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Ruling

Subject: Demerger relief

Question 1

Will the Commissioner confirm that X is entitled to choose demerger roll-over relief pursuant to section 125-55 of the ITAA 1997?

Answer

Yes, X will be entitled to choose a roll-over pursuant to section 125-55 of the ITAA 1997.

Question 2

Will the Commissioner confirm that if X chooses roll-over relief pursuant to section 125-55 of the ITAA 1997, X will be taken to have acquired the B Co shares X receives under the demerger on the same date as X acquired the corresponding shares in A Co?

Answer

If X chooses a roll-over pursuant to section 125-55 of the ITAA 1997, then because all X's shares in A Co were acquired before 20 September 1985, X will be taken under subsection 125-80(5) of the ITAA 1997 to have acquired the B Co shares X will receive under the demerger, before that date.

Question 3

Will the Commissioner confirm that all or any part of the in specie distribution of B Co shares to A Co shareholders that is a dividend for tax purposes will constitute a demerger dividend, and therefore be non-assessable non-exempt income of X under subsection 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

The part of the in specie distribution of B Co shares to A Co shareholders that would have been assessable to X under subsection 44(1) of the ITAA 1936 apart from subsections 44(3) and 44(4) of that Act will constitute a demerger dividend, and will therefore be non-assessable non-exempt income of X under subsection 44(4) of that Act.

Question 4

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of that Act will apply?

Answer

No, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of that Act will apply.

Question 5

Will the Commissioner confirm that Division 7A of Part III of the ITAA 1936 will not apply to any distributions made to X under the demerger arrangement?

Answer

A Co will not be taken to pay a dividend to X under section 109C or section 109D of the ITAA 1936 as a result of the distribution to X by A Co of shares in B Co under the demerger arrangement.

This ruling applies for the following periods:

Income year ending 30 June 2013

The scheme commences on:

NA

Relevant facts and circumstances

X is an individual shareholder of A Co, a private company.

1. X and X's spouse, Y, each own 50% of each class of shares in A Co.

2. X and Y acquired the shares before 20 September 1985.

3. X is a resident for income tax purposes.

4. A Co holds a majority of the shares in B Co, a private company.

5. The remainder of the shares in B Co are owned by the children of X and Y through interposed private companies.

6. All the shares in B Co are of the same class.

7. A Co and B Co each run a business, but of different types. The businesses are active and will continue to be so in future.

8. A restructure is proposed in which A Co will dispose of all its shares in B Co to X and Y, with 50% going to each of X and Y. All the shares in B Co are of the same class.

9. The disposal will be by way of an in specie distribution, and will be accounted for partly by a return of capital, with the remainder from A Co's retained profits. The sum of the two components will be the market value just before the restructure of the B Co shares disposed of.

10. The proportion of A Co's share capital returned to X and Y will be equal to the total market value of B Co's shares as a proportion of the total market value of A Co's shares just before the restructure.

11. After the restructure, B Co will carry on the same business as it did before, and just after the restructure, at least 50% by market value of all B Co's assets will be used in that business.

12. A Co will not make an election under section 44(2) of the ITAA 1936 that subsections 44(3) and 44(4) of that Act will not apply to the distribution to X and Y.

13. The pattern of dividends paid by A Co to X and Y over the years shows that typically, A Co pays minimal if any dividends.

14. X has no carried forward capital losses.

15. The commercial reasons advanced in favour of the restructure are as follows:

· The two companies will be free to focus on their own specialisations in their different industries with separate boards and management teams consisting of people with the appropriate specialised skills, and will be able to brand and market themselves separately.

· Conflicts of interest, which have led to lost business in the past, will be reduced.

· The ability of A Co to raise finance will not be impacted by the performance of B Co.

· A Co will be able to phase out parent company guarantees in favour of B Co which are currently tying up assets that A Co could use as security to obtain finance for its own projects.

Some of the children of X and Y are involved in running the businesses of A Co and B Co. The others play no role other than as passive investors in B Co: see fact 5.

Relevant legislative provisions

Income Tax Assessment Act 1997

section 104-70

section 104-135

Division 125

section 125-55

subsection 125-55(1)

subsection 125-55(2)

section 125-60

subsection 125-60(1)

section 125-65

subsection 125-65(1)

subsection 125-65(2)

subsection 125-65(3)

subsection 125-65(4)

subsection 125-65(5)

subsection 125-65(6)

subsection 125-65(7)

section 125-70

subsection 125-70(1)

paragraph 125-70(1)(a)

paragraph 125-70(1)(b)

subparagraph 125-70(1)(b)(i)

paragraph 125-70(1)(c)

paragraph 125-70(1)(d)

paragraph 125-70(1)(e)

paragraph 125-70(1)(g)

paragraph 125-70(1)(h)

subsection 125-70(2)

subsection 125-70(4)

subsection 125-70(5)

subsection 125-70(6)

subsection 125-70(7)

section 125-80

subsection 125-80(1)

subsection 125-80(2)

subsection 125-80(4)

subsection 125-80(5)

subsection 125-80(6)

subsection 125-80(7)

section 125-85

section 125-90

section 125-155

paragraph 125-230(a)

paragraph 125-230(b)

paragraph 202-45(i)

subsection 995-1(1)

