Edited version of private advice

Authorisation Number: 1051935860566

Date of advice: 21 December 2021

Ruling

Subject: Demerger relief

Question 1

Will CGT event G1 happen to ABC Pty Ltd as the Trustee for the Discretionary Trust ('the Discretionary Trust') in respect of the capital reduction amount of the demerger?

Answer

Yes.

Question 2

Pursuant to section 125-90 of the Income Tax Assessment Act 1997 ('ITAA 1997'), will the Discretionary Trust be required to adjust the cost base and reduced cost base of its XYZ Pty Ltd ('XYZ Co') shares, and calculate the cost base and reduced cost base of its Ally Co shares in accordance with section 125-80 of the ITAA 1997?

Answer

Yes.

Question 3

For the purposes of the CGT discount in Division 115 of the ITAA 1997, is the Discretionary Trust taken to have acquired its Ally Pty Ltd ('Ally Co') shares at the same time as it acquired its XYZ Co shares?

Answer

Yes.

Question 4

Will the Demerger Distribution be non-assessable non-exempt income of the Discretionary Trust by virtue of subsections 44(3) and (4) of the Income Tax Assessment Act 1936 ('1936')?

Answer

Yes.

Question 5

Will the Commissioner make a determination in relation to the Demerger Dividend under paragraph 45B(3)(a) that section 45BA of the ITAA 1936 applies to all or part of the demerger benefit?

Answer

No.

This ruling applies for the following period

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

On 1 June 20XX, ABC Pty Ltd as Trustee for ABC Discretionary Trust ('the Discretionary Trust') acquired 100% of the shares in XYZXYZ Pty Ltd ('XYZ Co') from a third party. At that time, XYZ Co owned 100% of Ally Pty Ltd ('Ally Co').

The third-party vendor's offer was to acquire Ally Co as a subsidiary of XYZ Co. The Discretionary Trust was not afforded the opportunity to acquire 100% of the shares in XYZ Co and, separately, 100% of the shares in Ally Co.

XYZ Co continues to own 100% of the shares in Ally Co.

The scheme which is the subject of this ruling request is the demerger by XYZ Coof Ally Co to the Discretionary Trust.

The Discretionary Trust

The Discretionary Trust is an Australian resident discretionary trust and is primarily an investment and holding trust. The Discretionary Trust is not a trading entity.

The Discretionary Trust does not have any carried forward capital losses.

The Discretionary Trust owns 100% of the shares in XYZ Co, which it acquired for $X million.

XYZ Co

XYZ Co is an Australian resident company. XYZ Co was incorporated in 20XX and its primary business is the provision of business services.

XYZ Co operates out of a business premises in Australia and currently has employees. XYZ Co's clients are primarily small to medium enterprises and individuals.

XYZ Co has key management staff.

XYZ Co has share capital of $100.

XYZ Co has paid a variety of franked and unfranked dividends over various income years.

XYZ Co has a related party loan from Ally Co.

XYZ Co owns 100% of the shares in Ally Co.

Ally Co

Ally Co is an Australian resident company. Ally Co was incorporated in 20XX and provides computer software under a subscription-based model. Ally Co's clients are businesses across Australia.

Ally Co has its own CEO and other key management staff.

Ally Co has its own employees. From 2021, XYZ Co and Ally Co have not shared any employees.

Over several years, Ally Co has developed and released its own cloud platform which hosts various software for businesses to use as part of its subscription-based model.

Ally Co has now reached an expansion phase;

•         During 20XX, Ally Co was listed on a software marketplace which is expected to lead to significant growth in sales,

•         During 20XX, Ally Co appointed a new sales team,

•         During 20XX, Ally Co launched a new marketing and branding campaign,

•         During 20XX, Ally Co won an award which increased its profile in the industry.

Ally Co's key CGT assets are its goodwill, software platform and cash assets.

Previously, XYZ Co and Ally Co shared the same business premises in Australia. However, since 20XX XYZ Co and Ally Co no longer share business premises and will not share business premises in the future. Ally Co is currently looking for separate business premises.

Since 1 July 20XX, Ally Co paid XYZ Co a monthly service fee which reimbursed XYZ Co for various operational expenses incurred by XYZ Co, including Office Rent, Computers & Software Infrastructure & Telephones, and various employee and principal employment costs.

Ally Co has $100 share capital.

As of 30 June 20XX, Ally Co had retained profits of approximately $X million.

Ally Co has paid franked dividends in the majority of, but not all, income years.

The current 'fair value' of Ally Co is $XX million based on an internal valuation of the company on a 'Software as a Service' basis.

The demerger

Prior to the demerger

•         Ally Co will declare and pay a fully franked dividend of $X million to XYZ Co, representing the retained profits as of 30 June 20XX.

•         XYZ Co will repay its related party loan owed to Ally Co in full such that Ally Co will no longer own the loan receivable as a CGT asset.

