According to Article 256 of the Indian Constitution: “No tax shall be levied or collected except by the authority of law”. Government is represented by statutory fiscal authorities, which alone has the authority to levy taxes. Examples of such bodies are The Central Board of Excise and Customs (CBEC), Central Board of Direct Taxes (CBDT), Central Board of Indirect Taxes & Customs (CBIC) amongst others.
In 2020, Supreme court gave it judgement in the case of State Tax Officer v. Rainbow Papers Limited[1]. In this case, the State tax authority filed an appeal against the rejection of their claim by NCLAT and NCLT, citing a delay in filing the claim and the classification of Gujarat VAT as an unsecured creditor and operational creditor. The appellant argued that being an operational creditor should not result in the loss of status as a secured creditor.
The Supreme Court two Judges bench ruled that the assets of the corporate debtor were subject to a ‘security interest’ under the Code, and as a result, the tax department was considered a secured creditor for the purposes of Section 53 of the Code, which establishes the order of priority for the distribution of liquidation assets among creditors. The court also accepted the state’s argument that they were a secured creditor and could claim the first charge over the property of the corporate debtor.
This created an ambiguity as earlier to this judgement; the statutory fiscal authorities were only equated to an operational creditor as government dues were defined to be an operational debt under clause 21 of Section 5 of IBC. (“operational debt” means a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority) and no such authority of first charge to have precedence over the property of corporate debtor and the position of secured creditor was awarded.
To add to the ambiguity, the aforementioned precedent of Rainbow case[2] was recently used as a basis for delivering a verdict in February 2023, in the matter of PCIT Vs Assam Company India Ltd[3]., by NCLAT Delhi. The NCLAT held that the outstanding amounts owed to the income tax department constitute “Government dues” and that they hold the status of secured creditors.
But to its contrary, it was rightly observed by the Partner and the Executive of Vinod Kothari & Company[4] that the terms ‘security interest’ and ‘secured creditors’ must be interpret in accordance with the definitions assigned in sections 3(31)[5] and 3(30)[6], respectively and one needs a “security interest” in order to be a secured creditor. A ‘security interest’ is defined as a right, title, or other property formed by a ‘transaction’ that secures payment or execution of an obligation. A written agreement or arrangement for the transfer of assets, money, products, or services from or to the corporate debtor is included in the definition of “transaction” in S3(33) of the IBC.
As a result, the idea of security interest, as applied in debt collection laws and the IBC, is intimately related to a mutual agreement or transaction between parties. The idea cannot be extended to cover forced or non-consensual conduct such as tax officials attaching property. As a result, while an attachment under tax laws may constitute a statutory charge in favor of the tax authority (under the relevant legislation), that does not grant the tax authority the status of a “secured creditor.” As a result, a charge in favor of the tax office under the tax laws is not a “security interest.”
The case of Ghanshyam Mishra v. Edelweiss Asset Reconstruction[7] dealt with the issue of whether a state taxation authority can be considered an operational creditor under the Insolvency and Bankruptcy Code, 2016. The Supreme Court of India ruled that the tax department can be considered an operational creditor, as taxes owed to the government are debts arising out of a transaction in the ordinary course of business. This decision clarified that the state taxation authorities can initiate insolvency proceedings against defaulting debtors.
In Leo Edibles and Fats Limited v. the Tax Recovery Officer[8], the Andhra Pradesh High Court clearly stated that income tax authorities cannot be equated to secured creditors and so cannot claim precedence. It also observed that tax dues, as an input to the Consolidated Fund of India and the States, obviously fall within the purview of section 53(1)(e) of the Code. If the Legislature, in its wisdom, placed such dues in the fifth spot in the order of priority, it is not the responsibility of this Court to examine or disparage the reasoning behind it.
Former Insolvency and Bankruptcy Board of India (IBBI) Chairperson M. S. Sahoo asserted[9] that the objective of the Code is to preserve the enterprise by balancing the interests of all stakeholders, for which a successful resolution is required. Holding out authorities as secured creditors would result in more corporate debtors being liquidated, which is counter to the IBC’s purpose.
The objective of the Code so called into assertion is “…to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues…”
February 2020 Report of the Insolvency Law Committee[10], stated that “The moratorium under Section 14 is intended to keep “the corporate debtor’s assets together during the insolvency resolution process and facilitating orderly completion of the processes envisaged during the insolvency resolution process and ensuring that the company may continue as a going concern while the creditors take a view on resolution of default.” Keeping the corporate debtor running as a going concern during the corporate insolvency resolution process helps in achieving resolution as a going concern as well, which is likely to maximize value for all stakeholders.”
It is arguable that in the waterfall hierarchy of Section 53 for distribution of assets, government dues are already placed at the end in Section 53(e)(i) so the alteration so mentioned in the Act would mean them going up in that hierarchy and equating them to secured creditors would be in consistency to this perspective and the objective of the Act but at the same time this would destroy the objective as promotion of entrepreneurship would be hampered.
Hence, it can be concluded that the decision of Supreme court in the Rainbow case[11] needs to be reviewed and the ambiguity on the issue of whether the statutory fiscal authorities should be equated to secured creditors and given preference over the assets must be resolved.
Author – Dimpal Khotele
BBA LLB, Amity University Chhattisgarh
[1] Civil Appeal No. 1661 of 2020
[2] ibid
[3] Company Appeal (AT) (Insolvency) No. 243 of 2022
[4] https://vinodkothari.com/2022/09/supreme-court-ruling-revives-the-quandary-holds-tax-authorities-to-be-secured-creditors/#_ftn9
[5] Section 3 (31) “security interest” means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person.
[6] Section 3 (30) “secured creditor” means a creditor in favour of whom security interest is created.
[7] Civil Appeal No. 8129 of 2019
[8] Writ Petition No. 8560 of 2018
[9]https://ibbi.gov.in/uploads/resources/Article%20Balancing%20the%20Interests%20of%20Stakeholders%20in%20IBBI%20Newsletter%20July-September%202017.pdf
[10] https://ibbi.gov.in/uploads/resources/c6cb71c9f69f66858830630da08e45b4.pdf
[11] Supra