Edited version of private advice

Authorisation Number: 1051963517069

Date of advice: 3 May 2022

Ruling

Subject: Business restructure

Question 1

Will the Class A Shares issued by Company A to Unit Trust be a membership interest in Company A as defined under section 960-135 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will there be a gross forgiven amount for the purposes of subsection 245-75(1) of the ITAA 1997 as a result of the capitalisation of the Shareholder Loan issued by Unit Trust to Company A ?

Answer

No.

Question 3

Will there be a gross forgiven amount for the purposes of subsection 245-75(1) of the ITAA 1997 as a result of repayment of the Existing Promissory Notes by Unit Trust transferring the Class A shares to the Existing Promissory Note Holders?

Answer

No.

Question 4

Will the transfer and novation of all the assets and liabilities of the Unit Trust to New Co and the issue of shares in New Co to the Unitholders of the Unit Trust meet the requirements for CGT rollover relief in Subdivision 124-N of the ITAA 1997?

Answer

Yes.

Question 5

Will CGT event J4 in section 104-195 of the ITAA 1997 happen if the ECL Unit Trust is wound up within 6 months of the transfer of the first CGT asset of the ECL Unit Trust to New Co?

Answer

No.

Question 6

Will Company A cease to be eligible to be the head company of the Company A income tax consolidated group under section 703-15 of the ITAA 1997 when New Co acquires all the ordinary shares in Company A ?

Answer

No.

Question 7

Will New Co be the head entity of a demerger group under section 125-65 of the ITAA 1997?

Answer

Yes.

Question 8

Will Company A be a demerger subsidiary of New Co under section 125-65 of the ITAA 1997?

Answer

Yes.

Question 9

Will the Shareholders of New Co be able to choose to obtain roll-over under the demerger relief provisions in Division 125 of the ITAA 1997?

Answer

Yes.

Question 10

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

Answer

Yes.

Question 11

Will the Shareholders of New Co who choose to obtain demerger roll-over in respect of their shares be taken, for the purpose of Division 115 of the ITAA 1997, to have acquired a proportionate number of shares in Company A on the same date as their units in Unit Trust pursuant to item 2 of the table at subsection 115-30(1) of the ITAA 1997?

Answer

Yes.

Question 12

Will any dividend paid to Unit Holders as part of the demerger transactions be treated as a demerger dividend that is not paid out of profits and is not assessable or exempt income under subsections 44(3) and 44(4) of the Income Tax Assessment Act 1936 (ITAA 1936) respectively?

Answer

Yes.

Question 13

For the shareholders of New Co who choose to obtain demerger roll-over in respect of their shares, will subsection 125-80(1) of the ITAA 1997 apply to disregard any capital gain made from CGT event G1 happening to their shares?

Answer

Yes.

Question 14

Will the Commissioner make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies inrespect of the whole or any part of the demerger benefit provided to the Shareholders of New Co?

Answer

No.

Question 15

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

Answer

Yes.

Question 15

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

Answer

Yes.

This ruling applies for the following period:

Years ending 30 June 20XX and 20XX

Relevant facts and circumstances

Glossary

The following abbreviations are used in this Application:

The Unit Trust was settled on XX November 20XX, with Unit Trust Trustee appointed as the trustee. Both Unit Trust Trustee and the Unit Trust are resident in Australia for income tax purposes.

In early 20XX, the Unit Trust established Company A. Company A operates a lending business.

Company A and Securitisation Trust are an Australian income tax consolidated group with Company A as the head entity.

Company A owns all the rights to income and capital of the Securitisation Trust.

The Securitisation Trust issues debt interests to investors to fund its lending business.

The trustee of the Securitisation Trust is Public Trustee Company, a public trustee company unrelated to the Company A Group.

The Unit Trust, Company A and the Securitisation Trust comprise the Company A Group.

Unitholders in Unit Trust

As at 1 April 20XX, there are XXXXX ordinary units in the Unit Trust on issue. All unitholders in the Unit Trust are Australian tax residents and all units are post-capital gains tax (CGT) assets.

Under the terms of the Unit Trust Deed, each ordinary unit entitles the unitholder to a proportionate beneficial interest in the capital, income and assets of the Unit Trust. The Unit Holders have a fixed entitlement to the capital of the trust. Whilst the Trustee has absolute discretion to pay sums out of the capital of the trust fund, to the extent the Trustee exercises this discretion, all such capital payments must be made to all Unit Holders in proportion to their holdings.

Details of the current unit holdings as at 1 April 20XX were provided.

Each unit is paid up to $0.00001. Accordingly, there is $XXX capital paid into the Unit Trust.

No Unit Holder holds more than 20% of the units the Unit trust

Current funding arrangements of Unit Trust

As at 1 April 20XX, there are promissory notes with a face value of $XXXX (Existing Promissory Notes) on issue. The holders of the Existing Promissory Notes are certain Unit Holders (Existing Promissory Noteholders).

The Existing Promissory Notes are non-interest bearing and are due and payable on the 10^th anniversary of their issue. Under the terms and conditions of the Existing Promissory Notes the Unit Trust may elect to repay them at a time prior to their expiry date.

The terms and conditions of the Existing Promissory Notes provide that if at any time prior to the 10th anniversary of the Existing Promissory Notes a restructure of the Unit Trust group occurs, the Unit Trust may convert the Existing Promissory Notes into shares in a new company, with those shares having no voting rights, no rights to dividends, no rights to participate in any surplus assets of the new company and give the holder a right only to priority payment in the amount paid up on the shares upon a reduction of capital or wind up of a new company.

Current capital and funding arrangements for Company A

Company A has 2 ordinary shares on issue with paid up capital of $2. The ordinary shares are owned by the Unit Trust.

In addition to the ordinary shares Unit Trust holds in Company A, the Unit Trust has also provided a shareholder loan to Company A to the value of $XXXX (the Shareholder Loan).

The Shareholder Loan is undocumented, non-interest bearing and has no fixed repayment date.

The Shareholder Loan is accounted for as a liability in Company A's financial statements.

Company A has largely funded its growth in its lending portfolio through retained earnings and the Securitisation Trust securitising interests in customer loans.

Future growth and funding requirements

Management considers that the Group's ownership structure should be in a form to enable it to attract additional sources of capital in order to continue to grow and expand the businesses and compete with Australian banks and non-bank lenders for business.

Company A has considered various options to diversify its funding sources including applying to the Australian Prudential Regulatory Authority (APRA) to be approved as an Authorised Deposit-Taking Institution (ADI), or seeking additional equity investors into Company A either privately or by an initial public offering of some or all of the company's equity on the Australian Securities Exchange (ASX).

These considerations have highlighted that ownership of Company A via the Unit Holders in Unit Trust is not suitable or appropriate. This is because of the way APRA's regulatory rules apply to companies versus trusts, the preferences of external investors to invest in companies versus trusts and the ASX listing rules for companies versus trusts. As such, the current ownership of Company A via the Unit Holders of Unit Trust may present a barrier to being authorised by APRA as an ADI, raising capital or proceeding with an initial public offering on the ASX.

The Unit Holders of the Unit Trust wish to restructure the Company A Group in a tax neutral manner and remove the Unit Trust from the Company A Group such that the Unit Holders own interests directly in Company A.

Given these commercial considerations, the Company A Group wishes to restructure its ownership structure such that the current Unit Holders own shares directly in Company A, rather than holding shares indirectly in Company A via the units in the Unit Trust.

Such an ownership structure would enhance Company A's eligibility to compete with other Australian banks and non-bank lenders with which Company A competes for capital.

To achieve the above commercial objectives, restructuring transactions will take place with the intent to:

•         Remove the Unit Trust from the ownership structure and wind-up the Unit Trust;

•         Replace Unit Holders current indirect interests in Company A with direct interests; and

•         Ensure the proposed restructuring steps do not give rise to any tax benefits or tax costs. That is, the transactions are proposed to be implemented in a way that gives rise to tax neutral outcomes.

Tax neutrality is important because:

•         The Unit Holders do not have any liquidity to fund any tax costs;

•         The Securitisation Trust is an insolvency remote special purpose entity with an external trustee, external debt holders and is a member of the Company A income tax consolidated group. Company A does not have any liquidity to fund any tax costs which could impact debt covenants, obligations under the securitisation arrangements and its ability to service and manage customer loans; and

•         It ensures there are no actual or perceived tax benefits associated with the Proposed Transaction which might attract the operation of any anti-avoidance rules.

To the extent that the restructuring transactions trigger a deconsolidation of the Company A income tax consolidated group, Company A would require consent from various parties to the existing securitisation arrangements. Given the potential for income tax implications to arise from a deconsolidation, it is likely that significant time would be involved in requesting the necessary commercial consents from lenders, which may or may not be forthcoming. For this reason, it is also important the restructuring transactions do not trigger any deconsolidation of the Company A income tax consolidated group.

Proposed Transaction

The proposed steps to restructure the ownership of the Company A Group are as follows: The Shareholder Loan from Unit Trust to Company A will be capitalised into Class A Shares to be issued by Company A.

Step 1. The Unit Trust will subscribe for Class A Shares in Company A in exchange for Unit Trust issuing UT Promissory Notes with a principal amount of $XXXX.

The Company A Constitution allows for directors of the company to issue shares on such terms and with such rights as they think fit.

The Class A Shares will be membership interests in Company A and will entitle the holders to repayment of capital in priority to the ordinary shareholders in Company A. The Class A Shares will not be profit participating and will be equity interests for the purposes of Division 974.

The Class A shares will be issued at market value in proportion to the face value of the Existing Promissory Notes.

Step 2. Company A will endorse $XXXX of the UT Promissory Notes in favour of the Unit Trust in full repayment of the Shareholder Loan. The balance of the UT Promissory Notes of $XXX will remain outstanding.

The Class A Shares issued by Company A are to be used by Unit Trust to repay the Existing Promissory Notes.

Step 3. Unit Trust will repay the Existing Promissory Notes in full by transferring the Class A Shares to the Existing Promissory Noteholders.

The purpose of steps 1 to 3, is to replace the Unit Holder's indirect interest in the Shareholder Loan to Company A with a direct interest in the Class A Shares in Company A.

Unit Trust will be restructured into a company (New Co), and shares in New Co will be issued to existing Unit Holders of Unit Trust.