Income Tax Assessment Act 1936

section 44

subsection 44(1)

subsection 44(2)

subsection 44(3)

subsection 44(4)

subsection 44(5)

subsection 6(1)

section 45

section 45A

section 45B

subsection 45B(2)

paragraph 45B(2)(c)

subsection 45B(3)

subsection 45B(4)

subsection 45B(5)

subsection 45B(6)

subsection 45B(10)

paragraph 45B(8)(a)

paragraph 45B(8)(b)

paragraph 45B(8)(c)

paragraph 45B(8)(d)

paragraph 45B(8)(e)

paragraph 45B(8)(f)

paragraph 45B(8)(g)

paragraph 45B(8)(h)

paragraph 45B(8)(i)

paragraph 45B(8)(j)

paragraph 45B(8)(k)

paragraph 45B(9)

section 45BA

section 45C

section 102L

subsection 102(10)

subsection 102(11)

subsection 102(13)

subsection 102(18)

section 102T

subsection 102T(11)

subsection 102T(12)

subsection 102T(14)

subsection 102T(19)

Division 7A of Part III

section 109B

section 109C

paragraph 109C(3)(c)

section 109D

subsection 109L(1)

subsection 109L(2)

section 109RA

subsection 128B(1)

subsection 128(3D)

Division 16K of Part III

section 159GZZZK

subsection 177A(1)

subparagraph 177D(b)(i)

subparagraph 177D(b)(ii)

subparagraph 177D(b)(iii)

subparagraph 177D(b)(iv)

subparagraph 177D(b)(v)

subparagraph 177D(b)(vi)

subparagraph 177D(b)(vii)

subparagraph 177D(b)(viii)

paragraph 177EA(3)(e)

section 318

Acts Interpretation Act (1901)

subsection 33(2A)

Reasons for decision

Before the answers to any of the questions can be given, it is necessary to establish whether there is a demerger as defined in section 125-70 of the ITAA 1997. In the case of questions 3, 4 and 5, it is also necessary to establish whether section 45B of the ITAA 1936 applies.

Applicable law - demergers

Introduction

1. On 24 October 2002, the demerger rules were enacted by New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Act 2002, section 3 and Schedule 16. The purpose of the rules is to remove tax impediments to the restructuring of businesses in situations where the restructuring would leave the owners in the same economic position as they were just before the restructuring. The rules were implemented via changes to the CGT rules in Part 3-3 of the ITAA 1997 and to the dividend income rules in Subdivision D of Division 2 of Part III of the ITAA 1936.

2. New Division 125 was introduced into the Income Tax Assessment Act 1997 (ITAA 1997). This Division defines 'demerger' and associated terms and sets out concessional CGT consequences for the 'original owners' of a 'demerging entity' and for a demerging entity itself. It is the consequences for the original owners that are relevant to the present case.

3. Section 44 of the Income Tax Assessment Act 1936 (ITAA 1936), which brings dividends into assessable income, was amended to provide an exemption for 'demerger dividends'. Section 45B of the ITAA 1936 was re-enacted in tandem with the contemporaneously introduced section 45BA, with the added purpose of combating schemes to gain inappropriate access to the demerger dividend exemption.

4. Where a group satisfying the definition of 'demerger group' in section 125-65 of the ITAA 1997 restructures in a manner that meets the requirements of section 125-70 of the ITAA 1997 (such that a 'demerger' happens to the group), the demerger rules provide specific relief from the income tax consequences that would otherwise have arisen. However, the exemption for demerger dividends is subject to sections 45B and 45BA (and possibly 45C) of the ITAA 1936.

Demerger group

5. A demerger group consists of a 'head entity' and one or more 'demerger subsidiaries' (subsection 125-65(1) of the ITAA 1997). Members of the demerger group must either be companies or trusts (section 125-65 of the ITAA 1997, subsections (3), (6) and (7)). However, a trust cannot be a member of the demerger group 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).

6. A company or trust that is the head entity has no 'ownership interest' held in it by other members of the demerger group (subsection 125-65(3) of the ITAA 1997). Further, if a company or trust is provisionally assumed to be the head entity of a demerger group, but it and all the entities that would (consistent with the assumption) be its demerger subsidiaries are themselves demerger subsidiaries of a company or trust in another demerger group, the first-mentioned company or trust is not a head entity of a demerger group (subsection 125-65(4) of the ITAA 1997).

7. A company or trust is a 'demerger subsidiary' of another company or trust that is a member of the group if the other company, in its own right or together with other group members, owns or has the right to acquire ownership interests in the company or trust that carry between them:

· the right to receive more than 20% of any distribution of income or capital by the company or trustee, and

· (in the case of a company) the right to exercise, or control the exercise of, more than 20% of the voting power of the company (section 125-65 of the ITAA 1997, subsections (6) and (7)).

8. An 'ownership interest' in a company or trust is a share in the company or unit or other interest in the trust, or an option, right or similar interest issued by the company or trustee entitling the owner to acquire a share in the company or a unit or other interest in the trust (subsection 125-60(1) of the ITAA 1997). An ownership interest in a corporate unit trust of public trading trust is treated for the purposes of Division 125 of the ITAA 1997 as if it were an ownership interest in a company (Paragraph 125-230(b) of the ITAA 1997).

