The appellants, sisters, were shareholders in M/s. Palkulam Estate (Private) Ltd., Nagercoil, which went into liquidation in 1964.
Under a compromise decree in 1969, the assets of the company, including agricultural lands, were distributed to the appellants and others.
The appellants received 479.89 acres of agricultural lands before the end of the relevant accounting year in 1970-71.
The appellants argued that agricultural lands should be excluded from capital gains tax under section 46(2) Income Tax Act, 1961 based on the definition of "assets" in section 2(14).
The Income Tax Officer included the value of agricultural lands as income subject to capital gains tax.
The Commissioner of Income Tax (Appeals) favours appellants, considering the definition of "capital assets" in section 2(14).
The tribunal also agreed, stating that "assets" in section 46(2) should mean "capital assets."
However, the High Court ruled against the appellants, stating that the definition of "capital assets" under section 2(14) is not relevant to interpreting section 46(2).
ISSUE
Whether the word "assets" in section 46(2) of the Income Tax Act, 1961, should be interpreted according to the definition of "capital assets" in section 2(14) of the Act.
RULE
Section 46(2) provides: 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 words ‗capital assets‘ has been defined in section 2(14) of the Act, provided: sec2 In this Act, unless the context otherwise requires * * * * *
(14) Capital assets‘means property of any kind held by an assessee, whether or not connected with his business or profession, but does not include ---------
(iii) agricultural land in India.
The invocation of section 2(14) is unnecessary for interpreting section 46(2), which imposes tax on the market value of all assets received from a company in liquidation.
HELD
In Commissioner of Income Tax, Madras v. Madurai Mills Co. Ltd. [1973 (89) ITR 45], established that the distribution of assets of a company in liquidation to shareholders does not constitute a transfer for the purpose of capital gains tax.
Indisputably, the object in introducing section 46(2) was to overcome the reasoning in Madurai Mills by broadening the base of the incidence of capital gains and expressly providing for receipt of assets of a company in liquidation by a shareholder as a taxable event.
In C.I.T. v. R.M. Amin, the court clarified that section 46(2) aims to tax all kinds of assets received by shareholders, not just capital assets. Therefore, shareholders are liable to pay tax on the market value of these assets, regardless of their classification as capital assets under section 2(14) of the Act.
Parliament used "asset" in section 46(1) and (2) to cover all types of assets for taxation.
Agricultural land, though excluded from the definition of "capital asset," can still be taxed under section 46(2).
The Supreme Court dismissed the appeals, holding that the word "assets" in section 46(2) should not be interpreted solely based on the definition of "capital assets" in section 2(14).
COMMENTARIES RATIO/NOTE
TAX TREATMENT IN THE HANDS OF SHAREHOLDERS (SEC. 46(2)]
When a distribution is made by the liquidator, the distribution is deemed to take place in same proportion in which share capital and accumulated profits stood in the accounts of the company mediately before the distribution. Therefore, that part of receipt which is attributable to the accumulated profit is treated as dividend [CIT v. Girdhardas & Co. (P.) Ltd [1967] ITR 300 (SC).
When money is received from liquidator in instalments, then the cost of acquisition has to be deducted from earlier payments and once the cost of acquisition is wiped off, any sum received thereafter will be capital gain-CIT v. Inland Agencies (P.) Ltd. [1983] 143 ITR 186 (Mad.)