•         XYZ Co will undertake an asset revaluation of its investment in Ally Co from $100 to the current 'fair value' of $XX million.

The demerger

•         XYZ Co will declare a dividend of $XX million to be paid to the Discretionary Trust.

•         XYZ Co will resolve to undertake a capital return of $50 to be paid to the Discretionary Trust.

•         XYZ Co will make an in-specie distribution of 100% of the shares in Ally Co to the Discretionary Trust in satisfaction of the dividend and capital return.

•         XYZ Co will not elect that subsections 44(3) and (4) of the ITAA 1936 do not apply to the dividend, under subsection 44(2) of the ITAA 1936.

•         The number and class of shares which will be transferred under the demerger will correspond to the proportion and class of shares the Discretionary Trust currently holds in XYZ Co (100%).

•         No XYZ Co shares will be cancelled.

•         The Discretionary Trust will be eligible for the roll-over in section 125-55 of the ITAA 1997 and will choose to obtain it.

After the Demerger

The Discretionary Trust does not plan to dispose of any of its shares in Ally Co after the Demerger and there is no post-separation capital raising proposed to occur in accordance with Tax Determination TD 2020/6 Income tax: what is a 'restructuring' for the purposes of subsection 125-70(1) of the Income Tax Assessment Act 1997?

XYZ Co's commercial objectives, business operations and activities will not change.

Ally Co's commercial objectives, business operations and activities will not change.

XYZ Co and Ally Co will each implement an employee share scheme ('ESS').

XYZ Co's dividend policy will not change.

Ally Co's dividend policy will not change.

Ally Co will appoint new directors to the Board of Directors.

XYZ Co and Ally Co will pay all of their retained profits out as franked dividends to the Discretionary Trust. Over the next few years, the Discretionary Trust will repay its bank borrowings. Subsequently, XYZ Co and Ally Co will enter independent loan facilities with a bank to provide sufficient working capital for each business.

Ally Co will continue to use its current CGT assets (as identified above) in carrying out its business.

Reasons for the Demerger

You have provided the following reasons in favour of the Demerger:

XYZ Co and Ally Co are distinct with fundamentally different operations and strategies

•         XYZ Co generates revenue from fees for service, whereas Ally Co has a subscription-based revenue model

•         The clients of XYZ Co and Ally Co are distinct

•         XYZ Co and Ally Co do not share any clients

•         XYZ Co and Ally Co have two separate management teams and employee teams

•         XYZ Co and Ally Co have two separate customer relationship management databases

•         XYZ Co and Ally Co have two separate marketing strategies

•         XYZ Co is an established business which will continue to pursue organic growth, whereas Ally Co has spent the last few years in its software development phase and is now in a growth phase.

Removal of perceived conflict

As a result of XYZ Co owning 100% of the shares in Ally Co there is a perceived conflict of interest in the marketplace. A perception exists that subscribing to Ally Co's software services contributes to the growth of XYZ Co. This perceived conflict is an impediment to the growth of Ally Co, and there have been multiple occasions where businesses have chosen not to subscribe to the packages offered by Ally Co because of this perceived conflict.

One of the key advantages of the Demerger is that XYZ Co will no longer directly benefit from the growth of Ally Co, which should remove the perceived conflict and lead to greater growth of the Ally Co business.

Employee incentives

The Demerger will allow for separate ESS to be implemented for key management staff of XYZ Co and Ally Co.

Under the current corporate structure, if an ESS were implemented for the personnel of XYZ Co, the personnel would have to pay a premium to account for XYZ Co' ownership of Ally Co and would also be exposed to the changes in value of Ally Co. In this regard, key management staff of XYZ Co are not involved with, and have no influence over, the business of Ally Co.

Ally Co and XYZ Co have engaged with a law firm in relation to the establishment of the two ESS and will establish the ESS immediately after the Demerger is implemented.

Ally Co and XYZ Co have identified the specific employees of each business that they wish to offer the ESS to. The ESS will encourage retention of key employees within each company and incentivise them to contribute to each business' growth.

Separate boards of directors

After the Demerger, separate Boards of Directors will be appointed to XYZ Co and Ally Co. Each company has different management teams and management protocols, IT systems, regulatory requirements, employees and strategic direction. In light of this, the separate Boards of Directors will be better able to focus on each company's direction independently of the other company's business and regulatory requirements.

Reduction of risk

The Demerger limits the litigation liability of each company and offers higher protection of Ally Co as an asset. The services provided by XYZ Co involve a risk of potential claims from aggrieved clients. Although XYZ Co has Professional Indemnity Insurance for each service it provides, there is a risk that the Professional Indemnity Insurance would not protect XYZ Co against potential claims of negligence. As the shares in Ally Co are a major asset of XYZ Co, those shares are exposed to high risk in any negligence claim.

