WHETHER GST, VAT, TDS, TCS ETC WHICH ARE COLLECTED ON BEHALF OF THE GOVERNMENTS ARE OPERATIONAL CREDITORS UNDER IBC
NATURE OF GST AND DUTY OF TAXABLE PERSON
Article 366 Article 366 of the Constitutional Amendment Bill refers to Goods and Service tax as any tax on supply of goods or services or both except taxes on the supply of the alcoholic liquor for human consumption.
GST – CONSUMPTION / DESTINATION BASED TAX
GST has been structured as a destination based comprehensive tax levied at a specified rate on sale and consumption of goods and services within a country. GST is a destination based Consumption Taxation where the TAX is levied on the supply of the goods and to be paid by the person who is the recipient of supply but the same is collected by the supplier of supply.
Section 9 of the CGST Act deals with the provisions relating to levy and collection of GST. Section 9(1) of the CGST Act reads as under:
Subject to the provisions of sub-section (2), there shall be levied a tax called the central goods and services tax on all intra-State supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, on the value determined under section 15 and at such rates, not exceeding twenty per cent., as may be notified by the Government on the recommendations of the Council and collected in such manner as may be prescribed and shall be paid by the taxable person.
The Key words for our purpose in the above section are two clauses.
- There shall be levied a Tax – which will be levied by the Government as may be notified by the Government on the recommendations of the GST Council
- Tax to be collected in such manner as may be prescribed and shall be paid by the Taxable Person.
Taxable Person has been defined under Section 2(107) – means a person who is registered or liable to be registered under Section 22 or Section 24.
Thus, the Tax levied by the Government has to be collected and paid by the Taxable Person. The Taxable Person is acting as an agent of the Government in the collection and payment of the GST. The Tax collected by the Taxable Person is not his funds but the funds collected on behalf of the Government and held in a fiduciary capacity.
Then there are provisions for the payment of the Tax so collected and other provisions for levy of interest and penal provisions for non-payment etc. However, for our purpose, the discussion is confined to the provision of Section 9(1) of CGST Act with reference to levy and collection of GST.
The Educational Material on the Ind AS – Revenue published by Institute of Chartered Accountants of India specifically deals with the situation as under:
Section 9(1) of the Central Goods and Services Tax Act, 2017 provides that, “Subject to the provisions of sub-section (2), there shall be levied a tax called the central goods and services tax (CGST) on all intra-state supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, on the value determined …… and collected in such manner as may be prescribed and shall be paid by the taxable person”.
Similar provisions are also included for State Goods and Services Tax Act (SGST), Integrated Goods and Services Tax Act (IGST) and Union Territory Goods and Services Tax Act (UGST).
In accordance with the above, the incidence of GST (i.e. CGST/SGST/IGST/ UGST) is on supply of goods or services and it is recovered from the Customer.
Paragraph 47 of Ind AS 115, inter alia, “an entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties”.
Amounts collected on behalf of third parties such as sales taxes, goods and services taxes and value added taxes are not economic benefits which flow to the entity. Therefore, they are excluded from revenue.
As per paragraph 9.1.3 of the ‘Guidance Note on Division II – Ind AS Schedule III to the Companies Act, 2013’, indirect taxes such as Sales tax, Service tax etc. are generally collected from the customer on behalf of the government in majority of the cases. However, this may not hold true in all cases and it is possible that a company may be acting as principal rather than as an agent in collecting these taxes.
Whether revenue should be presented gross or net of taxes should depend on whether the company is acting as a principal and hence, is responsible for paying tax on its own account or, whether it is acting as an agent, i.e. simply collecting and paying tax on behalf of the government authorities. If the entity is the principal, then revenue should also be grossed up for the tax billed to the customer and the tax payable should be shown as an expense. However, in cases, where a company collects such taxes only as an agent, revenue should be presented net of taxes.
Further, as per paragraph 9.1.6 of the said Guidance Note, under the GST regime, the collection of GST by an entity would not be an inflow on the entity’s own account but it shall be made on behalf of the government authorities. Accordingly, the revenue should be presented net of GST.
POSITION UNDER INSOLVENCY AND BANKRUPTCY CODE
Section 2(10) of the IBC, 2016 defines Creditor as – Means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder
Chapter I Section 5(20) defines Operational Creditor as – means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred
Section 5(21) defines Operational Debt as – means a claim in respect of the provision of goods or services including employment or a debt in respect of the 1[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;
Thus a joint reading of Section 5(21) and Section 5(20) will indicate in respect of 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 Central Government / State Government / or Local Authority is categorized as Operational Creditor.
The crucial words in the context of classification of the Government under the Operational Creditor category is “payment of dues arising under any law for the time being in force”.
