Edited version of private advice

Authorisation Number: 1052368428984

Date of advice: 11 April 2025

Ruling

Subject:CGT - demerger relief

Question 1

Will the shareholders of V be entitled to choose demerger roll-over relief for the demerger of the shares in Co under section 125-55?

Answer 1

Yes.

Question 2

Will the shareholders of V who choose demerger roll-over relief disregard any capital gain or loss they make from CGT event G1 happening under the demerger to their V shares under subsection 125-80(1)?

Answer 2

Yes.

Question 3

Will the first element of the cost base and the reduced cost base of the shares held by V shareholders in V and Co be subject to adjustment under subsection 125-80(2)?

Answer 3

Yes.

Question 4

Will the shareholders of V who choose demerger roll-over relief in respect of their shares be taken, for the purpose of Division 115, to have acquired a proportionate number of shares in Co on the same date as their shares in V pursuant to item 2 of the table in subsection 115-30(1)?

Answer 4

Yes.

Question 5

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 pursuant to subsections 44(3) to 44(5) of the ITAA 1936?

Answer 5

Yes.

Question 6

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

Answer 6

No.

Question 7

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

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

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

Answer 7

No.

Question 8

Will V remain entitled to disregard any capital gain under CGT event A1 that would occur upon the proposed transfer of its shares in Co to its shareholders under section 125-155?

Answer 8

Yes.

Question 9

Under the proposed transfer of shares in Co to V shareholders, will V be required under subsection 45D(1A) of the ITAA 1936 to give a copy of a notice to its shareholders?

Answer 9

No.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

Relevant facts and circumstances

V is a privately owned Australian company and the head company of the income tax consolidated group (the Group). VS is a wholly owned subsidiary of V and carrying on the VS Business.

The VS Business is in the manufacturing and packaging of X and selling under its own name and for other large household names in Australia.

V and VS own a commercial complex which was acquired in xxxx. This is where VS's business was carried on from. However, as the business has expanded, the Group now only uses part of the complex as an administration office, for product bagging lines and for storage. The other portions are now leased to other independent third parties and the Group manages the leasing.

V is considering restructuring the group's operations to facilitate the possible introduction of new shareholders and to deliver productivity or efficiency improvements. As part of this operational restructure, the Group is looking to consolidate the activities currently undertaken at the commercial complex to other locations currently occupied by them. The commercial complex would then be leased fully to third parties, increasing the extent of the Group's leasing activities.

V is considering the existing shareholders retaining the property leasing and management activities by a demerger of these activities with the new third-party investors investing in V's manufacturing and packaging business only.

This will include an incorporation of a new wholly owned entity (Co). Co will be a subsidiary of V and join the V tax consolidated group. After the incorporation of Co, the property leasing activities and assets will be transferred at original cost to Co to enable Co to separately manage the property ownership and leasing operations of the Group.

To demerge Co from the tax consolidated group by V, V will be transferring its 100% ownership interest in the company to the existing shareholders of V via a pro-rata in-specie distribution. This will be by V undertaking a selective reduction in share capital pursuant to section 256C of the Corporations Act 2001. The determination of the capital component of the demerger distribution is consistent with ATO's Practice Statement Law Administration 2005/21 (PSLA 2005/21).

The distribution will be undertaken on a proportionate basis and each shareholder's entitlements will remain the same. The share capital reduction will not involve the cancellation of shares.

V will not make the election referred to in subsection 44(2) of the ITAA 1936 that subsections 44(3) and (4) of the ITAA 1936 do not apply to the demerger dividend.

V's share capital account will not be tainted within the meaning of the Division 197 at the time of the demerger.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 45

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45D

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 section 112-115

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 section 125-55

Income Tax Assessment Act 1997 section 125-60

Income Tax Assessment Act 1997 section 125-65

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 section 125-75

Income Tax Assessment Act 1997 section 125-80

Income Tax Assessment Act 1997 section 125-155

Income Tax Assessment Act 1997 section 125-70

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 section 975-300

Does 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 fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

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-avoidancerule for income tax'.

Reasons for Decision

All references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Will the V shareholders be entitled to choose the demerger roll-over relief for the demerger of the shares in Co under section 125-55?

Summary

The V shareholders will be entitled to choose the demerger roll-over relief under section 125-55 for the demerger of the shares in Co by V.

