Edited version of private advice

Authorisation Number: 1052048318854

Date of advice: 25 October 2022

Ruling

Subject: Demerger

Question 1

Will demerger roll-over relief, pursuant to Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997), be available to Participating Shareholders who are Australian residents and hold Head co shares on capital account?

Answer

Yes

Question 2

Will the part of the in-specie distribution which is a dividend under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936), if any, be non-assessable, non-exempt income by virtue of subsections 44(3) and (4) of the ITAA 1936 (the demerger allocation)?

Answer

Yes

Question 3

Will the Commissioner seek to make a determination under Section 45B of the ITAA 1936 that sections 45BA or 45C applies to the whole, or any part, of the demerger allocation received by Participating Shareholders?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Summary

Head co is a privately owned Australian company.

Head co has 2 wholly owned subsidiaries that undertake different businesses

Company A

Company B

All shareholders are Australian residents with little to no capital losses.

Reasons for proposed demerger

Changes in the industries each subsidiary operate in has made it difficult to grow in the current structure. By demerging Head co aims to achieve the following commercial benefits:

•         Access to different financiers for Company A

•         Reduced credit risk profile for Company B

•         Greater borrowing capacity for all entities

•         Ability to undertake opportunities to grow each subsidiary that are missed as a result of the current structure.

Proposed transaction

Head co is proposing to demerge 100% of Company A by way of an in-specie distribution to its shareholders. For completeness Head co's 100% ownership in Company B will not be affected by the demerger, the scheme is aimed at separating Company A from Company B.

Company A will undertake a share split prior to the demerger to allow the ultimate beneficial owners to retain the precise interest they held prior to the demerger.

Head co will dispose of all of their shares in Company A to their Shareholders in equal proportions to their ownership proportions in the head entity prior to the demerger.

The owners of Head co will receive shares and nothing else, with each owner holding the same market value and proportion after the transaction as they did just before the demerger.

The demerger allocation will be the market value of Company A's shares.

Head co's share capital account will not be "tainted" in accordance with the "share capital tainting rules", within the meaning of Division 197 of the ITAA 1997, at the time of the demerger.

Head co shows a history of distributing regular dividends similar to the year's earnings.

Valuation

Head co will undertake a valuation at the time of the demerger that is consistent with the requirements of the ATO market valuation guidelines.

Post demerger

Company A and Company B already operate independently apart from a shared receptionist and internal accounts staff. Both companies will hire their own receptionist and account staff post demerger.

Company A will formally sub-lease the space they currently occupy from Company B. Prior to the demerger, occupancy costs are shared on a pro-rata basis.

The intercompany loan between Company A and Company B will be placed on a formal loan agreement.

Both entities already have separate management structures.

All CGT assets of Company A will be used in carrying on the business post demerger.

There are no plans to undertake an IPO, or for any of the shareholders to reduce their holdings post demerger.

Head co will not make the election referred to in subsection 44(2) of the ITAA 1936.

