Tax Entailments in Liquidation of Company

Shreya Patel

24 Aug, 2023

Introduction

There are many types of tax implications that occur during the liquidation process of the Company, be it solvent, insolvent, or company liquidation. One of the aspects of the Liquidation of a company is selling or transferring the assets. During the sale or transfer of assets, assets can result in taxable gain. The company’s assets are converted into cash in the liquidation process of the Company.

What are solvent and insolvent Liquidation?

At times, it can happen that a private limited company will take a decision to shut down. In these circumstances, all the company assets will be sold and converted into cash, which will be divided among all shareholders of the Company. Companies can sell their assets, whether they are solvent or not. One of the reasons for a solvent liquidation can be when Company voluntarily decides to stop all its operations and has no objective to work. Similarly, when company directors plan to start a new company or business, in order to get cash can liquidate the Company by selling all the assets and stopping all the workings of the Company. Solvent liquidation can also take place when directors of the Company retire.

Insolvent Liquidation takes place when the Company is not able to meet its liabilities, which means when the assets of the Company are less than its liabilities. The Company is not able to pay all of its liabilities. This Liquidation takes place in order to sell all the assets and shut down the Company in order to pay all the debts and make payments to creditors.

What is compulsory Liquidation?

When the court forces the Company to shut down, that is known as compulsory liquidation in simple terms. As soon as the Company goes into the compulsory liquidation stage, the business is stopped, all the directors of the Company are let go, and the assets of the Company are sold to repay the creditors. Through a winding-up petition, which is a type of court order, the creditor can initiate a compulsory liquidation process. The petition will inform the Company to stop its work and will inform the Company that a petition has been filed for the closure of the Company and the Liquidation of the company assets.

Liquidation process

1. Appointment of Liquidator
2. Liquidation is announced publicly
3. Reporting and verification of all claims
4. Asset preparation, along with other reports
5. Liquidation assets consideration and formation

What does a liquidator do in the liquidation process?

For every liquidation process, the liquidator has to make a statement, which is a final statement of account, that will include the amount which is released for assets as well as the distribution of the money. The primary obligation of the liquidator is to supervise the Liquidation of the Company. The liquidator will investigate and inspect every element of the Company and will check whether the assets of the Company are not sold at a lower value than the market value of the Company.

The final statement of accounts will include all the information about the cash receipts and the payments done. Most companies fail because they have more liabilities than assets, and these assets will then have to be sold to settle their debts. All the creditors receive their money during the process of Liquidation. Along with this, if there are any legal disputes going on relating to the Company and its directors, and then those are dropped too.

Tax Implications in Liquidity of Company

Many tax issues arise with the Liquidation of the Company. A taxable gain will be caused if the owner of the Company sells the assets of the Company. In some instances, the tax which is levied on the proceeds of the Liquidation must be paid by the liquidator. This payment of taxes shall be made before distributing any funds or assets to the shareholders or creditors. Some of the tax implications of a company’s liquidation process are:

• Tax Implications on Shareholder Returns during the Process of Liquidity of Company

The liquidation process results in the cancellation of a company’s shares, which can provide a capital gain or loss. The Income Tax Act states that the capital gain from a company’s Liquidation is taxable. The shareholders will have obtained a capital gain if the capital gains from the cancellation of shares surpass the cost base of the shares. The entire distribution that the liquidator made as part of the Company’s liquidation process is what constitutes the capital proceeds.

• Tax Implications on Foreign Investors during the Process of Liquidity of Company

A non-resident who receives corporate assets after the Company is dissolved can likewise be one of its shareholders. In compliance with section 9 of the Income Tax Act¹, Any dividend paid by an Indian company outside India is regarded as income earned and originated in India. There is a provision in Section 46 of the Income Tax Act that also applies to foreign shareholders.

• Tax Implications On Deemed Dividend Distributed

When a company distributes profits to its shareholders from the revenue generated by the business’s trading and operating operations, it is regarded as a dividend paid to shareholders out of benefits obtained from the Company. The Company is liable for distribution tax at a rate of 15% for deemed dividends distributed, in accordance with Section 115-O of the Income Tax Act. A business going through Liquidation could not have any accrued profits on hand. The Company is not required to pay dividend distribution tax in this case. Additionally, distribution by a liquidator does not necessitate paying tax on dividend income unless the Company has generated profits previous to entering Liquidation.

Conclusion

In conclusion, it is essential to understand the tax entailments for a smooth and lawful process of the Liquidation of the Company. There are various tax rules and regulations, such as capital gains, tax distribution, etc. which are vital to understand. Getting professional advice can lessen the chances of non-compliance with rules and regulations and financial risks. There are various advantages of the company liquidation to the stakeholders as well. Making wise decisions will help you avoid potential risks and gain all the benefits.

FAQs

1. https://incometaxindia.gov.in/pages/acts/income-tax-act.aspx