Private ruling: Demerger
Published: May 2015
Ruling period: Year of income ended 30 June 2015 | Year of income ended 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Q1: Will any capital gain that may arise to Company B shareholders from the demerger of Company A by Company B be disregarded? | A1: Yes | Q2: Will any capital gain that may arise to Company B from the demerger of Company A by Company B be disregarded? | A2: Yes | Q3: Will the demerger of Company A by Company B give rise to a demerger dividend which will not be assessable income pursuant to subsections 44(3) to 44(5) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A3: Yes | Q4: Will the Commissioner make a determination under section 45B of the ITAA 1936? | A4: No

Relevant facts and circumstances: 1. Company B was incorporated after 1983 with one shareholder. 2. Company A is 100% owned by Company B. 3. Company B's shares in Company A were acquired in three tranches. 4. As at 30 June 2014 the net assets of Company B were approximately $X, of which $Y is represented by paid-up capital and the remainder retained profits. 5. Prior to the demerger Company A will undertake several transaction to ensure that Company A's asset's will be related 100% to the business operated by Company A only. 6. Company B directly and indirectly through its subsidiaries and associated entities conducts the a number of unrelated businesses. 7. Company A as a subsidiary of Company B operates one of these businesses. 8. The sole shareholder of Company B has an interest Company C. Company C operates a complementary business to that operated by Company A. 9. It is foreseeable that Company A and Company C may merge in the future. 10. Currently Company A and Company B operate out of the same business premises. 11. It is intended that following the demerger, initially Company A will relocate to a different floor within these business premise. This will assist in separating staff into specific company roles and will begin the cultural change required. 12. Subsequently within the 12 months following the demerger Company A will be relocated to a more high profile, standalone business location. It is anticipated that a higher profile address would benefit the Company A business. 13. The warehouse and dispatch centres of the Company A business are also currently located at the current business premises. It is anticipated that following the demerger these operations will be located to a more cost effective location. 14. Currently, the administration and finance operations of Company A and Company B are operated jointly, with • shared facilities such as IT equipment and telephone systems • shared key internal accounting staff • shared key administration staff (data entry accounts payable, accounts receivable and payroll functions) 15. Following the demerger it is intended that staff and management will be allocated to Company B and Company A separately. This will enable a more focused approach to each of the core businesses of Company B and Company A. 16. In particular the staff allocated to Company A will be engaged to focus on cost and inventory control to help drive profitability of the business going forward. 17. The separation of staff will also assist with recruitment, whereby employees can be recruited to support the specific requirements of the Company A business, without consideration needing to be given to the requirements of the Company B businesses. 18. Following the demerger Company A will also fund operating costs such as telephone and electricity independently of Company B. 19. The demerger will be accounted for in the books of Company B as follows: Account Debit Credit Issued Shares $X Company A P/L Ord Shares $X (To account for the capital component of the Company A demerger allocation) Account Debit Credit Dividends Paid $Y Company A P/L Ord Shares $Y (To account for the dividend component of the Company A demerger allocation) 20. Company B will not elect that subsections 44(3) and 44(4) of the ITAA 1936 will not apply to the demerger dividend. 21. At least 50% by market value of the CGT assets held by Company A are used in carrying on Company A's business. 22. The intentions of the demerger are as follows: • to provide a level of protection for the Company A business from the trading risks associated with the other businesses conducted by the Company B group. • to enable the management and administrative teams which currently have a dual role across Company A and the Company B group to focus on the respective businesses of Company A and Company B. This is expected to deliver financial benefits and increased profitability for Company A. • facilitate the appointment of external board members to the Board of Company A, with specific expertise • to facilitate the re-location of distribution facilities for Company A's business to a lower cost location; and • to facilitate the expansion of the Company A business into overseas markets, potentially to be achieved through a subsequent merger with Company C.

Relevant legislative provisions: Income Tax Assessment Act 1935 section 44 | Income Tax Assessment Act 1935 section 45B and | Income Tax Assessment Act 1997 Division 125.