The Demerger reduces this risk by moving the ownership of the shares in Ally Co from a trading company (XYZ Co) to an investment only entity (the Discretionary Trust), enabling a higher protection of Ally Co as an asset.

Financing arrangements

Currently, the Discretionary Trust has business borrowings with a bank of approximately $X million.

As the Ally Co business grows, it will require further financing. Under the current structure, any future bank funding required will have to be secured over both Ally Co and XYZ Co.

XYZ Co is currently evaluating opportunities to purchase other businesses and grow its revenue such that flexibility as to future financing arrangements is desirable. The Demerger will allow future financing arrangements for each of XYZ Co and Ally Co to be independent and without cross-security and may also provide greater funding capacity.

Relevant legislative provisions

Income Tax Assessment Act 1936

Section 6

Section 44

Section 45B

Section 45BA

Section 47

Section 177D

Income Tax Assessment Act 1977

Section 103-5

Section 104-135

Section 115-25

Section 115-30

Section 115-34

section 125-55

Section 125-70

Section 125-80

Section 125-90

Section 112-115

Reasons for decision

Question 1

Will CGT event G1 happen to ABC Pty Ltd as the Trustee for the Discretionary Trust ('the Discretionary Trust') in respect of the capital reduction amount of the demerger?

Summary

Yes, CGT event G1 will happen.

Detailed reasoning

Pursuant to subsection 104-135(1) of the ITAA 1997, CGT event G1 happens if:

a)    a company makes a payment to you in respect of a share you own in the company (except for CGT event A1 or C2 happening in relation to the share); and

b)    some or all of the payment (the non-assessable part) is not a dividend or an amount that is taken to be a dividend under section 47 of the ITAA 1936; and

c)    the payment is not included in your assessable income.

Under the Demerger, XYZ Co will declare a dividend of $XX million payable to the Discretionary Trust (the 'Demerger Dividend'). XYZ Co will also resolve to make a capital reduction of $50.

XYZ Co will pay the Demerger Dividend and capital reduction by an in-specie distribution of 100% of the shares in Ally Co. A payment can include the giving of property (section 103-5 of the ITAA 1997). As shares are property, XYZ Co makes a payment to the Discretionary Trust in respect of the shares it owns in XYZ Co.

For the purpose of paragraph 104-135(1)(b), the term 'dividend' in section 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders, whether in money or other property, but does not include property distributed by a company to shareholders where the amount of the value of the property is debited against an amount standing to the credit of the share capital of the company. For completeness, section 47 of the ITAA 1936 is not applicable to your case.

Therefore, the capital reduction amount of $50 which is debited to the share capital account will not be a dividend pursuant to section 6(1) 'dividend', or taken to be a dividend under section 47, of the ITAA 1936 and is not otherwise included in the Discretionary Trust's assessable income.

Therefore, the $50 capital reduction will cause CGT event G1 to occur to the Discretionary Trust.

Question 2

Pursuant to section 125-90 of the Income Tax Assessment Act 1997 (ITAA 1997), will the Discretionary Trust be required to adjust the cost base and reduced cost base of its XYZ Co shares, and calculate the cost base and reduced cost base of its Ally Co shares in accordance with section 125-80 of the ITAA 1997?

Summary

Pursuant to subsection 125-80(2) of the ITAA 1997, the Discretionary Trust's original cost base in XYZ Co will be apportioned between its new shares in Ally Co and its original shares in XYZ Co.

Detailed reasoning

Subsection 125-80(1) of the ITAA 1997 states that if you choose the roll-over, a capital gain or capital loss you make from the CGT event happening under the demerger to an original interest you own is disregarded.

Pursuant to subsection 125-80(2) of the ITAA 1997, if you choose the roll-over, the first element of the cost base and reduced cost base of each new interest that you are not taken to have acquired before 20 September 1985 is proportioned based on the sum of the cost bases of all your original interests that you acquired on or after 20 September 1985 (worked out just before the demerger) as is reasonable having regard to the matters specified in subsection 125-80(3) of the ITAA 1997.

The matters specified in subsection 125-80(3) of the ITAA 1997 are:

a)    the market values of your remaining original interests just after the demerger, or an anticipated reasonable approximation of those market values; and

b)    the market values of your new interests just after the demerger, or an anticipated reasonable approximation of those market values.

Therefore, the first element of the cost base and reduced cost of each share in XYZ Co and Ally Co is calculated by:

•         calculating the sum of the cost base of each share in XYZ Co just before the Demerger, and

•         apportioning that sum between the shares in XYZ Co and shares in Ally Co acquired after the Demerger based on the market values of the shares in XYZ Co and Ally Co just after the Demerger.

Question 3

For the purposes of the CGT discount in Division 115 of the ITAA 1997, is the Discretionary Trust taken to have acquired its Ally Co shares at the same time as it acquired its XYZ Co shares?

Summary

The Discretionary Trust will be taken to have acquired its shares in Ally Co at the time XYZ Co acquired the original shares in Ally Co.

