TAXATION OF CAPITAL GAINS IN HANDS OF RECIPIENT OF ASSETS ON DISTRIBUTION OF ASSETS BY COMPANIES IN LIQUIDATION.

[C.A. DEV KUMAR KOTHARI]

Normally a transferor of capital asset is liable to pay capital gains tax under section 45:

Normally transferor of a capital asset is liable to pay capital gain tax because he receives consideration on transfer of capital asset by way of sale, exchange etc. If the consideration is more than the cost of acquisition and cost of improvement of asset and expenses incurred in connection with the transfer, then such excess is included as capital gains, in the gross total income of the transferor.

Exception- transferee is liable to capital gains tax under section 46:

We find an exception of general rule that transferor is liable to capital gains tax in section 46. The section with high lights reads as follows:

"Capital gains on distribution of assets by companies in liquidation.

Section 46. (1) Notwithstanding anything contained in section 45, where the assets of a company are distributed to its shareholders on its liquidation⁹⁹, such distribution shall not be regarded as a transfer by the company for the purposes of section 45.

(2) 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."

An analysis (besides by way of high lights given above):

This section provide exemption to company on liquidation.

This section create liability of capital gain tax on shareholder who getr assets from company by way of distribution.

The section 46(2) is a charging provision  and it is independent of section 45. Section 46 also provides method of computation of capital gains. Therefore, what apply to section 45 may not be applied to section 46.

In section 46(2) the words used are any money or other assets. Therefore, scope of this section is not restricted to 'capital assets'. Money and any asset received on distribution are regarded as assets fro computing and charging capital gain tax. Even a non capital asset item like stock-in-trade is distributed, it will be liable to capital gains tax because it is an item of asset distributed.

Therefore applicability of  section 46  cannot be excluded because the general section like section 45 does not apply  in any give case. Therefore, certain cases of capital gains, which may not be taxable when Section 45  is applicable e.g. when an assets is not a 'capital asset' or when there is no cost of acquisition. However, even in case of such assets Section 46 will  apply.

Exclusion of sum taxed as dividend under section 2(22) (c):

The capital gains are exempted to the extent the distribution is considered as dividend under section 2.22.c. The said clause reads as follows;

(22) "dividend" includes—

 (c) 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 capitalised or not ;

Example:

Suppose a shareholder get from a company on liquidation Rs. one lakh as dividend and the same is considered as dividend under section 2.22.c. The dividend may or may not be taxable in hands of shareholder depending on whether the company has paid tax under section 115 O. Even if the dividend is exempt in hands of shareholder, the capital gains will be reduced by the amount of dividend considered under section 2.22.c. Now suppose the shareholder get a property of market value of Rs.50 lakh, then taxable capital gain in his hands under section 46.2 shall be Rs. 49 lakh.

Some important decisions in relation to Section 46:

When the section apply: Applicability

This Provision will apply  only if company satisfies the statutory definition- The provisions of section 46(2) apply only to the distribution of assets by such companies in liquidation as are covered by the definition of the word 'company' in section 2(17). The Legislature having made no similar provision in respect of companies other than those which fall within the definition contained in section 2(17), there can be no tax on capital gains when such other companies distribute assets on liquidation to shareholders - CIT v. R.M. Amin [2008 -TMI - 6494 - SUPREME Court]. Therefore, this aspect need to be examined. Suppose in some situation alleged company is not a company, then the provision will not apply.

Important date is on which the company is completely wound up - There is a vital distinction between the expressions 'a company in liquidation' and 'a company on liquidation'. The word 'on' has many shades of meaning in different contexts. In the present context, the words 'on liquidation' must necessarily refer to the date on which the company was wound up or the winding up process is complete, and the right of the shareholder to return of capital after discharge of the liabilities of the company and preferential payments comes to an end - CIT v. Jaykrishna Harivallabhdas [1998] 231 ITR 108 (Guj.).

Distribution of assets

Liquidator can distribute more than one item of capital asset - Distribution of more than one item of capital assets is liable to be made and can justifiably be made by a liquidator from time to time. The distribution of assets and moneys made from time to time by a liquidator would fully and completely transfer the ownership thereof to its shareholders fully and completely at diverse different dates of distribution. The capital gains thus made by shareholders are in fact made by them in the year in which the capital assets and/or moneys are distributed to each of them and each becomes owner thereof. Thus the year in which the ownership of the capital assets and/or the moneys is transferred will be the 'previous year' for assessment of capital gains made by a shareholder - Cable and Wireless Ltd. v. V.H. Gangal [1973] 90 ITR 84 (Bom.).

Determination of value

Amount assessed as dividend under section 2(22)(c) must be excluded - In view of the provisions of section 46(2), value of assets received by the assessee on the liquidation of company towards the shares held by him in the company will be exigible to capital gains tax, excluding the amount assessed as dividend within the meaning of section 2(22)(c) - Vijay Kumar Jain v. CIT [2008 -TMI - 5429 - SUPREME Court].