Demerger

9. The definition of 'demerger' for the purposes of the ITAA 1997 and the ITAA 1936 is pointed to by subsection 995-1(1) of the ITAA 1997, which states that a demerger has the meaning given by section 125-70 of the ITAA 1997. Paragraphs 125-70(1)(a) and (b) of the ITAA 1997 state that a demerger happens to a demerger group if there is a restructuring of the demerger group, and under the restructuring:

· members of the demerger group dispose of at least 80% of their total ownership interests in the demerged entity to owners of original interests in the head entity of the group; or

· at least 80% of the total ownership interests of members of the demerger group in the demerged entity end and new interests are issued to owners of original interests in the head entity; or

· the demerged entity issues sufficient new ownership interests in itself such that owners of original interests in the head entity own at least 80% of the total ownership interests in the demerged entity; or

· some combination of the above three processes happens with the effect that members of the demerger group stop owning at least 80% of the total ownership interest owned by members of the demerger group in another member of the group.

10. Paragraphs 125-70(1)(c), (d), (e), (g) and (h) and subsection 125-70(2) of the ITAA 1997 set out additional requirements as follows:

· whether or not a CGT event happens to an original interest owned by an entity in the head entity, the entity acquires a new interest and nothing else. (CGT event G1 or CGT event E4 happens if there is respectively a capital payment for shares or trust interest in relation to the original interest.)

· entities acquire new interests only because they own or owned original interests

· the new interests must be ownership interests in a

i. company if the head entity is a company

ii. trust if the head entity is a trust

· neither the original interests nor new interests are in a trust that is a superannuation fund (as defined by section 10 of the Superannuation Industry (Supervision) Act 1993)

· the proportion of new interests acquired by each owner (the 'original owner') of original interests must equate as nearly as practicable to the proportion of original interests owned by the original owner

· each original owner must, just after the demerger, have the same proportionate total market value of ownership interests in the head entity and demerged entity as they had in the head entity just before the demerger.

11. An off-market share buy-back is not a demerger (subsection 125-70(4) of the ITAA 1997). There is also no demerger if the circumstances are such that an owner of original interests could have obtained a roll-over under the income tax law apart from Division 125 of the ITAA 1997 for each CGT event that happened to those interests under those circumstances (subsection 125-70(5) of the ITAA 1997).

Demerged entity

12. A 'demerged entity' is defined to be a former member of a demerger group where, under a demerger that happens to the group, ownership interests in the former member are acquired by shareholders, or unitholders or holders of interests in, the head entity of the group (subsections 125-70(6) and (7) of the ITAA 1997).

Demerging entity

13. A 'demerging entity' is an entity that is a member of a demerger group just before the CGT event referred to in section 125-155 of the ITAA 1997 happens, and under a demerger that happens to the demerger group, the entity, alone or together with other members of the group, stops owning at least 80% of the ownership interests owned by members of the group in another member of the group because of one or a combination of the processes described in the first three dot points in paragraph 10.

Demerger relief

14. Paragraphs 15.5 and 15.6 of the Explanatory Memorandum to the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002 (the EM) explain the context of demerger relief as follows:

15.5 The CGT relief and dividend exemption will facilitate the demerging of entities by ensuring that tax considerations are not an impediment to restructuring a business. These amendments are based on Recommendation 19.4 of A Tax System Redesigned, and recognise that there should be no taxing event for a restructuring that leaves members in the same economic position as they were just before the restructuring.

15.6 The CGT relief provided for demergers complements the scrip for scrip roll-over provided under Subdivision 124-M of the ITAA 1997. A Tax System Redesigned recommended tax relief for both demergers and for takeovers and mergers achieved by scrip for scrip exchanges.

15. The Review of Business Taxation - A Tax System Redesigned, Commonwealth of Australia, 1999 (the RBT) recommended (at p. 168) that demerger relief be provided 'where a widely held entity splits its operations into one or more new entities and issues membership interests in these entities to the original members in the same nature and proportion as their original membership interest.' It went on to explain the recommendation as follows (at p. 619):

The Review considers that where an entity undertakes a reorganisation of its operations, leaving members in the same economic position as they were immediately before the reorganisation, there should be no taxing event. … [E]quity holders may face CGT and/or income tax … This acts as an impediment to entities restructuring their operations and may therefore lead to a reduction in the overall efficiency of the economy. The provision of relief will enable widely-held entities to restructure their operation with a minimum of difficulty for members.

16. There are three elements of demerger relief:

· the CGT consequences for owners of original interests

· the CGT consequences for demerging entities; and

· the consequences for owners of original interests of receiving a demerger dividend.

The first and third of these are relevant to the present case.

CGT Consequences for owners of original interests

17. Owners of original interests in the head entity may choose a roll-over in relation to a CGT event that happens to those interests under a demerger (subsection 125-55(1) of the ITAA 1997). In that case, any capital gain or capital loss arising from the CGT event is disregarded (subsection 125-80(1) of the ITAA 1997). However, an owner of original interests that is a foreign resident cannot choose the roll-over if the new interest they acquire under the demerger is not taxable Australian property just after they acquire it (subsection 125-55(2) of the ITAA 1997). Whether or not the roll-over is chosen, or whether or not a CGT event happens to the original interest, cost base adjustments must be made as detailed in section 125-80 of the ITAA 1997 to any remaining original interests that are not pre-CGT and any new interests that are not taken to be pre-CGT. If the roll-over is chosen and all (or a proportion) of the original interests are pre-CGT, then all (or a similar proportion) of the new interests are taken to be pre-CGT (subsections 125-80(4)-(6) of the ITAA 1997). If the new interests are eventually disposed of, CGT event K6 may apply: see note to subsection 125-80(7) of the ITAA 1997. If a proportion of the original interests ends under the demerger, the same proportion of any pre-CGT original interests ends (subsections 125-80(4), (7) of the ITAA 1997).