Detailed reasoning

Division 125 provides demerger relief from the CGT consequences of a demerger. The shareholders of V would be eligible to choose the demerger relief for any CGT consequences of the demerger provided they meet the following conditions in subsection 125-55(1):

(a)          You own an ownership interest in a company

An ownership interest in a company is defined in section 125-60(1) as a share or similar interest issued by a company that gives the owner an entitlement to acquire a share in the company.

Each of the V shareholders own shares in V prior to the demerger. V is a company and this condition is satisfied.

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

Subsection 125-65(1) provides that a demerger group comprises of the head entity of the group and one or more demerger subsidiaries (being a subsidiary in which the head entity holds more than 20% interests).

V is the head entity of the demerger group because:

•                     no other member of the demerger group will hold ownership interests in Co (subsection 125-65(3), and

•                     there was no other company or trust capable of being a head entity of a demerger group of which Co could be a demerger subsidiary (subsection 125-65(4)).

Co will be a demerger subsidiary of V because V will hold 100% ownership interests in Co (subsection 125-65(6).

The demerger group in this case will be V, as the head entity, and V's business and Co, as the subsidiaries.

Paragraph 125-55(1)(b) is satisfied.

(c)           A demerger happens to the demerger group

Subsection 125-70(1) states that a demerger happens to a demerger group if:

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

(b)           under the restructuring:

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

(c)           under the restructuring:

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

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

(e)           the new interests acquired are:

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

(f)            [repealed]

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

and

(i)            the requirements of subsection (2) are met.

These elements for a demerger of a demerger group are examined below.

Restructuring of the demerger group

Taxation Determination Income tax: what is a 'restructuring' for the purposes of subsection 125-70(1) of the ITAA 1997? (TD 2020/6) sets out the Commissioner's views on what is 'restructuring'. A restructuring of a demerger group takes on its ordinary business meaning, referred to as the reorganisation of a group of companies or trusts.

The commercial understanding and objectively inferred plan for reorganisation will determine which steps or transactions will form part of the restructuring of the demerger group.

In this case, V will incorporate Co and Co will enter into the income tax consolidated group as a member. The rental operations of V will be transferred to Co to allow it to undertake the management and rental operations of the land and buildings through the issue of additional shares by Co.

V will dispose of all of its shares in Co to its shareholders. All of the shareholders will receive the replacement shares in the same proportion of their holdings in V as they held just before the demerger and nothing else.

The objectively inferred purpose of the restructuring is to fully separate the management and rental operations business from V.

The other preparatory steps and transactions that commonly form part of the reorganisation of a demerger group and are therefore included in the 'restructuring' are also outlined by TD 2020/6. Demergers provide an avenue for separate businesses to function independently from one another through separation of their ownership structures.

In addition to the ultimate separation of ownership, demergers will also involve steps such as transferring assets, forgiving debts between members of the demerger group and entering into new finance arrangements. These preparatory steps are part of the restructuring as they are steps that achieve the overall commercial objective of independence. The commercial drivers for the demerger are in the facts of the ruling.

The TD 2020/6 provides the common steps that usually occur prior to the delivery of ownerships interests to shareholders under the demerger. The occurrence of these common steps after the demerger does not of itself prevent these steps from forming part of the 'restructuring'. However, the strength of support that these steps should form part of a single plan for reorganisation requires consideration. This includes consideration of factors such as temporal proximity as well as how these steps relate back to the plans as they stood at the demerger time.

The demerger steps which involve the V shareholders acquiring direct interests in Co amount to the 'restructuring' of the demerger group for the purposes of subsection 125-70(1)(a).

Disposal of interests to owners

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

V will transfer 100% of the shares that it owned in Co to its shareholders on implementation of the demerger, therefore the requirements in subparagraph 125-70(1)(b)(i) are satisfied.

Acquisition of new interests and nothing else

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

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

Under the restructuring, V shareholders will acquire new ownership interests in the demerged entity, Co, and nothing else.

New interests a consequence of owning original interests

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

This requirement will be satisfied on the basis that the new interests will be acquired as payment for the capital reduction and dividend previously declared in respect of the V shareholders original interests.

Type of new interests acquired

The interests that will be provided to the shareholders are shares in Co which were ownership interests in a company.

The requirement in paragraph 125-70(1)(e), that the new interests are ownership interests in a company (where the head entity of the demerger group is a company), is satisfied.

Non-complying superannuation fund

V and Co are companies and the ownership interests in the companies are shares. The requirement in paragraph 125-70(1)(g) is satisfied.

