The Telangana and Andhra Pradesh High Court (High Court) in the case of Leo Edibles and Fats Limited v. TRO, Writ Petition No 8560 of 2018, has allowed the liquidation of assets of a company under the Insolvency and Bankruptcy Code, 2016 (IBC), despite the claim of the tax authorities that they have a charge over it, by virtue of having initiated attachment proceedings under the Income Tax Act, 1961 (IT Act). The High Court, while dealing with the interplay between the IT Act and the IBC, held that the income tax authorities are not at par with ‘secured creditors’ under the IBC.
The petitioner in the instant case had purchased certain property of a company undergoing liquidation under the IBC in an e-auction. The registrar refused to register the transfer in favour of the petitioner due to the attachment notice issued by the tax authorities. Accordingly, the petitioner filed a writ petition challenging the refusal of the registrar to register the sale deed – and sought issuance of direction to the income tax department to withdraw the said attachment.
The petitioners argued that section 33 of the IBC imposed a moratorium on the initiation or continuation of legal proceedings against the corporate debtor, from the date of appointment of the liquidator. Consequently, they claimed that the tax authorities should lift the impugned attachment as they could not attach the said property in view of the restrictions imposed under section 33 of the IBC. However, the tax authorities argued that section 33 of the IBC would not be applicable in the instant case as the tax proceedings had been initiated prior to the commencement of the liquidation proceeding before the National Company Law Tribunal (NCLT).
The High Court, having noted the aforementioned arguments, held that the tax authorities cannot claim any priority merely on the ground that the order of attachment issued by it was prior to the appointment of the liquidator under the IBC. Reliance in this regard was placed on the judgment in Ananta Mills Ltd. (In liquidation) v. City Deputy Collector, Ahmedabad, (1972) 42 Company cases 476 and Prem Lal Dhar v. Official Assignee, (1897) ILR 25 Cal. 179 (P.C.), where the Court had held that mere attachment of property does not create any interest in favour of the creditor. Further, the High Court also referred to the provisions of the IBC to note that ‘liquidation estate assets’ within section 36 of the IBC include encumbered assets as well, and hence the tax authorities could not treat the attachment as being a bar on the sale of the property, even if the attachment causes an encumbrance on the property. Consequently, an attachment would still not have the effect of excluding such assets from the ‘liquidating estate assets’ under section 36 of the IBC.
The Court also observed that section 178 of the IT Act (which obligates the liquidator to keep aside certain notified amounts for meeting pending tax demands, before liquidating the assets) would not be applicable in the case of liquidation under the IBC by virtue of the amendment made thereto, which provides that the provisions of the IBC shall prevail over the provisions of section 178 of the IT Act. The High Court also clarified that tax authorities are not at par with a ‘secured creditor’ covered by a mortgage or other security interest and can only submit its claim before the liquidator, who may consider it in accordance with the priorities set by section 53(1) of the IBC. The High Court, thus, allowed the petition and directed the registrar to register the transfer in favour of the petitioner.
Interestingly, the High Court remarked that though the tax authorities may not have a claim pursuant to the order of attachment, they may however claim the remedy under section 281 of the IT Act. Section 281 of the IT Act provides that where a taxpayer transfers any of his assets in favour of another party during the ‘pendency of any proceeding’ or ‘after completion of such proceedings but before the notice of tax recovery proceedings’ is served, such transfer would be void as against any claim in respect of any ‘tax’ or ‘any other sum’ payable by the taxpayer as a result of the completion of the pending proceeding. The provisions of section 281 of the IT Act, also provide that the said provision would not apply if the transfer is for ‘adequate consideration’ and without notice of any pendency of proceedings or done with prior approval of the tax authorities.
While the revenue never argued the applicability of section 281 of the IT Act, the High Court on its own made this observation. Thus, this observation being an ‘obiter dicta’ (i.e. an incidental non-binding observation of the Court) does not command a high precedential value and accordingly, it should not be relied upon solely. Having said this, it cannot be ruled out that the tax authorities could seek to invoke section 281 of the IT Act using the aforementioned observation . Thus, the risk of litigation on this account at ground level cannot not be dismissed.
If section 281 is to survive or operate in favour of the tax department in the case of companies undergoing an IBC resolution, then it would mean that the purchasers acquiring assets pursuant to such liquidation or transfer would need to insist that the company under the IBC obtain a no objection certificate under section 281 of the IT Act. The tax authorities, as per the Central Board of Direct Taxation (CBDT) circular dated July 7, 2011 may require such a company to furnish a bank guarantee or require it to create a charge in favour of the tax department, if there is a disputed tax demand. This would make the IBC process unworkable!
Thus, this observation could lead to unintended interpretation. The Court has clearly denied the claim of the tax authority over the liquidator’s right to sell the asset and recover whatever cash can be recovered, citing the IBC provisions and the amendment to section 178 of the IT Act, where the charge for tax was already crystallised. However, it seems that the Court is indicating that if there was no charge but the tax proceedings were pending at the time of sale in liquidation, the tax department could invoke section 281 to hold the transfer to be void in liquidation and recover the tax which is crystallised post completion of the tax proceedings.
It appears that the Court may have alluded to this due to the absence of any exemption provided under section 281 for the IBC proceedings, as it is provided under section 178. This could lead to an absurd result. Where a crystallised claim on account of attachment in liquidation fails, if section 281 were to survive, the contingent proceedings could hamper the IBC process! This could not have been the intention of the legislature. Though it is appreciated that the interest of the tax authority needs to be protected, it is important to ensure that such an interpretation of the provisions does not result in the sword of uncertainty dangling over the head of taxpayers. A clarification from the CBDT on this point would thus allay uncertainty in the ongoing IBC resolutions.