Consequences for owners of original interests of receiving demerger dividend

18. A demerger dividend is defined in subsection 6(1) of the ITAA 1936 as being 'that part of a demerger allocation that is assessable as a dividend under subsection 44(1) or that would be so assessable apart from subsections 44(3) and (4).' As defined in subsection 6(1) of the ITAA 1936, a dividend includes any distribution made by a company to any of its shareholders, whether in money or other property, but does not include any amount debited to the company's share capital account. A demerger allocation is defined in subsection 6(1) of the ITAA 1936 to be the total market value of the allocation represented by the ownership interests issued by the demerger entity in itself, or disposed of by a member of a demerger group, under a demerger to the owners of ownership interests in the head entity.

19. A demerger dividend is treated by subsection 44(3) of the ITAA 1936 as having not been paid out of profits (which means it is not assessable as a dividend in the shareholder's hands), and by subsection 44(4) of the ITAA 1936 as being not otherwise assessable or exempt income in that person's hands. However, the head entity may specifically elect that these subsections not apply (subsection 44(2) of the ITAA 1936). If the election is made, it applies to the total demerger dividend for all shareholders.

20. However, subsections 44(3) and (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 of the demerged entity and its demerger subsidiaries are used (directly or indirectly) in one or more businesses owned by one of more of those entities (subsection 44(5) of the ITAA 1936).

21. A demerger dividend is an unfrankable distribution (paragraph 202-45(i) of the ITAA 1997). A demerger dividend is also specifically excluded from being a deemed dividend under Division 7A of Part III of the ITAA 1936 (sections 109B and 109RA of the ITAA 1936) and is excluded from non-resident withholding tax (section 128B of the ITAA 1936, subsections (1) and (3D)). In relation to Division 7A, section 109C of the ITAA 1936, if not for the exclusion, may otherwise have applied, prima facie, to the demerger dividend, if paid by a private company to a shareholder or shareholder's associate (as defined in section 318 of the ITAA), to treat it as an assessable dividend. It is noted that for the purposes of section 109C, a payment includes a transfer of property (paragraph 109C(3)(c) of the ITAA 1936).

Concessional treatment of demerger dividend subject to application of section 45B of the ITAA 1936

22. Both exclusions, along with the treatment described in paragraph 20 are, however, subject to the application of section 45B of the ITAA 1936 which, if it applies, may result in the Commissioner making a determination under subsection (3) of that section that section 45BA of the ITAA 1936 applies to deem that the whole or a part of a demerger benefit is not a demerger dividend for the purposes of the income tax law for the owner of the ownership interest or relevant taxpayer. See further below under the discussion on anti-avoidance.

Anti-avoidance

23. As mentioned above, the third element of demerger relief (including the Division 7A and non-resident withholding exemptions) is subject to the application of sections 45B and 45BA of the ITAA 1936. These sections are discussed below.

24. Section 45B of the ITAA 1936 predates the demerger rules. It was originally enacted by Taxation Laws Amendment (Company Law Review) Act 1998 along with section 45C of the ITAA 1936 as part of a package of measures to protect the revenue following changes to the corporations law that made it easier for companies to substitute preferentially taxed capital payments to shareholders for dividends (see paragraphs 1.7 to 1.9 of the Explanatory Memorandum to Taxation Laws Amendment (Company Law Review) Bill 1998).

25. Subsequently, New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Act 2002 substituted the present sections 45B and 45BA of the ITAA 1936 for the original section 45B. The new section 45B essentially recreated the old version, but incorporated extra wording in order to also combat schemes that seek to take inappropriate advantage of the new demerger provisions introduced by the same Act.

26. Paragraph 15.67 of the EM has the following to say about sections 45B and 45BA of the ITAA 1936:

15.67 The demerger dividend exemption is supported by an integrity rule that is aimed at limiting the exemption to genuine demergers, rather than demergers that are directed at obtaining the dividend exemption. The effect of the integrity rule applying to a demerger is to exclude part or all of the demerger dividend from the demerger dividend exemption. So much of that excluded amount would then be considered within section 44 of the ITAA 1936, as an assessable dividend.

Section 45B

27. Section 45B of the ITAA 1936 applies if the following three conditions (set out in paragraphs 45B(2)(a), (b) and (c)) are all satisfied:

· there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company; and

· under the scheme, a taxpayer (the relevant taxpayer), whether or not the same person, obtains a tax benefit; and

· 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 part of the scheme) did so for a purpose of enabling the relevant taxpayer to gain a tax benefit. The purpose need not be the dominant purpose, but it must be more than an incidental purpose.

28. If the three conditions are satisfied, the Commissioner 'may' make, in writing, a determination under subsection 45B(3) of the ITAA 1936 that:

· section 45BA of the ITAA 1936 applies in relation to the whole, or a part, of the demerger benefit; or

· section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit.

29. Note that subsection 33(2A) of the Acts Interpretation Act 1901 states that '[w]here an Act assented to after the commencement of this subsection provides that a person, court or body may do a particular act or thing, and the word may is used, the act or thing may be done at the discretion of the person, court or body.'

Effect of a determination under subsection 45B(3) of the ITAA 1936

30. If the Commissioner determines that section 45BA of the ITAA 1936 applies, the amount of the demerger benefit, or the part of the benefit, is taken not to be a demerger dividend for the purposes of the income tax law.

31. If the Commissioner determines that section 45C of the ITAA 1936 applies, the amount of the benefit, or the part of the benefit, is taken for the purposes of the income tax law to be an unfranked dividend paid by the company out of its profits to the relevant taxpayer at the same time as the capital benefit is provided.

