Section 46 of the Income-tax Act: Capital Gains on Liquidation of a Company
Section 46 explains how distributions of money or assets during the liquidation of a company are treated for capital gains tax purposes. The company and its shareholders are treated differently.
What does Section 46 provide?
Section 46(1): Distribution by the liquidating company
Despite the general capital gains charging provision in Section 45, when a company distributes its assets to shareholders on liquidation, that distribution is not treated as a transfer by the company for the purposes of Section 45. This rule is specific to the distribution described in Section 46(1); it does not mean that every sale or disposal made during liquidation is exempt from tax.
Section 46(2): Receipt by shareholders
A shareholder who receives money or other assets from a company on liquidation may be liable to capital gains tax. The money received and the market value of non-cash assets on the date of distribution are taken into account, after subtracting the portion assessed as dividend under Section 2(22)(c). The resulting amount is treated as the full value of consideration for computation under Section 48.
Deemed consideration = Money received + Market value of assets received - Amount assessed as dividend under Section 2(22)(c)
The shareholder's taxable capital gain is then determined under the applicable computation provisions, taking into account the relevant cost, expenses, holding period and any applicable relief. The deemed consideration is not necessarily the taxable gain itself.
Important legal terms and related provisions
| Provision or term | Meaning and relevance |
|---|---|
| Liquidation | The process of winding up a company, settling its liabilities and distributing the remaining assets or proceeds to entitled persons. |
| Section 45, 1961 Act | General charging provision for capital gains arising from transfer of capital assets, subject to statutory exceptions. |
| Section 46(1), 1961 Act | Excludes the company's distribution of assets to shareholders on liquidation from being treated as a transfer for Section 45 purposes. |
| Section 46(2), 1961 Act | Specifies the shareholder's deemed consideration for capital gains when money or assets are received on liquidation. |
| Section 2(22)(c), 1961 Act | Includes liquidation distributions attributable to the company's accumulated profits immediately before liquidation within the definition of dividend, subject to statutory qualifications. |
| Section 48, 1961 Act | Provides the general method of computing capital gains from full value of consideration and allowable deductions. |
| Section 49, 1961 Act | Contains rules concerning the cost of acquisition in specified circumstances, including assets acquired on liquidation. |
| Section 68, 2025 Act | Corresponding provision for liquidation distributions under the Income-tax Act, 2025, referring to Sections 67, 2(40)(c) and 72. |
Illustration: How capital gains may be calculated
Assume a shareholder receives Rs. 8,00,000 in cash and assets worth Rs. 4,00,000 on the liquidation of a company. Of the total distribution, Rs. 3,00,000 is assessed as dividend under Section 2(22)(c).
| Particulars | Amount |
|---|---|
| Cash received | Rs. 8,00,000 |
| Market value of assets received | Rs. 4,00,000 |
| Less: Amount assessed as dividend | Rs. 3,00,000 |
| Deemed full value of consideration | Rs. 9,00,000 |
| Illustrative allowable cost of shares | Rs. 5,00,000 |
| Illustrative capital gain before other adjustments | Rs. 4,00,000 |
In this simplified example, the amount treated as dividend is separated from the capital gains computation to prevent counting the same amount as capital consideration. The final tax depends on the shareholder's facts, the applicable tax regime and the statutory rules governing deductions and rates.
Income-tax Act, 2025: Section 68
For tax years governed by the Income-tax Act, 2025, Section 68(1) states that distribution of assets by a company to shareholders on liquidation is not regarded as a transfer by the company for purposes of Section 67. Under Section 68(2), shareholders may be chargeable to capital gains on money and the market value of assets received, reduced by the dividend amount under Section 2(40)(c); the balance is deemed consideration for Section 72.
Read the official Income-tax Act, 2025 (PDF) for the full text and related provisions. The corresponding rules under the 1961 Act should be used for relevant earlier periods.
Practical points for shareholders
- Identify the date of distribution and the fair market value of any assets received.
- Determine the amount of distribution attributable to accumulated profits and assessed as dividend.
- Keep records of the original cost and acquisition date of the shares, as well as liquidation statements.
- Check the appropriate capital gains computation, holding-period classification, rate and any applicable treaty provisions.
- Consider the separate tax implications of a later sale of assets received on liquidation.
Frequently asked questions
Does a company pay capital gains tax simply for distributing assets on liquidation?
Section 46(1) of the 1961 Act excludes that distribution from being regarded as a transfer by the company for Section 45. Other taxable transactions undertaken by the company must be examined separately.
Is the entire liquidation distribution taxed as capital gains?
No. The portion assessed as dividend under Section 2(22)(c) is subtracted in determining deemed capital consideration. Taxable capital gains are then computed using the relevant statutory rules.
Which section applies from 1 April 2026?
Section 68 of the Income-tax Act, 2025 is the corresponding provision. Earlier years and proceedings may still require applying the 1961 Act, as relevant.
Official statutory sources
- Income Tax Department: Section 46, Income-tax Act, 1961
- Income-tax Act, 1961, as amended (official PDF)
- Income-tax Act, 2025 (official PDF), Section 68
- Income Tax Department: Capital gains guidance
This article is general legal and tax information. Specific treatment depends on the year, transaction, shareholder status and applicable law.