipated reasonable approximation of those market interests per subsection 125-80(3) of the ITAA 1997.

Taxation Determination TD 2006/73 Income tax: demergers in reallocating the cost bases of ownership interests under a demerger, as required by subsection 125-80(2) of the Income Tax Assessment Act 1997, is there more than one method that produces a reasonable apportionment? outlines the Commissioner's accepted methods for apportioning cost base. The Commissioner accepts the 'relative market value method', being the apportionment based on the market value of the interests relative to the total market value of all of the post demerger interests. This is the approach that will be applied in calculating the cost base of all interests held in Company A and Company B following the demerger.

Whether or not demerger rollover relief is chosen by the Company A Shareholders, the cost base adjustments of subsection 125-80(2) of the ITAA 1997 will apply to all of the Company A Shareholders. Section 125-85 of the ITAA 1997 states that you are to apply the cost base adjustments in subsection 125-80(2) of the ITAA 1997 as though you could have chosen a roll-over and you had done so.

The non-residentpartners of the VCLP cannot choose to apply demerger roll-over relief under subsection 125-55(2) of the ITAA 1997. However, the non-residentpartners of the VCLP will also be subject to the cost base adjustments of subsection 125-80(2) of the ITAA 1997 as though it could have chosen the roll-over and had done so.

Question 4

Summary

Yes. For the purposes of Division 115 of the ITAA 1997, the Resident Shareholders will be taken to have acquired their shares in Company B on the same date as their shares in Company A were acquired.

Detailed reasoning

By operation of item 2 of the table in subsection 115-30(1) of the ITAA 1997, a CGT asset acquired as a replacement asset under a "replacement asset roll-over" is taken to have been acquired when the taxpayer acquired the original asset involved in the roll-over.

The phrase "replacement asset roll-over" is defined in section 995-1 of the ITAA 1997 as meaning the circumstance where a taxpayer can defer a capital gain or loss from one CGT event until a later CGT event happens where ownership of one CGT asset ends and another one is acquired. The definition refers to the list of replacement asset roll-overs in section 112-115 of the ITAA 1997.

Item 14C in the table in section 112-115 of the ITAA 1997 refers to a Division 125 of the ITAA 1997 demerger as being a replacement asset roll-over. As a demerger is specifically included in this list, a share received under the demerger for which demerger roll-over relief is available and chosen will be an asset acquired under a replacement asset roll-over. Accordingly, the date of acquisition of the Company B shares for a Resident Shareholder will be taken to be the date they acquired their original Company A ordinary shares if they elect roll-over under subsection 125-55(1) of the ITAA 1997.

The non-residentpartners of the VCLP cannot elect to apply roll-over relief under subsection 125-55(2) of the ITAA 1997. Item 2 of the table in subsection 115-30(1) of the ITAA 1997 will not apply to the non-residentpartners of the VCLP.

Question 5

Summary

Yes. All or any part of the distribution of Company B shares to Company A 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

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 A 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 A 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 B shares will, in part, constitute a dividend of the Company A Shareholders. The total amount of the dividend will be the market value of the Company B shares at the time of the demerger excluding the amount debited to the share capital account of Company A.

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 Income tax: distributions of property by companies to shareholders - amount to be included as an assessable dividend).

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

• The dividend is a demerger dividend (as defined in subsection 6(1) of the ITAA 1936);

• The head entity does not elect that subsections 44(3) and (4) of the ITAA 1936 do not apply to the demerger dividend (subsection 44(2) of the ITAA 1936); and

• Subsection 44(5) of the ITAA 1936 is satisfied.

Demerger dividend

Demerger dividend is defined by subsection 6(1) of the ITAA 1936 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) of the ITAA 1936.

Demerger allocation is defined by subsection 6(1) of the ITAA 1936 and includes the total market value of the allocation represented by the ownership interests disposed of by a member of a demerger group under a demerger to the owners of ownership interests in the head entity.