Detailed reasoning

Section 115-30 of the ITAA 1997 provides special rules about the time of acquisition of assets in certain circumstances and for certain purposes, including for the purpose of determining the acquisition date under subsection 115-25(1) regarding discount capital gains.

Under Item 2 in the Table in subsection 115-30(1) of the ITAA 1997, a CGT asset that the acquirer acquired as a replacement asset for a 'replacement-asset roll-over' is taken to have been acquired when the acquirer acquired the original asset involved in the roll-over (other than a roll-over covered by paragraph 115-34(1)(c) of the ITAA 1997).

The 'replacement-asset roll-overs' are listed in section 112-115 of the ITAA 1997 and Item 14C in the Table in section 112-115 includes demergers under Division 125 of the ITAA 1997.

You will choose to obtain a roll-over under section 125-55 of the ITAA 1997 (that is, a demerger under Division 125 of the ITAA 1997). You will therefore acquire the shares in Ally Co as a replacement asset under a replacement asset roll-over and satisfy Item 14C in the Table in section 112-115 of the ITAA 1997.

Furthermore, paragraph 115-34(1)(c) of the ITAA 1997 does not apply to you.

Therefore, in working out the Discretionary Trust's acquisition date for the purpose of determining its eligibility to a discount capital gain under Division 115 of the ITAA 1997, Item 2 of the Table in subsection 115-30(1) applies such that the Ally Co shares acquired by the Discretionary Trust as a result of the Demerger are taken to have been acquired on the date the Discretionary Trust acquired the shares in XYZ Co.

Question 4

Will the Demerger Distribution be non-assessable non-exempt income of the Discretionary Trust by virtue of subsections 44(3) and (4) of the ITAA 1936?

Summary

Yes, the Demerger Dividend will not be assessable income or exempt income by virtue of subsections 44(3) and (4) of the ITAA 1936; the Demerger Dividend is a 'demerger dividend' as defined in subsection 6(1) of the ITAA 1936, no election will be made as specified in subsection 44(2) and subsection 44(5) is satisfied.

Detailed reasoning

Is a dividend paid under the demerger?

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a resident shareholder in a company includes dividends that are paid, whether by money or property, to the shareholder by the company out of profits derived from any source.

However, a dividend is taken not to have been paid out of profits and is neither assessable income nor an exempt income amount (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)), and

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

In the present circumstances:

The dividend is a Demerger Dividend

Pursuant to subsection 6(1) of the ITAA 1936 a demerger dividend means 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).

The 'demerger allocation' is defined as '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' - that is, the total market value of the Ally Co shares disposed of to the Discretionary Trust.

The total market value of the allocation represented by the Ally Co shares that are disposed of by XYZ Co to the Discretionary Trust under the demerger is the market value of $XX million. Therefore, the demerger allocation is $XX million.

The demerger allocation is comprised of a declared dividend of $XXX paid out of profits and a separate return of capital of $50.

The dividend of $XXX is therefore assessable under section 44(1) and, accordingly, is a 'demerger dividend' under subsection 6(1) of the ITAA 1936.

No election is made

XYZ Co, as the head entity of the Demerger Group, will not elect that subsections 44(3) and (4) of the ITAA 1936 do not apply to the demerger dividend, under subsection 44(2) of the ITAA 1936.

Subsection 44(5) - more than 50% of the CGT assets of Ally Co will be used in its business

Pursuant to subsection 44(5) of the ITAA 1936, subsections 44(3) and 44(4) do not apply to a demerger dividend unless, just after the demerger, CGT assets owned by the demerged entity, representing at least 50% by market value of all of the CGT assets owned by it, are used directly, or indirectly, in one or more businesses carried on by it.

Currently, the key CGT assets of Ally Co, the demerged entity, include its goodwill, software platform and cash assets. Each of these assets will be used in the business carried on by Ally Co after the Demerger.

Ally Co also has a current CGT asset being a related party loan, receivable from XYZ Co of approximately $X million (as at 30 June 20XX)('Loan Receivable'). However, prior to the Demerger, the Loan Receivable will be repaid in full such that immediately before and immediately after the Demerger, it will not be a CGT asset of Ally Co.

Therefore, just after the Demerger, more than 50% by market value of all the CGT assets owned by Ally Co will be used in the business carried on by Ally Co, whether directly or indirectly.

Therefore, the dividend will be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Question 5

Will the Commissioner make a determination in relation to the Demerger Dividend under paragraph 45B(3)(a) that section 45BA of the ITAA 1936 applies to all or part of the demerger benefit?

Summary

No. In considering, all the relevant circumstances listed in subsection 45B(8) of the ITAA 1936, the Demerger is not being undertaken for more than an incidental purpose of obtaining a tax benefit.