Market value of assets

The A.O. is duty bound to determine market value which may be different from value determined by the liquidator.- A contributory receiving assets from a company not necessarily receives the assets of the value determined by the liquidator. Where such a value has been determined by the liquidator, it is the duty of the ITO and within his power to determine the market value of the assets received by the shareholder and such a market value has to be determined as prevalent on the date of distribution - CIT v. Vijoy Kumar Budhia (supra)/Addl. CIT v. Uma Devi Budhia [1986] 157 ITR 478 (Pat.).

Cost of acquisition need not be deducted at every successive stage - It is patently wrong to say that cost of acquisition should be deducted from every successive receipt from the liquidator. The cost of acquisition that is contemplated by section 48 would have to be taken into account at the time of the distribution when it is first taxed. If in a case there is a negative amount resulting from the distribution being smaller than the cost of acquisition, then the assessee would be entitled to have the capital loss computed, and the capital loss would be set off against the further distribution made by the liquidator. When a positive figure emerges after such set-off, then the assessee would be liable to be taxed on the balance of the amount received from the liquidator. It is true that at the later stages it is only the amount received that would be liable to tax without any deduction therefrom, but as the deduction has already been given, there is no question of any further deduction from the said amount - CIT v. Inland Agencies (P.) Ltd. [1983] 143 ITR 186 (Mad.).

Some other important decisions about dividend are summarized below:

 'Dividend' in its ordinary connotations or meaning is a distributive share of the profits or income of a company given to its shareholders. By the definition in section 2(22), 'dividend' means dividend as normally understood and includes in its connotation several other receipts set out in the definition. The word 'dividend'  also means dividend as ordinarily understood under the Companies Act,  - Kantilal Manilal v. CIT [1961] 41 ITR 275 (SC). Hari Prasad Jayantilal & Co. v. V.S. Gupta, ITO [1966] 59 ITR 794 (SC).  'Dividend' is received by a shareholder proportionate to his shareholding in a company out of the total sum distributed.

Dividend is dividend and not the same thing or income as was in hands of company. Dividend distributed by a company being a share of its profits declared as distributable among the shareholders, is not impressed with the character of the profits from which it reaches the hands of the shareholders - CIT v. Nalin Behari Lall Singha [2008 -TMI - 5150 - SUPREME Court]. Therefore, even if exempted income is distributed, the dividend received by shareholder shall be dividend.

DISTRIBUTION AND PAYMENT:

'Distribution' is 'to give each a share, to give to several persons'. The expression 'distribution' connotes something actual and not notional. It can be physical; it can also be constructive. One may distribute amounts between different shareholders either by crediting the amount due to each one of them in their respective accounts or by actually paying to each one of them the amount due to him. The only difference between the expression 'paid' and the expression 'distribution' is that the latter necessarily involves the idea of division between several persons which is the same as payment to several persons. Distribution is a culmination of a process - Punjab Distilling Industries Ltd. v. CIT [1965] 57 ITR 1 (SC).

The expressions 'distribution' and 'payment' connote different meanings. 'Distribution' is division amongst several persons. It connotes an idea of apportionment among more than one person. In the case of 'distribution' the recipients would be more than one, while in the case of 'payment' the recipient may be a single person - CIT v. Jamnadas Sriniwas (P.) Ltd. [1970] 76 ITR 656 (Cal.).

The expressions 'distribution' and 'payment' connote different meanings, distribution is division amongst several persons. It connotes an idea of apportionment among more than one person. In the case of 'distribution' the recipients would be more than one, while in the case of 'payment' the recipients may be a single person - CIT v. P.V. John [1990] 52 Taxman 221 (Ker.).

ACCUMULATED PROFITS :

Section 2(22) has used the expression 'accumulated profits', whether capitalised or not. This expression tends to show that under section 2(22) it is only the distribution of the accumulated profits which are deemed to be dividends in the hands of the shareholders. By using the expression 'whether capitalised or not' the legislative intent clearly is that the profits which are deemed to be dividend would be those which were capable of being accumulated and which would also be capable of being capitalised. The amounts should, in other words, be in nature of profits which the company could have distributed to its shareholders. This would clearly exclude return of part of a capital to the company, as the same cannot be regarded as profit capable of being capitalised, the return being of capital itself. Profits mean only commercial profit - CIT v. Urmila Ramesh [2008 -TMI - 5635 - SUPREME Court].

 The expression 'accumulated profits' occurring in section 2(22)(e) or for that matter in any other clause, means profits in the commercial sense and not assessable or taxable profits liable to tax as income under the 1922 Act - P.K. Badiani v. CIT [2008 -TMI - 6489 - SUPREME Court].

 Accumulated profits within the meaning of section 2(22)(e) will necessarily be comprised of the amount available for being distributed as profits. The word 'accumulated' means the profit earned bit by bit and accumulated. It does not mean that it should be carried forward from year to year. Profits can accumulate even within a single year. The entire amount which is available for distribution as profits on a particular date would be the accumulated profit and any amount paid as advance or loan to the shareholder to the extent of this amount of accumulated profits will be dividend within the meaning of section 2(22)(e) - CIT v. Roshan Lal [1975] 98 ITR 349 (All.).