Step 4. New Co will be incorporated and the Unit Holders will subscribe for a total of XXXXX ordinary shares in a New Co at $0.00001 per share in the same proportions as their existing unit holding in the Unit Trust with the subscription price outstanding by way of Promissory Notes. Accordingly, there will be $XXX capital paid to New Co.

Each ordinary share in New Co will carry an equal right to dividends and capital of New Co and the right to vote and to attend meetings.

Additionally, the Company A Group will ensure that New Co does not have any rights that are CGT assets in relation to the proposed subsequent demerger of Company A, prior to the completion of the trust restructuring period in subsection 124-860(2) of the ITAA 1997.

At this time, the balance sheet of Unit Trust comprises:

Step 5. New Co will acquire all the assets and liabilities of the Unit Trust by way of assignment or novation, including the shares in Company A (Unit Trust will dispose of all of its CGT assets to New Co during the 'trust restructuring period' as defined in subsection 124-860(2) of the ITAA 1997), for $XXX and the consideration will be the Promissory Notes of $XXX from the Unit Holders.

At this time, the balance sheet of New Co should mirror the balance sheet of Unit Trust and comprise:

The purpose of steps 4 and 5, is to replace the Unit Holder's direct interest in the Unit Trust with a direct interest in New Co and to then facilitate a demerger of the shares in Company A to the Unit Holders in the Unit Trust.

Step 6. Unit Trust will redeem the ordinary units on issue in accordance with the trust deed totalling $167.64 by way of an in specie distribution of the Promissory Notes of $XXX received as consideration for the disposal of assets and liabilities to New Co at step 5.

Step 7. The Trustee of Unit Trust will terminate or wind up the Unit Trust in accordance with the trust deed within the six month period from just before the first CGT asset is disposed of by Unit Trust to New Co under the trust restructure.

The purpose of steps 6 and 7 is to facilitate the winding up of the Unit Trust.

Demerger of Company A.

Step 8. Company A will undertake a share split in accordance with section 254H of the Corporations Act 2001 and split its 2 ordinary shares on issue into XXXXX ordinary shares.

Step 9. New Co will undertake a proportionate return of capital that is satisfied by a transfer of the shares in Company A to the shareholders of New Co (Shareholders) with cash assets and the outstanding balance on the UT Promissory Notes to remain with New Co.

The amount of capital returned will be 99.99% of the subscribed capital reflecting Company A's allocation of the capital between the market value of the Company A shares and the market value of cash retained.

New Co will not make the election under subsection 44(2) of the ITAA 1936.

New Co will be retained by the Shareholders although there are no current plans in relation to its future activities.

The purpose of steps 8 and 9, is to replace the Unit Holder's indirect interest in the shares in Company A with a direct interest in the shares in Company A.

At the conclusion of Step 9, the Unit Trust will be removed from the Company A Group such that the Unit Holders own interests directly in Company A as the Shareholders and the Company A Group will have achieved their commercial rationale for the restructure.

Company A and New Co will not have a tainted share capital account.

Both Unit Trust and New Co will choose the Subdivision 124-N roll-over under section 124-865 of the ITAA 1997.

All Unit Holders will choose roll-over relief under section 124-870 of the ITAA 1997.

Relevant legislative provisions

As set out in the proposed transaction steps.

Does Part IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not considered the application of Part IVA in this private ruling in relation to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

Summary

The Class A Shares issued by Company A to Unit Trust will be a membership interest in Company A as defined under section 960-135 of the ITAA 1997.

Detailed reasoning

The term "membership interest" in an entity is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 960-135. Section 960-135 provides:

960-135 Membership interest in an entity

If you are a * member of an entity:

(a) each interest, or set of interests, in the entity; or

(b) each right, or set of rights, in relation to the entity;

by virtue of which you are a member of the entity is a membership interest of yours in the entity.

Item 1 of the table in subsection 960-130(1) of the ITAA 1997 provides that a 'member' of a company is 'a member of the company or a stockholder in the company'.

Relevantly, the term 'share' is defined in section 6 of the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 to include: 'in a company means a share in the capital of the company, and includes stock ...'.

For completeness, subsection 960-130(3) of the ITAA 1997 provides that an entity is not a member of another entity just because the entity holds one or more interests or rights relating to the other entity that are debt interests.

Company A will issue the Class A Shares on such terms that will not constitute a debt interest for the purposes of Subdivision 974-B of the ITAA 1997. A holder of a Class A Share will be entitled to be registered as a member of Company A. Further, a holder of a Class A Share will have a share in the issued share capital of Company A. Therefore, a holder of a Class A Share will be a member or a stockholder of Company A.

Accordingly, as the interests and rights comprising the Class A Shares will result in a holder of the Class A Shares becoming a 'member' of Company A, a Class A Share will constitute a 'membership interest' in Company A. Therefore, the Class A Shares the Unit Trust holds in Company A, will be a 'membership interest' in Company A pursuant to section 960-135 of the ITAA 1997.

Question 2

Summary

There will not be a 'gross forgiven' amount for the purposes of subsection 245-75(1) of the ITAA 1997 as a result of the capitalisation of the Shareholder Loan issued by Unit Trust to Company A.

Detailed reasoning

Commercial debt

Division 245 of the ITAA 1997 contains special rules to remove the tax benefit obtained by a taxpayer when the whole or part of a commercial debt owed by the taxpayer is forgiven. Division 245 of the ITAA 1997 applies when a commercial debt is forgiven by a creditor and the resulting gain is not included in the debtor's assessable income.

A debt is a commercial debt if:

Section 245-10 Subdivisions 245-C to 245-G apply to a debt of yours if:

a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

b) interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2) (a), (b) and (c)) that has the effect of preventing a deduction.

Note: Paragraphs 8-1(2) (a), (b) and (c) prevent deductions for capital, private or domestic outgoings and for outgoings relating to exempt income or non-assessable non-exempt income.

To determine whether a commercial debt exists we have to look at the borrower's purpose and not that of the lender (Federal Commissioner of Taxation v. Tasman Group Services Pty Ltd 2009 ATC (Tasman)). In Tasman the taxpayer did not succeed with their argument that various loans received from its overseas parent company were not commercial debt but instead were equity. They argued that although the loans had been made to fund its acquisition of a business, it later became clear to both parties that there was no intention for the loans to be repaid and as a result they became equivalent to an equity investment. The taxpayer also argued that the characterisation of the lending did not solely turn on the use to which the borrowed funds were put.

The Full Federal Court in Tasman found that it was the taxpayer's use of the loans (the borrower), rather than the lender's purpose of making the loans which was determinative of whether the loans were commercial debts. The loans were commercial debts despite the financial difficulties that the taxpayer was experiencing and the motives of the parent company in assisting the taxpayer to continue trading.

A commercial debt refers to a debt where the whole or any part of interest, or an amount in the nature of interest, paid or payable in respect of the debt is allowable as a deduction to the borrower. Where no interest is payable in respect of a debt (for instance, an interest-free loan), the debt is a commercial debt if, had interest been payable, it would have been deductible to the borrower: Section 245-10 of the ITAA 1997.

Whether interest has been incurred in the course of gaining or producing assessable income generally depends on the purpose of the borrowing and the use to which the borrowed funds are put. Where a borrowing is used to acquire an assessable income producing asset, or relates to expenses of an assessable income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income and is therefore deductible under section 8-1 of the ITAA 1997: Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith (TR 95/25) - which outlines the implications for individuals, partnerships and companies.

The Shareholder Loan from Unit Trust to Company A is an interest free loan and as such it would not be considered to be a commercial debt under paragraph 245-10(a) of the ITAA 1997 as no amount in the nature of interest has been paid or is payable.

However, on the basis that the funds from the Shareholder Loan have been used by Company A in carrying on its business for the purposes of gaining or producing assessable income, then had interest or such an amount been payable on the Shareholder Loan it would have been deductible under section 8-1 of the ITAA 1997. On this basis, the Shareholder Loan is considered to be a commercial debt under paragraph 245-10(b) of the ITAA 1997.

Forgiveness of a debt

Section 245-35 of the ITAA 1997 outlines what constitutes the forgiveness of a debt:

Section 245-35 What constitutes forgiveness of a debt

245-35 A debt is forgiven if and when:

a) the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full; or

b) the period within which the creditor is entitled to sue for the recovery of the debt ends, because of the operation of a statute of limitations, without the debt having been paid.

Section 245-37 of the ITAA 1997 expands the definition of 'forgiveness' to include circumstances where a subscription for shares enables payment of the debt:

Section 245-37 What constitutes forgiveness of a debt if a subscription for shares enables payment of the debt

245-37 If an entity subscribes for shares in a company to enable the company to make a payment in or towards discharge of a debt it owes to the entity, the debt is forgiven when, and to the extent that, the company applies any of the money subscribed in or towards payment of the debt.

Under the proposed transaction, the Unit Trust will subscribe for Class A shares in Company A with a market value of $XXXX in exchange for the Unit Trust issuing Company A the UT Promissory Notes with a principal amount of $XXXX. Company A will endorse $XXXX of the UT Promissory Notes received as consideration for the issue of Class A shares in favour of Unit Trust in full repayment of the Shareholder Loan. The balance of the UT Promissory Notes of $XXXX will remain outstanding.

The endorsement of a portion of the UT Promissory Notes, will not give rise to a 'forgiveness' of the Shareholder Loan under section 245-35 of the ITAA 1997, as the endorsement results in the extinguishment of the Shareholder Loan by repayment in full as both instruments are repayable in Australian currency.

However, as the Unit Trust subscribed for shares in Company A, the subscription proceeds enabled Company A to discharge the Shareholder Loan, the definition of forgiveness in section 245-37 of the ITAA 1997 will apply such that the Shareholder Loan will be deemed to be forgiven at the time it is extinguished.

Section 245-40 of the ITAA 1997 outlines the following circumstances where the debt forgiveness rules in Division 245 of the ITAA 1997 do not apply:

(i) a forgiveness of a debt that is a fringe benefit

(ii) a debt that has been or will be included in the debtor's assessable income (e.g. a loan that is a deemed dividend)

(iii) a forgiveness effected under an Act relating to bankruptcy

(iv) a forgiveness effected by will

(v) a forgiveness for reasons of natural love and affection, and

(vi) a debt that is a tax related liability or civil penalty.

The exceptions in section 245-40 of the ITAA 1997 do not apply to the repayment of the Shareholder Loan by Company A.