Detailed reasoning

Subsection 45B(1) of the ITAA 1936 provides that the purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts are treated as dividends for tax purposes if the capital and profit components of a demerger allocation n do not reflect the circumstances of the demerger, or certain payments, allocations or distributions are made in substitution for dividends.

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

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

•           under the scheme a taxpayer, who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936), and

•           having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).

Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) empowers the Commissioner to make a determination that section 45BA applies in relation to a demerger 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).

Scheme

A 'scheme' for the purposes of section 45B of the ITAA 1936 is defined in subsection 995-1(1) of the ITAA 1997. The term is widely drawn and includes any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The Demerger transaction by which 100% of the ordinary shares in Ally Co will be transferred to the Discretionary Trust under the Demerger would constitute a scheme for the purpose of section 45B of the ITAA 1936.

Demerger benefit

Pursuant to subsection 45B(4) of the ITAA 1936, a person is provided with a demerger benefit in relation to a demerger if a company provides the person with ownership interests in that or another company.

The distribution from XYZ Co to the Discretionary Trust of the shares in Ally Co under the Demerger therefore constitutes a demerger benefit.

Capital benefit

Pursuant to subsection 45B(5) of the ITAA 1936, a capital benefit is defined as a reference to any of the following:

(a) the provision of ownership interests in a company to the person;

(b) the distribution to the person of share capital or share premium;

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

However, subsection 45(6) of the ITAA 1936 provides that a person is not provided with a capital benefit to the extent that the person received a 'demerger dividend'.

The in-specie distribution from XYZ Co to the Discretionary Trust of the shares in Ally Co amounts to the provision of ownership interests in a company to the Discretionary Trust and would be a capital benefit under paragraph 45B(5)(a) of the ITAA 1936. However, due to the operation of subsection 45(6) of the ITAA 1936, that part of the demerger allocation of the Ally Co shares representing the demerger dividend of $XX million is taken not to be a capital benefit.

The capital reduction of $50 amounts to a capital benefit under paragraph 45B(5)(a) of the ITAA 1936. Therefore, there is a capital benefitof $50.

Tax benefit

Subsection 45B(9) of the ITAA 1936 stipulates that a relevant taxpayer 'obtains a tax benefit', for the purpose of paragraph 45B(2)(b), if an amount of tax payable, or any other amount payable under this Act,[1] by the relevant taxpayer would, apart from the operation of section 45B, be less than the amount that would have been payable if the 'demerger benefit' had been an assessable dividend or the capital benefit had been had been an assessable dividend.

As a result of the Demerger, the Discretionary Trust would, apart from the operation of section 45B of the ITAA 1936, receive a demerger dividend (nearly) equal to the market value of the shares in Ally Co at the time of the Demerger. The tax payable by the Discretionary Trust would be higher if the demerger benefit was an assessable dividend. Accordingly, the Discretionary Trust will obtain a tax benefit for the purposes of section 45B of the ITAA 1936.

More than incidental purpose and the relevant circumstances

Given that the Demerger is a scheme that provides a tax benefit to the Discretionary Trust, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c). The purpose does not need to be a dominant purpose but requires that it is more than an incidental purpose of the scheme. It is to be determined having regard to the 'relevant circumstances' of the scheme which are listed inclusively in subsection 45B(8) of the ITAA 1936. Each of the circumstances must be considered in order to determine whether, individually or collectively, they reveal the existence of the requisite purpose. These are considered below.

Paragraph 45B(8)(a) - appropriate capital and profit allocation

Paragraph 45B(8)(a) of the ITAA 1936 directs attention to the composition, as between share capital and profits (realised and unrealised) of the demerger benefit provided to the head entity's owners from the points of view of both their relative size generally and their potential for unnatural bias. If the composition of the demerger benefit is inconsistent with the substance (that is, the capital and profit it is attributable to) this would tend to a conclusion that the requisite purpose exists (paragraphs 50 to 51 of PS LA 2005/21 Application of section 45B of the Income Tax Assessment Act 1936 to demergers ('PS LA 2005/21')).

Where the composition of the demerger benefit involves an inordinately large profit element or a bias towards profit which is inconsistent with the natural profit element of the assets being demerged, a purpose of accessing demerger relief to obtain a non-assessable dividend could be inferred.

Ordinarily, in the case of a demerger, the distribution will be considered attributable to the disposal of the demerged entity to the head entity's owners, and thus it would be attributable to the amount of share capital that could reasonably be regarded as invested by the head entity's owners (indirectly) in the demerged entity and the profits (realised or unrealised) attributable to the demerged entity. The greater the extent to which a demerger benefit is attributable to profit, the greater or more permanent tax saving is achieved by undertaking a demerger. This presents a greater tax incentive to demerge.

Under the Demerger, XYZ Co will make a demerger allocation of $XX million. Of this amount, there will be a nominal return of capital of $50. Almost the entire demerger allocation will be debited to retained earnings of XYZ Co, which will be comprised almost entirely of an asset revaluation reserve based on a market valuation of the shares in Ally Co.

