- The Insolvency and Bankruptcy Code, 2016 (IBC) has a very important provision – in the form of section 238 – which gives this law an overriding effect over all other laws. Obviously, this provision can be invoked only if the other law is inconsistent with the provisions of the IBC and all attempts to harmoniously interpret the two laws fail1. In case of any conflict between the IBC and the provisions of the Income-tax Act, 1961 (IT Act), the Supreme Court has already held that the provisions of IBC shall prevail2. Similarly, in case of conflict between the provisions of IBC and the Customs Act, 1962, the former shall prevail3.
- Approving its Division Bench judgement in Monnet Ispat and Energy Limited and relying inter alia on section 238 of IBC, the Full Bench of the Supreme Court in Ghanashyam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited and (2021) 9 SCC 657 held that upon approval of the resolution plan under the provisions of IBC by the Adjudicating Authority viz. the National Company Law Tribunal (NCLT), all past tax dues which do not form part of the approved resolution plan shall stand extinguished and no proceedings in respect of those can be continued.
- But, does that enunciation bring an end to all controversies that can arise from the interplay between IBC and the IT Act?
Background of enactment of IBC
- Prior to the enactment of IBC, there was no single law in India that dealt with insolvency and bankruptcy. Provisions relating to insolvency and bankruptcy for companies were be found in the Sick Industrial Companies (Special Provisions) Act, 1985, the Recovery of Debt Due to Banks and Financial Institutions Act, 1993, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the Companies Act, These statutes provided for creation of multiple fora such as Board of Industrial and Financial Reconstruction, Debt Recovery Tribunal and NCLT and their respective Appellate Tribunals. Also, liquidation of companies was being handled by the High Courts. Individual bankruptcy and insolvency was dealt with under the Presidency Towns Insolvency Act, 1909, and the Provincial Insolvency Act, 1920 and was dealt with by civil Courts. Thus, the existing framework for insolvency and bankruptcy was found to be inadequate and ineffective that resulted in delays in resolution4.
- IBC was enacted with a view to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals for maximization of value of assets of such persons in a time bound manner. While judicial delays was one of the factors for inefficiencies in the previous regimes, IBC separates commercial aspects of insolvency and bankruptcy proceedings from judicial aspects. IBC gives primacy to resolution of corporate insolvencies rather than directly putting companies into liquidation. It recognizes a wider public interest in such resolution where the assets of companies undergoing resolution are put to value-generating use under a new management rather than liquidating those assets under a process of liquidation. Since the object of IBC is not the mere recovery of dues, it envisages liquidation to be matter of last resort only after attempts of finding a resolution fail5.
Broad scheme of resolution process under IBC
- An unpaid lender or financier (known as a financial creditor under IBC) or an unpaid seller of goods or services (known as an operational creditor under IBC) is empowered to file an application before the NCLT for initiation of corporate insolvency resolution proceedings against a defaulting company or limited liability partnership (known as the corporate debtor under IBC) if the amount of default is Rs. 1 crore or above. A defaulting company or limited liability partnership is also entitled to suo motu file such proceedings with respect to itself. The NCLT adjudicates upon the existence of a debt and default, and based on parameters prescribed under IBC and evolving through judicial precedents from time to time, either admits the application or rejects it.
- Corporate insolvency resolution process commences with the admission of the While admitting the application, an insolvency professional is appointed as an interim resolution professional in whom the powers of the board of directors or partners, as the case may be, vest and the powers of such board of directors or partners stand suspended. The corporate insolvency resolution process is a time-bound process and the process must be completed within a period of 330 days. Throughout the period of corporate insolvency resolution process, the interim resolution professional (and later the resolution professional) is required to make every endeavor to protect and preserve the value of the property of the corporate debtor and manage its operations as a going concern, while the corporate debtor awaits prospective suitors (known as resolution applicants under IBC) to submit their proposal for its revival (known as a resolution plan under IBC). During the corporate insolvency resolution process period, a moratorium or a ‘calm period’ is in force during which no suits can be filed or other legal action taken against the corporate debtor. The purpose of this moratorium is to protect the corporate debtor from pecuniary attacks against it in the moratorium period so that it gets breathing space to continue as a going concern in order to ultimately rehabilitate itself6.
