INTRODUCTION
The recent judgment by the National Company Law Appellate Tribunal (NCLAT) in the case of Avil Menezes (Liquidator) vs. Principal Chief Commissioner of Income Tax, Mumbai (2024- NCLAT) addresses significant issues concerning the applicability of the moratorium under Section 33(5) of the Insolvency and Bankruptcy Code (IBC) during the liquidation process. The judgment clarifies whether the Income Tax Department can adjust income tax refunds against past dues during liquidation and the scope of the moratorium in such scenarios. This case provides insights into the interpretation of Sections 14 and 33(5) of IBC, the concept of secured creditors, and the principle of set-off during the liquidation process, impacting the Corporate Insolvency Resolution Process (CIRP) and ongoing cases under consideration of the National Company Law Tribunals (NCLTs).
FACTS
- The Corporate Debtor was admitted into CIRP on 10.09.2018 and later on failure of the process, the Corporate Debtor went into liquidation on 25.06.2019. On examination of the Annual Information Statement (AIS) of the Corporate Debtor, it came to the notice of the Liquidator that the Corporate Debtor was entitled to receive Income Tax Refund for the A.Y. 2021-2022 for an amount of INR 5.84 cores and interest thereon amounting INR 11.46 lakhs.
- The above Income Tax Refund amount was adjusted on 12.11.2021 by the Income Tax Department (Respondent) against Income Tax demand for A.Y. 2010-2011 for INR 2.98 crores and for A.Y. 2011-2012 amounting INR 2.85 rores.The Corporate Debtor was also entitled to receive Income Tax Refund of INR 60.79 lakhs for A.Y. 2020- 2021 and this the said amount had also been adjusted by the Income Tax Department against pre-CIRP Income Tax dues.
- The NCLAT has dismissed the application filed by the Appellant-Liquidator seeking return of Income Tax refund amount of two previous assessment years of the liquidation estate of the Corporate Debtor-Sunil Hitech and Engineers Ltd.
CRITICAL FEATURES OF NCLAT JUDGMENT AND IMPACT ON CIRP AND LIQUIDATION PROCESS
Moratorium under Section 33(5) vs. Section 14 of IBC:
The judgment distinguishes the moratoriums under Section 14, applicable during CIRP, and Section 33(5), applicable during liquidation. While Section 14 imposes a broad moratorium on the institution and continuation of pending suits or proceedings, Section 33(5) only bars the institution of new suits, allowing pending suits or proceedings to continue during the liquidation process. This interpretation clarifies that ongoing legal actions can proceed without requiring permission from the Adjudicating Authority, thus providing more flexibility in handling such cases during liquidation.
Income Tax Department as Secured Creditor:
The NCLAT examined whether the Income Tax Department could be considered a secured creditor under Section 245(1) of the Income Tax Act, 1961. The tribunal referred to previous judgments and concluded that the Income Tax Department does not qualify as a secured creditor in this context. This distinction is crucial as it impacts the department's ability to claim priority in recovering dues during liquidation.
Principle of Set-off during Liquidation
The judgment clarifies that the principle of set-off is permissible during liquidation, as outlined in Regulation 29 of the Liquidation Regulations. However, the Income Tax Department's unilateral action in adjusting the income tax refund against pre-CIRP dues without filing claims with the Liquidator was deemed improper. This emphasizes the need for statutory compliance and equitable treatment of creditors in the liquidation process, ensuring that no creditor receives a disproportionate share of the liquidation assets.
ANALYSIS AND CORRECT PROCEDURE FOR CLAIMING SET-OFF
Findings of the Court:
The main issue before the Court was whether the NCLT had the jurisdiction to give directions to ED for release of the Corporate Debtor's attached properties by invoking Section 32A of IBC.
After consideration of the arguments advanced and the precedents cited by both the parties to the writ petitions, the Court inter alia held that NCLT was well within its jurisdiction in declaring that the Corporate Debtor would stand discharged from offences alleged to have been committed prior to CIRP and that the attached properties shall become free from attachment on approval of the resolution plan.