The size of the profit component highlights the significance of the tax benefit that the Discretionary Trust will obtain from the Demerger as a demerger dividend. Although a large demerger dividend may be a factor that inclines towards the requisite purpose being present, it is insufficient on its own to substantiate a conclusion that the requisite purpose exists. In this case, the substance of the demerger benefit, comprising almost entirely of a demerger dividend, is consistent with the substance (that the demerger benefit is almost entirely attributable to profits.)

To this end, we do not consider that a share capital reduction of $50 out of the total $100 recorded in XYZ Co share capital account outweighs the overall substance of the demerger benefit being reflective of profits. Therefore, this circumstance does not incline towards a conclusion that the requisite purpose exists.

Paragraph 45B(8)(b) - pattern of distributions

Paragraph 45B(8)(b) of the ITAA 1936 refers to 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. The inference here is that an interruption to the normal pattern of profit distribution and its replacement with a distribution under a demerger would suggest dividend substitution (paragraph 58 of PS LA 2005/21).

Since the Discretionary Trust's acquisition of the Demerger group, Ally Co' pattern of distributions of dividends has varied. Ally Co paid no dividends in some years whilst paying franked dividends in other years. Prior to the Demerger, Ally Co will declare and pay approximately $X million in franked dividends representing its retained profits as of 30 June 20XX.

Similarly, XYZ Co's pattern of distributions of dividends has varied over the years. Whilst no dividend was paid in one income year since it was acquired by the Discretionary Trust, XYZ Co has paid either unfranked or franked dividends in each other income year.

The demerger distribution can be distinguished from these regular franked and unfranked dividends as it is related to a significant one-off transaction by which XYZ Co is restructuring its business for strategic purposes. Going forward, XYZ Co does not intend to alter its current dividend policy and will continue to target the payment of annual fully franked dividends.

Therefore, the pattern of distributions does not point towards an interruption to the normal pattern of profit distribution and its replacement with a demerger distribution.

Paragraph 45B(8)(c) - Capital losses of shareholders

Paragraph 45B(8)(c) of the ITAA 1936 considers whether the owners of the head entity have capital losses that, apart from the scheme, would be carried forward to a later year of income.

The Discretionary Trust does not have unutilised capital losses. Therefore, this factor does not indicate the requisite purpose is present.

Paragraph 45B(8)(d) - pre-CGT ownership interests of shareholders and associates

Paragraph 45B(8)(d) of the ITAA 1936 considers whether some or all of the ownership interests held by the owners of the head entity in the head entity (or an associate) were acquired before 20 September 1985.

All of the Discretionary Trust's shares in XYZ Co and Ally Co were acquired after 20 September 1985.

Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(e) - residency of owners of the head entity

Paragraph 45B(8)(e) of the ITAA 1936 requires consideration of whether the owners of the head entity are non-residents.

Neither the Discretionary Trust nor its primary beneficiaries are non-residents. Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(f) - cost base of the ownership interests

Paragraph 45B(8)(f) of the ITAA 1936 considers whether the cost base (for the purposes of the ITAA 1997) of the relevant ownership interest is not substantially less than the value of the demerger benefit or capital benefit. The relevant ownership interest is the shares in the head entity.

Paragraph 68 of PS LA 2005/21 discusses that the decision to demerge could be influenced by the opportunity to obtain a distribution that allows a CGT rollover, in a situation that would otherwise result in a capital gain. The opportunity to defer the CGT taxing point may incline to a conclusion that the purpose of the demerger is to access the tax concessions as a means to an end in itself, rather than to increase business performance.

The Discretionary Trust's cost base in the XYZ Co shares is $X million. The value of the demerger benefit is $XX million. Therefore, the cost base of the Discretionary Trust's shares in XYZ Co is significantly less than the demerger benefit and there is an opportunity to defer a CGT taxing point.

Accordingly, this factor inclines for a conclusion as to the requisite purpose.

Paragraph 45B(8)(h) - nature of interest after demerger

Paragraph 45B(8)(h) of the ITAA 1936 requires, where the demerger involves a distribution of share capital, that regard be had to whether the interest held by the owners of the head entity after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead. However, ordinarily, it is unlikely that this circumstance will have significant relevance for demergers, as a demerger should not disturb the head entity's owner's existing ownership interests owing to the requirements of the proportion test in subsection 125-70(2) of the ITAA 1997.

The Demerger involves a distribution of share capital of $50 such that paragraph 45B(8)(h) of the ITAA 1936 is relevant. The Discretionary Trust will have a 100% interest in XYZ Co both before and after the Demerger. In the context of a Demerger, this factor does not point towards or against the requisite purpose.

Paragraph 45B(8)(i) - scheme involving the later disposal of ownership interests

Paragraph 45B(8)(i) of the ITAA 1936 directs attention to those cases where the scheme of demerger involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests; recognising that the proceeds on disposal of such ownership interests provide the equivalent of a cash dividend in a more tax-effective form.

