Shub Kartik Goenka
Introduction
The Insolvency and Bankruptcy Code, 2016 (“IBC”) is a landmark legislation that amends and consolidates the law on the reorganisation and insolvency resolution procedure of Indian corporations. Unlike liquidation, the objective of this IBC is to preserve the entity as a going concern. The pioneering nature was to provide simplicity and time-bound resolution, creditor-friendly approaches, maximisation of assets, and balancing the interests.
Corporate borrowings refer to debts a corporate entity owes to another party. Such debt may be classified as secured or unsecured, based on whether it is secured by collateral. Debts can also be categorised as financial or operational, wherein the latter directly relates to goods or services, employment or statutory dues. When a company undertakes an agreement to borrow money, it becomes imperative to determine the nature of the debt and the creditor’s standing therein. Such differentiation becomes essential in determining voting rights, the composition of the Committee of Creditors, and the priority of claims under the waterfall mechanism.
Tax dues also act as debts that may be owed by the corporate entity to the tax authority, as provided in any statute. Generally, they are treated as operational debt, as per the definition outlined in Section 5(21), since they are payable to the Government or such statutory authorities. However, the fundamental issue arises in determining whether a particular tax due is secured, its position in the waterfall mechanism, and its implications.
Landmark Case Laws
The NCLAT in DGIT v. M/s. Synergies Dooray[1] adjudged that if a company remains a going concern, then statutory dues in the form of Income Tax, VAT, GST, and Excise Duty shall be levied and operate as Operational Debts. The Tribunal stated that all taxes are operational, and the relevant collecting authorities are Operational Creditors under the IBC.
The Supreme Court in PCIT v. Monnet Ispat[2], the Apex Court stated that Section 238 of the IBC gives it an overriding effect over all the existing laws on the subject matter, including laws related to taxation, and any inconsistencies with the IBC shall be void to that extent. The Court clarified that tax dues are crown debts and thus cannot be given priority over the position of secured creditors.
In Jalgaon Janta v. Joint Commissioner of Sales[3], the Bombay High Court held that the terminology “first charge” as used in tax laws is subservient to charges created by a special law like the IBC and is thus rendered bogus. The Court also stated that tax dues are “unsecured debts” rather than secured; hence, they are bound to rank below them.
The recent State Tax Officer v. Rainbow Papers[4] has been a controversial Supreme Court judgement had significantly overturned various judgements on the subordinate position of tax debts. The Court held that the Gujarat VAT applicable to the respondent company created a security interest over its assets, and thus, the tax dues qualified as secured debt. Moreover, the words “first charge” given in the Gujarat VAT Act were literally interpreted to prioritise the tax authority, a priority of claims above other secured creditors.
In Paschimanchal Vidyut v. Raman Ispat[5], the Supreme Court held that tax dues created a statutory charge over the company’s assets may render it a secured debt; however, it does not put them above other secured debts in the waterfall mechanism. They shall be treated as a distinct class of secured debts while retaining their ranking. The Court departed from the Rainbow Papers judgment but did not override it. This case added to the ambiguities in the position of tax claims under the IBC.
Current Conundrum in the Indian Insolvency Regime
Firstly, statutory tax debts are inherently operational as per a catena of rulings. Further, they are predominantly unsecured debts for the purposes of IBC, but can also be ruled as secured debts if they create a statutory charge or security interest within the meaning of Section 3(31) of the IBC.
Secondly, the IBC, being a lex specialis and also vide Section 238, tends to override other laws of similar subject matter and tax legislation. Therefore, the terminology of the first charge of tax debts or such inconsistencies is subordinate to the waterfall mechanism envisaged by the IBC and ideally ranks below the claims of secured creditors and dues of the workers.
Thirdly, there is immense ambiguity owing to recent conflicting rationales pronounced by equal benches of the Supreme Court in Rainbow Papers and Raman Ispat on the ranking of tax debts in the waterfall mechanism. The fact that the Court clarified that applying either case depends on a factual matrix without specific guidelines or boundaries tends to worsen the legal standing of claims of secured creditors and the tax authorities.
Best Common Law Practices
In the United Kingdom, vide the 2020 Amendment of its Insolvency Act, 1986, His Majesty’s Revenue and Customs was elevated to a secondary preferential creditor in priority to other unsecured creditors[6]. The rationale was to protect Government revenues for public consideration against the interests of other creditors.
Whereas, in Singapore, Section 203(1)(i) of the Insolvency, Restructuring and Dissolution Act, 2018, ranks pre-insolvency tax claims below other preferential creditors but above unsecured ones. Section 203(1) can be credited for comprehensively ranking preferential claims, leaving no room for ambiguity.
The Way Forward
Firstly, considering that tax is a concern of the Concurrent List of the Constitution, there are bound to be complexities and charges of a different nature. Since IBC has an overriding effect on this legislation to the extent of the insolvency framework, it would be ideal to consolidate all taxes, whether secured or unsecured, on an equal footing. Granting a unique position to all taxes, as envisaged in the Raman Ispat case, can form the basis.
Secondly, there needs to be a balanced outlook regarding the rank of tax claims in the waterfall mechanism. The elevated position of tax authorities, such as those in the United Kingdom, or as per the Rainbow Papers judgment, is not ideal for the Indian context. If tax claims are prioritised over the rights of other creditors, creditors would be disincentivised to finance the growth of corporate entities, especially MSMEs, which is essential for our economy.
Thirdly, however, it may also be noted that the current position granted to the tax under Section 53(1)(e)(i) of the IBC may be detrimental to the Government’s power to tax for public purposes. Since many corporate debtors fail to pay hefty taxes that apply to their substantial turnover, the non-availability of sufficient funds will similarly affect them. The same principle is reflected in Singaporean law on insolvency, which prioritises tax dues over unsecured debts. Therefore, it is suggested that the ranking of tax debts between secured and unsecured creditors be elevated exclusively.
Notes:
[1] Pr. Director General of Income Tax (Admn. & TPS) v. Synergies Dooray Automotive Ltd. and Ors., (2019) ibclaw.in 443 NCLAT
[2] Pr. Commissioner of Income Tax v. Monnet Ispat and Energy Ltd., (2018) ibclaw.in 30 SC
[3] Jalgaon Janta Sahakari Bank Ltd. & Anr. vs. Joint Commissioner of Sales Tax Nodal 9, Mumbai, & Anr., (2022) ibclaw.in 192 HC
[4] State Tax Officer (1) Vs. Rainbow Papers Ltd., (2022) ibclaw.in 107 SC
[5] Paschimanchal Vidyut Vitran Nigam Ltd. Vs. Raman Ispat Pvt. Ltd. & Ors., (2023) ibclaw.in 81 SC
[6] HM Revenue & Customs, HMRC as a preferential creditor, Gov.UK (Nov. 30, 2020), available at https://www.gov.uk/government/publications/hmrc-as-a-preferential-creditor/hmrc-as-a-preferential-creditor.
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The views expressed in the article are solely those of the author and do not constitute legal or professional advice.
– Shub Kartik Goenka (4th Year Law Student at Symbiosis Law School, Pune)
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