Supreme Court Holds Tax Authorities to be Secured Creditors: Quandary Revived

[Sikha Bansal is a Partner and Neha Sinha an Executive at Vinod Kothari & Company. They can be reached at [email protected]]

Earlier this week, in State Tax Officer v. Rainbow Papers Limited (6 September 2022), the Supreme Court (‘SC’) dealt with the question whether the provisions of Insolvency and Bankruptcy Code, 2016 (‘IBC’), especially section 53, overrides section 48 of the Gujarat Value Added Tax Act, 2003 (‘GVAT’). Section 48 of the GVAT is a non-obstante clause and creates a statutory first charge on the property of the dealer in favour of tax authorities against any amount payable by the dealer on account of tax, interest or penalty for which it is liable to pay to the Government.

The SC held that if the resolution plan excludes statutory dues payable to government or a government authority, it cannot be said to be in conformity to the provisions of IBC and, as such, not binding on the government. Further, section 48 of the GVAT is not inconsistent with the IBC and, hence, it was held that the IBC does not override the GVAT. The SC went on to rule that by virtue of the ‘security interest’ created in favour of the State under GVAT, the State is a ‘secured creditor’ according to the definition in the IBC.

In the view of the authors, the conclusions as above are different from the well-settled jurisprudence around the subject matter of conflict between the IBC and tax statutes and the question of priorities between these. A plethora of rulings, including by SC itself, go on to hold that crown debts would be subordinate to the dues of secured creditors, and none of these rulings ever equated tax dues to secured dues. The authors thus analyse the SC ruling in light of the construct of the IBC, intent of the lawmakers and policymakers, and various precedents and offer their views as to how this ruling has actually reopened a can of worms.  

Authors’ Analysis

Established jurisprudence on priority of secured creditors over tax dues

There have been instances in the past where the SC was faced with a similar question in the context of income-tax law, customs law, and similar legislation. In all such cases, the SC has upheld the precedence of secured creditor dues over tax dues. For instance, in Sundaresh Bhatt v. Central Board of Indirect Taxes and Customs (26 August 2022), the Court had held that the IBC has an overriding effect on Customs Act (which too, creates a statutory charge in favour of the customs authorities). Similarly, in PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited (2018), the SC relied on Dena Bank v. Bhikhabhai Prabhudas Parekh & Co. (2000), and unequivocally ruled that income-tax dues, being in the nature of Crown debts, do not take precedence even over secured creditors, who are private persons. Notably, in Dena Bank, the SC had held that “ the common law doctrine of priority of crown debts would not extend to providing preference to crown debts over secured private debts”. It may be noted that none of these past rulings have been referred to in the instant SC ruling. On similar lines, in Leo Edibles and Fats Limited v. the Tax Recovery Officer (2018), the Andhra Pradesh High Court has clearly ruled that income tax authorities cannot be equated to secured creditors, and thus cannot claim priority.

Further, the mere creation of a first charge in favour of the tax authorities does not accord ‘priority’ to them. In this respect, the Bombay High Court in the recent judgement of Jalgaon Janta Sahakari v. Joint Commissioner of Sales (30 August 2022) held tax dues to be subservient to secured creditors’ dues under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (the “SARFAESI Act’) and observed that “…there is no magic in the words ‘first charge’. Even a ‘first charge’, by express statutory intendment, can be made subordinate or subservient to a paramount charge.”

Hence, by no stretch of imagination can the tax dues be ranked at par with secured creditors’ dues. In fact, there are precedents where the courts asked the tax authorities and other statutory authorities to release the attachments with respect to properties of a corporate debtor under IBC. An instance on point is the ruling in Sundaresh Bhatt.

Definition of ‘security interest’ to be read with the definition of ‘transaction’

In the instant case, the SC ruled that because a statutory charge is created in terms of section 48 of the GVAT, the claim of the tax department of the State falls within the meaning of ‘security interest’ as defined in section 3(31) of the IBC. Thus, the State becomes a ‘secured creditor’ as defined in section 3(30) of IBC. The SC accepted the contentions of the State that the definition of ‘secured creditor’ is comprehensive and wide enough to cover all types of security interests. Further, the SC stated that the definition of secured creditor in the IBC does not exclude any government or governmental authority.

However, the authors’ view, the expressions ‘security interest’ and ‘secured creditors’ have to be read in accordance with the definitions assigned under section 3(31) and section 3(30) respectively. Therefore, in order to be a secured creditor, one has to have a ‘security interest’. The definition of ‘security interest’ reads to mean a right or title created by a ‘transaction’ which secures payment or performance of an obligation.

‘Transaction’, as defined in section 3(33) of IBC, includes an agreement or arrangement in writing for the transfer of assets, or funds, goods or services, from or to the corporate debtor. Hence, the concept of security interest, as used in debt recovery laws (such as the SARFAESI Act) as well as the IBC is inextricably linked to a consensual arrangement or a transaction between parties. It implies that the corporate debtor must be a party to the transaction who concludes such agreement or arrangement. Therefore, the definition seemingly covers only those security interests that are created by acts of parties. The concept cannot be stretched to include forced or non-consensual acts such as attachment of property by tax authorities[1]. As such, while an attachment under tax laws may create a statutory charge in favour of the tax authority (under respective laws); however, that does not impart the status of a ‘secured creditor’ in favour of the tax authority. Therefore, in no way a charge in favour of the tax authority under the tax laws can be said to be ‘security interest’.