Section 53 of the CGST Act prescribes the waterfall mechanism for the settlement of dues in the event of liquidation. Section 53 reads as under:
53. Distribution of assets.
(1) Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period as may be specified, namely: –
(a) the insolvency resolution process costs and the liquidation costs paid in full;
(b) the following debts which shall rank equally between and among the following
(i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and
(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;
(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;
(d) financial debts owed to unsecured creditors;
(e) the following dues shall rank equally between and among the following: –
(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;
(f) any remaining debts and dues;
(g) preference shareholders, if any; and
(h) equity shareholders or partners, as the case may be.
(2) Any contractual arrangements between recipients under sub-section (1) with equal ranking, if disrupting the order of priority under that sub-section shall be disregarded by the liquidator.
(3) The fees payable to the liquidator shall be deducted proportionately from the proceeds payable to each class of recipients under sub-section (1), and the proceeds to the relevant recipient shall be distributed after such deduction.
Explanation. – For the purpose of this section-
(i) it is hereby clarified that at each stage of the distribution of proceeds in respect of a class of recipients that rank equally, each of the debts will either be paid in full, or will be paid in equal proportion within the same class of recipients, if the proceeds are insufficient to meet the debts in full; and
(ii) the term “workmen’s dues” shall have the same meaning as assigned to it in section 326 of the Companies Act, 2013 (18 of 2013).
Thus under the Waterfall Mechanism the Due payables to Central Government / State Government or Local Authority get the share in the fifth place on pari passu with basis with debts owed to a secured creditor for any amount unpaid following the enforcement of security interest
However, we need to also look at the provisions relating to Liquidation Estate as per the IBC, 2016. Section 36 of IBC, 2016 deals with the provisions of Liquidation Estate and is reproduced below for ease of reference:
36. Liquidation estate.
(1) For the purposes of liquidation, the liquidator shall form an estate of the assets mentioned in sub-section (3), which will be called the liquidation estate in relation to the corporate debtor.
(2) The liquidator shall hold the liquidation estate as a fiduciary for the benefit of all the creditors.
(3) Subject to sub-section (4), the liquidation estate shall comprise all liquidation estate assets which shall include the following: –
(a) any assets over which the corporate debtor has ownership rights, including all rights and interests therein as evidenced in the balance sheet of the corporate debtor or an information utility or records in the registry or any depository recording securities of the corporate debtor or by any other means as may be specified by the Board, including shares held in any subsidiary of the corporate debtor;
(b) assets that may or may not be in possession of the corporate debtor including but not limited to encumbered assets;
(c) tangible assets, whether movable or immovable;
(d) intangible assets including but not limited to intellectual property, securities (including shares held in a subsidiary of the corporate debtor) and financial instruments, insurance policies, contractual rights;
(e) assets subject to the determination of ownership by the court or authority;
(f) any assets or their value recovered through proceedings for avoidance of transactions in accordance with this Chapter;
(g) any asset of the corporate debtor in respect of which a secured creditor has relinquished security interest;
(h) any other property belonging to or vested in the corporate debtor at the insolvency commencement date; and
(i) all proceeds of liquidation as and when they are realised.
(4) The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation: –
(a) assets owned by a third party which are in possession of the corporate debtor, including –
(i) assets held in trust for any third party;
(ii) bailment contracts;
(iii) all sums due to any workmen or employee from the provident fund, the pension fund and the gratuity fund;
(iv) other contractual arrangements which do not stipulate transfer of title but only use of the assets; and
(v) such other assets as may be notified by the Central Government in consultation with any financial sector regulator;
(b) assets in security collateral held by financial services providers and are subject to netting and set-off in multi-lateral trading or clearing transactions;
(c) personal assets of any shareholder or partner of a corporate debtor as the case may be provided such assets are not held on account of avoidance transactions that may be avoided under this Chapter;
(d) assets of any Indian or foreign subsidiary of the corporate debtor; or
(e) any other assets as may be specified by the Board, including assets which could be subject to set-off on account of mutual dealings between the corporate debtor and any creditor.
Of particular interest for us are the provisions specified under Section 36(4) which deal with exclusions from the liquidation estate.
Since GST has been collected on behalf of the Government and is to be payable by the Taxable Person the funds so collected are not the property of the Taxable Person (under GST) -also known as the Corporate Debtor under IBC. Thus such amounts will be covered under Section 36(4)(a)(i) for the monies i.e. the tax dues collected are done behalf of the Government i.e. those funds belong to the Government and held for payment back to the Government.
In Ganesh Export and Import Co Vs Mahadeolal Nathmal AIR 1956 Cal 188: 1955 25 Com Cas 357 Cal 59 CWN 89 it was held as follows:
What the General body of creditors can claim to be distributed among them are the assets of the Company. What then are the assets of a company? It does not require a statutory provision to establish that no property in which the company has not a beneficial interest can be one of its assets, even though it be a property held in its hands. In a property held by an insolvent, wholly in trust for another person, he has no beneficial interest and therefore such property cannot be one of his assets liable to distribution upon his own insolvency.
