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Corporate Tax Planning

Notes (iv) Special proceedings for various types of companies: The legislation provides for special
liquidation procedures for certain types of companies under their special laws particularly
banks and insurance companies. Banks are liquidated upon the decision of the Central
bank and the liquidation procedures are carried out under the supervision of the Deposit
Insurance Corporation while the insurance companies are liquidated by the Board of the
Insurance Regulatory Commission.

Self Assessment
State whether the following statements are true or false:
1. Liquidation may not result from the sale of the business by mutual agreement of the
partners from the death of a partner or from bankruptcy.
2. After the companies’ assets have been converted to cash the company must repay creditors
for any outstanding debts.
3. The Liquidator is appointed by the partners in the event of voluntary liquidation and by
the court in the case of involuntary forced liquidation.
4. If the liquidation proceedings are completed with within one year the Liquidator shall
notify the Controller and in all cases proceedings shall not exceed three years.

11.2 Tax Considerations in Liquidations

Generally when a person is experiencing extreme financial distress income tax liability is not
a major concern. After all, the lack of income is at least partially responsible for the person’s
fi nancial difficulties. If rather than selling assets the taxpayer turns the assets over to a creditor in

partial or total satisfaction of the debt or the creditor exercises the right to foreclose on the assets
the outcome is essentially the same. The transfer of property to a creditor and a foreclosure are
both treated as a sale of the property for an amount equal to the property fair market value. There
is of course the possibility of further income tax liability if the indebtedness that is discharged by
the transfer or foreclosure is greater than the value of the assets. When property is transferred or
foreclosed upon in satisfaction of a debt the general rule is that the taxpayer realises.
(i) Gain on the property transferred possibly capital gain to the extent that the fair market
value of the property exceeds the income tax basis in the property; and
(ii) Debt discharge income to the extent the amount of debt discharged exceeds the fair market
value of the property.

Example: In the case of farming operations however income tax liabilities present real
difficulties. For farm debtors using the cash method of accounting the income tax basis of raised

animals or stored grain is zero Machinery and equipment have often been depreciated rapidly
with a resulting low basis and land that was purchased some time ago frequently has a low basis
derived from the original purchase price and adjusted for improvements made in depreciation
claimed. Thus there is a potential income tax liability created when assets are sold or turned over
to creditors. In addition income taxes may be generated when debt is forgiven.

There are several options available to the farmer in dealing with these income tax problems. If farm
assets are liquidated outside of bankruptcy any resulting tax liability is solely the responsibility
of the debtor as the taxpayer In the event of liquidation tax liabilities may take several forms:
(i) Ordinary income will result from the sale of assets such as grain or live stock held for
resale.
(ii) Ordinary income will result from the recapture of certain previously claimed tax benefi ts
such as depreciation soil and water conservation expenses land clearing expenses and
government cost sharing payments excluded from income.

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