The case involves appeals relating to the computation of capital gains tax for the Assessment Year 1991-92 by shareholders one of which being T R Balasubramanium[1] (‘the Appellant’) of Jupiter Press Pvt Ltd, a company in voluntary liquidation. The Appellant and other shareholders received immovable property assets from the company upon its liquidation.
Facts:
- The Appellants held shares in Jupiter Press Pvt Ltd and purchased 120 shares at Rs. 21,000 each.
- Upon voluntary liquidation of the company on May 21, 1990, immovable property at 552, Mount Road, Madras was distributed to shareholders proportionate to their shareholding.
- The property was valued at Rs. 1,36,51,000, translating to Rs. 27,302 per share for 120 shares.
- The Appellants declared capital gains of Rs. 7,56,240 in their income tax returns for AY 1991-92, computed under Section 55(2)(b)(iii) of the Income Tax Act, 1961.
- The Income Tax Department, however, initiated reassessment proceedings and computed the cost of acquisition per Section 49(1)(iii)c, leading to a higher tax liability.
- Appeals by the Revenue and the Appellants were variously decided, with contradictory outcomes in the Income Tax Appellate Tribunal (ITAT).
The critical legal question was the correct basis for calculating the “cost of acquisition” when an asset is distributed on liquidation and sold. The contention was between applying:
- Section 55(2)(b)(iii) – which states that if the capital asset becomes the property of an assessee on liquidation and is assessed to capital gains under Section 46, the cost of acquisition shall be the fair market value of the asset on the date of distribution.
- Section 49(1)(iii)c – which provides that in case of distribution of assets on liquidation, the cost of acquisition of the asset in the hands of the shareholder shall be deemed to be the cost to the previous owner (the company), i.e., original cost incurred by the company.
Section 46 deals with the chargeability of capital gains for shareholders receiving assets on liquidation, and Section 48 provides the method for computing capital gains (deducting cost of acquisition and improvement from full value of consideration).
Appellants argued Section 55(2)(b)(iii) overrides Section 49(1)(iii)c since they acquired the shares before liquidation and have been assessed to capital gains tax on the distribution under Section 46 for the asset.
Revenue claimed Section 49(1)(iii)c should apply because the capital gains on receipt of the asset were not assessed in the earlier year, and adopting the fair market value would reduce tax liability improperly.
The court analyzed the transactions as two events occurring on liquidation:
- Transaction A: Transfer of shares by shareholders extinguishing their rights in exchange for the asset received on liquidation.
- Transaction B: Subsequent sale of the asset by the shareholder.
The court used hypothetical computations to demonstrate different tax impacts under the two provisions. It concluded:
- If capital gains from Transaction A are taxed in the year in which they accrue, Section 55(2)(b)(iii) applies, and the cost of acquisition for the asset in Transaction B is the fair market value on distribution.
- If the assessee postpones taxing the gain in Transaction A, then Section 49(1)(iii)c applies, resulting in the cost being the company’s acquisition cost.
- However, in this case, the two transactions took place in the same financial year, and the appellants offered the capital gains for Transaction A for taxation in the relevant year.
- The Tribunal’s approach to treat the transactions as untaxed and invoke Section 49(1)(iii)c was incorrect.
- The court held that the proper method aligns with Section 55(2)(b)(iii), recognizing the fair market value at the time of distribution as the cost of acquisition when calculating capital gains on subsequent sale.
- The court also noted the Tribunal should have referred the issue for a Larger Bench instead of following inconsistent precedents.
Conclusion:
The Madras High Court allowed the appeals of T.R. Balasubramanium and co-appellants, answering substantial questions of law in their favor. The court held that where capital gains on liquidation assets are assessed in the year of accrual, Section 55(2)(b)(iii) governs, applying the fair market value as the cost of acquisition for subsequent sale of the asset, overriding Section 49(1)(iii)c. The appeals against the Revenue’s reassessment orders were allowed with no costs.
This ruling provides clarity on capital gains computation in liquidation cases and stresses the importance of proper sequencing and tax treatment of transactions under the Income Tax Act, 1961.
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[1] T.R. Balasubramanium vs The Assistant Commissioner of Income Tax City Circle VII2, Chennai