A trustee of monies can claim a refund from an insolvent company in priority over all creditors, not on the ground than obligation to return trust property must be discharged before an obligation to repay debts, but on the ground that the monies never became the property of the company and are not therefore divisible among its creditors.
If the monies have been kept separate, they must be handed back. Even if they have been mixed up with other funds of the Company, an equal amount if available, must first be extracted and paid over to the truster, subject to such deductions, if any, as may be provided for the by the trust itself. In order however that a property may be excluded from the assets of a company, divisible among its creditors, it is not necessary that it should be held formally in trust for a third party.
Where there is such a trust, the company has obviously no beneficial interest in it of the nature divisible among creditors upon insolvency. But there may also be a trust in effect. Property held by an insolvent in a fiduciary capacity is treated as property held in trust for the purposes of the insolvency laws and property held for a specific purpose is treated as clothed with a species of trust, subject to the same principles as trust property.
In all these cases, the property concerned is outside the divisible assets of the company. The party who put the property in the hands of the company can claim it back in a winding up as his property, while the creditors cannot claim that it should be brought into the distribution”
Adverting to the BLRC Report, the report at para 5.5.5. Establishing Assets in Liquidation stated as follows:
5.5.5. Establishing Assets in Liquidation
The Committee debated what assets of the entity must be available for realisation in liquidation. Not all assets that are present within the entity, from the start of the IRP, can be considered for Liquidation. The Committee agrees that the following sets of assets must be kept out of the liquidation process
1. Assets held by the entity in trust (such as employee pensions).
2. Assets held as collateral to certain financial market institutions (such as clearing corporations or similar financial transactions to either creditors or non-creditors). In other jurisdictions, these may be referred to as “assets subject to netting and set-off in multi-lateral trading or clearing transactions”.
In defining these assets, the Code will take cognizance of the assets that are used as collateral to ensure counterparty guarantees in financial transactions where clear legal documentation is available as proof of transaction (Reference to IFC). These funds and assets cannot be used for recovery in Liquidation.
3. Assets held as part of operational transactions where the entity has rights over the asset but is not the owner of the title of the asset. For example, there could be goods belonging to third parties given to the debtor for processing or value addition. The entity only has rights over goods held in inventory. But these are owned by the producer or a wholesale distributor of these goods. These can be claimed back by the owner, and cannot be sold to realise value in liquidation.
In Box 5.19 of the BLRC report dealing with Drafting instructions for establishing the assets of the entity in Liquidation it was mentioned at point No. 1 –
Only assets where the entity is a beneficial owner before the start of the IRP can be considered as available to realisation during Liquidation.
1. The assets that are not owned by the entity include:
2. Assets held in trust. An example are funds and securities held for employees pensions programs.
i. Assets that are held as security by financial market institutions that are laid out in the Indian Financial Code. These include collateral posted to the clearing corporation.
ii. Assets held as part of operational transactions which have been provided to the entity with reservation of title. These include goods in inventory where the title of the goods belongs to a trade creditor or a wholesale distributor.
iii. All such assets cannot be used by the liquidator to realise recoveries for creditors.
3. Access to security in contracts that were entered into prior to the IRP and Liquidation will not be changed as a consequence of Liquidation
A close reading of the above indicate that just like the employee contributions of Provident fund which is collected from the Employee for payment to PF Authorities / PF Trust which is excluded from the Liquidation Estate (see 2.(a) above) the GST collected on behalf of the Government to be paid also get covered under the same clause because of the nature of the transaction is similar to the amount of pension collected
Coming to the provisions of IBC in respect of the definition of a claim and debt which are necessary for the context of determining whether the repayment demanded of GST is a claim or debt under the provisions of IBC, 2016, let us look at the definitions of Claim and Debt under IBC.
Section 3(6) “claim” means –
(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured;
(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured;
Section 3(11) “debt” means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt;
There are two limbs to the definition of the Word Claim under Section 3(6) – (a) Right to Payment and (b) Right to remedy.
In the case of demand for payment of GST dues, the demand is not for a claim on the liquidation estate i.e. for distribution of the liquidation estate res. It is a demand for return of the monies collected on behalf of the Government which need to be restituted to the Government and it is not a contractual right. In this case, the Corporate Debtor does not have any beneficiary interest in the amount being demanded.
Coming to the definition of Debt, this definition can be invoked only if there is a liability or obligation in respect of a claim. When in the first place, the amount being demanded does not fit in the definition of claim, there is no question of its being called as a debt – whether financial or operational debt.
In view of the foregoing, any statutory dues collected such as GST, TDS, TCS, VAT, Employee contribution of PF/ESI deducted by Employer etc on behalf of the Government are monies held by the Corporate Debtor in Trust i.e. third party property held in trust and shall not therefore be part of the liquidation estate.
The respective Governments shall have an overriding title on the monies so collected and not refunded as the Corporate Debtor is holding such monies under Trust in a fiduciary capacity. The right of the respective Government is not a right under Creditors but a right of restitution for funds held by the Corporate Debtor under Trust.
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