Taxability under Income Tax Act during Voluntary Liquidation of a Company

20 January 2021 • Rahul Verma

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20 January 2021 • Rahul Verma

When Distributions are to be made during Liquidation, the same can be taxable in the form of Capital Gains or Deemed Dividend in the hands of Contributory.

What are Capital Gains?

Section 45 of Income Tax Act, 1961 (“the Act”) provides that any profits or gains arising from the transfer (sale) of a capital asset effected in the previous year will be chargeable to income-tax under the head ‘Capital Gains’. Such capital gains will be deemed to be the income of the previous year in which the transfer took place.

Period of holding:

Section 2 (42A) provides that in determining the period for which any capital asset is held by the assessee in the case of a share held in a company in liquidation, there shall be excluded the period subsequent to the liquidation commencement date.

Section 46 of the Act states that:

“Notwithstanding anything contained in section 45, where the assets of a company are distributed to its shareholders on its liquidation, such distribution shall not be regarded as a transfer by the company for the purposes of section 45.

Where 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 dividend within the meaning of sub-clause (c) of clause (22) of section 2 and the sum so arrived at shall be deemed to be the full value of the consideration for the purposes of section 48.”

The above section makes use of the words “on liquidation” and not “in liquidation”. Therefore, the liquidation should be completed before any assets are distributed.

Applicability of Section 46 on Foreign Investor:

Section 9 of the Act provides that any dividend paid by an Indian company outside India shall be deemed to accrue or arise in India. Therefore, Section 46 is also applicable to a Foreign Investor.

Taxation in case of Asset Distribution:

As per section 46(1), where the assets of a company are distributed to its shareholder on its liquidation, such distribution shall not be regarded as a transfer by the company. Therefore, there will be no capital gain for the company. The shareholder will be chargeable to capital gain tax. Further, TDS and withholding tax provisions [in accordance with Double Taxation Avoidance Agreement (DTAA), if there is any] may also be applicable on asset distribution to shareholders.

Sale of assets received on Liquidation:

As per section 55(2)(b)(iii), if the asset (other than cash) acquired by the shareholder, at the time of liquidation, is subsequently transferred by the shareholder; then for the purpose of computation of capital gain of such transfer, the cost of acquisition of such asset shall be the market value of the asset on the date of distribution.

To know more on taxability of Deemed Dividend, please click here.

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