The first condition for section 45B of the ITAA 1936 to apply

32. In relation to the first condition in paragraph 27, 'scheme' means any 'arrangement'; or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise (subsection 45B(10) of the ITAA 1936 and subsection 995-1(1) of the ITAA 1997). 'Arrangement' means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings (subsection 995-1(1) of the ITAA 1997). The definition is very widely drawn, and it would be expected that a demerger or part of a demerger would constitute a scheme or part of a scheme (Practice Statement PS LA 2005/21, paragraphs 27-28).

33. According to subsection 45B(4), a person is 'provided with demerger benefits' if:

· a company provides the person with ownership interests in that or another company; or

· something is done in relation to an ownership interest owned by the person with the effect of increasing the value of that or another ownership interest owned by the person.

Because of the definition of 'demerger' in section 125-70 of the ITAA 1997 (see particularly paragraph 9), it is inevitable that under a demerger the owners of original interests in the head entity of the demerger group will be provided with ownership interests in the entity that is to be demerged. Therefore, where the provider of the ownership interests is a company and the ownership interests are in a company, the first dot point would inevitably be satisfied.

34. According to subsection 45B(5) of the ITAA 1936, a reference to a person being 'provided with a capital benefit' is a reference to any of:

· the provision of ownership interests in a company to the person

· the distribution to the person of share capital or share premium; or

· something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (whether or not the same interest) that is held by the person.

There is clearly a degree of overlap between the concepts 'provided with a demerger benefit' and 'provided with a capital benefit'. In recognition of this, subsection 45B(6) of the ITAA 1936 provides that a person is not provided with a capital benefit to the extent that any of these things involves the person receiving a demerger dividend.

The second condition for section 45B of the ITAA 1936 to apply

35. In relation to the second condition in paragraph 27, the relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under the income tax law, by the relevant taxpayer would, apart from section 45B of the ITAA 1936, 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 or capital benefit had been an assessable dividend (subsection 45B(9) of the ITAA 1936). It would normally be expected (though there is no requirement) that the relevant taxpayer(s) would be the owners of the head entity of the demerger group, as it is they who would be in receipt of a demerger benefit (Practice Statement PS LA 2005/21, paragraph 33). A demerger benefit usually involves a tax benefit as any amount of the demerger benefit that would have been an assessable dividend if not for subsection 44(3) and (4) of the ITAA 1936 is neither assessable as a dividend or otherwise and is also non-exempt under those subsections.

The third condition for section 45B of the ITAA 1936 to apply

36. In relation to the third condition in paragraph 27, regardless of what the primary purpose of entering into or carrying out the scheme is, section 45B of the ITAA 1936 will apply if, taking into account objectively the relevant circumstances of the scheme, it would be concluded that there is a more than incidental purpose (the 'requisite purpose') of enabling the relevant taxpayer to gain a tax benefit. The Explanatory Memorandum to Taxation Laws Amendment (Company Law Review) Bill 1998 stated, at paragraph 1.32:

A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with one of the main or substantial purposes of the scheme, or merely follows that purpose as its natural incident.

37. This does not necessarily mean that an incidental purpose is relatively unimportant to the design of the scheme. The High Court, in its unanimous decision in Mills v Commissioner of Taxation [2012] HCA 51; 2012 ATC 20-360 at paragraph 66, stated in relation to the almost identically worded condition in paragraph 177EA(3)(e) of the ITAA 1936:

… a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose. Indeed, the centrality of a purpose to the design of a scheme directed to the achievement of another purpose may be the very thing that gives it a quality of subsidiarity and therefore incidentality.

38. To avoid the application of the section, any purpose of enabling the relevant taxpayer to gain a tax benefit must be objectively subordinate to the other substantial purposes (if any) (Practice Statement PS LA 2005/21, paragraphs 43-45). There is a non-exhaustive list of matters that are (or might be) relevant circumstances of a scheme to be taken into account for the purposes of determining whether or not the third condition in paragraph 27 applies. The list, which is in paragraphs 45B(8)(a) - (k) of the ITAA 1936, is as follows:

(a) the extent to which the demerger benefit or capital benefit is attributable to capital or profits (realised and unrealised) of the company or of an associate of the company ('associate' is as defined in section 318 of the ITAA 1936)

(b) the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate of the company

(c) whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income

(d) whether some or all of the ownership interest in the company or in an associate of the company held by the relevant taxpayer were acquired, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985

(e) whether the relevant taxpayer is a non-resident

(f) whether the cost base of the relevant ownership interest is not substantially less than the value of the applicable demerger benefit or capital benefit

(g) repealed by Tax Laws Amendment (Repeal of Inoperative Provision) Act 2006

(h) if the scheme involves the distribution of share capital or share premium - whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital or share premium. Note that a demerger would not normally disturb the head entity shareholder's existing ownership interests because of the requirements of the proportion tests - see the last two dot points in paragraph 10 (Practice Statement PS LA 2005/21, paragraph 72). This fact is therefore not usually of significant relevance for demergers.

(i) if the scheme involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests:

(j) the period for which the ownership interests are held by the holder of the interests; and

(i) when the arrangement for the disposal of the ownership interests was entered into

(ii) for a demerger only:

i. whether the profits of the demerging entity and demerged entity are attributable to transactions between the entity and an associate of the entity; and

ii. whether the assets of the demerging entity and demerged entity were acquired under transactions between the entity and an associate.

This factor directs attention to any concentration of profits or assets in the demerging entity or demerged entity prior to the demerger beyond what might be expected under a business restructure. The implication is that any excess concentration might be a device for delivering assets or profits tax free to the head entity's owners in the form of an ownership interest (Practice Statement PS LA 2005/21, paragraph 82).

(k) any of the matter referred to in subparagraphs 177D(b)(i) to (viii) of the ITAA 1936.

39. The matters referred to in subparagraphs 177D(b)(i) to (viii) of the ITAA 1936 are as follows:

(i) the manner in which the scheme was entered into or carried out;

(ii) the form and substance of the scheme

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme ('this Part', in the present context presumably means 'section 45B of the ITAA 1936' - see Practice Statement PS LA 2005/21, paragraphs 91-93)

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

(viiii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi).

Application to the facts

Is there a demerger group, and if so, what is the relevant demerger group?

40. There is a demerger group with A Co as the head entity and B Co as its demerger subsidiary (paragraphs 5-8, fact 4).

Does a demerger happen to the relevant demerger group?

41. The restructure described in facts 8-10 constitutes a demerger happening to the demerger group described in paragraph 40 as defined in section 125-70 of the ITAA 1997, since (see paragraphs 9-11):

· there would be a demerger group as described in paragraph 40

· the steps referred to in facts 8-10 would bring about a restructuring of the demerger group

· under the restructuring, A Co, a member of the demerger group that owns all the ownership interests in B Co - another member of the demerger group - that are owned by members of the demerger group, would dispose of all those interests to X and Y, who are owners of original interests in A Co (fact 1), which would be the head entity of the demerger group

· under the restructuring, CGT event G1 would happen to both X's and Y's original interests in A Co because of the return of capital (fact 9), and X and Y would each acquire 50% of the shares in B Co disposed of by A Co and nothing else (fact 8)

· X and Y would only receive the shares in B Co because they held original interests in A Co

· the ownership interests that X and Y would receive are shares in a company, B Co, and A Co, the head entity of the demerger group, is a company (facts 0, 1, 4)

· neither A Co (in which X and Y own original interests) nor B Co (in which X and Y would own new interests) is a trust that is a superannuation fund

· X and Y would be the only owners of original interests in A Co, the head company of the demerger group, and each would own 50% of those interests (fact 1). They would own the same proportion of the new interests in B Co (fact 8). As there is nothing to distinguish their shareholdings in A Co and B Co (facts 1, 6, 8), they will each have 50% of the total market value of ownership interests in A Co just before the restructure, and 50% of the total market value of ownership interests in both A Co and B Co just after the restructure

· The restructure does not constitute an off-market share buy-back

· There is no roll-over in the circumstances of the restructuring available to either X or Y due to a provision of the income tax law outside Division 125 of the ITAA 1997 in relation to CGT event G1 that is the only CGT event that happens to their original interests in A Co in those circumstances.

CGT consequences for taxpayer

42. The CGT consequences for X are as detailed in paragraph 17. X will be entitled to choose a roll-over under section 125-55 of the ITAA 1997. If X does so, no cost base adjustments will be required to either X's shares (original interests) in A Co or the shares X will receive (new interests) in B Co under the demerger, as all X's shares in A Co are pre-CGT (fact 2), and consequently all the shares X will receive in B Co will be taken to be pre-CGT.

Treatment of dividend in hands of taxpayer

43. Of the distribution by A Co to X of B Co shares, all of it will constitute a dividend (the shares being 'other property') except the amount returned to X as capital, which is debited to A Co's share capital account. The amount of the dividend on which X would be assessable under subsection 44(1) of the ITAA 1936 is the market value of the B Co shares less the amount returned as capital (fact 9). However, this dividend consists entirely of a demerger dividend (see paragraph 18), and the consequences for X are as described in paragraphs 18-21.

44. The demerger dividend is non-assessable non-exempt income of X, as A Co will not be electing otherwise (paragraph 19, fact 12), and more than 50% of the CGT assets of B Co will, both before and just after the demerger, be used in the business carried on by B Co (paragraph 20, fact 11). Division 7A of Part III of the ITAA 1936 does not apply to the demerger dividend.

45. However, as mentioned at paragraph 23, this concessionary treatment of the demerger dividend is contingent upon a determination not being made under subsection 45B(3) of the ITAA 1936 that section 45BA of that Act applies. Whether section 45B of the ITAA 1936 applies in relation to the proposed scheme is now examined. This requires examining the three conditions in paragraph 27.

Application of section 45B of the ITAA 1936

46. In relation to the first condition in paragraph 27, there is a scheme under which X and Y are provided with a demerger benefit, being the shares provided by A Co in B Co.

47. In relation to the second condition in paragraph 27, under the scheme, X and Y will each receive a tax benefit in the form of shares in B Co, which, apart from the return of capital, represents non-assessable non-exempt income. Because the distribution is unfrankable (paragraph 21), any franking credits that A Co has that would have been attached to the distribution had it been an assessable dividend will instead be preserved as an offset against X's and Y's basic income tax liability for future income years. There is a roll-over in relation to CGT event G1 that happens to their shares in A Co if they choose it, but these shares are pre-CGT, so no tax benefit will derive from the roll-over itself. However, if they do choose the roll-over, they will benefit by having the B Co shares they will receive under the demerger treated as pre-CGT assets, although this benefit may be largely negated by the prospect of CGT event K6 happening to the shares upon subsequent disposal.