- Upon commencement of the corporate insolvency resolution process, the interim resolution professional issues a public announcement in this regard inter alia inviting claims from creditors. All claims must be submitted to and are required to be decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order to take over and run the business of the corporate debtor. Based on claims collated by the interim resolution professional / resolution professional, a committee of creditors is constituted by him. While in the earlier regimes, the management of the insolvent company continued to be possession of the assets of such company, under IBC, this committee of creditors takes decisions pertaining to the manner of resolving the insolvency. The decisions of the committee of creditors are taken by a vote of not less than 51% of voting share (except in matters of special significance such as the approval of a resolution plan which requires a vote of not less than 66% of the voting share of the committee of creditors). Unless the corporate debtor does not have any financial creditors, operational creditors are excluded from the committee of creditors. The voting share assigned to a financial creditor depends on the proportion of the financial debt owed to such a financial creditor in relation to the total financial debt owed by the corporate Thus, IBC marks a paradigm shift in the efforts towards insolvency resolution making a radical departure from the ‘creditor-in-control’ model to the ‘debtor-in-possession’ model. This has fundamentally reset the power balance between corporate debtors and its creditors in the face of a default by corporate debtors.
- Based on parameters prescribed under IBC, its regulations and criteria as determined by the committee of creditors based on commercial considerations, prospective resolution applicants prepare and submit their resolution plans which are put to the vote of the committee of A prospective resolution applicant completely relies on the claims so collated by the resolution professional. Based on these claims, the resolution plans submitted by the prospective resolution applicants propose payments to the creditors towards their debts (either in full or in part). This phase of corporate insolvency resolution is usually coupled with extensive negotiations between the committee of creditors and the prospective resolution applicants.
- It is important to note that a resolution plan is not a sale. A resolution applicant does not buy the corporate It is, on the other hand, resolution of the corporate debtor as a going concern7. A resolution plan must inter alia mandatorily contain the term of the plan, its implementation schedule, management & control of the business during its term, adequate means of supervising the implementation and demonstrate its feasibility & viability and the capability of the resolution applicant to implement the resolution plan8. The committee of creditors then votes on the resolution plans, and if the resolution plan is approved by a vote of not less than 66% of the voting share, such a resolution plan is submitted before the NCLT for its approval. In the absence of the committee of creditors approving the resolution plan with the requisite votes, a corporate debtor is required to be put into liquidation.
- The Supreme Court has consistently held that the scope of judicial review by the NCLT of a resolution plan duly approved by a committee of creditors is limited to the parameters prescribed under section 30(2) of IBC and that the ‘commercial wisdom’ of the committee of creditors is paramount9. This is how IBC seeks to separate commercial aspects of insolvency and bankruptcy proceedings from judicial aspects. The same is on the basis that the financial creditors (which in most cases constitute the committee of creditors) are typically understood to be better equipped to go into the viability of corporate enterprises, both at the stage of grant of the loan and at the stage of default10.
- Once a resolution plan is approved by the NCLT, by virtue of section 31(1) of IBC, it is binding on the corporate debtor & its employees, members, creditors including the Central Government to whom a debt is owed, guarantors and other stakeholders involved in the resolution Due to the binding nature of a resolution plan, any liability or debt which is not included in the resolution plan by virtue of a creditor not submitting a claim in respect of its dues before the interim resolution professional / resolution professional gets extinguished. The Supreme Court has held that because the successful resolution applicant takes over the business of a corporate debtor on a fresh slate, he cannot suddenly be faced with undecided claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw the amounts payable by him into uncertainty11.
Status of past tax dues after approval of resolution plan
- Many times the Income Tax Department (IT Department) (and even other tax departments) do not file claims in respect of pending tax dues (IT dues) before the resolution professional during the corporate insolvency resolution process and yet pursue their claims against the corporate debtor after it has successfully emerged out of corporate insolvency. The corporate debtor now is obviously the company in a new avatar under a new management.
