The issue was also discussed at one of the sessions at the International Symposium on Insolvency and Bankruptcy Code, 2016 organised by the Centre for Transnational Commercial Law at National Law University, Delhi on 7-1-2021, where I had moderated the panel discussion on the session on “Corporate Liquidation and Key Issues”. I must express my appreciation towards Sh. Ravi Sharma, Advocate Pricewaterhouse Coopers for his succinct presentation on this issue at the session.
In the present post, I shall briefly discuss the conflict between Insolvency and Bankruptcy Code, 2016 (IB Code) vis-à-vis the tax statutes during the stage of liquidation of a corporate debtor. In examining the interplay of IB Code vis-à-vis the tax statutes and its impact on the latter, it is relevant to refer to the non-obstante clause in the IB Code under Section 238 which stipulates:
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Provisions of this Code to override other laws.— The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.
This particular provision purports to address numerous conflicts arising between the IB Code and other statutes. In the subsequent discussion, we shall see how the provisions of the IB Code have circumvented other statutory laws and the same has been given effect to by virtue of Section 238 of the IB Code.
Introduction
Several issues have arisen when during the liquidation proceedings under the IB Code, the tax authorities have invoked their right to recover dues. Section 53 of the IB Code is relevant provision which has been a bone of contention for the tax authorities with the IB Code. The provision provides for a waterfall mechanism ranking the relevant stakeholders and designating the priority of their claim in the following manner:
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Distribution of assets.— (1) Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period and in such manner as may be specified, namely—
(a) the insolvency resolution process costs and the liquidation costs paid in full;
(b) the following debts which shall rank equally between and among the following—
(i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and
(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in Section 52;
(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;
(d) financial debts owed to unsecured creditors;
(e) the following dues shall rank equally between and among the following:
(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;
(f) any remaining debts and dues;
(g) preference shareholders, if any; and
(h) equity shareholders or partners, as the case may be.
Explaining the rationale behind keeping the right of the Central and State Governments in the distribution waterfall in liquidation at a priority below the unsecured financial creditors, the Bankruptcy Law Reforms Committee stated that the same will be helpful in:
… promoting the availability of credit and developing a market for unsecured financing (including the development of bond markets). In the long run, this would increase the availability of finance, reduce the cost of capital, promote entrepreneurship and lead to faster economic growth. The Government also will be the beneficiary of this process as economic growth will increase revenues. Further, efficiency enhancement and consequent greater value capture through the proposed insolvency regime will bring in additional gains to both the economy and the exchequer.[1]
Keeping this objective in mind, we will discuss the issues that have arisen during the liquidation proceedings under the IB Code vis-à-vis the tax authorities.
Issue 1 – Sections 178, 179 of the Income Tax Act, 1961 versus Section 53 of the IB Code
In LML Ltd., In re,[2] issue arose as to under which “head” will the payment of capital gain tax on the sale of assets of the corporate debtor during liquidation fall into.
Option (a) was to include such capital gain tax as part of the “liquidation expense”.
Option (b) was to rule it as creditor’s due and the same will come under the “operational debt”.
The distinction was crucial since option (a) would have meant that the tax dues would be ranked higher up in the priority list under the IB Code. The same would have to be paid in priority of the other claims such as of workers’ dues or the dues of the secured creditors in terms of the waterfall mechanism specified under Section 53 of the IB Code.
The National Company Law Tribunal (NCLT) in this case ruled that such a capital gain tax has to fall under option (b) and has to be recovered in accordance with the waterfall mechanism provided under Section 53 of the IB Code. The reasoning of the NCLT was also premised on the reading of Section 178[3] of the Income Tax Act, 1961 which in the marginal note states “company in liquidation” and sub-clause (6) of which was amended by the legislature to read as:
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(6) 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.
Based on this, it was concluded that the legislature intended to give the provisions of the IB Code (Section 53, in the present case) to override the provisions of Section 178 of the Income Tax Act, 1961.