Forgiven amount

Division 245 of the ITAA 1997 provides that an amount equal to the tax benefit obtained, known as the net forgiven amount, is applied to reduce the taxpayer's tax losses, net capital losses, some expenditures and CGT cost bases which are otherwise available to reduce the taxpayer's assessable income. However, before the net forgiven amount can be determined, the gross forgiven amount must be determined.

Section 245-55 of the ITAA 1997 outlines the general rule for determining the value of a debt. Subsection 245-55(1) of the ITAA 1997 states the value of the debt at the time it is forgiven is the amount that would have been its market value at the forgiveness time, assuming that:

(a) when the debt was incurred, the debtor was able to pay all their debts as and when they fell due; and

(b) the debtor's capacity to pay the debt is the same at the forgiveness time as when the debtor incurred it.

Relevantly, the assumption in paragraph 245-55(1)(a) of the ITAA 1997 does not apply when calculating the value of the debt if the creditor was an Australian resident at the forgiveness time, the debt was not a moneylending debt and the debtor and the creditor were not dealing with each other at arm's length in respect of incurring the debt (subsection 245-55(3) of the ITAA 1997).

'Arm's length' is a defined term under section 995-1 of the ITAA 1997. In determining whether parties are dealing at arm's length, consider any connection between them and any other relevant circumstance.

The interpretation of the phrase 'not dealing with each other at arm's length' was considered (for the purposes of interpreting the same phrase in subsection 102AG(3) of the ITAA 1936) by the Federal Court in The Trustee for the Estate of the late AW Furse No. 5 Will Trust v. FC of T[12]((1990) 21 ATR 1123 at 1132; 91 ATC 4007 at 4014-15) (Furse) where Hill J noted:

The first of the two issues [i.e. whether the parties to the relevant agreement were dealing with each other at arm's length] is not to be decided solely by asking whether the parties to the relevant agreement were at arm's length to each other. The emphasis in the subsection is rather upon whether those parties, in relation to the agreement, dealt with each other at arm's length. The fact that the parties are themselves not at arm's length does not mean that they may not, in respect of a particular dealing, deal with each other at arm's length. This is not to say that the relationship between the parties is irrelevant to the issue to be determined under the subsection. The distinction was pointed out by Davies J in connection with similar words used in sec. 26AAA(4) of the Act in Barnsdall v. FC of T 88 ATC 4565 at p. 4568, in a passage which with respect I agree:...

What is required in determining whether parties dealt with each other in respect of a particular dealing at arm's length is an assessment whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining.

In line with Hill J's comments in Furse, parties are not dealing with each other at arm's length when they are not involved in real bargaining.

More relevantly, the authority in Barnsdall and Furse was considered and applied by the Federal Court in Granby Pty Ltd v. Federal Commissioner of Taxation (1995) 129 ALR 503 (Granby) in the statutory predecessor to the current market value substitution rule in the CGT rules. In Granby at 507, Lee J followed Barnsdall and Furse and added:

... the term 'at arm's length' means, at least, that the parties to a transaction have acted severally and independently in forming their bargain....

If the parties to the transaction are at arm's length it will follow, usually, that the parties will have dealt with each other at arm's length. That is, the separate minds and wills of the parties will be applied to the bargaining process whatever the outcome of the bargain may be.

That is not to say, however, that parties at arm's length will be dealing with each other at arm's length in a transaction in which they collude to achieve a particular result, or in which one of the parties submits the exercise of its will to the dictation of the other, perhaps, to promote the interests of the other. As in Minister of National Revenue v. Merritt 69 DTC 5159 at 5166 where the parties to the transaction were parties at arm's length, the terms of a loan transaction made between them had been dictated by a unilateral decision of one of them and no independent will in the formation of that transaction had been exercised by the other.

As concluded in Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income:

199....... if the relationship of the parties is such that one party has the ability to influence or control the other, this will suggest that the parties may not be dealing with each other at arm's length, but it will not be determinative. The Commissioner will only be satisfied that the parties are not dealing with each other at arm's length in relation to a transaction if it is established that the independent minds and wills of the parties are not applied to the transaction such that their dealing is not a matter of real bargaining.

In the current circumstances, the creditor (Unit Trust) is an Australian resident at the forgiveness time, the promissory note is not a moneylending debt as defined in subsection 995-1(1) of the ITAA 1997 (i.e.'moneylending debt means a debt resulting from a loan of money in the ordinary course of a *business of lending money carried on by the creditor.'); although the Unit Trust and Company A are related parties it is accepted that they are dealing at arm's length in respect of incurring the debt, based on the facts provided, it was expected, at the time these debts were incurred that the Company A would have been able to repay its debts as and when they fell due. Accordingly, the value of the debt for the purposes of section 245-55 of the ITAA 1997 in this case will be the face value of the debt at the time of forgiveness.

Amounts offset against the value of the debt

Subsection 245-65(1) of the ITAA 1997 provides a table to explain how to work out the amount (if any) that is offset against the value of a debt when it is forgiven (calculated under sections 245-55, 245-60 or 245-61 of the ITAA 1997) in working out the gross forgiven amount of the debt. Relevantly, Item 2 of the table in subsection 245-65(1) of the ITAA 1997 applies except where Item 3, 4, 5 or 6 applies. In this case Item 2 does not apply because Item 6 applies. Item 6 provides that if 'the debt is *forgiven by subscribing for *shares in a company as mentioned in section 245-37' the amount to offset is 'the amount worked out using the formula in subsection (3)'.

The amount offset is worked out by using the formula in subsection 245-65(3) of the ITAA 1997 as follows:

where:

amount applied means the amount applied by the company as mentioned in section 245-37.

amount subscribed means the amount subscribed as mentioned in section 245-37.

market value of shares subscribed for means the *market value of all the shares in the company that were subscribed for as mentioned in section 245-37, immediately after those shares were issued.

In this case:

•         the 'Amount applied' is the Shareholder Loan amount (ie $XXXXX) which is endorsed in favour of Unit Trust by Company A.

•         the 'Amount subscribed' is the principal amount of the UT Promissory Notes of $XXXX provided by the Unit Trust as its subscription price for the Class A Shares; and

•         the market value of the shares subscribed for is $XXXX.

As such, the amount offset against the value of the debt is $XXXXX.

Under section 245-75 of the ITAA 1997 the following applies;

245-75 (1) The gross forgiven amount of a debt is:

(a) if section 245- 65 does not apply to the debt - the value of the debt when it was *forgiven (worked out under section 245- 55, 245-60 or 245- 61); or

(b) if the value of the debt when it was forgiven exceeds the amount offset under section 245-65 in relation to the debt - the excess.

245-75 (2) If the value of the debt when it was *forgiven is equal to or less than the amount offset:

(a) there is no gross forgiven amount in respect of the debt; and

(b) Subdivisions 245-D to 245-F (about how to work out the net forgiven amount of a debt and how to treat it) do not apply in respect of the debt.

In this case, pursuant to paragraph 245-75(2) of the ITAA 1997, the value of the debt forgiven is equal to or less than the amount of the offset so there is no gross forgiven amount in respect of the debt and Division 245 of the ITAA 1997 has no further application.

Question 3

Summary

There will not be a gross forgiven amount for the purposes of subsection 245-75(1) of the ITAA 1997 as a result of repayment of the Existing Promissory Notes by Unit Trust transferring the Class A shares to the Existing Promissory Note Holders.

Detailed reasoning

See the reasoning provided for question 2 above for discussion of the debt forgiveness provisions.

The Existing Promissory Notes issued by Unit Trust to the Existing Promissory Noteholders are an interest free loan and, as such, are not considered to be a commercial debt under paragraph 245-10(a) of the ITAA 1997 as there has been no interest paid or payable.

However, on the basis that the funds from the Existing Promissory Notes have been used by Unit Trust to invest in Company A and that it is expected that this investment will derive assessable income (in the form of dividends on the Company A ordinary shares), then to the extent that had interest been charged on the Existing Promissory Notes that interest would be deductible under section 8-1 of the ITAA 1997, therefore the Existing Promissory Notes are considered to be a commercial debt under paragraph 245-10(b) of the ITAA 1997.

Relevantly, paragraph 245-35(a) of the ITAA 1997 provides that a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full.

In this case the Existing Promissory Notes debt is extinguished in full by the transfer of property of equivalent market value, being the Class A Shares in Company A, to the Existing Promissory Noteholders.

Accordingly, the Existing Promissory Notes commercial debts will not be 'forgiven' within the meaning of that term as set out in section 245-35 of the ITAA 1997 and as a consequence there will be no gross forgiven amounts for the purposes of subsection 245-75(1) of the ITAA 1997.

Question 4

Summary

The proposed arrangement will satisfy the requirements of Subdivision 124-N of the ITAA 1997. The original Unit Holders in the Unit Trust will receive replacement interests in New Co. Those replacement interests will be held in the same proportions as their original units in the Unit Trust. The market value of the replacement interests will be substantially the same as their original units.

Detailed reasoning

As set out in section 124-855 of the ITAA 1997 entities may be able to choose to obtain rollover under Subdivision 124-N of the ITAA 1997 where a unit trust disposes of all its assets to a company and the units in the trust are replaced by shares in the company.

Paragraph 124-855(1)(a)of the ITAA 1997 provides:

124-855(1)(a)(1) A roll-over may be available for a restructuring (a trust restructure) if:

a trust, or 2 or more trusts, (the transferor) *dispose of all of their *CGT assets to a company limited by *shares (the transferee);

...

Section 995-1 defines 'dispose of a CGT asset' to mean where the disposal of the CGT assets gives rise to CGT event A1 under section 104-10 of the ITAA 1997.

Section 104-10 of the ITAA 1997 provides:

104-10(1) CGT event A1 happens if you *dispose of a *CGT asset.

104-10 (2) You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

...

Under the Proposed Transaction, the Unit Trust will transfer all its assets, consisting of cash and ordinary shares in Company A and novate the remaining UT Promissory Notes with a face value of $951,845 to New Co. As legal and beneficial ownership of all the assets of the Unit Trust will be acquired by New Co, the Proposed Transaction will trigger CGT event A1 for all CGT assets. As such, the requirement in paragraph 124-855(1)(a) of the ITAA 1997 will be satisfied.

Paragraph 124-855(1)(b) provides:

124-855(1)(b) *CGT event E4 is capable of applying to all of the units and interests in the transferor;

...

Under section 104-70of the of the ITAA 1997, CGT Event E4 happens if the trustee of a trust makes a distribution to a beneficiary of the trust in respect of the beneficiary's ongoing unit or interest in the trust and some or all of the payment is not assessable. The amount that is not included in the taxpayer's assessable income is referred to as the 'non-assessable part'.