Continuity of proportionate interests

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

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

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

The ownership interests in both V and Co consist of the same number of shares. The disposal of the shares in Co to the V shareholders will be distributed based on each owner's proportionate shareholding in Co.

Each original V shareholder will have the same proportionate interest in the combined total market value of V and Co as they had in V before the demerger.

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

Paragraph 125-55(1)(c) is satisfied.

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

The CGT event G1 will be triggered in relation to the shares held by the V shareholders in V to the extent of the return of capital that V will make to its shareholders. Under the demerger steps, V shareholders acquired shares in Co via an in-specie distribution.

Paragraph 125-55(1)(d) is satisfied.

All of the requirements of subsection 125-55(1) will continue to be satisfied for each of the V shareholders because:

•                     each V shareholder owns an ownership interest in V (the original interest);

•                     V is the head entity of a demerger group;

•                     a demerger will happen to the demerger group; and

•                     under the demerger, a CGT event (G1) will be triggered for each shareholder's original interest and a new or replacement interest will be acquired in the demerged entity (Co). Question 2 reasoning has further information on the CGT event G1.

Therefore, the shareholders of V are entitled to choose demerger roll-over relief under section 125-55.

Question 2

Will the shareholders of V who choose demerger roll-over relief disregard any capital gain or loss they make from CGT event G1 happening under the demerger to their V shares under subsection 125-80(1)?

Summary

If the shareholders of V who choose demerger roll-over, they can disregard any capital gain or loss they make from CGT event G1 happening under the demerger to their V shares.

Detailed Reasoning

The shareholders can choose to obtain demerger roll-over under subsection 125-55(1) for their V shares.

In accordance with subsection 125-80(1), if the shareholders of V choose the rollover a capital gain or loss from CGT event G1 happening to their V shares will be disregarded.

Question 3

Will the first element of the cost base and the reduced cost base of the shares held by V shareholders in V and Co be subject to adjustment under subsection 125-80(2)?

Summary

The first element of the cost base and the reduced cost base of your V shares will be adjusted having regard to the market values just after the demerger of the V and Co shares.

Detailed Reasoning

In subsection 125-80(2) if you choose demerger roll-over for your V shares, the first element of the cost base and reduced cost base of each of your V share and corresponding Co share is worked out by:

•                     taking the total of the cost bases of your V shares just before the demerger, and

•                     apportioning that total between your V shares and your Co shares acquired under the demerger.

The apportionment will be done on a reasonable basis having regard to the market values (just after the demerger) of the V and Co shares, or an anticipated reasonable approximation of those market values (subsections 125-80(2) and 125-80(3)).

Question 4

Will the shareholders of V who choose demerger roll-over relief in respect of their shares be taken, for the purpose of Division 115, to have acquired a proportionate number of shares in Co on the same date as their shares in V pursuant to, item 2 of the table in subsection 115-30(1)?

Summary

The shareholders of V who choose demerger roll-over will be taken to have acquired those Co shares on the same date they had acquired their corresponding V shares pursuant to, item 2 of the table in subsection 115-30(1).

Detailed reasoning

Section 115-30 provides special rules about the time of acquisition.

The replacement asset, acquired in a replacement-asset rollover, will be treated for the purposes of subsection 115-30(1) as having been acquired at the time the original asset involved in the rollover was acquired.

The definition of replacement-asset roll-over in section 112-115 includes demerger rollovers.

The shareholders of V who chooses roll-over will be taken to have acquired those Co shares on the same date they had acquired their corresponding V shares (item 2 of the table in subsection 115-30(1)).

Question 5

Will the part of the in-specie distribution which is a dividend under subsection 6(1) of the ITAA 1936, if any, be non-assessable, non-exempt income pursuant to subsections 44(3) to 44(5) of the ITAA 1936?

Summary

The dividend portion of the in-specie distribution to V shareholders will be non-assessable, non-exempt income.

Detailed Reasoning

In subsection 6(1) of the ITAA 1936 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.

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).

A 'demerger allocation' in subsection 6(1) of the ITAA 1936 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 44(1) of the ITAA 1936 provides that the assessable income of a shareholder of a company includes dividends paid to the resident shareholder by the company out of profits derived by it from any source...

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 do 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 nor 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 V'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, in accordance with 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 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 Co shares that V disposes of to its shareholders under the demerger is the demerger allocation.

The Co share distribution:

•                     will be debited against V's share capital account

•                     the remainder is a dividend under subsection 6(1) of the ITAA 1936.

