Capital gains on distribution of assets by company in liquidation

Introduction

If a company on liquidation distributes the assets to its equity shareholders, it is not treated as transfer by the company. However, shareholder shall be chargeable to tax under the head capital gains, in respect of the money so received or the market value of the other assets on the date of distribution, as reduced by the amount assessed as deemed dividend.

1. Scope of provision

Where the assets of a company are distributed to the shareholders on its liquidation, such distribution is not regarded as transfer by the company. Therefore, no tax liability arises in the hands of the company on account of any distribution of assets to the shareholders. However, shareholder shall be liable to pay capital gain tax on market value of asset so received as consideration for shares held in the company.

If the company sells the assets and distributes the cash so realised to the shareholders, then this provision shall not apply. The company shall be liable to tax on the capital gains arising from sale of the assets

2. Tax liability of shareholders

2.1. Taxable as dividend

Any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalized or not, is taxable as deemed dividend under Section 2(40)(c).

2.2. Taxable as capital gains

Any amount distributed over and above the amount treated as dividend is taxable as capital gains in the hands of shareholder. The capital gains accruing to a shareholder from such distribution is determined in accordance with the following provisions:

3. Factors for calculation of capital gains

When a shareholder on the liquidation of a company receives any money or other assets from the company, he shall be chargeable to income-tax under the head capital gains, in respect of the money so received or the market value of the other assets on the date of distribution, as reduced by the amount assessed as deemed dividend. For computation of capital gains in such case, the following factors are considered:

(a) Period of holding;

(b) Full value of consideration;

(c) Cost of acquisition;

(d) Cost of improvement;

(e) Expenditure incurred in connection with transfer;

(f) Adjustment for the capital gains taxed under Section 67(10);

(g) Exemptions allowed under Section 82 to 88.

3.1. Computation of period of holding

The period of holding shall be counted from the date of purchase or acquisition of shares till the date of liquidation of the company.

3.2. Computation of full value of consideration

The full value of consideration a shareholder is deemed to have received in case of liquidation of the company shall be aggregate of money and market value of assets received by the shareholder on such liquidation less distribution attributable to accumulated profits of the company as on the date of liquidation. The balance portion of distribution, if any, is taken as the full value of consideration for ascertaining the capital gains.

The value of the assets received by a shareholder on liquidation is determined by the Assessing Officer on the basis of its market value, which might be different from the value taken by the liquidator.

If payment by liquidator is made in instalments, the cost of acquisition cannot be deducted at every point of time when there is a receipt from the liquidator. The entire cost of acquisition should be deducted at the time when first instalment is paid. It may result into capital loss. Such loss may be set off/carried forward as per rules in this behalf. When any subsequent instalment is received, it is fully taxable as capital gain

3.3. Computation of cost of acquisition

The cost of acquisition of the equity shares shall be computed as per general provisions. If a non-resident acquires shares or debentures of an Indian company in foreign currency, capital gain in such cases is computed in foreign currency and thereafter it is converted in Indian currency in accordance with Rule 52.

3.4. Computation of cost of improvement

The cost of improvement of the equity shares shall be computed as per general provisions.

3.5. Adjustment for the capital gain taxable under Section 67(10)

Where the amount is chargeable to tax as income of partnership firm under Section 67(10), the firm shall attribute such amount to the capital asset remaining with it, including capital assets forming part of block of asset. Such attribution is allowed, at the time of computation of capital gains from the transfer of such capital asset remaining with the partnership firm, by way of deduction under Section 72(5). The deduction under Section 72(5) is allowed if the following conditions are satisfied:

(a) There should be a reconstitution of the partnership firm;

(b) Capital asset or money or both should be given to the partner on such reconstitution;

(c) Capital gain is computed and taxed in the hands of the firm under Section 67(10); and

(d) The book value (or historical value or WDV) of at least one of the capital assets remaining with the firm after such reconstitution should be less than its fair market value. It may also include the self-generated asset.

The amount chargeable to tax under Section 67(10) shall relate to revaluation of any capital asset or valuation of self-generated asset or self-generated goodwill of firm if the revaluation is based on a valuation report obtained from a registered valuer defined under Rule 56.

3.6. Computation of exemptions

Certain exemptions can be claimed under Sections 82 to 88 from the capital gains arising from transfer of equity shares subject to fulfilment of certain conditions.

3.7. Year in which taxable

The capital gains shall be taxable in the tax year in which assets are distributed to the shareholders.

4. Cost of acquisition of asset acquired under liquidation

4.1. If assessed to capital gains

If shareholder is assessed to income-tax under the head capital gains in respect of the asset acquired on liquidation of company, the cost of acquisition of the assets acquired by him shall be its fair market value on the date of distribution.

4.2. If not assessed to capital gains

If shareholder has not been assessed to income-tax under the head capital gains in respect of the asset acquired on liquidation of company, the cost of acquisition of assets acquired is deemed to be the cost for which the company under liquidation had acquired it and as increased by the cost of improvement of the assets incurred or borne by the company or the assessee.

References

Sri Kannan Rice Mills Ltd. V. CIT [1954] 26 ITR 351 (Mad.)

CIT v. Inland Agencies P. Ltd. (1983) 143 ITR 186 (Mad.)

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.