TREATING TAX AUTHORITIES AT THE SAME PEDESTAL WITH SECURED CREDITORS: UNDOING THE SETTLED PRECEDENTS
[Mayank Gandhi is a third year student at Maharashtra National Law University, Nagpur]
Recently, the Supreme Court of India (“SC”) in the case of State Tax Officer v. Rainbow Papers Limited, has held that a Resolution Plan that does not include provisions for payment of tax due to the concerned state authorities will not have any binding value in the eyes of law. The Apex Court overruled the observations laid down by the National Company Law Appellate Tribunal (NCLAT). As a result, it is viewed that the charge created in favour of the secured creditor will include unpaid state taxes. In this respect, the author will analyse the decision of the Supreme Court considering ‘state’ as a secured creditor under the Insolvency and Bankruptcy Code, 2016 (“the Code”).
Background of the Case
Rainbow Papers Limited is engaged in the business of manufacturing and selling rafts and oars. As per the statement of accounts, an amount of Rs.53,71,65,489/- in the form of Value Added Tax and Central Sales Tax was owed by the corporate debtor against state tax authorities. Later on, an operational creditor initiated a Corporate Insolvency Resolution Process (“CIRP”) against the debtor, and claims were called by the resolution professional. The state authorities filed a claim of Rs.47.36 crores (approximately), under the Gujarat Value Added Tax act, 2003 (“GVAT Act”). Thereafter, a resolution plan was submitted. On October 22, 2018, the Resolution Professional apprised the state that their total claim has been waived off. The state appealed against the decision of the resolution professional before the National Company Law Tribunal and subsequently before the NCLAT. NCLAT dismissed the appeal of the state by declaring that it is not a secured creditor under Sections 3(30) and 3(31) of the Code. Being aggrieved by the decision of NCLAT, the appellant filed an appeal before the SC.
The decision of the Supreme Court
The Apex Court held that a resolution plan excluding any statutory dues owed to a statutory authority must be rejected by the adjudicating authority. The Court further held that statutory debt owed to tax authorities under the GVAT Act will create a secured interest in favour of the state, and accordingly, the state will be considered a secured creditor. Moreover, it was ruled that the provisions of Section 48 of the GVAT act are not inconsistent with or contrary to that of Section 53 of IBC or any other provisions of the Code. Lastly, the Court ruled that statutory debt owed to the state will fall within the ambit of debt owed to secured creditors as provided under Section 53 of the Code.
Analysis of the Court’s Decision
Inconsistency between the Code and GVAT Act: In the present case, the Supreme Court has observed that the provisions of section 48 of the GVAT do not conflict with the provisions of Section 53 of the Code. However, the author argues that Section 48 of the GVAT Act has given the first charge over property to the government, whereas Section 53 of the Code has ranked crown debts at fifth rank. Hence, prima facie, there exists an inconsistency between these two provisions. In this context, the Supreme Court in the case of Pr. CIT v. Monet Ispat and Energy has ruled that the Code by virtue of section 238 will prevail over all other legislations containing provisions inconsistent with the Code. Accordingly, the Code would take precedence over GVAT Act.
Non-obstante Clause:- The Supreme Court in the case of Solidaire India Ltd. v. Fair growth Financial Services has held that where there is a conflict between two special acts containing the non-obstante clause, the later one will prevail. The Court reasoned that the government at the time of enacting the latter one, would be aware of the earlier legislation and its non-obstante clause. Thus, even after being aware of such a clause, if the government enacted the later statute with a non-obstante clause, it implies the government’s intention that the later statute prevails over all other statutes. Applying the said reasoning to the present case, the author argues that since the Code was enacted later, the non-obstante clause of the Code will prevail over the GVAT Act.
Emphatic Language:- The Apex Court in the case of Kumaon Motor Owners’ Union Ltd. v. the State Of Uttar Pradesh has observed that if there exists any conflict/inconsistency between two Sections, then the Section having more emphatic language will prevail. Similar reasoning was observed in the case of Punjab National Bank vs Union of India. In the present case, Section 238 of the Code provides that the provisions of the Code will prevail over all the conflicting laws, whereas Section 48 of the GVAT Act later provides that, notwithstanding anything to the contrary contained in any law for the time being in force, tax payable to the government will be the first charge on the property. Hence, while interpreting both of these provisions, the author argues that the language used in Section 238 of the Code is more emphatic as compared to that used in Section 48 of GVAT Act. Hence, based on the above judicial pronouncements and reasoning, the author argues that the Code having more emphatic language will prevail over the GVAT Act.