The note to subsection 124-855(1) of the ITAA 1997 states that rollover is not available for a restructure undertaken by a discretionary trust. For CGT event E4 to be capable of applying all the beneficiaries' interest must have a fixed capital component.

Under the terms of the trust deed for the Unit Trust the Unit Holders have a fixed entitlement to the capital of the trust. Whilst the Trustee has absolute discretion to pay sums out of the capital of the trust fund, to the extent the Trustee exercises this discretion, all such capital payments must be made to all Unit Holders in proportion to their holdings.

In effect, the Trustee cannot make non-assessable distributions to different Unit Holders, such that any capital distribution made will be considered to be a fixed capital component. Therefore, CGT event E4 is capable of applying to all of the units and the requirement in paragraph 124-855(1)(b) of the ITAA 1997 will be satisfied.

Paragraph 124-855(1)(c)/subsection 124-860(1)

Paragraph 124-855(1)(c) of the ITAA 1997 provides:

(c) the requirements in section 124-860 are met.

...

Subsection 124-860(1) of the ITAA 1997 provides:

(1) All of the *CGT assets owned by the transferor must be disposed of to the transferee during the *trust restructuring period. However, ignore any CGT assets retained by the transferor to pay existing or expected debts of the transferor.

...

The 'trust restructuring period' is defined in subsection 124-860(2) of the ITAA 1997 as:

(2) The trust restructuring period for a trust restructure:

(a) starts just before the first *CGT asset is *disposed of to the transferee under the trust restructure, which must happen on or after 11 November 1999; and

(b) ends when the last CGT asset of the transferor is disposed of to the transferee.

...

Under the Proposed Transaction the Unit Trust will dispose of all of its CGT assets to New Co during the 'trust restructuring period'. The trust restructuring period will commence just before the first CGT asset of the transferor (i.e. Unit Trust) is disposed of to the transferee (i.e. New Co) and ends when the last CGT asset of the transferor is disposed of to the transferee.

Accordingly, the trust restructuring period will commence at the time the Unit Trust transfers all of its Company A shares to New Co and will end when the Unit Trust transfers all of its remaining CGT assets to New Co. Therefore, subsection 124-860(1) of the ITAA 1997 will be satisfied.

Subsection 124-860(3)

Paragraph 124-860(3)of the ITAA 1997 provides:

(3) The transferee must not be an exempt entity.

An 'exempt entity' is defined in subsection 995-1(1) as:

(a) an entity all of whose *ordinary income and *statutory income is exempt from income tax because of this Act or because of another *Commonwealth law, no matter what kind of ordinary income or statutory income the entity might have; or

(b) an *untaxable Commonwealth entity.

Subdivision 50-A provides a list of the type of entities that may be considered exempt entities for income tax purposes.

As New Co is a newly incorporated company and not characterised as any type of exempt entity listed in Subdivision 50-A, the requirement in subsection 124-860(3) of the ITAA 1997 will be satisfied.

Subsection 124-860(4)

Paragraph 124-869(4) of the ITAA 1997 provides:

124-869 (4) The transferee must be a company that:

(a) has never carried on commercial activities; and

(b) has no *CGT assets, other than any or all of the following:

(i) small amounts of cash or debt;

(ii) its rights under an *arrangement, if (collectively) those rights only facilitate the transfer of assets to the transferee from the transferor; and

(c) has no losses of any kind.

Example: It could be a shelf company.

New Co will be incorporated at or around the time Company A shares are transferred to it by the Unit Trust, that is it will be a newly incorporated company that has not previously existed. Immediately before the start of the restructuring, New Co will not have carried on any commercial activities, will not have losses or CGT assets, other than:

•         receivables in respect of initial share issue to Unit Holders, and

•         rights under an arrangement that will facilitate the transfer of assets from the Unit Trust to New Co as part of the Proposed Transaction.

Additionally, the Company A Group will ensure that New Co does not have any rights that are CGT assets in relation to the proposed subsequent demerger of Company A, prior to the completion of the trust restructuring period in subsection 124-860(2) of the ITAA 1997.

Therefore, the requirement in subsection 124-860(4) of the ITAA 1997 will be satisfied.

Subsection 124-860(5) of the ITAA 1997 provides that subsection 124-860(4) of the ITAA 1997 does not apply to a transferee that is the trustee of the transferor. This requirement is not applicable.

Subsection 124-860(6) of the ITAA 1997 states:

124-860 (6) Just after the end of the *trust restructuring period:

(a) each entity that owned interests in a transferor just before the start of the trust restructuring period must own replacement interests in the transferee in the same proportion as it owned those interests in that transferor; and

(b) the *market value of the replacement interests each of those entities owns in the transferee must be at least substantially the same as the market value of the interests it owned in the transferor or transferors just before the start of the trust restructuring period. ...

Satisfying the conditions in subsection 124-860(6) of the ITAA 1997 requires determining what is meant by the term 'replacement interests'.

The term 'replacement interests' is defined in paragraph 124-870(1)(b) of the ITAA 1997 as the shares in a transferee company where ownership of units in a transferee trust end under a trust restructure in exchange for those shares.

The replacement interests are the shares held by the Unit Holders in New Co that are intended to replace the units held by the Unit Holders in Unit Trust following the restructure.

Before the end of the restructuring period, New Co will issue XXXXX ordinary shares at $0.00001 each to Unit Holders and these replace the XXXXX ordinary units paid up to $0.00001 each in the Unit Trust.

The 'proportionate interest' test in paragraph 124-860(6)(a) of the ITAA 1997 compares the proportionate ownership of interests held by the Unit Holders in Unit Trust (the transferor) just before the trust disposes of its first CGT asset to New Co (the transferee) under the trust restructure, with the proportionate ownership of shares in New Co that each Unit Holder will have just after the trust restructuring period.

Unit Holders will have the same proportionate holding in New Co that they had in Unit Trust. Therefore, the requirement in paragraph 124-860(6)(a) of the ITAA 1997 will be satisfied.

The 'market value test' in paragraph 124-860(6)(b) of the ITAA 1997 requires that the market value of the replacement shares in New Co just after the trust restructuring period be at least substantially the same as the market value of the interests in Unit Trust just before the start of the trust restructuring period.

All Unit Holders will have the same rights under the ordinary shares in New Co that Unit Holders had under the ordinary units in Unit Trust and all assets and liabilities of the Unit Trust will be transferred to New Co. Accordingly, the market value of the ordinary shares in New Co will be substantially the same as the market value of the ordinary units in Unit Trust. Therefore, the requirement in paragraph 124-860(6)(b) of the ITAA 1997 will be satisfied.

Accordingly, the requirements in subsection 124-860(6) of the ITAA 1997 will be satisfied.

Conclusion

Since all the requirements of subsection 124-855(1) of the ITAA 1997 will be satisfied, rollover is available for the transferor (i.e., Unit Trust) and transferee (i.e., New Co) if both the entities choose to obtain it in accordance with section 124-865 of the ITAA 1997. Both Unit Trust and New Co will choose to obtain the rollover.

Under section 124-875 of the ITAA 1997, the effect of the rollover relief under Subdivision 124-N of the ITAA 1997 is that:

•         any capital gain or capital loss from CGT event A1 happening to the transferor (i.e., Unit Trust) under the trust restructure is disregarded; and

•         the first element of the cost base and reduced cost base of each CGT asset that the transferee (i.e., New Co) acquires under the trust restructure is the same as the cost base and reduced cost base of that asset for the transferor (i.e., Unit Trust) just before the acquisition.

Further, since all the requirements of subsection 124-855(1) of the ITAA 1997 will be satisfied, rollover is also available for Unit Holders if they choose to obtain it in accordance with section 124-870 of the ITAA 1997 because:

•         the Unit Holders own units in Unit Trust; and

•         the Unit Holders' ownership of all of their units in the Unit Trust end under a trust restructure in exchange for shares in New Co.

Under section 124-10 of the ITAA 1997, the consequences of the rollover relief under Subdivision 124-N are that:

•         a capital gain or a capital loss that a Unit Holder makes on the redemption of the ordinary units in Unit Trust is disregarded; and

•         the first element of the cost base and reduced cost base of the shares in New Co is equal to cost base and reduced cost base of the ordinary units in Unit Trust just before they were redeemed.

Accordingly, the transfer and novation of all the assets and liabilities of the Unit Trust to New Co and the issue of shares in New Co to the Unit Holders of the Unit Trust meet the requirements for CGT rollover relief in Subdivision 124-N of the ITAA 1997.

Question 5

Summary

CGT event J4 in section 104-195 of the ITAA 1997 will not happen as the Unit Trust will be wound up within 6 months from just before the transfer of the first CGT asset from the Unit Trust to New Co.

Detailed reasoning

Section 104-195 states:

104-195 (1)

CGT event J4 happens if:

(a) there is a roll-over under Subdivision 124-N for a trust *disposing of a *CGT asset to a company under a trust restructure; and

(b) the trust fails to cease to exist:

(i) within 6 months after the start of the *trust restructuring period; or

(ii) if that is not possible because of circumstances outside the control of the trustee--as soon as practicable after the end of that 6 month period; and

(c) the company owns the asset when the failure happens.

...

104-195(2)

CGT event J4 also happens if:

(a) there is a roll-over under Subdivision 124-N for an entity (the shareholding entity) receiving a *share in a company in exchange for a unit or interest in a trust under a trust restructure; and

(b) the trust fails to cease to exist:

(i) within 6 months after the start of the * trust restructuring period; or

(ii) if that is not possible because of circumstances outside the control of the trustee--as soon as practicable after the end of that 6 month period; and

(c) the shareholding entity owns the share when the failure happens.

104-195(3)

The time of the event is when the failure to cease to exist happens.

The 'trust restructuring period' is set out in subsection 124-860(2) of the ITAA 1997 as:

124-860(2)

The trust restructuring period for a trust restructure:

(a) starts just before the first *CGT asset is *disposed of to the transferee under the trust restructure, which must happen on or after 11 November 1999; and

(b) ends when the last CGT asset of the transferor is disposed of to the transferee.

In this case the Trustee of the Unit Trust will terminate or wind up the Unit Trust in accordance with the trust deed within 6 months of the first CGT asset transfer from the Unit Trust to New Co, so CGT event J4 will not happen.