It is crucial to understand that while Section 178 of the Income Tax Act, 1961 was amended, the legislature did not amend Section 179 of the Income Tax Act, 1961 which provides for the personal liability of the directors of a private company in liquidation.
Section 179 provides that where any tax is due from a private company and if the same could not be recovered, then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.
Similar issue arose in Pooja Bahry, In re,[4] where the liquidator sold certain properties relinquished by the secured creditors. Issue before the adjudicating authority was whether the liquidator is required to deposit “capital gains” on the sale of secured assets which was relinquished by the secured creditors and include it in the “liquidation cost”. Reiterating Section 178(6) of the Income Tax Act, 1961, the Tribunal held that the tax on capital gains must be distributed in accordance with the waterfall mechanism under Section 53 of the IB Code.
The Tribunal also noted that under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002, a secured creditor can effect a sale of the secured asset and appropriate the entire amount towards its dues, without any liability to first pay capital gain. However, if the capital gain is to be first provided for under the IB Code by including the same under “liquidation cost”, the Tribunal opined that an anomalous situation will be created where the secured creditor shall get a lesser remittance under the IB Code than what it could have realised under the SARFAESI Act, had it not released the security into the common corpus.
An issue was brought before the Telangana High Court in Leo Edibles & Fats Ltd.,[5] where the petitioner purchased an immovable property in the liquidation proceeding of a corporate debtor. When the Income Tax Department claimed a charge over the property on account of an attachment order, and refused to allow the transfer of the immovable property in the name of the successful bidder, the issue arose with respect to Sections 52 and 53 of the IB Code vis-à-vis the Income Tax Act, 1961.
The High Court held that the Income Tax Department cannot claim any priority on the ground that:
(a) 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 IB Code.
(b) The order of attachment of assets is issued by the Income Tax Department is prior to the initiation of liquidation proceedings under the IB Code.
(c) Under Section 36(3)(b) of the IB Code, a “liquidation estate” includes “assets that may or may not be in possession of the corporate debtor, including but not limited to encumbered assets”. Resultantly, the court opined that even if the order of attachment constitutes an encumbrance on the property, the same will not take out the property outside the purview of the liquidation estate.
(d) Section 178 of the Income Tax Act, 1961 stands excluded by virtue of the amendment of Section 178(6) of the Income Tax Act, 1961.
Similarly, in Om Prakash Agarwal v. Tax Recovery Officers,[6] an order attaching the bank accounts of the corporate debtor under liquidation was set aside by considering the tax dues as operational debt and a reference to the provision of Section 178(6). Thus, held that it is entitled to be claim distribution as envisaged under Section 53 of the IB Code.
Issue 2 – Sections 88 and 89 of Central Goods and Services Tax Act, 2017 (CGST Act, 2017) versus Section 53 of the IB Code
The provisions of Sections 88[7] and 89[8] of the CGST Act, 2017 are to an extent pari materia to the provisions of Sections 178 and 179 of the Income Tax Act, 1961.
Under Section 88(1) of the CGST Act, just like Section 178(1) when any company is being wound up or liquidated, the “liquidator” appointed shall give intimation of his appointment to the Commissioner.
Sections 88(3) and 89 of the CGST Act, similar to Section 179(2) of the Income Tax Act, 1961 incorporated the principle of vicarious liability of the directors of the debtor company. It provides that when any private company is liquidated and any tax, interest or penalty determined under this Act remains unrecovered, then the directors of such debtor company shall be jointly and severally liable for the payment of such tax, interest or penalty.
The issue herein shall be with respect to Section 88(1). While it is similar to Section 178(1), it does not contain the provision of Section 178(6) of the Income Tax Act, 1961, which explicitly provides for the overriding effect of the IB Code over the provisions of Section 178 of the Income Tax Act, 1961.