Reasons for decision: Summary: 1. Any capital gain that may arise to Company B shareholders from the demerger of Company A by Company B can be disregarded. 2. Any capital gain that may arise to Company B from the demerger of Company A by Company B can be disregarded. 3. The demerger of Company A by Company B gives rise to a demerger dividend which will not be assessable income pursuant to subsections 44(3) to 44(5) of the Income Tax Assessment Act 1936 (ITAA 1936). 4. The Commissioner will not make a determination under section 45B of the ITAA 1936. | Detailed Reasoning - Capital Gains: 5. Provided the conditions for choosing demerger roll-over relief under Division 125 of the ITAA 1997 are satisfied, the shareholders of Company B can choose roll-over relief for the demerger (section 125-55 of the ITAA 1997). 6. Section 125-155 of the ITAA 1997 provides that any capital gain or capital loss a demerging entity makes from CGT event A1, CGT event C2, CGT event C3 or CGT event K6 happening to its ownership interests in a demerged entity under a demerger is disregarded. | Detailed Reasoning - Division 125 of the ITAA 1997 conditions for demerger roll-over relief: 7. Immediately prior to the demerger Company B will have a 100% shareholding interest in Company A. Therefore Company B and Company A constitute a demerger group pursuant to subsection 125-65(1) of the ITAA 1997. 8. Company A is a demerger subsidiary pursuant to 125-65(6) of the ITAA 1997 as Company B has a right to exercise or control the exercise of more than 20% of the voting power of Company A. 9. Section 125-70 of the ITAA 1997 specifies the conditions that must be met for a shareholder to be eligible to choose roll-over. Under the current scheme, all of these conditions will be satisfied. 10. Therefore, as all the conditions for choosing demerger roll-over relief under Division 125 of the ITAA 1997 are satisfied, Company B shareholders can choose roll-over relief for the demerger. 11. Additionally, under section 125-155 of the ITAA 1997 any capital gain or capital loss Company B makes from CGT event A1, CGT event C2, CGT event C3 or CGT event K6 happening to its ownership interests in a demerged entity Company A under the demerger is disregarded. | Detailed Reasoning - Distribution is not a dividend for income tax purposes: 12. Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividends, as defined in subsection 6(1) of the ITAA 1936, paid to the shareholders out of profits derived by the company from any source (if the shareholder is a resident of Australia) and from an Australian source (if the shareholder is a non-resident). 13. The term 'dividend' in subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders. However, paragraph (d) of the definition of 'dividend' in subsection 6(1) excludes a distribution from the meaning of 'dividend' if the amount of a distribution is debited against an amount standing to the credit of the company's share capital account. 14. The term 'share capital account' is defined in section 975-300 as an account which the company keeps of its share capital, or any other account created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital. 15. Subsection 975-300(3) of the ITAA 1997 states that an account is not a share capital account if it is tainted. 16. In the circumstances of this demerger, Company B proposes to debit a capital reduction amount to its share capital account as that term is defined in subsection 6(1) of the ITAA 1936 and section 975-300 of the ITAA 1997. This amount is therefore not a dividend for the purposes of subsection 6(1) of the ITAA 1936 and is not assessable as a dividend under subsection 44(1) of the ITAA 1936. 17. However, Company B's shareholder will receive a dividend to the extent that the market value of the Company A shares distributed under the demerger exceed the amount debited against the share capital account (see Taxation Ruling TR 2003/8). 18. This dividend is neither assessable income nor exempt income (subsection 44(3) and 44(4) of the ITAA 1936) if: • the dividend is a 'demerger dividend' (as defined in subsection 6(1) of the ITAA 1936); • Company B (as the head entity of the demerger group) does not elect that subsections 44(3) and 44(4) of the ITAA 1936 will not apply to the demerger dividend (subsection 44(2) of the ITAA 1936); and • subsection 44(5) of the ITAA 1936 is satisfied. 19. In the current scheme, there is a demerger dividend, and Company B will not elect that subsections 44(3) and 44(4) of the ITAA 1936 will not apply to the demerger dividend and at least 50% by market value of all the CGT assets held by Company A and its subsidiaries are used directly or indirectly, in one or more businesses carried on by Company A and its subsidiaries. 20. Accordingly the dividend received by Company B shareholders under the demerger is neither assessable income nor exempt income by operation of subsections 44(3) and 44(4) of the ITAA 1936. | Detailed Reasoning - Application of section 45B of the ITAA 1936: 21. Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B applies where: • there is a 'scheme' under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936), • under the scheme a person (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936), and • having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into or carried out the scheme, or any part of the scheme for a purpose (other than an incidental purpose) of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). 22. The arrangement involving the in specie distribution of Company A shares to CJJCO shareholders constitutes a scheme for the purposes of section 45B of the ITAA 1936. 23. For the purposes of paragraph 45B(2)(c) of the ITAA 1936, the Commissioner is required to consider the 'relevant circumstances' set out in subsection 45B(8) to determine whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a relevant taxpayer to obtain a tax benefit. However, the list of relevant circumstances in subsection 45B(8) of the ITAA 1936 is not exhaustive and regard may be had to other circumstances on the basis of their relevance. 24. On the basis of the information surrounding the in specie distribution of Company A shares as described in the factual arrangement, the Commissioner has formed the view that the demerger benefits and capital benefits provided to the Company B shareholders have not been made for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit. | Detailed Reasoning - Conclusion: 25. Having regard to all the relevant circumstances of this scheme, the Commissioner will not therefore come to the objective conclusion that a non-incidental purpose of providing a capital benefit to Company B shareholders is to obtain a tax benefit. The Commissioner will therefore not make a determination under paragraph 45B(3)(a) that section 45BA applies. Nor will the Commissioner make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C applies.