Question 6

Summary

Company A remains eligible to be the head company of the Company A income tax consolidated group under section 703-15 of the ITAA 1997 when New Co acquires all the ordinary shares in Company A and the shareholders hold the Class A shares

Detailed reasoning

Section 703-15 of the ITAA 1997 provides the requirements for an entity to be a head entity of a consolidated group. Specifically, Item 1 of the table in subsection 703-15(2) of the ITAA 1997 states:

As Company A is currently the head company of the Company A income tax consolidated group, consideration is required to be given to whether Company A continues to satisfy the ownership requirement in column 4 above. That is whether or not Company A becomes a wholly-owned subsidiary of another entity that meets the requirements of column 2 and 3 by virtue of New Co acquiring the ordinary shares in Company A under the Proposed Transaction.

The definition of a wholly-owned subsidiary is contained in section 703-30 of the ITAA 1997. Subsection 703-30(1) of the ITAA 1997 states:

703-30 (1) One entity (the subsidiary entity) is a wholly-owned subsidiary of another entity (the holding entity) if all the *membership interests in the subsidiary entity are beneficially owned by:

(a) the holding entity; or

(b) one or more wholly-owned subsidiaries of the holding entity; or

(c) the holding entity and one or more wholly-owned subsidiaries of the holding entity.

The term 'membership interest' in an entity is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 960-135 of the ITAA 1997. Section 960-135 of the ITAA 1997 provides:

960-135 Membership interest in an entity

If you are a * member of an entity:

(a) each interest, or set of interests, in the entity; or

(b) each right, or set of rights, in relation to the entity;

by virtue of which you are a member of the entity is a membership interest of yours in the entity.

Item 1 of the table in subsection 960-130(1) of the ITAA 1997 provides that a 'member' of a company is 'a member of the company or a stockholder in the company'.

Relevantly, the term 'share' is defined in section 6 of the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 to include: 'in a company means a share in the capital of the company, and includes stock ...'.

Subsection 960-130(3) of the ITAA 1997 provides that an entity is not a member of another entity just because the entity holds one or more interests or rights relating to the other entity that are debt interests.

The terms 'beneficially owned' and 'beneficial ownership' are not defined terms for these purposes. Therefore, they have their ordinary meaning. The Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 6) Bill 2004 which clarifies beneficial ownership for the consolidation membership rules states:

1.21 Case law has considered beneficial ownership as meaning the real owner of the property and, in a case where the legal and equitable ownership is divided, the owner of the property in equity.

The remainder of the subsections of section 703-30 of the ITAA 1997 are not relevant on the facts of the Proposed Transaction.

Company A will have two classes of 'membership interests' on issue:

•         the ordinary shares in Company A; and

•         the Class A Shares in Company A.

As a result of the Proposed Transaction:

•         New Co will acquire and beneficially own all the ordinary shares in Company A; and

•         The Class A Shares will be beneficially owned and held directly by the Existing Promissory Noteholders.

Accordingly, all membership interests in Company A will not be wholly owned by any entity for the purposes of subsection 703-30(1) of the ITAA 1997 and Company A should therefore not cease to be eligible as the head company of the Company A income tax consolidated group.

Question 7

Summary

New Co will be the head entity of a demerger group under section 125-65 of the ITAA 1997.

Detailed reasoning

New Co

Subsection 125-65(1) of the ITAA 1997 provides that a 'demerger group' consists of: 'the *head entity of the group and one or more *demerger subsidiaries.'

A company or trust is the 'head entity' of the demerger group if:

•         no other member of the demerger group owns 'ownership interests' in the company or trust ( subsection 125-65(3) of the ITAA 1997); and

•         the company or trust is not a 'demerger subsidiary' of another company or trust in another demerger group (subsection 125-65(4) of the ITAA 1997).

An 'ownership interest' is defined in subsection 125-60(1) of the ITAA 1997. Specifically, under paragraph 125-60(1)(a) of the ITAA 1997, for an interest in a company, it means a 'share' in the company, or an option, right or similar interest issued by the company that gives the owner an entitlement to acquire a share in the company. The term 'share' is defined in subsection 995-1(1) of the ITAA 1997 and includes a share in the capital of the company and includes stock.

A 'demerger subsidiary' is defined in subsection 125-65(6) of the ITAA 1997. A company will be a 'demerger subsidiary' of another company that is a member of the demerger group where that other company, either alone or together with other members of the group, owns or has the right to acquire ownership interests in the company that carry between them:

•         the right to receive more than 20% of any distribution of income or capital by the company; or

•         the right to exercise or control the exercise of more than 20% of the voting power of the company.

At the completion of step 6 of the Proposed Transaction, New Co will directly own 100% of the ordinary shares in Company A. While the Class A Shares in Company A will be owned by the Existing Promissory Noteholders, as the Class A Shares do not have a right to participate in distributions of income by Company A or any voting rights, Company A and any wholly owned subsidiaries are considered to be a demerger subsidiary of New Co.

New Co will also be considered to be the head entity of a demerger group provided that it is not otherwise a demerger subsidiary of another entity.

In this regard, as a result of the Proposed Transaction a company will hold more than 20% of the shares in New Co and a discretionary Trust will also hold more than 20% of the shares in New Co such that New Co could be a demerger subsidiary of either of these entities. However, the company holds the shares in New Co in its capacity as custodian or nominee and it is not the beneficial owner and no other entity for the company acts as the beneficial owner holds more than 20% of the shares in New Co in its own right. On this basis, New Co is not a demerger subsidiary of the company or any of the beneficial owners for which the company acts.

A discretionary trust cannot be a member of a demerger group (see subsection 125-65(2) of the ITAA 1997).

On this basis, there is no shareholder in New Co which is a company or trust that would meet the 20% threshold under subsections 125-65(6) and (7) of the ITAA 1997, and accordingly New Co cannot be a subsidiary member of another company or trust in another demerger group.

For these reasons, New Co is the head entity of a demerger group.

Question 8

Summary

Company A is a demerger subsidiary of New Co under section 125-65 of the ITAA 1997.

Detailed reasoning

Refer to the definition of a 'demerger subsidiary' including the analysis provided under question 7.

New Co will directly own at least 20% of the ordinary shares in Company A, which carry all the rights to vote and participate in distributions of income, Company A and its wholly owned subsidiary, the Company A Trust, are demerger subsidiaries of New Co.

Question 9

Summary

The Shareholders will be entitled to choose demerger roll-over under section 125-55 of the ITAA 1997 and the consequence of choosing the roll-over under section 125-55 of the ITAA 1997 is that the Shareholders can disregard any capital gain arising from CGT event G1.

Detailed reasoning

Demerger - CGT roll-over: shareholders

Division 125 of the ITAA 1997 provides roll-over relief for CGT consequences of a demerger.

Subdivision 125-B of the ITAA 1997 sets out the rules and consequences for shareholders.

Section 125-55 of the ITAA 1997 sets out the requirements for shareholders to choose to obtain demerger roll-over:

a)    you own an ownership interest in the company (your original interest); and

b)    the company or trust is the head entity of a demerger group; and

c)    a demerger happens to the demerger group; and

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

You own an ownership interest in a company

Ownership interests include shares,units or other interests in a trust and options, rights or similar interests that entitle the owner to acquire a share, a unit or other interest in a trust (subsection 125-60(1) of the ITAA 1997).

Each of the Unit Holders (i.e. Shareholders) own shares in New Co.

The only ownership interests in New Co are the ordinary shares that are owned by the Shareholders. Each of these ordinary shares in New Co is an 'original interest' for the purposes of section 125-55 of the ITAA 1997.

The company is the head entity of a demerger group

Subsection 125-65(1) of the ITAA 1997 provides that a demerger group consists of the head entity of the group and at least one demerger subsidiary.

A company or trust is a head entity of a demerger group if no other member of the group owns ownership interests in the company or trust (subsections 125-65(3) and (4) of the ITAA 1997).

Broadly, a company or trust is a demerger subsidiary if another company or trust in the demerger group owns or has the right to acquire ownership interests that carry between them the right to receive 20% of any distribution of income or capital or exercise 20% of the voting power of the company (subsection 125-65(5) of the ITAA 1997).

New Co is the head entity of a demerger group and includes Company A and the Securitisation Trust as demerger subsidiaries: i.e. the demerger group consists of New Co, Company A and Securitisation Trust for the purposes of section 125-55 of the ITAA 1997.

A demerger happens

A demerger happens to a demerger group if there is a restructuring of the demerger group (paragraph 125-70(1)(a) of the ITAA 1997) 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, 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, 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 (paragraph 125-70(1)(b) of the ITAA 1997)

A demerged entity is an entity that is a former member of a demerger group if under the demerger that happens to the group, ownership interests in the entity are acquired by shareholders in the head entity of the group if it is a company or unitholders or holders of interests in the head entity if it is a trust (subsection 125-70(6) of the ITAA 1997).

A demerging entity is an entity that is a member of a demerger group just before the CGT event happens, and under a demerger that happens to the group, the entity, alone or together with other members of the demerger group, stops owning at least 80% of their total ownership interests in another member of the demerger group including by disposing of the interest to owners of original interests (subsection 125-70(7) of the ITAA 1997).

•         Whether or not a CGT event happens to an original interest owned by an entity, in the head entity of the group, the entity acquires a new interest and nothing else (paragraph 125-70(1)(c) of the ITAA 1997).

•         The acquisition by entities of new interests happens only because those entities own or owned original interests (paragraph 125-70(1)(d) of the ITAA 1997).

•         The new interests acquired are ownership interests in a company, if the head entity is a company or are ownership interests in a trust, if the head entity is a trust (paragraph 125-70(1)(e) of the ITAA 1997).

•         Neither the original interests nor the new interests are in a trust that is a non-complying superannuation fund (paragraph 125-70(1)(g) of the ITAA 1997).

•         Each owner (the 'original owner') of original interest in the head entity of the demerger group must acquire the same proportion, or as nearly as practicable the same proportion, of the new interests in the demerged entity as the original owner owned in the head entity just before the demerger (paragraph 125-70(1)(h) and paragraph 125-70(2)(a) of the ITAA 1997).

•         Each original owner, just after the demerger, must have the same proportionate total market value of ownership interests in the head entity and demerged entity as they owned in the head entity just before the demerger (paragraph 125-70(2)(b) of the ITAA 1997).

A demerger does not encompass an off-market share buy-back that is subject to Division 16K of Part III of the ITAA 1936 (subsection 125-70(4) of the ITAA 1997) or occur where roll-over will be available under another provision of the ITAA 1936 or ITAA 1997 (subsection 125-70(5) of the ITAA 1997).