Intent of the Legislation:- The GVAT Act was enacted with the intention to levy and collect tax on a value-added basis in respect of sales or purchases of goods in the State of Gujarat, whereas the Code was enacted with an aim to regulate insolvency and the resolution process in the whole of India. Hence, after considering the objective of the laws under consideration, the Code must prevail over the GVAT Act.
Doctrine of Priority of Crown Debts: This is a common law principle that was duly recognised and applied by the Indian judiciary prior to 1950. Further, this principle, by virtue of Article 372(1) of the Constitution, became a law in force and the Apex Court has also upheld this principle in its decision. As per the said principle, the priority of crown over recovery debts is limited only to unsecured creditors. The crown’s preferential right over the recovery of debts will be subordinate to that of secured creditor. Crown debt implies debt owed to the state or king. In the Supreme Court case of Rana Girders Ltd. v. Union of India has prioritised a secured creditor over the Central Excise dues. Similarly, the Bombay High Court in the case of State Bank of India v. State of Maharashtra has ruled that a secured creditor will be prioritised over tax dues to statutory authorities. Further, the Apex Court has held that tax dues are a part of crown debts and will be subordinate to dues owed to secured creditors. Therefore, based on the above decisions, the author argues that statutory dues created in favour of the state cannot be equated with charge created in favour of a secured creditor, and thereby, the Apex Court has failed to recognise its earlier decisions and common law principles relating to crown debts.
Legislative Intent: Further, in addition to the fact that the Code was enacted at a later point of time, the Supreme Court in the cases of Kumaon Motor Owners’ Union Limited v. the State Of Uttar Pradesh and Solidaire India Limited v. Fairgrowth Financial Services, has held that to resolve a conflict between two statutes, the object behind both the statutes must be looked into. Further, it can be inferred from several court decisions that if the charge created in favour of secured creditor under central legislation is ranked higher than dues owed to state tax authorities under state legislation, then a priority of charge in favour of a secured creditor over state is created under the central statute. As per Section 53 of the Code, debts owed to a secured creditor is mentioned under clause (b), whereas debt owed to a central or state government is mentioned in clause (e). Hence, it can be inferred that priority is given to secured creditors over the state, and accordingly, the author argues that the decision of the Supreme Court to treat statutory/state dues at par with the dues owed to secured creditors will go against the legislative intent and its settled precedents.
Secured Interest vis-à-vis Tax Charges Owed to State: In the present case, the Supreme Court held that state falls within the meaning of secured creditor. As per, section 3(30) of the Code, a secured creditor means a creditor in whose favour a security interest has been created. Further, as per Section 3(31) of the Code, secured interest means “a right, title or interest or a claim to property, created in favour of a secured creditor by a transaction securing payment or performance of any obligation of any person”. The definition of security interest is similar to that provided under section 2(zf) of the Securitisation And Reconstruction Of Financial Assets And Enforcement Of Security Interest Act, 2002 (SARFAESI Act).
Further, as per SARFAESI Act, “secured creditor means any bank or financial institution or any consortium or group of banks or financial institution”. This definition does not include state (tax authority) as secured creditor. Further, the principle of priority of crown debt refers that state is an unsecured creditor.
The Supreme Court in AI Champdany Industries Ltd. v. The Official Liquidator has held that the dues of municipal taxes do not create any encumbrance, right, title, or interest or a claim to property rather, it is a charge on the property that is owed to an unsecured creditor.
Drawing a reference from the above reasoning, the author is of the view that firstly, the state in the present question is not a secured creditor, and secondly, the claim of the state tax authorities over property by virtue of tax owed to the corporate debtor would not fall within the meaning of ‘security interest’. Hence, the Supreme Court has erred in holding that a statutory charge in terms of Section 48 of the GVAT Act would create a ‘security interest’ in favour of the state.
The author in this article has analysed the issue of whether statutory dues can be treated at par with dues owed to a secured creditor. The article has discussed various Supreme Court and High Court decisions to come to a conclusion that the preferential right of the state is limited to unsecured creditors only, and accordingly, dues owed to the state cannot be equated at par with secured creditors. In this context, the present decision of the Supreme Court is altogether on a different pedestal as compared to its past decisions. Hence, the author believes that the present decision is incorrect and requires reconsideration because treating state as a secured creditor defeats the intent of the legislature.
Lastly, the author finds that the present decision of the Court will strike directly at the waterfall mechanism and ‘priority of ranking’ provided under the Code under Section 53. The author concludes that the present decision will adversely affect the rights of workmen and secured creditors in resolution and liquidation process because now the assets/money will be distributed among three parties, leading to less share for workmen and secured creditors.