Issue 3 – TDS versus Section 53 of the IB Code
Section 194-IA(1) of the Income Tax Act, 1961 stipulates:
194-IA Payment on transfer of certain immovable property other than agricultural land.—.(1) Any person, being a transferee, responsible for paying (other than the person referred to in Section 194-LA) to a resident transferor any sum by way of consideration for transfer of any immovable property (other than agricultural land), shall, at the time of credit of such sum to the account of the transferor or at the time of payment of such sum in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct an amount equal to one per cent of such sum as income tax thereon.
(2)-(3) ***
In Pooja Bahry, In re,[9] the adjudicating authority held that the applicability of Section 194-IA of the Income Tax Act will not have an overriding effect on the waterfall mechanism provided under Section 53 of the IB Code.
However in Om Prakash Agarwal v. CIT (TDS),[10] issue arose on deduction of TDS by the successful bidder on the purchase of a liquidation asset. The liquidator sought a direction from the adjudicating authority to prevent the bidder from deducting TDS on the payment to be made for successfully purchasing the asset.
The NCLT rejecting the submission observed that the overriding effect under Section 238 is applicable to the issues between the creditor and the debtor but not to TDS deductions. The reasoning was predicated on the fact that deduction of TDS does not tantamount to payment of government dues in priority to other creditors, because it is not a tax demand for realisation of tax dues and the Government is not making any claim against the corporate debtor, rather it is incumbent on the purchaser to credit the TDS to the Income Tax Department. Hence the provision of Sections 53 and 238 of the IB Code was held to be inapplicable.
Miscellaneous issues
Apart from the above issues, there are several other inconsistencies that may arise during the corporate insolvency resolution process as well as the liquidation process.
For instance, Section 5(13) of the IB Code defines the term “insolvency resolution process costs” on account of the costs incurred by a resolution professional during the resolution process. The same includes costs such as the fees payable to any person acting as a resolution professional; any costs incurred by the resolution professional in running the business of the corporate debtor as a going concern. The issue arises on the tax treatment of such expenses. Which part of these expenses will fall under the head of “capital expenditure” and which may fall under the head of “revenue expenditure” is a question that remains to be seen. It is also argued that costs on restructuring can be classified as a “revenue expenditure”.[11]
Then there is also the issue of Section 56(2)(x) of the Income Tax Act, 1961, which imposes taxes on “gifts”. The provision stipulates that if any person receives any property, other than an immovable property, for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, will be charged income tax under the head “income from other sources”.
In cases of restructuring such instances do arise where lenders convert their outstanding loans into equity of the borrower company at a price which is less than the prescribed fair market value of such shares. The same is argued to be open to invocation of Section 56(2)(x) of the Income Tax Act, 1961.[12]
Conclusion
In conclusion, the issues discussed above show that the nitty-gritties of the taxation system vis-à-vis the objective of the IB Code are the next line of challenges that may require a conclusive position of law. One thing is certain that the breadth of the tax laws and the traditional priority of the claims under it have certainly in a lot of issues taken a subordinate position post the enactment of the IB Code.
Notwithstanding the above, Section 179 of the Income Tax Act, 1961 as well as Sections 88(3) and 89 of the CGST Act, 2017, still show that the personal liability of the directors of the company, vicariously, may subsist for the non-recovery of taxes due.
†Akaant K M, Advocate, National Company Law Tribunals and Constitutional Courts and author of the commentary “Insolvency and Bankruptcy Code – Law and Practice” foreworded by Justice Suryakant and available HERE
[1] Report of the Bankruptcy Law Reforms Committee, Executive Summary – Chapter 2, “Liquidation”, accessible at <https://ibbi.gov.in/uploads/resources/BLRCReportVol1_04112015.pdf>.
[2] 2017 SCC OnLine NCLT 1685.
[3] Income Tax Act, 1961, S. 178 stipulates:
“178. Company in liquidation.— (1) Every person—
(a) who is the liquidator of any company which is being wound up, whether under the orders of a court or otherwise; or
(b) who has been appointed the receiver of any assets of a company,(Mark as RI2)
(hereinafter referred to as “the liquidator”) shall, within thirty days after he has become such liquidator, give notice of his appointment as such to the assessing officer who is entitled to assess the income of the company.(Mark as RI1)
(2) The assessing officer shall, after making such inquiries or calling for such information as he may deem fit, notify to the liquidator within three months from the date on which he receives notice of the 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.