48. In relation to the third condition in paragraph 27, taking into account the factors in paragraph 38:

(a) The return of capital (fact 9) is not in substitution for a dividend. It represents the same proportion of the pre-demerger share capital of A Co as the proportion of the market value of B Co shares bears to the pre-demerger market value of A Co (fact 10). The balance of the distribution is sourced from retained earnings (fact 9). The capital / profit split correctly reflects the circumstances of the demerger, so this factor does not incline to the requisite purpose mentioned in paragraph 45B(2)(c) of the ITAA 1936.

(b) From an examination of the pattern of dividends paid by A Co, it is evident that A Co neither pays dividends regularly nor pays large dividends when it pays them at all (fact 13). Therefore, there is no regular pattern of dividend payments which is obviously interrupted by the demerger-related distribution. However, whilst Practice Statement PS LA 2005/21 acknowledges that a demerger is unlikely to be used to replace standard profit distributions, the fact that minimal dividends have been paid over the years has allowed retained earnings to grow to the point where there is an opportunity to distribute a large amount as a non-assessable non-exempt dividend. Therefore, this factor inclines toward the requisite purpose.

(c) X has no capital losses to carry forward (fact 14), so this factor is not relevant.

(d) All X's interests in A Co were acquired before 20 September 1985 (fact 2), with the result that the interests X will receive in B Co under the demerger will be taken to have been acquired before that date (paragraph 17). This inclines toward the requisite purpose, although it is noted that were the shares in either company to be subsequently disposed of, it is probable that CGT event K6 would occur, which would diminish the advantage of holding shares that were, or were taken to be, pre-CGT.

(e) X is a not a non-resident (fact 3), so this factor is not relevant.

(f) X would gain no advantage from X's access to the roll-over in respect of the CGT event G1 that happens to X's shares in A Co under the demerger. Since those shares are pre-CGT (fact 2), X would not be subject to any capital gain in any case. Therefore any comparison between the cost base of those shares and the return of capital made in relation to them under the demerger is not of any consequence.

(g) (relevant provision repealed)

(h) regarding the distribution of share capital to X, the proportion tests are satisfied (see paragraph 41, eighth dot point), so this factor is not relevant.

(i) The facts do not indicate that X will dispose of the ownership interests X will acquire under the demerger. Therefore this factor is not relevant.

(j) There are no transactions between associated entities that would appear to suggest a concentration of profits or assets in A Co or B Co prior to the demerger. Therefore this factor is not relevant.

49. Further in regard to the third condition in paragraph 27, taking into account the factors in paragraph 39:

(i) The scheme will be carried out by way of a demerger (paragraph 41) in which A Co will dispose of its shares in B Co to its own shareholders, X and Y at market value (fact 9). The proportion of share capital returned to X and Y will reflect the pre-demerger market value of B Co shares as a proportion of the pre-demerger market value of A Co shares (fact 10). X and Y will, just after the demerger, be in the same economic position as they were just before.

A Co and B Co carry on different types of business (fact 7). The demerger will end the parent-subsidiary relationship between A Co and B Co (although both will have X and Y as common shareholders). The commercial benefits expected from the demerger are as indicated in fact 15.

This factor demonstrates that commercial considerations are foremost in relation to the demerger, and the demerger concessions are incidental to those considerations. Therefore, on balance, this factor inclines against the requisite purpose.

(ii) The form of the scheme is that of a demerger that meets the definition of that term in section 125-70 of the ITAA 1997 (paragraph 41). In substance, the scheme will simplify the structure of the group and make it easier for its members to pursue their different businesses independently as indicated in fact 15.

(iii) There does not appear to be an issue with the timing of the scheme that would incline toward the requisite purpose.

(iv) The result of the scheme in relation to X in the absence of section 45B of the ITAA 1936 would be as described in paragraphs 43-44. (The CGT consequences described in paragraph 42 happen irrespective of whether or not section 45B applies.) Similarly in relation to Y. The benefit that is at risk from the application of section 45B is the treatment of the demerger dividend as non-assessable non-exempt income. This factor inclines toward the requisite purpose.

(v) X and Y will each receive shares in B Co under the demerger to which no income tax liability would attach. However, A Co will then not have those same shares, so the market value of X's and Y's shares in A Co would be expected to decline by the same amount as a result of the demerger. In the immediate sense, their economic position will remain unchanged, an outcome which is consistent with the aims of the demerger provisions (paragraph 14).

X and Y may gain some advantage from having direct ownership of an asset they previously owned only indirectly. For example, any dividends paid by B Co that, pre-demerger, would have been paid to A Co, will be paid to X and Y instead; and they can dispose of the shares (or not) as they wish, or use them as security (Practice Statement PS 2005/21, paragraph 95).

Also, if the commercial benefits identified as drivers for the demerger (fact 15) come to pass, it would be expected that X and Y as shareholders would gain from the fruits of the increased profitability of A Co and B Co in the form of higher dividends and / or capital appreciation of their shares on those two companies. However, such benefits as may (or may not) come to pass are no more than would be expected of a business restructure undertaken for sound commercial reasons, and are not out of line with the purpose of the demerger provisions outlined in paragraph 14.

On balance, this factor neither inclines towards or away from the requisite purpose.

(vi) To the extent (if any) that B Co becomes more profitable as a result of the demerger, the children of X and Y that hold shares in B Co through their respective companies (fact 5) can be expected to benefit from the demerger. Again, however, such benefits as may (or may not) come to pass are no more than would be expected of a business restructure undertaken for sound commercial reasons. This factor does not incline towards the requisite purpose.