The distribution of the Company B shares, reduced by the return of capital amount, will be a demerger dividend as defined in subsection 6(1) of the ITAA 1936.

No election

Company A will not make an election under subsection 44(2) of the ITAA 1936 that subsections 44(3) and (4) of the ITAA 1936 do not apply to the demerger dividend.

50% CGT assets test

Subsection 44(5) of the ITAA 1936 provides that subsections 44(3) and 44(4) of the ITAA 1936 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. In applying this test, you disregard any assets that are ownership interests in a demerger subsidiary unless they are used in a business referred to in that subsection.

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 Company B will, following the demerger, operate independently of the Company A group.

Following the restructure steps which include the proposed demerger of Business Y, at least 50% of the market value of CGT assets owned by Company B (being the demerged entity) and each of its subsidiaries, will be used directly or indirectly in the business.

As such, subsection 44(5) of the ITAA 1936 does not apply.

Conclusion

The dividend paid to the Company A Shareholders under the demerger will satisfy the conditions necessary to be a demerger dividend and would therefore be non assessable non exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Question 6

Will section 45 or section 45A of the ITAA 1936 apply to the whole or any part of the proposed demerger scheme?

Summary

No. Section 45 or section 45A of the ITAA 1936 will not apply to the whole or any part of the proposed arrangement.

Detailed reasoning

Section 45 of the ITAA 1936 applies in circumstances where, whether in the same year of income or in different years of income, shares are streamed to some shareholders but not all shareholders, and some or all of the shareholders that do not receive shares receive minimally franked dividends.

Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholders) and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or would receive dividends.

With respect to the proposed demerger:

• All of the issued shares in Company A are ordinary shares which have proportionate rights to distributions of capital and dividends.

• Under the proposed demerger, the amount of the return of capital and dividend to be paid to each Company A Shareholder will be proportionate to the number of shares held by that shareholder.

There will be no streaming of shares, capital or dividends as part of the proposed demerger. Sections 45 or 45A of the ITAA 1936 will have no application to the proposed demerger.

Question 7

Will the Commissioner make a determination in respect of the demerger or capital benefit provided to the shareholders of Company A under:

(a) Paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies in respect of the whole or any part of the demerger benefit; or

(b) Paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in respect of the whole or any part of the capital benefit.

Summary

No. The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of the ITAA 1936 will apply to the whole, or any part, of any benefit provided to the Company A shareholders under the proposed demerger.

Detailed reasoning

Subsection 45B(3) of the ITAA 1936 allows the Commissioner to make a determination in relation to a demerger benefit and a capital benefit. However, for this provision to apply, the relevant scheme must fall within the scope of section 45B.

Subsection 45B(2) of the ITAA 1936 details various conditions for the application of section 45B. The conditions are:

(a) A person is provided with a demerger or capital benefit;

(b) A taxpayer obtains a tax benefit; and

(c) It would be concluded in all the relevant circumstances that any person who entered into or carried out the scheme or any part of the scheme did so for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit.

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) and will not be treated as non assessable non exempt income.

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).

Demerger benefit and capital benefit

A demerger benefit is defined in subsection 45B(4) of the ITAA 1936 to include the provision by a company of an ownership interest in that or another company. The provision of the shares in Company B under the proposed demerger will constitute a demerger benefit for the Company A Shareholders.

The provision of the Company B shares also constitutes a capital benefit as defined in subsection 45B(5) of the ITAA 1936. However, the provision of Company B shares will only be a capital benefit to the extent it is not a demerger dividend (subsection 45B(6) of the ITAA 1936). The distribution of the Company B shares, reduced by the return of capital amount, will be a demerger dividend as defined in subsection 6(1) of the ITAA 1936. As such, only the portion of the Company B shares distributed under the demerger attributable to the return of capital is a capital benefit provided to the Company A Shareholders.

The Company A Shareholders will be provided with a demerger benefit and a capital benefit.