The Demerger does not involve a later disposal of the shares in Ally Co and the Discretionary Trust is not contemplating disposing of its shares in Ally Co.

Therefore, this factor does not incline for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(j) - transactions between the entity and an associate

Paragraph 45B(8)(j) of the ITAA 1936 applies to circumstances where the profits and assets of the demerging entity are attributable to or acquired under transactions with associated entities. This relevant circumstance aims to expose instances where demerger relief is being used as a vehicle for distributing corporate earnings by way of non-assessable dividend.

The factor is an extension of the circumstance detailed at paragraph 45B(8)(a) of the ITAA 1936 (paragraph 81 of PS LA 2005/21). Paragraph 82 of PS LA 2005/21 notes that if the profits and assets of the demerging entity are referable to those of an associate and are not explicable by the demerging entity's need to be a viable, standalone entity, this is suggestive of a purpose of enabling a taxpayer to obtain a tax benefit by way of a non-assessable dividend.

The profits of XYZ Co are primarily derived from genuine commercial transactions from the provision of services to third parties. However, XYZ Co has derived some profits that are attributable to Ally Co. Since 1 July 20XX, Ally Co has paid XYZ Co a monthly service fee as reimbursement for various operational expenses incurred by XYZ Co, including Office Rent, Computers & Software Infrastructure & Telephones, and various employee and principal employment costs.

After the Demerger, the Service Fee will be substantially reduced and will solely relate to costs incurred in relation to the principal's employment costs. This amount is nominal compared to the profits derived by XYZ Co from genuine commercial transactions.

The assets and profits of XYZ Co are explainable by its need to be a viable, standalone entity.

Therefore, we do not consider that the origin of the profits or assets of XYZ Co inclines for, or against, a conclusion as to the requisite purpose.

Paragraph 45B(8)(k) - the Part IVA matters

Paragraph 45B(8)(k) of the ITAA 1936 requires regard to be had to any of the matters referred to in subsection 177D(2)of the ITAA 1936.

Manner in which the scheme was entered into or carried out- paragraph 177D(2)(a) of the ITAA 1936

An inquiry into the manner of a scheme is a consideration of the decisions, steps and events that combine to make up the scheme. In effect, it is an objective inquiry into the reasons a taxpayer had for entering into it (PS LA 2005/21 at paragraph 86).

In this regard, the Demerger is being undertaken for the following commercial reasons:

•         XYZ Co and Ally Co are distinct and fundamentally different businesses with distinct business operations and marketing strategies, distinct client bases and separate customer relationship management databases.

•         XYZ Co is an established business which will continue to pursue organic growth, whereas Ally Co is currently in the growth phase of its business life cycle.

•         The Demerger removes a perceived conflict of interest in the marketplace that subscribing to Ally Co software services contributes to the growth of XYZ Co, which is a direct competitor to businesses.

•         The Demerger will allow for separate ESS to be implemented for key management staff of XYZ Co and Ally Co.

•         The Demerger will enable separate Boards of Directors to be appointed and facilitate independent focus on the entirely disparate management teams and management protocols, IT systems, regulatory requirements, employees and strategic direction.

•         The Demerger reduces the risk to Ally Co of being owned by a trading entity.

•         The Demerger facilitates future financing arrangements for each of XYZ Co and Ally Co to be independent and without cross-security.

Therefore, it is considered that the manner of the scheme will be carried out for commercial business reasons to achieve separation of the Ally Co and XYZ Co businesses.

The form and substance of the scheme - paragraph 177D(2)(b)

Paragraph 177D(2)(b) of the ITAA 1936 refers to the form and substance of the scheme. The form of a scheme is the way it presents, and the substance of a scheme is a reference to its essential nature which normally would be determined from the effects of the scheme on the commercial and economic circumstances of the parties involved in the scheme.

The form of the scheme is the Demerger. The substance of the scheme is that tfhe Discretionary Trust, the shareholder of XYZ Co, will receive ownership interests in Ally Co, a subsidiary of XYZ Co.

This factor does not incline for, or against, a conclusion as to the requisite purpose.

The time of the scheme - paragraph 177D(2)(c)

Paragraph 177D(2)(c) of the ITAA 1936 requires consideration of the time at which the scheme was entered into and the length of the period during which the scheme was carried out. Time, in this case, also includes a reference to the timing of the scheme from the point of view of the scheme's coincidence with events or circumstances beyond the scheme itself, including schemes designed to take advantage of tax or non-tax events or changes.

Beyond the timing of the scheme itself, the Demerger is timed several years after the Discretionary Trust first acquired the shares in XYZ Co. At that time, the Discretionary Trust could not acquire the shares in Ally Co directly from the third-party vendor, despite a desire of the Discretionary Trust to do so.

The timing of the scheme to demerge Ally Co correlates with commercial drivers, including that Ally Co has reached a 'growth' business phase and has a need to reduce perceptions of conflict in the market. Additionally, the timing of the scheme aligns with discussions between key management staff at XYZ Co to establish an employee share scheme.

Further, as the Discretionary Trust does not propose to dispose of the Ally Co shares after the demerger, the timing of the scheme does not indicate that it was designed to take advantage of tax benefits arising from a disposal of the shares.

Result but for section 45B - paragraph 177D(2)(d)

Paragraph 177D(2)(d) of the ITAA 1936 requires consideration of the result in relation to the operation of this Act[2] that, but for "this Part", would be achieved by the scheme. As noted at paragraph 92 of PS LA 2005/21, the issue to be considered is the identification of the tax results of the scheme if section 45B of the ITAA 1936 did not apply. It is therefore critical to consider just what constitutes the scheme, as this will have a direct bearing on the breadth and scope of the tax results for the relevant taxpayers that are taken into consideration. Accordingly, regard must be had to all of the relevant tax outcomes produced by the scheme. From the perspective of the head entity's shareholders, this would include both the capital gains tax and other income tax implications of the transfer of ownership interests from the group.

But for the application of this part, the demerger dividend would be NANE income to the Discretionary Trust.

In regard to this matter, it is critical that the scheme does not involve a subsequent disposal of the shares in Ally Co such that, from the perspective of the Discretionary Trust, the relevant tax outcome from a capital gains perspective, does not indicate that the requisite purpose is present.

Changes in financial position of the relevant taxpayer - paragraph 177D(2)(e)

Paragraph 177D(2)(e) of the ITAA 1936 requires a consideration of the change in the financial position of the head entity's owners that has resulted, will result, or may be reasonably expected to result from the scheme. As discussed in PS LA 2005/21 at paragraphs 93 to 94, a demerger provides the head entity's owners with a direct ownership interest in the demerged entity in which they only had an indirect interest. In financial terms, this gives the head entity an asset which they can liquidate, exchange or use as financial security. It may also improve the head entity's owners' position in regard to an investment return on their equity interests.

In your case, the Demerger effects a reallocation of the Discretionary Trust's investment in XYZ Co and Ally Co, converting an indirect interest in Ally Co to a direct interest. The Demerger delivers to the Discretionary Trust an asset which it can liquidate, exchange or use as a financial security, being a commercial benefit separate to the tax advantage derived from the scheme. The Demerger may also be reasonably expected to enhance the Discretionary Trust's position in regard to its investment return on its equity interests in each of XYZ Co and Ally Co by enabling the improved operational effectiveness of each business.

Change in financial position of others who have, or had, a connection with the relevant taxpayer - paragraph 177D(2)(f)

Paragraph 177D(2)(f) of the ITAA 1936 requires that consideration be given to any change in the financial position of any person who has, or has had, any connection with the head entity's owners, being a change that results, will result or may reasonably be expected to result from the demerger scheme. This paragraph provides the opportunity to identify any financial changes that are consistent with a business restructure.

XYZ Co will have a nominal reduction in its share capital. Consistent with the business restructure, Ally Co will no longer be an asset of XYZ Co. Additionally, XYZ Co will no longer derive dividend income from Ally Co. Rather, the Discretionary Trust will derive dividend income directly from Ally Co. XYZ Co will also derive less related party service fee income from Ally Co due to a separation of various operational expenses (as discussed above) which is also consistent with a business restructure.

Any other consequences - paragraph 177D(2)(g)

Paragraph 177D(2)(g) of the ITAA 1936 directs attention to any 'other' consequence of the demerger scheme for the head entity's owners or for any person connected with the head entity's owners. As discussed at paragraph 99 of PS LA 2005/21, the question is of other consequences of the demerger itself and not the consequences of something that will occur post-demerger.

There are no other materially relevant consequences of the Demerger itself.

Nature of any connection between the relevant taxpayer and any person referred to in 177D(2)(f) - paragraph 177D(2)(h)

Subparagraph 177D(2)(h) of the ITAA 1936 requires consideration of the nature of any connection between the head entity's owners and any person referred to in paragraph 177D(2)(f). The nature of the connection between the Discretionary Trust and XYZ Co is that of shareholder and company, consistent with a demerger. Therefore, this is factor is neutral.

Conclusion

Having regard to the relevant circumstances of the proposed scheme, as set out in subsection 45B(8) of the ITAA 1936, it is considered that the Demerger is not being undertaken for more than an incidental purpose of obtaining a tax benefit.

Accordingly, the Commissioner will not make a determination under subsection 45B(3)(a) of the ITAA 1936 that section 45BA applies to the whole, or a part, of the demerger benefit.

[1] As defined in subsection 6(1) 'this Act' of the ITAA 1936.

[2] As defined in subsection 6(1) 'this Act' of the ITAA 1936.