Income Tax dues are operational debts under IBC

The Center has set up National Company Law Tribunal (NCLT) on June 1, 2016 to look into cases relating to insolvency and bankruptcy of companies, especially those that have a huge bank debt. It works like the courts of law in the country and determines the facts of each case and decides in accordance with principles of natural justice.

There were multiple petitions filed with NCLT benches by Tax departments pertaining to treatment of their dues during the Corporate Insolvency Resolution Process (CIRP) under Insolvency and Bankruptcy Code (IBC), 2016.

Why taxman is running to NCLT for relief?

·         Adjudicating Authority has granted huge Income Tax benefits to the Respondent- ‘Synergies Castings Ltd.’ without impleading the Appellant department as a Respondent to the said proceedings. ( No. 205 of 2017 - Synergies Dooray Automotive Ltd. & Ors.)

·         The grievance of the tax department is that the Income Tax liability/ demand in respect of the ‘Corporate Debtor’ was settled for 1% of the ‘crystallized demand’ against the mandate of the Income Tax Act, 1961. (CA. No.671 of 2018-. Raj Oils Mills Ltd. & Ors)

·         ‘Resolution Professional’ had not intimated during the CIRP to attend the meeting of the ‘Committee of Creditors’ (CoC) and plan has been approved prejudicial to the rights of the Tax departments, Further, the ‘Sales Tax’ and ‘Value Added Tax’ (VAT) do not come within the meaning of ‘Operational Debt’ and thereby, ‘Sales Tax Department, State of Maharashtra’ cannot be treated to be an ‘Operational Creditor’.( No. 309 of 2018- Sales Tax Department Vs M/s. Raj Oil Mills Limited & Vs Parte Casters Pvt. Ltd. & Ors )

·         Reduction of VAT to 1% is against the existing VAT law which say’s ‘liability under the Act to be the first charge’ (559 of 2018- Sales Tax Department, State of Maharashtra vs Phoenix Erectors Pvt. Ltd. & Ors)

Stand taken by various tax departments:

·         The ‘Resolution Plan’ approved by the Adjudicating Authority (which reduces the statutory dues liability) is in contravention of provisions of Section 220 read with Section 156 of the Income Tax Act, 1961

·         Similar plea has been taken by the ‘Sales Tax Department, State of Maharashtra’ by relying on Section 37(1) of the ‘Maharashtra Value Added Tax, 2002’

The question taken by NCLAT from these appeals:

1.      Whether the ‘Income Tax’, ‘VAT’ or other statutory dues, such as ‘Municipal Tax’, ‘Excise Duty’, etc. come within the meaning of ‘Operational Debt’ or not?

2.      Whether the Central Government, the State Government or the legal authority having statutory claim, come within the meaning of ‘Operational Creditors’?

Legal Provisions:

Sec 5(20) of IBC, 2016 “operational creditor” means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred;

Sec 5(21) “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;”

Court decision

While considering tax liabilities, court says that when a Company is operational and remains a going concern, only in such case, the statutory liability, such as payment of Income Tax, VAT etc., will arise. As the ‘Income Tax’, ‘VAT’ and other statutory dues arising out of the existing law, arose when the Company was operational, NCLAT hold such statutory dues has direct nexus with operation of the Company. For the said reason also hold that all statutory dues including ‘Income Tax’, ‘VAT’ etc. come within the meaning of ‘Operational Debt’.

Also held that ‘Income Tax Department of the Central Government’ and the ‘Sales Tax Department(s) of the State Government’ and ‘local authority’, who are entitled for dues arising out of the existing law are ‘Operational Creditor’ within the meaning of Section 5(20) of the IBC.
No interferences were made regarding earlier orders of Adjudication Authority on plea that “tax department is not made party to the proceedings” or their liabilities are settled at very low/ negligible rate.

Operational debtors’ position in IBC

·         Rights of operational creditors/ Tax Dept in CIRP: Operational creditors are mute spectators in CIRP process and they don’t have any say in the committee of creditors (CoC) which constitute all the financial creditors. In case operational creditors having debts 1/10^th in value of total debts, they can attend CoC meeting but can’t vote. There is one exception, when there are no financial creditors, in that case CoC will consist of operational creditors.

·         Distribution of Assets: As per sec 53 of IBC, in case of distribution of assets as per order of priority payment, financial creditor will get their dues in priority over operational creditors debts. Government dues (state & Centre) are mentioned separately and ranked 4^th just above other operational creditors.

·         Resolution plan pay-outs: As per section 30(2)(b) of IBC, a Resolution plan should provide for the payment of the debts of operational creditors which shall not be less than the amount to be paid to them in the event of a liquidation of the corporate debtor which is in most cases is almost Nil. Since resolution plan must take care of interest of all stakeholders, small amount is kept for settling the dues of operational creditors including government dues without giving preference to one over another.

·         Overriding effect of IBC: As per Sec 238 of IBC, 2016, the provisions of this code has overriding effect on anything inconsistence contained in any other law for the time being in force, hence even if various tax acts specify recovery mechanism of outstanding tax dues same will not be possible if company in is CIRP process.

Conclusion

At the time of liquidation government dues are specifically mentioned and are considered first amongst other operational creditors and ranked 4^th in the waterfall payment, whereas in resolution plan they are treated at par with operational creditor and no longer have any preference over other operation debts.  

If income tax or sales tax dues are long outstanding from a company, tax departments must be more vigilant about their recovers well within the time before a company is dragged into Insolvency Process, once process is started, they take a back seat and recovery chances of outstanding dues drastically reduces.