The term restructuring in paragraph 125-70(1)(a) of the ITAA 1997 has its ordinary business meaning, which is the reorganisation of a group of companies or trusts. All steps occurring under a single plan or reorganisation will usually constitute the restructuring. These may include transactions occurring before and/or after the transactions mentioned in paragraph 125-70(1)(b) of the ITAA 1997, and as such must be taken into account in determining whether the conditions in subsections 125-70(1) and (2) of the ITAA 1997 are satisfied.

TD 2020/6 Income tax: what is a 'restructuring' for the purposes of subsection 125-70(1) of the Income Tax Assessment Act 1997, explains that the Commissioner considers all of the facts and circumstances in determining the scope of the restructure for the purposes of the demerger provisions.

TD 2020/6 provides that the commercial understanding and the objectively inferred plan for reorganisation will determine which steps or transactions form part of the restructuring of the demerger group.

The objectively inferred purpose of the proposed restructuring is to transfer the ownership of Company A shares from Unit Trust to the Unit Holders (i.e. Shareholders). The steps which are integral to achieving that outcome and are considered to satisfy the first element required under a demerger (i.e. that there is a restructuring of the demerger group) are:

Step 4. New Co will be incorporated and the Unit Holders will subscribe for a total of 16,763,649 ordinary shares in New Co at $0.00001 per share in the same proportions as their existing unit holding in the Unit Trust with the subscription price outstanding by way of Promissory Notes. Accordingly, there will be $XXX capital paid into the New Co.

Each ordinary share in New Co will carry an equal right to dividends and capital of New Co and the right to vote and to attend meetings.

Step 5. New Co will acquire all the assets and liabilities of the Unit Trust by way of assignment or novation, including the shares in Company A, for $167.64 and the consideration will be the Promissory Notes of $167.64 from the Unit Holders.

At this time, the balance sheet of Unit Trust comprises:

The purpose of steps 4 and 5, is to replace the Unit Holder's direct interest in the Unit Trust with a direct interest in New Co and to then facilitate a demerger of the shares in Company A to the Unit Holders in the Unit Trust.

Step 6. Unit Trust will redeem the ordinary units on issue in accordance with the Trust Deed totalling $XXX by way of an in specie distribution of the Promissory Notes of $XXX received as consideration for the disposal of assets and liabilities to New Co.

Step 7. The Trustee of Unit Trust will terminate or wind up the Unit Trust in accordance with the trust deed within 6 months of the last asset transfer.

Step 8. Company A will undertake a share split in accordance with section 254H of the Corporations Act 2001 and split its 2 ordinary shares on issue into XXXXX ordinary shares.

Step 9. New Co will undertake a proportionate return of capital that is satisfied by a transfer of the shares in Company A to the Shareholders of New Co (Shareholders) with cash assets and the outstanding balance on the UT Promissory Notes to remain with New Co.

The amount of capital returned will be 99.99% of the subscribed capital reflecting Company A's allocation of the capital between the market value of the Company A shares and the market value of cash retained.

All of the above steps in this instance are considered to occur under a single plan of reorganisation notwithstanding, each step may be considered legally independent of the other (paragraph 3 of TD 2020/6.)

For completeness, the restructure does not begin and end at the start and end at step 9, since such an interpretation of restructure would not give effect to the purpose of undertaking the proposed demerger. Defining the restructure so narrowly excludes other steps which are inherently involved to meet the objectively inferred purpose of transferring direct ownership of Company A shares to the Shareholders. It is necessary for steps 4 to 9 above to occur for this to be achieved.

In this case, the Commissioner considers the transaction relating to the capitalisation of the Shareholder Loan from Unit Trust to Company A into Class A shares is a separate scheme to the demerger. The Class A shares are to be issued to, in broad terms, to convert the promissory notes/shareholder loan currently in existence and replicate most of the terms of the promissory notes/shareholder loan - i.e. no interest/dividends, no voting rights, right only to capital etc. The existence of Class A shares will not affect the economic interests of the Unit Holders of Unit Trust (i.e. Shareholders of New Co).

Demerger Conclusion

A demerger will happen to the demerger group of which New Co is the head entity and Company A and the Securitisation Trust as demerger subsidiaries as:

•         the distribution of Company A shares to the Shareholders will effect a restructuring of the demerger group for the purposes of paragraph 125-70(1)(a) of the ITAA 1997;

•         under the restructuring, New Co will dispose of 100% of its ownership interests (shares) in Company A to the Unit Holders, being the owners of original interests (shares) in New Co for the purposes of paragraph 125-70(1)(b) of the ITAA 1997. Company A is the demerged entity as the Shareholders will receive Company A shares under a demerger and New Co is the demerging entity as it will dispose of 100% of its shares in Company A to the Shareholders under a demerger;

•         under the restructuring, CGT event G1 will happen to New Co's shares (refer to the discussion below), and the Shareholders will receive shares in Company A, being the new interests, and nothing else for the purposes of paragraph 125-70(1)(c) of the ITAA 1997;

•         the Shareholders will receive shares in Company A solely on the basis of their shareholding in New Co for the purposes of paragraph 125-70(1)(d) of the ITAA 1997;

•         New Co is a company and the new interests acquired, being Company A shares, are ownership interests in a company for the purposes of paragraph 125-70(1)(e) of the ITAA 1997;

•         neither New Co nor Company A is a trust that is a non-complying superannuation fund for the purposes of paragraph 125-70(1)(g) of the ITAA 1997;

•         each of the Shareholders will acquire the same proportion of new interests in the demerged entity (the shares in Company A distributed to the Shareholders) as the proportion of shares they owned in New Co just before the demerger for the purposes of paragraph 125-70(2)(a) of the ITAA 1997;

•         just after the demerger, each of the Shareholders will have the same proportionate total market value of shares in New Co as they owned in Company A just before the demerger for the purposes of paragraph 125-70(2)(b) of the ITAA 1997;

•         the restructuring will not constitute an off-market share buy-back subject to Division 16K of Part III of the ITAA 1936 for the purposes of subsection 125-70(4) of the ITAA 1997, and

•         no other roll-over applies in these circumstances for the purposes of subsection 125-70(5) of the ITAA 1997.

A CGT event happens to your original interest and you acquire a new or replacement interest

Under section 104-135 of the ITAA 1997, CGT event G1 happens if:

•         a company makes a payment to a shareholder in respect of a share they own in the company (other than where CGT event A1 or C2 happens in relation to the share),

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

•         the payment is not included in the taxpayer's assessable income.

Broadly, the taxpayer makes a capital gain if the amount of the non-assessable part exceeds the share's cost base. They cannot make a capital loss (subsection 104-135(3) of the ITAA 1997).

In these circumstances:

a)    New Co will make a payment to the Shareholders in respect of the shares each Shareholder owns in New Co and that payment does not relate to CGT events A1 or C2 happening to the shares as there is no disposal or cancellation of any share owned by the Shareholders in New Co, thereby satisfying paragraph 104-135(1)(a) of the ITAA 1997. This payment comprises each Shareholder's portion of the in-specie distribution of 100% of New Co shares in Company A. Section 104-135 of the ITAA 1997 provides that payment can include giving property.

b)    There is at least some part of the payment that is not a dividend, thereby satisfying paragraph 104-135(1)(b) of the ITAA 1997. A dividend in this regard is defined in subsection 6(1) of the ITAA 1936 to include distributions made by a company to any of its shareholders; but excludes 'property distributed by a company to shareholders.... where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company'. It is proposed that the value of the Company A's shares will be partly debited against New Co's share capital account. The portion of the distribution debited against the share capital account is not a dividend.

It is also noted that there is no evidence on the facts provided in this case to suggest the existence of an arrangement under subsection 6(4) of the ITAA 1936 which provides an exception to the abovementioned rule.

c)    The payment will not be included in the Shareholders' assessable income, thereby satisfying paragraph 104-135(1)(c) of the ITAA 1997. Part of the payment that is debited to the share capital account is a return of capital; the remaining part will be a 'demerger dividend' under subsection 6(1) of the ITAA 1936, being part of the 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)'. A demerger dividend is not assessable income or exempt income (subsection 44(4) of the ITAA 1936).

CGT event G1 will happen in relation to the shares held by the Shareholders in New Co to the extent that New Co makes a return of capital to the Shareholders.

Consequences

As the conditions in section 125-55 of the ITAA 1997 will be satisfied under the terms of the proposed demerger, the Shareholders may choose to obtain a roll-over under that provision.

If the roll-over is chosen, a capital gain or capital loss a taxpayer makes from a CGT event happening under the demerger to an original interest the taxpayer owns is disregarded (subsection 125-880(1) of the ITAA 1997) - including any capital gain arising from CGT event G1.

Question 10

Summary

Each Unit Holder will be required to transfer some of the cost base in their original interest in New Co to the newly acquired interests in Company A. On the basis that the Unit Holders qualify and elect for rollover relief in relation to the trust to company rollover as set out at Question 4, the first element of each Unit Holders' cost base and reduced cost base of the shares in New Co is equal to the cost base and reduced cost base of the ordinary units in Unit Trust just before they were redeemed. The precise allocation of this cost base will be based on the proportion of each company's (i.e. New Co' and Company A') market values.

Detailed reasoning

Subsection 104-135(1) of the ITAA 1997 provides that CGT event G1 will happen to the Unit Holders' original interests in New Co, as New Co will make a payment in respect of a share that the Unit Holders own (paragraph 104-135(1)(a) of the ITAA 1997) and some or all of that payment will not be assessable (paragraph (b)). However, under subsection 104-135(3) of the ITAA 1997 the shareholders make a capital gain if the non-assessable part is greater than the cost base of the shares.

As outlined in relation to Question 9, CGT event G1 happens to the Unit Holders' original interests in New Co to the extent of the return of capital that is made by New Co. Accordingly, to the extent the market value of the shares in Company A received by way of a return of capital is greater than the cost base of the Unit Holder's respective shares in New Co, the Unit Holders will make a capital gain.

Where a Unit Holder chooses to obtain demerger roll-over relief, subsection 125-80(2) of the ITAA 1997 provides that the total aggregate cost base of the Unit Holder's original interests prior to the proposed demerger is to be allocated to the first element of the cost base and reduced cost base of each new interest (in Company A, the demerger entity) and each original interest (in New Co) they hold in such proportion as is reasonable having regard to the matters set out in subsection 125-80(3) of the ITAA 1997.