The demerger dividend is that part of the demerger allocation that is not debited to V's share capital account. It would be assessable under subsection 44(1) of the ITAA 1936 but for subsections 44(2), 44(3) and (4) of the ITAA 1936.

V 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. Therefore, the demerger dividend will be non-assessable nor exempt income under subsections 44(3) and 44(4) of the ITAA 1936.

Question 6

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

Summary

The circumstances of the return of capital and dividends indicate that there was no streaming of capital benefits and sections 45 or 45A will not apply to V shareholders under the proposed demerger.

Detailed Reasoning

Section 45 of the ITAA 1936 applies where a company streams the provision of shares and the payment of minimally franked dividends to its shareholders in such a way that the shares are received by some but not all the shareholders and the shareholders who do not receive shares instead receive minimally franked dividends. The minimally franked dividends are dividends which are franked to less than 10%.

If these conditions are satisfied, the value of the share at the time it is provided to the shareholder is taken to be an unfrankable dividend paid by the company to the shareholder at that time out of the company's profits.

Section 202-45 exhaustively defines what is meant by an 'unfrankable' distribution (distributions that are not unfrankable are frankable: section 202-40). Subparagraph 202-45(h)(i) includes within the definition an amount that is taken to be an unfranked dividend for any purpose under section 45 of the ITAA 1926. Paragraph 202-45(i) includes a demerger dividend within the definition.

Section 45A of the ITAA 1936 applies where capital benefits are streamed to some shareholders (the advantaged shareholders), who would derive a greater benefit from the receipt of capital than other shareholders (the disadvantaged shareholders) and the disadvantaged shareholders receive, or are likely to receive, dividends (subsection 45A(1) of the ITAA 1936).

With respect to the proposed demerger:

•                     all of the issued shares in V are ordinary shares which have proportionate rights to distributions of capital and dividends.

•                     the amount of the return of capital and dividend to be paid to each V shareholder will be proportionate to the number of shares held by that shareholder.

Although a capital benefit and a dividend were provided to V shareholders, the circumstances of the return of share capital indicate that there was no streaming of capital benefits to some V shareholders and dividends to the other V shareholders. In addition, all of the V shareholders were entitled to receive a number of Co share for each V share owned.

Furthermore, the Commissioner will not make a determination under subsection 45A(2) that section 45C applies in relation to the whole, or a part, of the returns of share capital.

Question 7

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

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

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

Summary

The Commissioner will not make a determination under subsection 45B(3)(a) or (b) of the ITAA 1936 that sections 45BA or 45C of the ITAA 1936 will apply to the whole, or any part, of any benefit provided to the V shareholders under the demerger.

Detailed reasoning

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

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

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

•                     under the scheme a taxpayer, who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and

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

Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) empowers the Commissioner to make a determination under either or both of section 45BA in relation to a demerger benefit and section 45C in relation to a capital benefit.

The effect of a determination made under paragraph 45B(3)(a) of the ITAA 1936 is that part or all of a demerger benefit will be treated as not being a demerger dividend (subsection 45BA(1) of the ITAA 1936) and will not be treated as non-assessable non-exempt income.

The effect of a determination made under paragraph 45B(3)(b) of the ITAA 1936 is that part or all of a capital benefit will be an unfranked dividend paid to the relevant taxpayer out of profits (subsections 45C(1) and (2).

PSLA 2005/21 is the Commissioner's instruction and practical guidance for tax officers to assess the application of section 45B of the ITAA 1936 for a demerger of an entity. The analysis below references the practice guidance provided by PSLA 2005/21 as relevant.

Scheme

A 'scheme' for the purposes of section 45B of the ITAA 1936 is taken to have the same meaning as provided in subsection 177A(1) of Part IVA of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan, or proposal. In particular, a scheme is anything that satisfies any of the terms in the statutory definition.

A demerger may be part of a wider scheme which includes a subsequent transaction such as a share buy-back, liquidation or proposed sale of either the demerged entity or the head entity to a third-party. The identification of the scheme and, in particular, whether other transactions connected to the demerger form part of the scheme or not, will depend on the circumstances of the case. However the 'scheme' is defined, it must be related to the tax benefit obtained.

The tax benefit as outlined above is the reduction in tax payable compared to the tax that would otherwise apply if the distribution of the Co shares had been treated as an assessable dividend. The transfer of the shares in Co shares to V shareholders under the demerger relates directly to the tax benefit obtained under the demerger.