(vii) There do not appear to be any other consequences of the scheme of any significance for X, Y or any other person mentioned in subparagraph (vi) above. This factor does not incline towards the requisite purpose.

(viii) A Co and B Co are family companies. X and Y and their children are all shareholders in the group (facts 0, 1, 5). Some of the children are involved in running the businesses of the group, while others are merely passive investors in B Co via their respective companies (fact 0).

50. Taking into account the relevant circumstances of the scheme as set out in paragraphs 48 and 49, it is apparent that, objectively speaking, a purpose of the scheme is to obtain a tax benefit for X and Y as described in paragraph 47. However, on balance, it is considered that the relevant circumstances establish that the principal purpose of the scheme is to realise the commercial benefits summarised in fact 15, and that it would be reasonable to conclude that the purpose of obtaining the tax benefit mentioned is incidental to this principal purpose.

51. Accordingly, the third condition in paragraph 27 is not satisfied, and section 45B of the ITAA 1936 does not apply.

52. It is now possible to answer the questions asked in this ruling.

Question 1

53. X will be entitled to choose a roll-over under section 125-55 of the ITAA 1997 because:

· X owns shares in a company, A Co (fact 0)

· just prior to the implementation of the proposed scheme, A Co will be the head entity of a demerger group (paragraph 40)

· under the scheme, a demerger will happen to the demerger group (paragraph 41), and

· under the demerger, CGT event G1 will happen in relation to X's shares in A Co (paragraph 41), and X will acquire shares in B Co, the demerged entity under the demerger (paragraph 41).

Question 2

54. If X chooses a roll-over pursuant to section 125-55 of the ITAA 1997, then because all X's share in A Co were acquired before 20 September 1985 (fact 2), X will be taken under subsection 125-80(5) of the ITAA 1997 to have acquired the B Co shares X will receive under the demerger, before that date (paragraph 17).

Question 3

55. The part of the in specie distribution of B Co shares to A Co shareholders that would have been assessable to X under subsection 44(1) of the ITAA 1936 apart from subsections 44(3) and 44(4) of that Act will constitute a demerger dividend, and will therefore be non-assessable non-exempt income of X under subsection 44(4) of that Act.

56. Firstly, the in specie distribution was made under a demerger (paragraph 41).

57. Secondly, according to the definition of 'demerger dividend' and 'demerger allocation' (paragraph 18), that part of the total market value of the allocation represented by the in specie distribution of B Co shares to A Co shareholders under the proposed scheme that would, apart from subsections 44(3) and (4) of the ITAA 1936, be included in X's assessable income under subsection 44(1) of the ITAA 1936, will constitute a demerger dividend.

58. Thirdly, under the proposed scheme, the amount of the distribution to be paid out of retained earnings is equal to the market value of the B Co shares in the distribution less the amount to be debited to A Co's share capital account in relation to the distribution. 50% of this amount would be assessable to X under subsection 44(1) of the ITAA 1936 apart from subsection 44(3) and (4) of the ITAA 1936. All of the amount that would have been so assessable is a demerger dividend. (See facts 8-10.)

59. An amount may be treated as not being a demerger dividend if the Commissioner makes a determination under subsection 45B(3) of the ITAA 1936 that section 45BA of the ITAA 1936 applies in relation to all or part of a demerger benefit (paragraphs 28 and 30). However, the Commissioner cannot make such a determination, as section 45B of the ITAA 1936 does not apply (paragraph 51).

60. Subsection 44(4) of the ITAA 1936 will apply such that the demerger dividend will be neither assessable income nor exempt income of X for the purposes of the ITAA 1936 and the ITAA 1997 (paragraph 19), based on the following:

· A Co will not elect under subsection 44(2) of the ITAA 1936 that subsections 44(3) and (4) of the ITAA 1936 will not apply (paragraph 19, fact 12).

· Subsections 44(3) and (4) of the ITAA 1936 will not be prevented by subsection 44(5) of the ITAA 1936 from applying because just after the demerger, CGT assets owned by Georgiou Family and its demerger subsidiaries that will be used in the construction business carried on by those entities will constitute more than 50% by market value of all the CGT assets owned by those entities (paragraph 20, fact 11).

Question 4

61. The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45BA or section 45C of that Act will apply, as section 45B will not apply (paragraph 51).

Question 5

62. A Co will not be taken to pay a dividend to X under section 109C or section 109D of the ITAA 1936 as a result of the distribution to X by A Co of shares in B Co under the demerger arrangement.

63. Sections 109B and 109RA of the ITAA 1936 will exclude Division 7A of Part III of the ITAA 1936 from applying to the demerger dividend received by X under the proposed demerger, as section 45B of the ITAA 1936 will not apply to that demerger dividend (paragraphs 21, 51).

64. The definition of 'dividend' in subsection 6(1) of the ITAA 1936 would exclude the return of capital from being assessable under subsection 44(1) of the ITAA 1936 (paragraph 18), and so subsection 109L(2) of the ITAA 1936 would prevent it from being taken to be a dividend under section 109C (or section 109D) of the ITAA 1936.

65. If, despite the answer to question 3 above, it were the case that any of the distribution of B Co shares to X under the demerger apart from the return of capital under the distribution were not a demerger dividend, it would fall for assessment under subsection 44(1) of the ITAA 1936, and subsection 109L(1) of the ITAA 1936 would prevent it from being taken to be a dividend under section 109C (or section 109D) of the ITAA 1936.