The relevant matters in subsection 125-80(3) of the ITAA 1997 are the market values of the shareholder's new interests, and of the remaining original interests, just after the proposed demerger, or an anticipated reasonable approximation of those market values.

Accordingly, each Unit Holder will be required to transfer some of the cost base in their original interest in New Co to the newly acquired interests in Company A. On the basis that the Unit Holders qualify and elect for rollover relief in relation to the trust to company rollover as set out at Question 4, the first element of each Unit Holders' cost base and reduced cost base of the shares in New Co is equal to cost base and reduced cost base of the ordinary units in Unit Trust just before they were redeemed. The precise allocation of this cost base will be based on the proportion of each company's (i.e. New Co and Company A) market values.

It is expected that this allocation will be 99.99% to the shares in Company A and 0.01% to the shares in New Co.

To the extent that Unit Holders do not elect demerger roll-over relief, subsection 125-85(2) of the ITAA 1997 provides that Unit Holders will adjust the first element of the cost base and reduced cost base in the same manner as provided under section 125-80 of the ITAA 1997. In either instance (i.e. whether demerger roll-over relief is chosen or not), the cost base adjustments are governed by the requirements of section 125-80 of the ITAA 1997 and not section 104-135 of the ITAA 1997.

Question 11

Summary

For the purposes of Division 115 of the ITAA 1997, the shareholders of New Co who choose to obtain roll-over relief in respect of their shares will be taken to have acquired a proportionate number of shares in Company A on the same date as their ordinary units in the Unit Trust.

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) of the ITAA 1997 regarding discount capital gains.

Item 2 of the table in subsection 115-30(1) of the ITAA 1997 provides that a CGT asset acquired as a replacement asset under a 'replacement asset roll-over' is taken to have been acquired when the taxpayer acquired the original asset involved in the roll-over.

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

Item 14B in the table in section 112-115 of the ITAA 1997 refers to a Subdivision 124-N - exchange of interests in a trust as a result of a trust restructure as being a replacement asset rollover.

Item 14C in the table in section 112-115 of the ITAA 1997 refers to a Division 125 of the ITAA 1997 demerger as being a replacement asset roll-over.

Accordingly, if Unit Holders choose the rollover under section 124-870 of the ITAA 1997 in respect of the trust restructure and under section 125-55 of the ITAA 1997 in respect of the demerger, the date of acquisition of the Company A shares for a Unit Holder will be taken to be the date they acquired their ordinary units in the Unit Trust.

Question 12

Summary

The in-specie distribution of shares in Company A will not give rise to assessable income under subsection 44(1) of the ITAA 1936.

Detailed reasoning

A 'demerger dividend' is that part of a 'demerger allocation' that is assessable as a dividend under subsection 44(1) of the ITAA 1936 or that would be so assessable apart from subsections 44(3) and 44(4) of the ITAA 1936 (subsection 6(1) of the ITAA 1936).

A 'demerger allocation' is the sum of the market values of the allocations represented by:

•         the ownership interests issued by a demerged entity in itself under a demerger to the owners of ownership interests in the head entity of the relevant demerger group, and

•         the ownership interests disposed of by a member of the demerger group under the demerger to those owners (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, and any amount credited by a company to any of its shareholders as shareholders. However, a dividend does not include moneys paid or credited, or property distributed, by a company to shareholders where the amount of the money or the value of the property is debited against an amount standing to the credit of the company's share capital account (subsection 6(1) of the ITAA 1936).

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a shareholder of a company (whether resident or non-resident) includes:

•         if the shareholder is a resident, dividends paid to the shareholder by the company out of profits derived by it from any source; or

•         if the shareholder is a non-resident, dividends paid to the shareholder by the company to the extent to which they are paid out of profits derived by it from sources in Australia.

Taxation Ruling TR 2003/8 Income tax: distributions of property by companies to shareholders - amount to be included as an assessable dividendexplains that where dividends are taken to be paid out of profits, they would fall within the scope of subsection 44(1) of the ITAA 1936:

13. In most cases a company which distributes property to its shareholders and debits part of the value of that property to its share capital account would debit the remaining part to another account or reserve. Where that account or reserve does not represent share capital, it would, for subsection 44(1) purposes, represent profits derived by the company so that the amount debited to it would be included in the shareholder's assessable income under that subsection.

However, subsection 44(2) of the ITAA 1936 states that subsections 44(3) and 44(4) of the ITAA 1936 apply to a demerger dividend unless the head entity of the relevant demerger group makes an election within the prescribed time that they not apply.

Subsection 44(3) of the ITAA 1936 states that section 44 of the ITAA 1936 applies to a demerger dividend as if it had not been paid out of profits, which means the demerger dividend is not included in the assessable income of shareholders in the head entity under subsection 44(1) of the ITAA 1936.

Subsection 44(4) of the ITAA 1936 provides that a demerger dividend is not assessable income and is not exempt income.

However, subsection 44(5) of the ITAA 1936 prevents subsections 44(3) and 44(4) of the ITAA 1936 from applying unless CGT assets owned by the demerged entity or a demerger subsidiary representing at least 50% by market value (or a reasonable approximation of market value) of all the CGT assets owned by the demerged entity and its demerger subsidiaries are used, directly or indirectly, in one or more businesses carried on by one or more of those entities.

In applying subsection 44(5) of the ITAA 1936, CGT assets that are ownership interests in a demerger subsidiary are to be disregarded unless they are used in a business referred to in subsection 44(6) of the ITAA 1936.

In respect of the amount debited against New Co's share capital account, the definition of 'dividend' under subsection 6(1) of the ITAA 1936 specifically excludes:

(d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company.

However, pursuant to subsection 6(4) of the ITAA 1936, paragraph (d) does not apply if:

'...under an arrangement:

(a) a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property; and

(b) the company pays or credits any money, or distributes property to another person, and debits its share capital account with the amount of the money or the value of the property so paid, credited or distributed...'

In such cases, such an amount will be considered to be a dividend and, as a consequence, would fall within the scope of subsection 44(1B) of the ITAA 1936. This would in turn bring it within the scope of subsection 44(1) of the ITAA 1936.

However, in the present case, there is no arrangement to which subsection 6(4) of the ITAA 1936 applies. Therefore the exclusion in paragraph 6(1)(d) applies, with the consequence that this amount would fall outside the scope of subsection 44(1) of the ITAA 1936.

The market value of the Company A shares that New Co disposes of to its shareholders under the demerger is the demerger allocation.

The Company A share distribution:

•         will be debited against an amount standing to the credit of New Co's share capital account.

•         the remaining part is a dividend because it is a 'distribution made by a company' to its shareholders: see definition of 'dividend' under subsection 6(1) of the ITAA 1936.

The demerger dividend is that part of the demerger allocation that is not debited to New Co's share capital account. It would be assessable under subsection 44(1) of the ITAA 1936 were it not for subsections 44(3) and (4) of the ITAA 1936. New Co will not make the election referred to in subsection 44(2) of the ITAA 1936, and the requirement in subsection 44(5) of the ITAA 1936 is satisfied, so that neither subsection prevents subsections 44(3) and 44(4) of the ITAA 1936 applying, such that the dividend will constitute a demerger dividend and therefore be neither assessable income nor exempt income pursuant to subsections 44(3) and 44(4) of the ITAA 1936.

Question 13

Summary

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

Detailed reasoning

Subsection 104-135(1) of the ITAA 1936 provides:

104-135(1) 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 Income Tax Assessment Act 1936; and

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

The payment can include giving property: see section 103-5.

Section 103-5 of the ITAA 1997 states that to the extent that a payment includes giving property, it is the market value of the property that is used in working out the amount of the payment, cost or expenditure.

Subsection 125-80(1) provides:

If you choose the roll-over, a *capital gain or *capital loss you make from a *CGT event happening under the *demerger to an original interest you own is disregarded.

Payment in respect of shares

To the extent that the proposed return of capital by New Co to its shareholders is satisfied by a transfer 100% of the shares in Company A, this will be a 'payment' made to the Unit Holders in respect of shares they own in New Co (as it will constitute the giving of property). As such, paragraph 104-135(1)(a) of the ITAA 1997 is satisfied.

Is the payment a dividend

A dividend includes any distribution made by a company to any of its shareholders, whether in money or other property, and any amount credited by a company to any of its shareholders as shareholders. However, a dividend does not include moneys paid or credited, or property distributed, by a company to shareholders where the amount of the money or the value of the property is debited against an amount standing to the credit of the company's share capital account (subsection 6(1) of the ITAA 1936).

Assessable income

Subsection 44(1) provides that the assessable income of a shareholder of a company (whether resident or non-resident) includes:

•         if the shareholder is a resident, dividends paid to the shareholder by the company out of profits derived by it from any source.

•         if the shareholder is a non-resident, dividends paid to the shareholder by the company to the extent to which they are paid out of profits derived by it from sources in Australia.

The amount of the payment represented by the transfer of the Company A shares is not a dividend as defined or an amount taken to be a dividend under section 47 of the ITAA 1936 as:

•         the return of capital is debited to New Co's share capital account and is not tainted for income tax purposes,

•         the distribution will be debited against the share capital of New Co, such that paragraph (d) of the section 6(1) of the ITAA 1936 definition will apply to exclude the distribution from being a 'dividend' for income tax purposes, and

•         the distribution will not constitute a return of capital by a liquidator, such that section 47 will apply.

Accordingly, paragraph 104-135(1)(b) of the ITAA 1997 will be satisfied to the extent that the return of capital by New Co will be debited to its share capital account.

As the distribution by New Co will not be included in the assessable income of a shareholder for income tax purposes, the requirements of paragraph 104-135(1)(c) of the ITAA 1997 will be satisfied.

Pursuant to subsection 104-135(3) of the ITAA 1997, a taxpayer will make a capital gain in respect of CGT event G1 if the amount of the non-assessable part of the payment made by the company in respect of the relevant share is more than the cost base of the share.

Accordingly, on the basis that the demerger requirements will be satisfied, if roll-over is chosen under subsection 125-55(1) of the ITAA 1997, any resulting capital gain arising for Unit Holders in respect of CGT event G1 will be disregarded pursuant to subsection 125-80(1) of the ITAA 1997.

Question 14

Summary

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

Detailed reasoning

The purpose of section 45B of the ITAA 1936 is to treat amounts as dividends where either the capital/profit split of a demerger dividend does not reflect the circumstances of a demerger, or certain payments, allocations and distributions are substituted for dividends.