The Court observed that Section 32A of the IBC is a non-obstante provision enabling an automatic discharge from prosecution. This immunity is available solely to the Corporate Debtor and only when the resolution plan is approved governing a complete change in control and management of the Corporate Debtor. The aforesaid protection is also extended to the property of the Corporate Debtor under sub-clause (2) of Section 32A. The Court also examined the purpose and object of Sections 31 and 60(5) of IBC which explicitly depicts that the legislature has enjoined NCLT with the duty to ensure that the resolution plan can be effectively implemented and with the jurisdiction to dispose any question of law arising in relation to resolution proceedings.
The Court relied on the landmark Supreme Court judgement of Manish Kumar vs. Union of India1 upholding the constitutional validity of Section 32A of IBC, to feature the legislative intent behind Section 32A which provision gives immunity to the Corporate Debtor from actions taken by authorities, including attachment under PMLA.
Hence, once the conditions under Section 32A of IBC are met, any further prosecution against the Corporate Debtor and its properties shall cease and the Corporate Debtor is only required to cooperate/assist the authorities in the continued prosecution against the individuals involved in the offence.
ANALYSIS AND CORRECT PROCEDURE FOR CLAIMING SET-OFF
- Continuation of Legal Proceedings During Liquidation: As mentioned above, the moratorium under Section 33(5) of the IBC applies only to the initiation of new suits or legal proceedings and not to the continuation of existing ones. This is distinct from the moratorium under Section 14 of the IBC, which bars both the initiation and continuation of proceedings during the CIRP. In this context, the IT Department was legally entitled to continue with the Income Tax assessment proceedings during the liquidation process, as there was no statutory bar on such continuation.
- Principle of Set-Off During Liquidation: The IBC does not impose any restriction, prohibition, or embargo on the principle of set-off during liquidation proceedings. Regulation 29 of the Liquidation Regulations explicitly provides for the right of set-off, enabling mutual credits and dealings between the parties. The principle of set-off stands on the premise of mutual credits and dealings. However, this principle must be applied correctly within the procedural framework laid down by the IBC.
- Distinction Between Pre-Liquidation and Post-Liquidation Set-Off: The case of Devarajan Raman (Liquidator) v. Principal Commissioner Income Tax (2024 NCLAT) clarified that set-off claimed during the CIRP (pre-liquidation) was not permissible. However, in the present case, the set-off was claimed post-liquidation order, which is legally permissible under Chapter III Part II of the IBC. This distinction is crucial in understanding the permissibility of the set-off action taken by the IT Department.
- Infirmity in Suo-Motu Set-Off by the IT Department: The IT Department unilaterally appropriated the Income Tax Refund amount by setting it off against the tax arrears of the pre-CIRP period without following the due process prescribed under the IBC. According to the Sundaresh Bhatt judgment, while statutory authorities can determine tax dues during the moratorium, they cannot enforce recovery of these dues unilaterally. This principle extends to the liquidation process, emphasizing that the IT Department does not have the jurisdiction to suo-motu adjust refunds without filing claims in accordance with the IBC procedures.
- Ensuring Equitable Treatment of Creditors: The principle of set-off must ensure that no creditor receives a disproportionate share of the liquidation assets. All claimants must stake their claims for the distribution of proceeds as per Section 53 of the IBC. The IT Department's unilateral action placed it in a better footing than other creditors, violating the equitable treatment principle mandated by the IBC.
CORRECT PROCEDURE FOR CLAIMING SET-OFF
- Filing Claims with the Liquidator: The IT Department, like any other creditor, must submit its claims to the Liquidator in the prescribed form (Form D) as per Regulation 18 of the Liquidation Regulations. The claims should detail the tax arrears and any anticipated refunds, following the public announcement made by the Liquidator inviting claims from all stakeholders.
- Determination of Claims: The Liquidator will verify the claims submitted by the IT Department along with claims from other creditors. The verified claims will be admitted into the liquidation process, and the creditors' entitlements will be determined based on their verified claims.