Demerger benefit and capital benefit

A demerger benefit is defined in subsection 45B(4) of the ITAA 1936 to include the provision by a company of an ownership interest in that or another company. The provision of the shares in Co under the demerger constitutes a demerger benefit for the V shareholders.

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

The V shareholders were provided with both a demerger benefit and a capital benefit.

Obtains a tax benefit

Subsection 45B(9) of the ITAA 1936 provides that a relevant taxpayer obtains a tax benefit if an amount of tax payable by that taxpayer would, apart from the operation of section 45B, be less than the amount that would have been payable if the demerger benefit or the capital benefit had been an assessable dividend.

As a result of the demerger, the V shareholders received shares in Co. Apart from the operation of section 45B, the income tax consequences for the Co shareholders would have been disregarded upon receipt of the Co shares as follows:

•                     The return of capital amount was not assessable income of the shareholders of V for the purposes of subsection 44(1) of the ITAA 1936 as it is excluded from the definition of a dividend in subsection 6(1) of the ITAA 1936.

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

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

The tax payable by the V shareholders on the demerger would have been higher if the demerger dividend component or the return of capital component are assessable dividends under subsection 44(1) of the ITAA 1936. Accordingly, the V shareholders obtain a tax benefit for the purposes of subsection 45B(9) of the ITAA 1936.

More than incidental purpose

Given that the proposed demerger is a scheme that provides a tax benefit to the V shareholders, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c). This paragraph provides that section 45B will apply if enabling the shareholder to obtain the tax benefit is a more than incidental purpose of the scheme.

To be an incidental purpose, the tax purpose must be objectively subordinate to the other substantial purposes. For example, if the tax purpose of the demerger merely follows the commercial purpose for the demerger as its natural incident, the tax purpose will be incidental.

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

A number of commercial reasons were provided as the reasons as detailed in facts of the case for undertaking the demerger.

The relevant circumstances of the scheme to be considered are listed in subsection 45B(8) of the ITAA 1936. Each of the circumstances must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose.

Having regard to the relevant circumstances of the proposed scheme in the facts of the case and as set out in subsection 45B(8) of the ITAA1936, it is considered that the demerger was not being undertaken for more than incidental purpose of obtaining a tax benefit.

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

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

Accordingly, the Commissioner will not make a determination under subsection 45B(3)(a) or (b) of the ITAA 1936 that sections 45BA or 45C will apply to the whole, or any part, of any benefit provided to the V shareholders under the demerger.

Question 8

Will V remain entitled to disregard any capital gain under CGT event A1 that would occur upon the proposed transfer of its shares in Co to its shareholders under section 125-155?

Summary

V will remain entitled to disregard any capital gain under CGT event A1 that would occur upon the transfer of its shares in Co under the demerger to the V shareholders.

Detailed Reasoning

Section 125-155 provides that a demerging entity may ignore capital gains or capital losses arising from certain CGT events (including CGT event A1) happening to its ownership interests in a demerged entity under a demerger.

In the present case:

•                     V is the demerging entity;

•                     CGT event A1 will be triggered when V disposes of its shares in Co (the demerged entity) and transfers them to the V shareholders (per section 104-10); and

•                     the disposal will occur under the demerger.

Therefore, any capital gain or loss under CGT event A1 made by V on the disposal of its Co shares under the demerger will continue to be disregarded.

Question 9

Under the proposed transfer of shares in Co to V shareholders, will V be required under subsection 45D(1A) of the ITAA 1936 to give a copy of the notice to its shareholders?

Summary

Subsection 45D(1A) of the ITAA 1936 does not apply.

Detailed reasoning

Subsection 45D(1) of the ITAA 1936 provides that if the Commissioner makes a determination under section 45A, 45B or 45C of the ITAA 1936, the Commissioner must give a copy of the determination to the company concerned.

Subsection 45D(1A) of the ITAA 1936 provides that where the Commissioner gives notice of a determination to a company in accordance with subsection 45D(1) of the ITAA 1936 that company must, in the case of a determination under section 45A or 45B of the ITAA 1936, give a copy of the notice to:

•                     the advantaged shareholder referred to in section 45A; or

•                     the relevant taxpayer referred to in section 45B.

The Commissioner will not make a determination under sections 45A, 45B or 45C of the ITAA 1936 in relation to the whole or part of the capital benefits as detailed in the reasons for the decision on questions 6 and 7 above. Therefore, subsection 45D(1A) of the ITAA 1936 does not apply.