In a landmark ruling, the Hon’ble High Court of Hyderabad (“High Court”) has held that the Income-tax Department (“Department”) does not enjoy the status of a secured creditor on par with a secured creditor covered by Section 52 of the Insolvency and Bankruptcy Code, 2016 (“Code”), once a liquidation order has been passed against a corporate debtor under the provisions of the Code.
The High Court ruled the above in the matter of Leo Edibles & Fats Limited vs. The Tax Recovery Officer (Central), Income Tax Department, Hyderabad and others vide an order dated 26 July 2018 (available here), where it primarily dealt with the construction and interpretation of the provisions of the Code in juxtaposition with the Income-tax Act, 1961 (“IT Act”).
Keeping in mind the non-obstante nature of the Code, the High Court further ruled that in so far as liquidation of a company under the Code is concerned, the Department can no longer claim a priority in respect of clearance of tax dues of the said company, as provided under the IT Act and must necessarily take recourse to distribution of the liquidation assets as per Section 53 of the Code, wherein it is assigned the fifth position in the order of priority to such dues.
In the context of aforementioned, following are certain relevant facts:
1. A liquidator (“Liquidator”) was appointed pursuant to the order of the Hyderabad Bench of the National Company Law Tribunal, dated September 21, 2017 for the liquidation of VNR Infrastructure Limited (“Company”) as per the provisions of the Code.
2. As process for the liquidation, the Liquidator pooled in all the assets of the Company and formed the liquidation estate, and initiated e-auction. Leo Edibles & Fats Limited (“Petitioner”) participated in the auction and was declared the highest bidder for the residential / commercial land of the Company (“Subject Property”), with a bid of INR 11,55,00,000/-. The Petitioner made a part payment for the Subject Property, however, before it could make full payment, it came to know that the Subject Property was subjected to attachment by the Department pursuant to the recovery proceedings initiated by the Department against the Company. The Registrar would also not register the sale deed in view of the same.
3. Thereafter, the Petitioner filed two writ petitions requesting the High Court to (i) issue an interim order directing the Department to recall the attachment and direct the Sub-Registrar to register the sale of the Subject Property; and (ii) to ensure that the Liquidator shall not insist upon the Petitioner to pay the remaining amount with respect to the Property till the sale deed was registered in their favour. However, the High Court vide an interim order directed the Petitioner to deposit the due amount to the Liquidator, with the direction that the Liquidator shall not disburse any of the amounts paid by them, pending further orders by the High Court.
4. The Department refuted the claims of the Petitioner by contending that the tax proceedings had been initiated prior or the liquidation proceedings and as per Section 178(6) of the IT Act the Department is protected in relation to the liquidation of estates of the Company.
5. Notably, Section 178 of the IT Act was amended by the Code, which incorporated the supremacy of the Code. Prior to it being amended by the Code, Section 178 of the IT Act would require the Assessing Officer to notify the liquidator within three months from the date on which he receives the notice of appointment of the liquidator, the amount which, in the opinion of the Assessing Officer, would be sufficient to provide for any tax which is then or is likely thereafter to become payable by the company. It also provided that the liquidator shall not, without the leave of the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner, part with any of the assets of the company or the properties in his hands till he has been notified by the Assessing Officer and on being so notified, the liquidator shall set aside an amount, equal to the amount notified and, until he so sets aside such amount he shall not part with any of the assets of the company or the properties in his hands. It also provided by non-obstante nature of Section 178 in the words:
“The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other law for the time being in force.”
6. Section 178 of the IT Act was amended by the Code, to vary the non-obstante nature of Section 178 as follows:
“The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other law for the time being in force except the provisions of the Insolvency and Bankruptcy Code, 2016.”
7. Section 52 of the Code provides protection to a secured creditor of the corporate person in liquidation. Section 52(1) provides that a secured creditor in the liquidation proceedings may either relinquish its security interest to the liquidation estate and receive proceeds from the sale of assets by the liquidator in the manner specified in Section 53 or realize its security interest in the manner specified thereunder.
Observations of High Court:
1. The High Court noticed the scheme of Section 178 of the IT Act prior and after the amendment carried out to it by the Code, and held that it is clear that the Department does not enjoy the status of a secured creditor, on par with a secured creditor covered by a mortgage or other security interest, who can avail the provisions of Section 52 of the Code, and at best, it can only claim a charge under the attachment order, in terms of Section 281 of the IT Act.
2. Viewing the scheme of Section 178 of the IT Act, it observed that liquidation could be under the provisions of different enactments, but in so far as the liquidation of a company is under the provisions of the Code is concerned, Section 178 of the IT Act stands excluded by virtue of the amendment to Section 178(6) of the IT Act from November 1, 2016.
3. In the event an assessee company is in liquidation under the Code, the Department can no longer claim a priority in respect of clearance of tax dues of the said company, as provided under Sections 178(2) and (3) of the IT Act. In the context of liquidation of an assessee company under the provisions of the Code, the Department, not being a secured creditor, must necessarily take recourse to distribution of the liquidation assets as per Section 53 of the Code.
4. Tax dues, being an input to the Consolidated Fund of India and of the States, clearly come within the ambit of Section 53(1)(e) of the Code. If the Legislature, in its wisdom, assigned the fifth position in the order of priority to such dues, it is not for this Court to delve into or belittle the rationale underlying the same.
The ruling will have far reaching impact on the income-tax dues, and the High Court has clearly gone on to establish the supremacy of the Code, even against the dues to the Income-tax Department. The ruling will also protect the purchasers participating in auction process / or those purchase the assets of the corporate debtor undergoing liquidation as per the provisions of the Code. It will be interesting to see if the Income-tax Department will appeal against this ruling, and what will be the stand taken by the Apex Court.