- Application of Set-Off: The principle of set-off can be applied once the claims are verified. The IT Department can then request the Liquidator to set off the tax arrears against the Income Tax Refund amount. The set-off will be executed, ensuring that the IT Department does not receive more than its entitlement as per the distribution matrix under Section 53 of the IBC.
- Distribution of Liquidation Proceeds: The Liquidator will distribute the proceeds from the liquidation estate in accordance with Section 53 of the IBC, ensuring proportional and equitable distribution among all creditors, including the IT Department.
- Adjudicating Authority's Approval: Any disputes or excess amounts adjusted by the IT Department beyond its entitlement must be brought before the Adjudicating Authority for review. The Adjudicating Authority will determine the correct quantum of set-off and direct the IT Department to refund any excess amount if necessary.
IMPACT ON PENDING CASES UNDER NCLTS
This judgment will influence pending cases under NCLTs by providing clear guidelines on the continuation of legal proceedings during liquidation and the treatment of claims by statutory authorities like the Income Tax Department. It reinforces the importance of following due process and the hierarchy of claims as prescribed under the IBC, promoting fairness and transparency in the resolution and liquidation processes.
CONCLUSION
The NCLAT's decision in Avil Menezes (Liquidator) vs. Principal Chief Commissioner of Income Tax, Mumbai offers essential clarifications on the interplay between IBC provisions and income tax regulations during liquidation. By distinguishing the moratorium scopes under Sections 14 and 33(5) of IBC and addressing the principle of set-off, the judgment ensures a more predictable and equitable framework for resolving insolvency and liquidation cases.
The NCLAT's decision also highlights the importance of following the correct procedural framework under the IBC for claiming set-offs during liquidation. The IT Department's unilateral appropriation of the Income Tax Refund amount was found to be improper, emphasizing the need for statutory compliance and equitable treatment of all creditors. The judgment provides clarity on the continuation of legal proceedings during liquidation and reinforces the principle that all claims, including those from statutory authorities, must follow the due process prescribed by the IBC.
ANNEXURES
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List of Judgments Referred and Gist Principal Commissioner of Income Tax Vs Assam Company India Ltd. (2023- NCLAT) Gist: This judgment considered whether the Income Tax Department could be deemed a secured creditor. The tribunal initially held that government authorities, including the Income Tax Department, could be considered secured creditors based on statutory provisions. However, this position was later confined to specific statutory contexts, particularly under the Gujarat Value Added Tax Act, as clarified by subsequent judgments. State Tax Officer (1) Vs. Rainbow Papers Limited (2022- SC) Gist: The Supreme Court held that the operational creditor could be treated as a secured creditor based on specific statutory provisions of the Gujarat Value Added Tax, 2003. This case was pivotal in determining the status of government dues and their priority during insolvency proceedings. Paschimanchal Vidyut Vitran Nigam Ltd. Vs. Raman Ispat Pvt. Ltd. & Ors (2023- SC) Gist: The Supreme Court clarified that the ratio of the Rainbow Papers case should be confined to its specific statutory context, emphasizing that not all government dues automatically qualify as secured under insolvency proceedings. Mr. Devarajan Raman (Liquidator) v. Principal Commissioner Income Tax and Ors (2024 – NCLAT) Gist: This case held that set-off of tax dues by the Income Tax Department was impermissible during the CIRP phase. The principle of set-off could not be applied until after the liquidation order was passed, reinforcing the distinct procedural requirements during CIRP and liquidation. Sundaresh Bhatt, Liquidator of ABG Shipyard v. Central Board of Indirect Taxes and Customs (2022 – SC) Gist: The Supreme Court ruled that while statutory authorities could determine the quantum of tax dues during the moratorium, they could not enforce or recover these dues unilaterally. This judgment highlighted the limited jurisdiction of statutory authorities during the insolvency process. Principal Commissioner of Income Tax Vs Monnet Ispat and Energy Ltd. (2018) 18 SCC 786 Gist: The Supreme Court held that Section 238 of IBC, which provides an overriding effect over other laws, includes tax laws. This judgment reinforced the precedence of IBC provisions over conflicting statutory claims, including those from the Income Tax Department. |
Footnote
1. 2021 5 SCC 1
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