Ranking of claims under section 53: Different treatment to secured creditors and Government dues

The construct of the IBC in terms of payment waterfall is quite clear. Section 53 puts secured creditors in second position in order of priority along with workmen’s dues, while dues to the Government are ranked fifth. If the intent of the lawmakers (and, thus, the construct of the IBC) was to treat the tax authorities on the same pedestal as secured creditors, then the purpose of having a separate rank for Government dues is not clear. And to say that tax dues will not form part of government dues is altogether counter-intuitive. In this respect, the Andhra Pradesh High Court in Leo Edibles had rightly observed that “…tax dues, being an input to the Consolidated Fund of India and of the States, clearly come within the ambit of section 53(1)(e) of the Code. If the Legislature, in its wisdom, assigned the fifth position in the order of priority to such dues, it is not for this Court to delve into or belittle the rationale underlying the same.

Intent and recommendations of Bankruptcy Law Reforms Committee (‘BLRC’)

The BLRC, in its interim as well as the final report, has elaborately discussed the prioritisation (or otherwise) of the crown debts. One of the recommendations of the BLRC in the interim report was that “there should be a separate declaratory provision that upholds the priority rights of secured creditors on their security interests notwithstanding anything to the contrary contained in any state or central law that imposes a tax or revenue payable to the Government by virtue of a specific statutory provision made as a first charge on the assets of the assessee; provided that such first charge may be allowed for claims that existed on the date when such security interest was created”.

In its final Report too, the BLRC had clearly envisaged priority of secured creditors over government dues: “The Committee has recommended to keep the right of the Central and State in the distribution waterfall in liquidation at a priority below the unsecured financial creditors in addition to all kinds of secured creditors for promoting the availability of credit and developing a market for unsecured financing (including the development of bond markets). In the long run, this would increase the availability of finance, reduce the cost of capital, promote entrepreneurship and lead to faster economic growth.” 

Overriding provisions of IBC

By virtue of section 238 of IBC, the legislation has an overriding effect over any other conflicting law. See Innoventive Industries Ltd. v. ICICI Bank (2017), Rajendra K. Bhutta v. Maharashtra Housing And Area Development Authority (2020). 

In this case, the SC held that section 48 of the GVAT Act is not inconsistent with the IBC. However, a bare perusal of section 53 of the IBC and section 48 of the GVAT indicates the conflicting scheme in terms of priority to Government dues. Nonetheless, even if the impugned provision of the GVAT has a non-obstante clause, it would not prevail over the IBC.  In Innoventive Industries, the SC had ruled the non-obstante clause of a Parliamentary enactment would prevail over the non-obstante clause of the State enactment. Even otherwise, pursuant to the doctrine of repugnancy, the central legislation, i.e., the IBC, shall prevail over the State legislation, i.e., GVAT. 

Closing Thoughts

The authors have already discussed how tax dues have always been held to be subservient to dues of secured creditors. Each of the competing creditors is entitled to a share of payments under resolution plan on the basis of liquidation value ascribable to such creditor (which again, is based on the concept of vertical comparison in terms of section 53). The courts have, from time to time, upheld the commercial wisdom of the committee of creditors. This is evident from a reading of section 30(4) of IBC, and an array of rulings like in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta (2019) and India Resurgence Arc Private Limited v. Amit Metaliks Limited (2021).

As such, saying that the tax dues must be paid-off under resolution plan without considering liquidation value and section 53 would be counter-intuitive. Consequently, the authors are of the view that a resolution plan cannot be rendered invalid solely because it does not provide for payment of tax dues.

Thus, the SC’s stance in the present judgement appears to be at considerable variance to its approach in the past. Ascribing the status of a secured creditor to tax authorities defeats the purpose of the priority ranking and waterfall mechanism in the IBC and strikes at the foundation of that legislation. This dictum would result in Government dues being treated pari passu with secured creditors and workmen’s dues which may result in dilution of the rights enjoyed by workmen, as well as secured creditors as a whole. Further, putting secured creditors, tax authorities and workmen in the same pedestal would create a new tussle in the payment of dues on liquidation as well as other resolution processes. 

Sikha Bansal & Neha Sinha

[1] In Law Relating to Insolvency and Bankruptcy Code 2016, Taxmann (2016), Vinod Kothari and Sikha Bansal observe:  “Noticeably, the words “created in favour of, or provided for a secured creditor” are qualified by “by a transaction” which secures payment or performance of an obligation. This implies that there must be a ‘transaction’ which purports to secure payment or performance of an obligation and for this purpose, creates or provides security interest in favour of or for a secured creditor . . . Transaction, as defined under clause (33) of section 3, includes an agreement or arrangement in writing for the transfer of assets, or funds, goods or services, from or to the corporate debtor. It implies that the corporate debtor must be a party to the transaction who concludes such agreement or arrangement. Therefore, the definition seemingly covers only those security interests that are created by acts of parties.


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