- It is in light of the scheme of IBC that the Supreme Court in Ghanashyam Mishra and Sons Private Limited (supra) held that upon approval of the resolution plan under the provisions of IBC by the NCLT, claim towards pending IT dues and other tax dues not filed before the resolution professional and consequently not forming part of the resolution plan or those pertaining to periods prior to the approval of the resolution plan stand extinguished. A similar view has been reiterated by the Supreme Court in the case of Ruchi Soya Industries Limited & Ors. UoI & Ors.12
- The judgement of the Supreme Court prompted many corporate debtors – through their new managements – to file Writ Petitions before High Courts challenging notices under the IT Act for periods prior to the approval of the resolution In one such case viz. Murli Industries Limited v. ACIT & Ors.13, a Division Bench of the Bombay High Court quashed notices under section 148 of the IT Act on the ground that the notices pertained to assessment years falling prior to the date of approval of resolution plan. Similarly, in The Sirpur Paper Mills Limited and Ors. v. Union of India and Ors.14, a Division Bench of the Telangana High Court quashed notices under section 143(2) of the IT Act for an assessment year prior to the date of the approval of the resolution plan. In other words, the Telangana High Court was of the view that the IT Department could not even undertake scrutiny of a return of income pertaining to a period prior to the date of the approval of the resolution plan.
- Based on the judgement in Ghanashyam Mishra and Sons Private Limited (supra), in Jet Airways (India) Ltd.15, the IT Department even withdrew its appeals against the orders of the Income-tax Appellate Tribunal (ITAT) before the Bombay High Court presumably since the claim in respect of the IT dues were not submitted before the resolution professional and the same did not form part of the approved resolution In many cases, the ITAT has dismissed pending appeals of the IT Department upon approval of a resolution plan in respect of the assessee.
- However, in the context of customs duty claimed by the Customs Department to be payable by a corporate debtor for a period prior to the approval of the resolution plan, a Single Judge of the Madras High Court in Ruchi Soya Industries v. Union of India and Ors.16 has held that though it was never the intention of the Parliament to enact IBC to have such far reaching impact on the tax administration, the decision of the Supreme Court in Ghanashyam Mishra and Sons Private Limited (supra) has held it otherwise. The relevant portion of the judgement of the Madras High Court is as follows:
“69. Though it was also never the intention of the Parliament to enact Insolvency and Bankruptcy Code 2016 (IBC, 2016) to have such far reaching impact on the tax administration, the decision of the Hon’ble Supreme Court has held it otherwise.
70. The entire tax administration of the country is now in a pell-mell. All the tax authorities will have to make a beeline before the National Company Law Tribunal every time to recover tax dues if under any circumstances proceedings are initiated against corporate debtor under the IBC, 2016. This was not the intention when the Act was enacted. …
81. The corporate applicant has indirectly taken over the petitioner in their “Corporate Resolution Plan” before the said Tribunal. It is for the petitioner to prove that the “customs duty” payable to the respondent under the subject Bill of Entry was factored by the Corporate Applicant in the Corporate Resolution Plan submitted before the National Company Law Board.”
- A Writ Appeal against the above judgement has been admitted and is pending before a Division Bench of the Madras High Court17. In State Tax Officer (1) v. Rainbow Papers Limited18, the Supreme Court has observed that there was no obligation on the part of the tax authorities to lodge a claim in respect of dues which are statutory dues for which recovery proceedings have also been initiated and a resolution plan which does not factor in the same is not binding on the tax authorities. Furthermore, in Dishnet Wireless Ltd. v. ACIT19, the Single Judge of the Madras High Court has also held that approval of a resolution plan cannot impinge on the rights of the IT Department to pass any fresh assessment order under section 148 read with sections 143(3) and 147 of the IT In a pending Civil Appeal filed by the IT Department in the case of Jet Airways (India) Limited, the Supreme Court has, in an interim order, observed that the pendency of an appeal would amount to a claim by the IT Department20. In this case, it was the further submission of the IT Department before the Supreme Court that approval of a resolution plan would not extinguish “ramifications on the criminal side”. The Civil Appeal is pending final adjudication.
Consequences of quashing notices and precluding assessment
- Under the IT Act, usually the starting point for any proceeding that can result in adverse consequences for any person is the issuance of a communication from the IT Department to the assessee (except a search and seizure or a survey proceeding). The communication may be a notice under section 142(1) making an inquiry before assessment, or an intimation under section 143(1) with a tax demand, or a notice under section 143(2) proposing a scrutiny assessment of the return of income, or a notice under sections 147 read with 148A (followed by issuance of notice under section 148). The principles of natural justice are ingrained in the provisions of the IT Act inasmuch as without the issuance of a valid notice, the IT Department cannot proceed ahead to verify whether the assessee has made correct claims with respect to its income, paid the taxes due thereon, whether any interest or penalty ought to be levied and whether any prosecution ought to be initiated.
- An assessment order making an addition or disallowance then becomes a starting point for further proceedings such as penalty proceedings for misreporting / underreporting of income or underpaying taxes in any manner or for launching prosecution in appropriate cases. Penalty and prosecution provisions in the IT Act are meant to fix culpability for, and act as a deterrent against, committing fiscal By quashing the above notices – which are starting points not only for imposing income-tax liability but also for initiating appropriate action for misreporting / underreporting of income or underpayment of taxes against persons responsible for these acts – effectively the Courts have granted reprieve to persons responsible for these acts.
- Viewing the notices issued by the IT Department as an attempt to recover income-tax from the company under the new management for periods prior to the date of the approval of the resolution plan is looking at the matter through one side of the legal prism, the other side being that these notices are also starting points for the IT Department to initiate other proceedings and invoke other statutory remedies available to it. The necessary evidence for prosecution is often collected in penalty proceedings. The material relied on in penalty proceedings often has its foundation in the facts unearthed during assessment proceedings. With the quashing of foundational notices under section 143(2)/ 148 of the Act, the IT Department is unable to proceed in any manner or collect the requisite material / evidence to proceed against the erstwhile management in case of any wrong doing.
- Considering the object and purpose of IBC i.e. to promote resolution of insolvent companies by encouraging new companies to offer resolution plans for them, there is an obvious need to assure the new management that they need not be scared that the taxman will come after them for the faults of the earlier promoters21. Keeping this in mind and the express statutory provisions of IBC under section 31(1), the enunciation by the Supreme Court in Ghanashyam Mishra and Sons Private Limited (supra), that IT dues and other tax dues which do not form part of the approved resolution plan cannot be recovered from the company emerging after successful resolution or its new management, is unexceptionable. However, the legal consequence of quashing scrutiny or reassessment notices at the threshold is also virtually a grant of immunity to the erstwhile management for their acts. This is contrary to legislative intent as evident from the clarification issued by the Finance Minister in the Rajya Sabha22 that “Once the resolution plan is accepted, the earlier promoters will be dealt with as individuals for their criminality but not the new bidder who is trying to restore the company” and section 32A of IBC which grants immunity only to the new management against liability for past offences by the old management. The approach of quashing the foundational notices under the IT Act has the effect of preventing (or at least making it more difficult) the IT Department from initiating otherwise permissible action against the erstwhile promoters. For instance, without an assessment order or an order imposing penalty, the IT Department would be unable to launch prosecution against the erstwhile management for tax evasion or other fiscal wrongs, if committed by the erstwhile management.
- Having said that, the views of the Single Judge of the Madras High Court in Ruchi Soya Industries Ltd. (supra) also do not appear to represent the correct view. It interprets the provisions of IBC in a rather constricted For instance, requiring a successful resolution applicant to prove that the tax dues in respect of which a claim was not filed by the tax department before the resolution professional have been factored in the resolution plan as a pre-condition is contrary to the scheme of IBC. This view also fails to appreciate that a resolution plan can factor in payments only for claims which were filed before the resolution professional.
The middle-path approach
- The answer may lie somewhere at the middle of the two In order to give full effect to the provisions of the IT Act as well as IBC, it may not be desirable to quash the notices which are foundational to assessment proceedings. Under the IT Act, proceedings for assessment and recovery are different. Permitting the IT Department to continue with the assessment proceedings with a clear direction that the tax demand, if any, at the conclusion of the assessment proceedings shall not be recovered from the company in question now under the new management should be the way forward. This will enable the IT Department to use the findings in the assessment proceedings for initiating appropriate proceedings against the old promoters / management of the company. For instance, section 179 of the IT Act empowers the IT Department to recover income-tax due from the directors of a private company if the recovery cannot be made from the company in certain situations. These provisions may be invoked by the IT Department to recover the tax which would have been payable by the company in question. The Bombay High Court in Murli Industries Ltd. (supra), while referring to a similar provision in the Maharashtra Value Added Tax Act, 2002, failed to take note of section 179 of the IT Act.
- A harmonious interpretation of IBC with the IT Act does not warrant the in limine quashing of assessment / reassessment notices but only a prohibition on recovery of tax dues pertaining to past years from the company or its new A quashing of the notices at the initial stage itself would seriously jeopardise the remedies available to the IT Department or at least an opportunity to explore ways in which the earlier management could be made accountable for its actions. At the same time, continuing assessment proceedings with respect to the company in its new avatar in order to foist liability on, or take action against, the erstwhile promoters without the participation of the erstwhile promoters may run foul of the well-established principles of natural justice embedded in the IT Act since the company under the new management being aware that the assessment proceedings cannot result in any adverse consequences for them (since they relate to a period prior to the date of approval of the resolution plan), is not likely to participate in the assessment proceedings in the best possible manner. In addition, there may even be serious actual impediments to the participation of the company such as lack of information and documents pertaining to the past years since in many insolvency resolution processes, it is experienced that all information and documents are not available. A successful resolution applicant has to make do with whatever is made available to it and has to solely rely on the resolution professional for the same.
- While every case is likely to have its own peculiarities, a more fact specific approach would be desirable on these issues. The first step however that the IT Department and other tax departments must undertake to protect the interests of the revenue is to diligently file claims before the resolution professional. Since all companies and limited liability partnerships are invariably assessees of the IT Department, it is quite simple to act on a public announcement regarding commencement of corporate insolvency resolution process and to file a claim, if any, before the resolution professional. The importance of filing a claim before the resolution professional can be gauged from the judgement of the Supreme Court in State Tax Officer (1) v. Rainbow Papers Limited (supra), wherein a resolution plan, not factoring in a claim in respect of tax dues under the Gujarat Value Added Tax Act, 2003 which was filed with the resolution professional, was set aside.
- In respect of tax claims that may arise for past years owing to information received after the approval of the resolution plan (but before the expiry of the limitation period within which the assessment can be reopened under the IT Act), obviously, the IT Department would be unable to file any claim before the resolution professional. This is where Courts must take a middle-path approach whereby the company under its new management is not made to pay any amount towards tax claims not factored in the resolution plan but at the same time the other provisions of the IT Act which the IT Department may invoke against the erstwhile promoters are also not completely shut Similar should be the approach in case of scrutiny assessments for periods prior to the approval of the resolution plan but picked up for scrutiny after its approval. In Vadraj Energy (Gujarat) Limited v. ACIT23, the Bombay High Court has for instance quashed assessment orders passed in respect of the company after its successful resolution but remanded the matters back to the assessing officer to consider the legal effect of the company having emerged out of insolvency resolution process.
- The tax departments must also realise that their actions, if held to be contrary to the provisions of IBC and the law laid down in Ghanashyam Mishra and Sons Private Limited (supra), are unlikely to withstand judicial scrutiny. Therefore, unmindful insistence on recovering taxes for past years from the company now under the new management must give way to a more practical and solution oriented approach of exploring alternatives within the statutory framework for taking steps in relation to the past promoters as this is the approach which is likely to yield better results. The respective Boards under the relevant tax laws ought to play a more proactive role in this regard.
- The divergent views expressed by Courts as above and different fact-situations having implications on the criminal as well as civil side that could arise after the approval of a resolution plan under IBC for the actions of erstwhile managements have opened up new and interesting There are many unanswered and unconsidered aspects under the tax laws that arise with the approval of a resolution plan.
- Supreme Court’s judgement in Ghanashyam Mishra and Sons Private Limited (supra) does not seem to be the end of all controversies that can arise from the interplay between IBC and the IT Act qua tax assessments and past tax dues. Each case that comes before a Court has its own factual situation or legal peculiarities which may not have been examined earlier. The law on these aspects is likely to develop and evolve further. In the meantime, while approval of a resolution plan may extinguish monetary claims not factored in the resolution plan, an approved resolution plan is only likely to ignite new legal controversies.