In a company liquidation, the distribution of assets to shareholders is treated as the “transfer” or “realization” of the capital asset (i.e. the shares held). Although the process of winding up is distinct from a typical share sale, the Income-tax Act, 1961 treats the receipt of assets on liquidation in a manner similar to a sale or exchange.

Relevant Sections and Concepts:

1. Capital Asset and Transfer:

   • Section 2(14) of the Act defines “capital asset” without any qualification on the mode of holding. Shares, irrespective of the holding mode, are treated as capital assets.

   • Section 45 and Section 48 set out the framework for computing capital gains on the transfer of a capital asset. In a liquidation, the distribution is considered as full or partial consideration received in exchange for the shares.

2. Computation of Capital Gains on Liquidation:

   • Full Value of Consideration:
     In liquidation, the “consideration” is the aggregate of the assets distributed (which may be in cash or kind) by the company to the shareholder.

   • Cost of Acquisition:
     The cost of acquisition of the shares is that which was initially paid (or deemed to have been paid) on acquiring those shares.

     Section 48 specifies that capital gain is the difference between the “full value of the consideration received” and the “cost of acquisition (plus any expenses on transfer).”

3. Holding Period and Nature of Gain:

   • Under Section 2(42A), the holding period of shares is considered from the date of purchase to the date of liquidation distribution.

   • Depending on whether the holding period meets the thresholds (more than 12 months for listed shares or more than 24 months for unlisted shares), the resulting gain will be classified as either short-term or long-term. This classification determines the applicable tax rates.

Step-by-Step Computation Method:

Step 1: Determine the Total Consideration Received

The total consideration is the aggregate market value of all assets (cash and non-cash) received by the shareholder in the liquidation process.

Example: If you receive cash of ₹80,000 and assets (e.g., property, investments) valued at ₹20,000, the total consideration is ₹1,00,000.

Step 2: Ascertain the Cost of Acquisition

This is the original amount paid (or the deemed cost) for the shares acquired in the company.

Example: Suppose your cost of acquisition for these shares was ₹70,000.

Step 3: Compute the Capital Gain

Using the formula from Section 48:

Capital Gain = (Total Consideration Received) – (Cost of Acquisition + Expenses on Transfer)
If there are no additional transfer expenses: Capital Gain = ₹1,00,000 – ₹70,000 = ₹30,000

Step 4: Adjust for Holding Period and Tax Rates

• For Listed Shares:

  • Long-Term Capital Gains (LTCG) apply if the shares are held for more than 12 months.

  • Short-Term Capital Gains (STCG) apply if held for 12 months or less.

• For Unlisted Shares:

  • The holding period threshold is 24 months.

Indexation benefits (if applicable) may be considered in the case of long-term capital gains, thereby adjusting the cost of acquisition to reflect inflation.

Section 5(2) says that A non-resident is taxable in India only on income that:

1. Is received or deemed to be received in India, or

2. Accrues or arises or is deemed to accrue or arise in India

Capital gain on transfer of assets:

If the capital asset is situated in India, the gain is taxable in India, even for non-residents. This is supported by Section 9(1)(i).

Section 48, First Proviso (Simplified Text) provide the method of calculating the tax in case of a non-resident, capital gains arising from the transfer of shares or debentures of an Indian company shall be computed by:

• Converting the cost of acquisition, expenditure incurred, and sale consideration into the same foreign currency used to purchase the asset;

• Then computing the capital gain in that foreign currency;

• Finally, converting the capital gain into Indian Rupees.

• Indexation benefit is NOT allowed in this computation.

For assets other than shares/debentures, e.g., immovable property, the First Proviso of Section 48 does not apply.

➡️ Computation follows normal rules:

• Sale Price – (Indexed Cost + Transfer Expenses)

• Indexation is allowed for long-term capital assets

➡️ Tax Rates:

• LTCG (on immovable property) → 20% with indexation

• STCG → Taxed at slab rates

Conclusion:

• Capital gain is taxable in India for non-residents if the asset is located in India

• For shares/debentures of Indian companies, Section 48 First Proviso applies – computation must be in foreign currency without indexation

• For other assets, capital gains are computed in INR, with indexation allowed for LTCG

• Special tax regime for NRIs under Section 115C–115I applies only if they invest in foreign currency in specified assets

• TDS rules under Section 195 are applicable on remittance/payments to non-residents

TWO TYPES OF TRANSFERS INVOLVED:

A. Transfer by Partner to Firm (Section 45(3))

When a partner contributes capital asset to the firm then Section 45(3) is applicable which says that: “The amount recorded in the books of the firm for such asset shall be deemed to be the full value of consideration for computing capital gain in the hands of the partner.”

✅ Computation in hands of Partner:

📌 Capital gain is taxed in the year of contribution.

B. Transfer by Firm to Partner (Section 45(4) & Section 9B)

Applicable when firm reconstitutes (retirement/admission/death) or distributes assets (including dissolution).

Section 45(4): Capital Gain in Hands of Firm Inserted by Finance Act, 2021 (effective from AY 2021–22) says that “If a specified person receives capital asset or money from firm upon reconstitution and value exceeds balance in capital account, then capital gain shall be taxed in the hands of the firm.”

🔹 Computation (Section 45(4)):

Capital Gain = A – B

Where:

• A = Value of money + FMV of capital asset received

• B = Balance in capital account of partner (without revaluation/self-generated goodwill)

➡️ Tax is in the hands of the firm.

Summary:

As per Section 45(2) “Notwithstanding anything contained in sub-section (1), the profits or gains arising from the transfer by way of conversion of a capital asset into stock-in-trade… shall be chargeable to income-tax as income of the previous year in which such stock-in-trade is sold or otherwise transferred.”

TWO-PART TAXATION MECHANISM:

Part A – Capital Gain under Section 45(2)

This portion represents appreciation in value till the date of conversion.

Capital Gain = FMV on date of conversion – Indexed Cost of Acquisition

• FMV = Fair Market Value on date of conversion (as per Section 45(2))

• Indexed Cost = Original cost adjusted using Cost Inflation Index (CII)

💡 Long-Term or Short-Term?
✔️ Depends on the holding period till date of conversion.

Part B – Business Income under Section 28(i)

This portion represents appreciation after conversion, i.e., the gain between FMV on conversion date and actual sale price.

Business Income = Sale Price – FMV on date of conversion

💡 Taxed as business profit in the year of actual sale.