The decision of the Hon’ble Supreme Court in the case of STATE TAX OFFICER (1) v RAINBOW PAPERS LIMITED rendered under the Insolvency and Bankruptcy Code (IBC) has ruled on a significant aspect of priority of Government dues. The Court has held that statutory dues under Gujarat VAT Act (GVAT Act) are secured creditors and would require consideration as such in the resolution plan. It was this held that Sec. 48 of the GVAT Act which states that-
“any amount payable by a dealer or any other person on account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case maybe, such person”
is not contrary to or inconsistent with Sec. 53 or any other provisions of the IBC. The Court further held that a resolution plan which does not confirm to the provisions of Sec. 31(2) of the IBC inter-alia prescribing payment of dues of operational creditors, dissenting financial creditors, etc. would not be binding on the parties to whom a debt in respect of dues arising under any law is owed. Such resolution plan ought to be rejected. The Court has also held that the time period of submitting the claims as prescribed under the IBC are not mandatory but only directory.
The decision of the court has raised considerable apprehensions, and rightly so, on the aspect of priority of settlement of statutory dues under the IBC.
SC Observations
The SC has made certain observation suggesting that if the corporate debtor is unable to pay statutory dues to the government and there is no plan to dissipate the debts, the corporate debtor would need to be liquidated and its assets sold. In this respect, the court observed as under:
“52. If the Resolution Plan ignores the statutory demands payable to any State Government or a legal authority, altogether, the Adjudicating Authority is bound to reject the Resolution Plan.
- In other words, if a company is unable to pay its debts, which should include its statutory dues to the Government and/or other authorities and there is no plan which contemplates dissipation of those debts in a phased manner, uniform proportional reduction, the company would necessarily have to be liquidated and its assets sold and distributed in the manner stipulated in Section 53 of the IBC.
- In our considered view, the Committee of Creditors, which might include financial institutions and other financial creditors, cannot secure their own dues at the cost of statutory dues owed to any Government or Governmental Authority or for that matter, any other dues.”
The aforesaid observations, considered in isolation have far reaching implication. However, it would be reasonable to infer that such observation will have to be regarded in the context of the issue before hand. The court having held that statutory dues were secured creditors (by virtue of operation of law), such debts require consideration in the same light as other secured creditors. It is only if the resolution plan does not contemplate dissipation of such debts in the manner specified u/s 53 would the question of liquidation of the company arise. Reading beyond the context would render relevant provisions of the IBC and principles established over time nugatory which cannot be the intent.
Statutory dues are unsecured operational debts unless secured by operation of law
It is settled law that statutory dues are operational debts. This is also clear from the definition contained u/s 5(21) of IBC which defines ‘operational debt’ as under:
“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;
Such operational debts can however be ‘secured’ if a security interest is created on such debts. Sec. 2(31) of IBC defines “security interest” to 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”:
Security interest in relation to a debt thus implies creating a “right, title or interest or a claim to property”. Generally, assessment of statutory dues by government authorities does not create an automatic interest in the property of the debtor, unless mandated under law as was the case under Gujarat VAT Act under consideration by the SC or by specific action. Though the decision has been rendered in context of Sec. 48 of the Gujarat VAT Act, it has direct bearing on government dues under statutes which similarly create a charge over assets of the taxpayer.
Illustratively, similar provisions are specified u/s 82 of the CGST Act, 2017 and Sec. 142A of the Customs Act, 1962 which read as under:
Section 82 of the CGST Act, 2017:
“Tax to be first charge on property.- Notwithstanding anything to the contrary contained in any law for the time being in force, save as otherwise provided in the Insolvency and Bankruptcy Code, 2016, any amount payable by a taxable person or any other person on account of tax, interest or penalty which he is liable to pay to the Government shall be a first charge on the property of such taxable person or such person.”
Section 142A of the Customs Act, 1962
“Liability under Act to be first charge – Notwithstanding anything to the contrary contained in any Central Act or State Act, any amount of duty, penalty, interest or any other sum payable by an assessee or any other person under this Act, shall, save as otherwise provided in section 529A of the Companies Act, 1956 (1 of 1956), the Recovery of Debts Due to Banks and the Financial Institutions Act, 1993 (51 of 1993) and the Securitisation and Reconstruction of Financial Assets and the Enforcement of Security Interest Act, 2002 and the Insolvency and Bankruptcy Code, 2016 be the first charge on the property of the assessee or the person, as the case may be.”
The import of the aforesaid provisions under the GST and Customs laws is the classification of statutory dues as ‘secured debts’, and therefore a priority on distribution of assets as secured debts u/s 53 of IBC. However, the ruling cannot be regarded as laying the general proposition having application to all government and statutory dues. Nature of statutory dues will need to be examined on a case-to-case basis in light of specific legislative act.
Nature of Income tax dues
Income tax dues generally constitute a significant component of claims under a resolution process. Under the Income tax law, manner of recovery of taxes is provided u/s 222 of the Income Tax Act, 1961. As per the provisions, where the assessee is in default in making payment of taxes, the Tax Recovery Officer (TRO) can proceed to recover the taxes by way of attachment and sale of moveable or immovable property of the taxpayer. Such attachment requires positive action of the TRO as per prescribed rules. Till such process is set in motion, there may not be any question with regard to income tax dues being regarded as secured debts. Even where recovery of taxes is secured by attachment of property, it is argued that such act of attachment does not create ‘a right, title or interest or a claim to a property’ and hence income tax dues will stay outside the purview of ‘secured debts’.
The fine distinction between an attachment of property and charge created over the property was explained by the Gujarat High Court in Shree Radhekrushna Ginning and Pressing Pvt. ltd. Versus State of Gujarat (CA no. 5413 of 2022). The court explained as under: