Section 179 (‘the section’) of the Income-tax Act, 1961 (‘the Act’) provides for recovery of tax from the directors of a private company in an exceptional circumstance when the same is not recoverable from the company itself. The non-recovery has to be on account of any gross neglect, misfeasance or breach of duty on the part of the director in relation to the affairs of the company. The section places joint and several liability on the directors of a private company unless he is able to prove that non- recovery cannot be attributable to his actions. The section was first introduced in the 1961 Act. The section creates a unique situation where limited liability accorded to a company is set aside by the department who has been given wide powers under the Act to lift the corporate veil of a company directly without involvement of a court. Thus even though the Act and the Companies Act 2013 recognise the concept of a company being a separate legal entity with limited liability, those who are actually running the show behind the corporate shield are not allowed to get away with fraud, misconduct and non-compliance of legal provisions, etc leaving the government remedy-less against any potential loss of revenue.
2. Background and amendments made till date
Section 179 was introduced for the first time in the Income tax Act, 1961 effective for the Assessment Years (AY) commencing from 1st April, 1962 onwards. There was no corresponding provision for recovery of tax in the Income-tax Act, 1922. Section 179 underwent major changes by way of the Income-tax (Amendment) Act, 19751 (hereinafter referred to as ‘the 1975 amendment’ for the sake of brevity) wherein the section was substituted by sub- sections (1) & (2) as they stand at present. Prior to the amendment, section 179 was applicable only in case of a private company undergoing liquidation and it would not apply even in case of a private company being dissolved or struck off by the registrar of companies under section 560 of the Companies Act, 19562. Post the 1975 amendment, the language of the section was changed to include all the private companies from whom tax due for any AY(s) had become unrecoverable and those public companies which were functioning as private companies during the relevant Previous Years (‘PY’). Thus notwithstanding the misleading heading of section 179, the directors of a private company though not under liquidation, may be held liable for the dues outstanding against the company if they were found guilty of misconduct, negligence, etc. in conducting the affairs of the private company. These amendments were given retrospective application by the legislature which were effective for AYs beginning from 1st April, 1962.3 The Hon’ble Supreme Court in case of Hardip Singh4 has held that ‘the section will be attracted if any one or more of the three events (stages of winding up) occurred after the commencement of the Act even though the first or the first and second events had happened earlier.’
Subsequently, vide the Finance Act, 2013, an explanation for the expression “tax due” was inserted after sub-section (2) of section 179 which became effective from 1st June, 2013 onwards. “Tax due” has been defined to include “penalty, interest or any other sum payable under the Act”. As per the memorandum explaining the Finance Bill of 2013, the amendment was introduced to clear the position as to what is included within the term “tax due” as some courts interpreted the phrase to hold that it does not include penalty, interest and other sum payable under the Act.
In spite of the 1975 amendment to section 179 of the Act, where the section became applicable to all private companies from whom tax was non- recoverable irrespective of a liquidation process being undertaken, the words “in liquidation” continued to exist in the marginal heading to the section. This position was corrected by the Finance Act, 2022 through which the words “in liquidation” were deleted. Also the explanation to the section was amended to include “fees” within the meaning of the term “tax dues” under the section to avoid any unnecessary litigation and to provide further clarity5. These amendments are effective from 1st April, 2022 onwards. Therefore, language of section 179 has been expanded and scope for recovery of tax due is widened under this latest amendment.
3. Analysis of the section
Now that we are up to date with the latest provisions of section 179 of the Act, let us proceed to analyse the said provisions as they stand today. For ease of reference section 179 is reproduced below:
“Section 179- Liability of directors of private company:
- Notwithstanding anything contained in the Companies Act, 1956 (1 of 1956), where any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered, then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non- recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.
- Where a private company is converted into a public company and the tax assessed in respect of any income of any previous year during which such company was a private company cannot be recovered, then, nothing contained in sub-section (1) shall apply to any person who was a director of such private company in relation to any tax due in respect of any income of such private company assessable for any assessment year commencing before the 1st day of April, 1962. Explanation.—For the purposes of this section, the expression “tax due” includes penalty, interest [,fees] or any other sum payable under the Act.
- First of all the section starts with a non- obstante clause, which means that even though under Companies Act 1956 (now replaced with Companies Act, 2013) the director of a company is not personally liable to pay any tax due by the company, under the Act the directors of a private company shall be held liable in case the tax dues are non-recoverable from such private company.6
- Sub-section (1) can be broken down into two parts
Part-1- “(1) Notwithstanding anything contained in the Companies Act, 1956 (1 of 1956), where any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered,…”
Thus, tax recovery proceedings can be initiated against the directors under this section only in case of private companies and private companies who were subsequently converted into public companies in respect of income of AYs where such a public company was a private company.
Part 2- “…then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non- recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.”
The section fixes joint and several liability to pay unrecovered outstanding taxes on all the individuals who were directors of the Company during the relevant Previous Year (PY). It is necessary that the non-recovery of the tax can be attributed to the actions of the director i.e. gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company during the relevant PY. Therefore, the primary onus is on the concerned director to prove his innocence in the manner of conducting the affairs of the company.7
4. Position held by Courts
It naturally follows that a director can be held liable for unrecoverable taxes only from that AY from which he assumed the directorship of the company8. But if a director resigns from the directorship during a PY in which taxes were unrecoverable from the company it will not absolve him from all the liabilities incurred during the period he was a director of the company.9
Even if the primary onus is on the directors to prove that non-recovery of taxes cannot be attributed to his actions, it does not discharge the Assessing Officer (AO) from his duty of ascertaining that tax for the relevant AYs could not be recovered from the company in the first place. It is expected that the AO has taken effective steps to recover the outstanding tax due from the company but has not been able to recover the entire tax liability. In other words the AO is required to record a categorical finding that tax due for the PY cannot be recovered from the company, in absence of which assumption of jurisdiction by the AO under this section is invalid10. The AO has to satisfy the preconditions before proceeding against the director. The Hon’ble Bombay High Court in case of Jaison S. Panakkal v. PCIT & Anr11 has relied upon its earlier decisions in Madhavi Kerkar v. ACIT (WP. No.567 of 2016 dated 05/01/2018 and Mehul Jadavji Shah v. DCIT (WP. No. 291 of 2018 dated 05/04/2018) to reinforce the precondition that the directors of the private company against which it intends to initiate proceedings under this section should be issued a notice under this section and such notice should indicate what steps had been taken to recover the dues from such delinquent company and the failure thereof. Thus two preconditions are to be satisfied viz. (a) to take substantial steps to recover outstanding taxes from the private company (b) to issue proper notices to the directors before taking any steps of recovery under this section.
It is also important to discuss that, department is empowered to lift the veil to look into the actual running of the company. In exercise of powers under this section, the department can lift the corporate veil of a public company if it is able to prove that the affairs of the company were arranged in a manner of a private company so as to defraud the revenue. This was the situation before the Hon’ble Gujarat High Court in case of Ajay Surendra Patel v. DCIT12. In this case the Hon’ble Court held that sufficient material was placed on record by the revenue to show that the Company which was a public limited company was actually functioning as a private limited company and that a hypertechnical interpretation should not be given to statutory provisions which frustrates the very object for which it was it has been included in the statute. Subsequently the Petitioner i.e. Ajay Surendra Patel moved an application for review of the order passed by the Hon’ble Gujarat High Court, wherein it was pointed out that the Hon’ble Court had inadvertently held that no substantial business was carried out by the company after resignation of director (Petitioner) and also sufficient opportunity was not provided to the Petitioner before passing the order under section 179 of the Act. Accordingly the order was recalled by the High Court and it is pending disposal.
It is important that a reasonable opportunity of hearing is given to the directors of such delinquent private companies before continuing with recovery proceedings under the section. Recently, the Hon’ble Bombay High Court has held that exercise of jurisdiction by the revenue department was violative of principles of natural justice when the director of the delinquent private company were not given an opportunity of hearing before applying the principle of lifting of the corporate veil13.
5. Remedies available to directors under section 179
An order passed under this section is not an appealable order under section 246 of the Act and therefore, a person aggrieved by proceedings initiated under section 179 has to approach the court with a writ petition. Though the courts have allowed the writ petitions and quashed the notices issued and orders passed under the section, on several occasions the issue of proceedings under the section are set aside to the officer of the department to re-initiate such proceedings when jurisdictional conditions were not satisfied by the departmental officer. The aggrieved director also has a right of revision under section 264 of the Act. Such an application shall be filed within a period of one year from the date the order under this section was communicated to the applicant or the date on which he otherwise came to know of it, whichever is earlier.
Though directorship is a position of power, it is a double edged sword where they are the first persons to be held accountable in respect of any misconduct or non-compliance by the company. The directors of a company have to be mindful of their actions. Even though the section places joint and several liability on the directors of a private company, a window is available to the director to prove that there was no misconduct, misfeasance or gross neglect on his part in conducting his duties. Even though the primary onus is on the accused director to prove his innocence the department is not given unbridled powers to arbitrarily proceed under the section. It is only when the department has taken considerable steps for recovery against the company and failed can they proceed against its directors.