(3) The liquidator—
(a) 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 until he has been notified by the assessing officer under sub-section (2); and
(b) on being so notified, shall set aside an amount, equal to the amount notified and, until he so sets aside such amount, shall not part with any of the assets of the company or the properties in his hands:
Provided that nothing contained in this sub-section shall debar the liquidator from parting with such assets or properties for the purpose of the payment of the tax payable by the company or for making any payment to secured creditors whose debts are entitled under law to priority of payment over debts due to Government on the date of liquidation or for meeting such costs and expenses of the winding up of the company as are in the opinion of the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner reasonable.
(4)-(5) ***
(6) 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.”
[4] Pooja Bahry, Liquidator v. Gee Ispat Pvt. Ltd. [CA 666/2019 in (IB)/250(ND)/2017, Order dt. 22.10.2019].
[5] Leo Edibles & Fats Ltd. v. Tax Recovery Officer, 2018 SCC OnLine Hyd 193.
[6] Item No. 301, IA-992/2020 in CP/294/2018 Principal Bench, Order dt. 15.06.2020.
[7] Central Goods and Services Tax Act, 2017, S. 88 states:
“88. Liability in case of company in liquidation.— (1) When any company is being wound up whether under the orders of a court or tribunal or otherwise, every person appointed as receiver of any assets of a company (hereafter in this section referred to as “the liquidator”), shall, within thirty days after his appointment, give intimation of his appointment to the Commissioner.
(2) The Commissioner shall, after making such inquiry or calling for such information as he may deem fit, notify the liquidator within three months from the date on which he receives intimation of the appointment of the liquidator, the amount which in the opinion of the Commissioner would be sufficient to provide for any tax, interest or penalty which is then, or is likely thereafter to become, payable by the company.
(3) When any private company is wound up and any tax, interest or penalty determined under this Act on the company for any period, whether before or in the course of or after its liquidation, cannot be recovered, then every person who was a director of such company at any time during the period for which the tax was due shall, jointly and severally, be liable for the payment of such tax, interest or penalty, unless he proves to the satisfaction of the Commissioner that such non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.”
[8] Central Goods and Services Tax Act, 2017, S. 89 stipulates
“89. Liability of directors of private company.— (1) Notwithstanding anything contained in the Companies Act, 2013 (18 of 2013) where any tax, interest or penalty due from a private company in respect of any supply of goods or services or both for any period cannot be recovered, then, every person who was a director of the private company during such period shall, jointly and severally, be liable for the payment of such tax, interest or penalty unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.
(2) Where a private company is converted into a public company and the tax, interest or penalty in respect of any supply of goods or services or both for any period during which such company was a private company cannot be recovered before such conversion, then, nothing contained in sub-section (1) shall apply to any person who was a director of such private company in relation to any tax, interest or penalty in respect of such supply of goods or services or both of such private company:
Provided that nothing contained in this sub-section shall apply to any personal penalty imposed on such director.”
[9] Pooja Bahry, Liquidator v. Gee Ispat Pvt. Ltd. [CA 666/2019 in (IB)/250(ND)/2017, Order dt. 22.10.2019].
[10] [Item No. 203 CP/294/2018]
[11] Insolvency and Bankruptcy Code beyond the Tip of the Iceberg, a Deloitte Research Study referring to the decision in CIT v. Akzo Nobel India Ltd., 2018 SCC OnLine ITAT 14623, accessible at <https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/in-tax-ibc1-noexp.pdf>.
[12] Insolvency and Bankruptcy Code beyond the Tip of the Iceberg, a Deloitte Research Study, accessible at <https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/in-tax-ibc1-noexp.pdf>.