Obtains a tax benefit

Subsection 45B(9) of the ITAA 1936 provides 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 or the capital benefit had been an assessable dividend.

As a result of the demerger, the Company A Shareholders will receive shares in Company B. Apart from the operation of section 45B, the income tax consequences for the Company A Shareholders upon receipt of the Company B shares will be disregarded as follows:

• The Resident Shareholders are eligible to apply demerger roll-over relief to disregard any capital gain from CGT event G1 for the return of capital component.

• The non-residentpartners of the VCLP should not be exposed to capital gains on a return of capital given that the shares of Company A are not indirect Australian real property interests as defined in section 855-25 of the ITAA 1997.

• The demerger dividend component (being the market value of the shares reduced by the amount debited to the share capital account) will be eligible to be treated as non assessable non exempt income for the resident and non-residentshareholders.

The tax payable by Company A Shareholders on the demerger would be higher if the demerger dividend component of the Company B shares had been an assessable dividend under subsection 44(1) of the ITAA 1936, or subject to withholding tax in the case of the non-resident shareholder. Accordingly, Company A Shareholders will obtain a tax benefit for the purposes of subsection 45B(9) 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 demerger restructuring steps which include the transfer of shares in Company B to the Company A Shareholders constitutes the relevant scheme for the purposes of section 45B of the ITAA 1936.

More than incidental purpose

Given that the proposed demerger is a scheme that provides a tax benefit to the Company A 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 section 45B will apply if enabling the shareholder to obtain the tax benefit is a more than incidental purpose of the scheme.

Practice Statement PS LA 2005/21 Application of section 45B of the Income Tax Assessment Act 1936 to demergers (PS LA 2005/21) is the Commissioner's instruction and practical guidance for tax officers to assess the application of section 45B of the ITAA 1936 for a demerger of an entity. To be an incidental purpose, the tax purpose must be objectively subordinate to the other substantial purposes. For example, if the tax purpose of the demerger merely follows the commercial purpose for the demerger as its natural incident, the tax purpose will be incidental.

PS LA 2005/21 also states that Section 45B does not require any inquiry into subjective motives of those carrying out the demerger. It is concerned with determining the objective purpose. In practical terms, the approach to determining objective purpose is that all the relevant circumstances of the scheme, including the commercial reasons advanced for entry into it, are to be properly considered and weighed against the tax benefits conferred.

A number of commercial reasons were provided as the reason for undertaking a demerger.

The relevant circumstances of the scheme listed in subsection 45B(8) of the ITAA 1936 have been considered by the Commissioner. Each of the circumstances has been considered in order to determine whether or not, individually or collectively, they revealed the existence of the requisite purpose.

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.

Conclusion

Company A has provided factors supporting commercial objectives for the proposed demerger. These are considered against the factors that would incline towards the conclusion that the scheme is being implemented for a more than incidental purpose for the relevant taxpayer to obtain a tax benefit.

Notwithstanding that paragraphs 45B(2)(a) and 45B(2)(b) are satisfied, having regard to the relevant circumstances of the scheme as stipulated within subsection 45B(8), it cannot be concluded that the scheme will be implemented for a more than incidental purpose of enabling the relevant person to obtain a tax benefit for the purposes of paragraph 45B(2)(c). There are substantive business reasons whereby the provision of tax benefits to the Company A Shareholders appears to be a mere incident of the demerger rather than a significant purpose of it.

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 A Shareholders under the proposed arrangement.

Question 8

Summary

No. The demerger dividend will not give rise to a liability to withholding tax pursuant to section 128B of the ITAA 1936 or withholding tax collection obligations under Subdivision 12-F or Subdivision 12A-C of Schedule 1 of the TAA.

Detailed reasoning

Section 128B of the ITAA 1936, which forms part of Division 11A of the ITAA 1936, sets out the circumstances in which a liability to non-resident dividend withholding tax may arise.