Subsection 45B(2) of the ITAA 1936 sets out when this applies:

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

b)    under the scheme, a taxpayer ('the relevant taxpayer'), who may or may not be the person provided with the demerger benefit or capital benefit, obtains a tax benefit, and

c)    having regard to the relevant circumstances of the scheme, it would be (objectively) concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of it did so for a purpose of enabling a taxpayer (the relevant taxpayer) to obtain a tax benefit. The requisite purpose may or may not be the dominant purpose, but does not include an incidental purpose.

The Commissioner may make a determination in writing that section 45BA of the ITAA 1936 applies to all or part of the demerger benefit, or that section 45C applies to all or part of the capital benefit (subsection 45B(3) of the ITAA 1936). In the latter case, the Commissioner may make a further determination under subsection 45C(3) of the ITAA 1936 that all or part of the capital benefit was paid under a scheme for which a non-incidental purpose was to avoid franking credits arising.

The effect of applying section 45BA of the ITAA 1936 is that all or part of the demerger benefit is taken for the purposes of the income tax law not to be a demerger dividend. Where the benefit is the provision of ownership interests, the amount of the demerger benefit is the market value of the interests at the time they were provided. This means that all or part of what would otherwise have been the demerger dividend is brought to tax in the hands of the company's shareholders under subsection 44(1) of the ITAA 1936 as subsections 44(3) and (4) would not apply.

The effect of section 45C of the ITAA 1936 applying to a capital benefit is that the amount of the capital benefit, or part of the benefit, is taken to be an unfranked dividend paid by the company to the shareholder or relevant taxpayer at the time that the shareholder or relevant taxpayer is provided with the capital benefit.

The effect of a determination under subsection 45C(3) of the ITAA 1936 is that on the day the notice of the determination is served in writing on the company, a franking debit of the company arises in respect of the capital benefit. The amount of the debit is the amount of the franking credit on a dividend of an amount equal to the capital benefit or the part of the benefit had the company paid such a dividend at the time it provided the capital benefit, and fully franked it.

A 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) An 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 (section 995-1 of the ITAA 1997).

Subsection 45B(4) of the ITAA 1936 provides that a person is provided with a demerger benefit if in relation to a demerger:

•         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 that increases the value of an ownership interest (whether or not the same one) owned by the person.

Subsection 45B(5) provides that a person is provided with a capital benefit if:

•         they are provided with ownership interests in a company;or

•         share capital or share premium is distributed to them; or

•         something is done in relation to an ownership interest that increases the value of an ownership interest (whether or not the same one) that is held by the person.

However, to the extent that the provision of interests, the distribution or the thing done involves the person receiving a demerger dividend, the person is not provided with a capital benefit (subsection 45B(6) of the ITAA 1936).

A 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 the capital benefit had been an assessable dividend (subsection 45B(9) of the ITAA 1936).

The relevant circumstances of the scheme that the Commissioner must have regard to in order to determine whether or not the requisite purpose exists include those set out in subsection 45B(8) of the ITAA 1936, paragraphs (a) to (k):

a)    the extent to which the demerger benefit or capital benefit is attributable to capital or to profits (realised and unrealised) of the company or an associate of the company (within the meaning of section 318). [It is the Commissioner's view that where it is not possible to precisely trace the amount of capital contributed by the head entity's shareholders that is invested in the demerged entity, that amount should be determined in accordance with the relative market value of the demerged entity to the corporate group (Practice Statement PS LA 2005/21, paragraph 57).]

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

c)    whether the relevant taxpayer has capital losses that, apart from the scheme, would be unutilised (i.e. not utilised according to the meaning of 'utilise' in section 960-20) at the end of the relevant 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

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.

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:

                                            i.    the period for which the ownership interests are held by the holder of the interests; and

                                           ii.    when the arrangement for the disposal of the ownership interests was entered into.

j)      In the case of a demerger:

                                            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 of the entity.

k)    Any of the matters referred to in subsection 177D(2).

The matters referred to in subsection 177D(2) of the ITAA 1936 are:

a)    the manner in which the scheme was entered into or carried out,

b)    the form and substance of the scheme,

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

d)    the result in relation to the operation of the Act that would be achieved by the scheme, if not for section 45B,

e)    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,

f)     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,

g)    any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out, and

h)    the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Application to the proposed demerger

The definition of 'scheme' is sufficiently broad to encompass the sequence of steps required to carry out the demerger. Under the demerger, New Co provides the Shareholders with ownership interests in a company, being shares in Company A.

The provision of ownership interests to a shareholder under a demerger constitutes the shareholder being provided with a demerger benefit (subsection 45B(4) of the ITAA 1936). Therefore, under the proposed scheme, but for subsection 104-135(5) of the ITAA 1997, the market value of Company A shares provided to the Shareholders constitutes a demerger benefit.

The provision of shares also constitutes a capital benefit to the extent it is not a demerger dividend (paragraph 45B(5)(a) and subsection 45B(6) of the ITAA 1936). As such, but for subsection 104-135(5) of the ITAA 1997, the market value of Company A shares distributed under the demerger less the demerger dividend is a capital benefit provided to the Shareholders.

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

New Co may disregard any capital gain it makes under CGT event A1 on the disposal of Company A shares to its shareholders. Accordingly, the New Co will obtain a tax benefit for the purposes of section 45B.

Relevant circumstances

Having regard to the relevant circumstances of the scheme as set out in subsection 45B(8) of the ITAA 1936:

•         Paragraph (a) does not incline for, or against, a conclusion as to the requisite purpose as the proposed demerger will result in a return of capital and a demerger dividend sourced from profits which are considered to be attributable to share capital and profits in accordance with PSLA 2005/21.

•         Paragraph (b) does not incline against the requisite purpose as the history does not evidence a consistent pattern of paying out the majority of its profits to shareholders in the form of dividends, rather than accumulating the profits to be distributed all at once in a tax effective manner.

•         Having regard to the Shareholders' profile, paragraphs (c) to (f) are neutral, or at most incline only slightly toward the requisite purpose.

•         Paragraph (h) is not a relevant factor given that the proportion tests in subsection 125-70(2) of the ITAA 1997 would be satisfied in relation to the demerger.

•         Paragraph (i) does not incline toward the requisite purpose as there is no arrangement for a later disposal of Company A shares that the Shareholders receive. The Shareholders will make their own decisions as to how long to retain their Company A shares before disposing of them.

•         Paragraph (j) does not incline for, or against, a conclusion as to the requisite purpose as New Co has not concentrated assets or profits in Company A so as to effect a tax-free distribution of assets and profits to the Shareholders through their ownership of Company A shares beyond that which would be explicable by a business restructure.

As for the factors in paragraphs 177D(2)(a) to (h) of the ITAA 1936 referred to in paragraph 45B(8)(k):

•         The manner in which New Co proposes to carry out the scheme is to effect a business restructure by means of a demerger of Company A. There are commercial reasons for the demerger:

­    Operational and strategic requirements that could not be met by the current structure.

­    Funding, future investment and growth.

•         The form of the scheme is the steps involved in carrying out the demerger in accordance with the conditions in subsection 125-70(1) of the ITAA 1997. The economic substance of the scheme is that the Shareholders will continue to own directly the shares in Company A that they had previously owned indirectly through Unit Trust and New Co, and New Co will have reduced its share capital proportionately with the relative market value of Company A.

•         Apart from section 45B of the ITAA 1997, the results in relation to the operation of the Act that would be achieved by the scheme are that:

­    The Shareholders will be able to choose roll-over relief in relation to CGT event G1 that happens to their shares under the demerger.

­    The resident Shareholders will not be taxed on the dividend component of the distribution they receive (subsections 44(3) and (4) of the ITAA 1936).

­    New Co will disregard any capital gain or capital loss on the disposal of Company A shares under the demerger.

•         The demerger delivers to the Shareholders direct ownership of interests in Company A that they previously owned indirectly through Unit Trust and New Co, in theory leaving them in the same economic position as before. In practice, direct ownership of the Company A shares provides the Shareholders with a choice to dispose of or exchange the shares or use them as a financial security.

•         The demerger will result in a diminution of New Co's assets, as it will cease to own 100% of Company A's shares.

•         The nature of the relevant connections are the relationships between New Co and the Shareholders as shareholders - the significance of those relationships for income tax purposes is that distributions of New Co's profits are assessable income of its shareholders. The proposed demerger will preserve the economic substance of these relationships. It will not make special provision for some shareholders as against others: rather, it will provide benefits to each of the Shareholders in proportion to their shareholding.

Taking into account the relevant circumstances above, there are undoubtedly tax benefits to the Shareholders, the main reasons for carrying out the demerger are commercial in nature.

Given the commercial reasons for the demerger, it is considered that an essential object of the proposed demerger is to restructure for those reasons as outlined above. Therefore, the tax benefit that the Shareholders would receive is an incidental object of the demerger and it is considered that the manner of the scheme does not point toward there being a more than incidental purpose of obtaining the tax benefit.

Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA applies in relation to the demerger benefit identified above and will not make a determination under paragraph 45B(3)(b) that section 45C applies to the capital benefit identified above. Since no determination will be made under paragraph 45B(3)(b), it follows that the Commissioner will make no additional determination under subsection 45C(3).

Question 15

Summary

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

Detailed reasoning

Demerger - CGT roll-over: company

Section 125-155 of the ITAA 1997 provides that any capital gains or capital losses a demerging entity makes as a result of CGT events A1, C2, C3 or K6 happening to its ownership interests in a demerged entity are disregarded.

In this case, CGT event A1 will happen when New Co (the demerging entity) disposes of its shares in Company A (demerged entity) when it transfers the Company A shares to the Shareholders (section 104-10 of the ITAA 1997).

This disposal occurs under a demerger.

The requirements of section 125-155 of the ITAA 1997 are satisfied as:

•         New Co is a demerging entity as it is member of the demerger group of which New Co is head entity

•         CGT Event A1 will happen when New Co's shares in the demerged entity (i.e. Company A shares) are disposed of to the Unit Holders

•         New Co will make a capital gain as a result CGT event A1 happening; and

•         The disposal of the 100% of the Company A shares will happen under the demerger.

Section 125-155 of the ITAA 1997 will apply such that New Co will disregard any capital gain or loss from CGT event A1 happening to transfer of the shares in Company A to the Unit Holders.