Relevant legislative provisions

Subsection 104-135(5) of the Income Tax Assessment Act 1997

Division 125 of the Income Tax Assessment Act 1997

Section 125-55 of the Income Tax Assessment Act 1997

Subsection 125-55(2) of the Income Tax Assessment Act 1997

Section 125-60 of the Income Tax Assessment Act 1997

Subsection 125-65(1) of the Income Tax Assessment Act 1997

Subsection 125-65(3) of the Income Tax Assessment Act 1997

Subsection 125-65(4) of the Income Tax Assessment Act 1997

Subsection 125-65(5) of the Income Tax Assessment Act 1997

Subsection 125-70(1) of the Income Tax Assessment Act 1997

Subsection 125-70(2) of the Income Tax Assessment Act 1997

Subsection 125-70(4) of the Income Tax Assessment Act 1997

Subsection 125-70(5) of the Income Tax Assessment Act 1997

Subsection 125-70(6) of the Income Tax Assessment Act 1997

Subsection 125-70(7) of the Income Tax Assessment Act 1997

Section 125-155 of the Income Tax Assessment Act 1997

Subsection 6(1) of the Income Tax Assessment Act 1936

Subsection 6(4) of the Income Tax Assessment Act 1936

Section 44 of the Income Tax Assessment Act 1936

Subsection 44(1) of the Income Tax Assessment Act 1936

Subsection 44(1B) of the Income Tax Assessment Act 1936

Subsection 44(2) of the Income Tax Assessment Act 1936

Subsection 44(3) of the Income Tax Assessment Act 1936

Subsection 44(4) of the Income Tax Assessment Act 1936

Subsection 44(5) of the Income Tax Assessment Act 1936

Subsection 44(6) of the Income Tax Assessment Act 1936

Section 45B of the Income Tax Assessment Act 1936

Subsection 45B(2) of the Income Tax Assessment Act 1936

Subsection 45B(3)of the Income Tax Assessment Act 1936

Subsection 45B(4)of the Income Tax Assessment Act 1936

Subsection 45B(5) of the Income Tax Assessment Act 1936

Subsection 45B(6) of the Income Tax Assessment Act 1936

Subsection 45B(8) of the Income Tax Assessment Act 1936

Subsection 45B(9) of the Income Tax Assessment Act 1936

Section 45BA of the Income Tax Assessment Act 1936

Section 45C of the Income Tax Assessment Act 1936

Subsection 45C(3) of the Income Tax Assessment Act 1936

Subsection 177D(2) of the Income Tax Assessment Act 1936

Reasons for decision

Summary

Demerger roll-over relief will be available to Head co's shareholders who are Australian residents and hold the shares on capital account.

Detailed reasoning

Division 125 of the Income Tax Assessment Act (ITAA 1997) provides entities with CGT relief for a demerger with section 125-55 of the ITAA 1997 outline when roll-over relief is available for a demerger.

Under subsection 125-55 of the ITAA 1997, an entity can choose to obtain relief if:

(a)  You own an ownership interest in a company or trust (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 replacement interest) in the demerged entity.

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

(a)  You are a foreign resident; and

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

You own an ownership interest in a company

An ownership interest is defined under paragraph 125-60(1)(a) of the ITAA 1997 as a share in the company.

As all applicants to the ruling own shares in Head co, this condition is satisfied.

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).

Head co is the head entity as it is wholly owned by the applicants. While Company A and Company B are demerger subsidiaries as they are wholly owned by Head co. Collectively, these three entities form the demerger group.

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 (TD 2020/6), 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 proposed steps to the demerger satisfy the requirements for a demerger to happen. That is, Head co disposes of all of their interests in Company A to its shareholders. All shareholders receive replacement interests in the same proportion of their holdings in the group that they held just before the demerger and nothing else.

Therefore, demerger roll-over relief will be available to Head co shareholders who are Australian residents and hold the shares on capital account.

Question 2

Summary

The dividend portion of the in-specie distribution to Head co shareholders will be non-assessable, non-exempt income under subsections 44(3) and (4) of the Income Tax Assessment Act 1936 (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 dividend (TR 2003/8) explains 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:

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 Head 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 the demerger dividend would fall outside the scope of subsection 44(1) of the ITAA 1936.

The market value of the Company A shares that Head 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 Head 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 Head 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. Head 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 3

Summary

The Commissioner will not seek to make a determination under section 45B of the ITAA 1936 and sections 45BA and 45C apply to the whole, or any part, of the demerger allocation received by the participating shareholders.

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, Head 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's 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.

Head co may disregard any capital gain it makes under CGT event A1 on the disposal of Company A's shares to its shareholders. Accordingly, Head 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 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. There are shareholders who have capital losses but not to the size or saturation that would indicate a 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 Head 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 Head 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 Head co, and Head co will have reduced its share capital with the carrying value of Company A. The Market value of the Company A enterprise will be determined by valuation in line with the Commissioner's advice, and the excess over share capital will be a demerger dividend.
• The scheme will be entered into shortly after a favourable ruling outcome and it is expected the scheme will be complete shortly after commencement
• 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).
  • Head 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 Head 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 Head 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 Head co and the Shareholders as shareholders - the significance of those relationships for income tax purposes is that distributions of Head 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, while 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).