Subsection 128B(3D) of the ITAA 1936 states that section 128B does not apply to a demerger dividend to which section 45B does not apply. Accordingly, the value of the Company B shares distributed that exceeds the amount debited to the share capital account (the demerger dividend) will not give rise to a withholding tax liability under section 128B of the ITAA 1936.

There are two relevant collection mechanisms for a withholding tax liability:

• Subdivision 12-F of Schedule 1 of the TAA sets out the circumstances in which an obligation to collect non-resident dividend withholding tax may arise.

• Subdivision 12A-C of Schedule 1 of the TAA sets out the circumstances in which an obligation to collect non-resident dividend withholding tax may arise in the context of attribution-MITs (AMITs) that are withholding-MITs.

Subdivision 12-F

Section 12-300 of Schedule 1 of the TAA states that subdivision 12-F does not require an entity:

(a) to withhold an amount from a dividend...if no withholding tax is payable in respect of the dividend...

In essence, section 12-300 of Schedule 1 of the TAA prevents an obligation to collect non-resident dividend withholding tax from arising in circumstances where no liability to non-resident dividend withholding tax exists under section 128B of the ITAA 1936.

The part of the demerger allocation that is a demerger dividend is not capable of giving rise to a liability to withholding tax pursuant to section 128B of the ITAA 1936.

Subdivision 12A-C

Subdivision 12A-C of Schedule 1 of the TAA outlines the collection mechanisms for AMITs. Subdivision 12A-C does not contain a specific exclusion such as the section 12-300 exclusion for subdivision 12-F. Instead the types of payments that are captured by subdivision 12A-C ultimately refer back to amounts relating to assessable income and amounts and that are subject to a requirement to withhold under subdivision 12-F as follows:

• Sections 12A-215 and 12A-220 of Schedule 1 of the TAA are the provisions that can require withholding amounts to be paid to the Commissioner in respect of AMITs

• These sections require, amongst other things, that there be:

- A deemed payment arising under section 12A-205 of Schedule 1 of the TAA

- That the deemed payment be either a fund payment or an AMIT DIR payment

• Section 12A-205 of Schedule 1 of the TAA requires you to work out the amount of the deemed payment by first working out the determined member components of all the members of the AMIT of a character relating to assessable income (see paragraph 12A-205(2)(b)(i) of Schedule 1 of the TAA).

• Fund payment for an AMIT is given meaning by section 12A-110 in Schedule 1 to the TAA (see section 995-1 of the ITAA 1997). It refers to the sum of amounts including the total of the determined member components for the AMIT for the income year of a character relating to assessable income.

• The demerger dividend is non assessable non exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

• AMIT DIR payments includes an AMIT dividend payment (see section 12A-25 of Schedule 1 of the TAA).

• AMIT dividend payment refers to the total of the determined member components for the AMIT for the income year of the character of a division that is subject to a requirement to withhold under Subdivision 12-F (see subsection 12A-30(3) of Schedule 1 of the TAA).

• There is no requirement to withhold from the demerger dividend under subdivision 12-F.

In essence, the subdivision only creates an obligation to collect non-resident dividend withholding tax in respect of a deemed payment of a dividend if an actual payment of the dividend would have fallen within the remit of subdivision 12-F.

Conclusion

The part of the demerger allocation that is a demerger dividend is not capable of giving rise to a liability to withholding tax pursuant to section 128B of the ITAA 1936 or withholding tax collection obligations under Subdivision 12-F or 12A-C of Schedule 1 of the TAA.

Question 9

As a consequence of section 125-155 of the ITAA 1997, will Company A disregard any capital gain under CGT event A1 upon the proposed transfer of its shares in Company B to its shareholders?

Summary

Yes. Company A will disregard any capital gain under CGT event A1 upon the transfer of its shares in Company B under the demerger to Company A shareholders.

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:

• Company A is the demerging entity;

• CGT event A1 will happen when Company A disposes of its shares in Company B and transfers them to the Company A Shareholders (per section 104-10 of the ITAA 1997); and

• This disposal happens under the demerger.

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

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