Liquidation marks the legal end of a company’s existence. In this process, the company’s assets are sold or distributed to creditors and shareholders. But what are the tax consequences when assets are distributed to shareholders upon liquidation?
Section 46 of the Income Tax Act, 1961 plays a crucial role in determining how capital gains are treated during such distributions. It seeks to tax shareholders, not the company, on the capital gain arising from the receipt of assets, ensuring that gains are not left untaxed during the liquidation process.
Scope and Applicability
Section 46 specifically applies in the context of:
- Domestic and foreign companies undergoing liquidation
- Shareholders receiving assets (cash or kind) on liquidation
⚠️It does not apply to:
- Distribution of assets to creditors
- Distribution of assets in non-liquidation scenarios (e.g., demerger, amalgamation—separate provisions apply)
Who is Taxed and When?
| Party | Taxability | Timing of Taxation |
| Company | Not taxed on distribution | NA |
| Shareholder | Taxed under capital gains | In year of receipt |
Why Capital Gains in Hands of Shareholders?
The logic is rooted in the concept that:
- A shareholder essentially “exchanges” their shares for cash and/or assets during liquidation.
- This is a realization of investment, which is why capital gains arise.
- Section 46(2) treats this as a deemed transfer for tax purposes, even though it’s not a regular sale or exchange.
What is Consideration?
Under Section 46(2), the full value of consideration is:
- 💰Cash received +
- 🏠FMV of other assets received on the date of distribution
This becomes the deemed sale price for calculating capital gains.
Cost of Acquisition and Indexation
- Normal cost of acquisition of shares applies (from purchase records).
- Indexation benefit is available only for long-term capital assets (i.e., if shares are held for more than 24 months in the case of unlisted shares).
- 🟨Exception: Indexation is not available for shares treated as short-term capital assets.
Key Provisions of Section 46
🔹 Section 46(1) – Company Not Liable to Capital Gains
“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.”
✔Implication:
The company is not taxed on the capital gains from the distribution of its assets in liquidation. It is treated as non-transfer in the hands of the company.
🔹 Section 46(2) – Shareholders Liable to Capital Gains
“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 and the market value of the other assets so received…”
📌Taxability in the hands of shareholder:
- Consideration = Money received ++ FMV of assets received
- Less: Cost of acquisition of shares
- Less: Exempt portion under deemed dividend u/s 2(22)(c)
Formula:
Capital Gains = [Money received + FMV of assets received] – Cost of acquisition of shares – Amount taxed as deemed dividend
Computation of Capital Gains (Illustrative Example)
| Particulars | Amount (₹) |
| Cash received on liquidation | 3,00,000 |
| FMV of asset received (e.g., land) | 5,00,000 |
| Total consideration | 8,00,000 |
| Less: Cost of acquisition of shares | 2,00,000 |
| Less: Deemed dividend u/s 2(22)(c) | 1,50,000 |
| Capital Gain Taxable | ₹4,50,000 |
Compliance and Reporting Requirements
➤ For the Company:
- Final Return of Income in ITR-6
- Inform ROC and ITD of liquidation proceedings
- No capital gains reporting on asset distribution
➤ For Shareholder:
- Capital gain computation to be shown in ITR-2 or ITR-3
- Attach computation and proof of FMV (valuation report if needed)
Disclose dividend component under “Income from Other Sources”