Question

Distributing C Corporation has some assets that would produce a substantial gain if sold, and other assets that would produce a substantial loss if sold. Its goal is to transfer assets to its shareholders, but in a manner that would enable it to defer the gains, or at least deduct those losses against the gains.

If Distributing C Corporation asked your advice, what issues would you raise?

Answer 1

Assets can be transferred to shareholders either by way of non cash dividend, in case of demerger or at the time of winding up if the funds with the company are not sufficient to repay the shareholders.

If you give cash or Assets to shareholders at less than their value without any consideration in return, then u/s the Income Tax Act it will be treated as Deemed Dividend u/s 2(22) and will be taxed in the hands of shareholders as Deemed Dividend at the rate prescribed.

If it is not a case of demerger or winding up then proper care has to be taken to ensure that the value of the Assets given up is not less than the fair market value or else taxability will arise in the hands of company as well as the shareholders. In the hands of the companies as capital gain u/s 56 and in the hands of the shareholders as deemed dividend u/s 2(22).

To avoid taxability in the hands of Shareholders, the company can sell the Asset to the shareholders in the ordinary course of Business, as if he was another person not related to the company and then whatever capital gain/ loss arises in the course of sale can be set off against each other in the books of the companies (ie. Long term capital gain can be set off against Long term capital Loss) and no taxability will arise in the hands of shareholders as he will pay proper consideration for the same.

Hope this helps