Direct Tax

Empty Liquor Bottles Are Not Scrap: Madras High Court

by

The Madras High Court in a recent decision[1] held that empty liquor bottles do not constitute scrap under Section 206C, IT Act, 1961. Accordingly, it held that the petitioner, M/s Tamil Nadu State Marketing Corporation Ltd (‘TASMAC’), was not obliged to deduct tax at source when collecting licence fee from bar licencees who were authorized to sell empty bottles left behind by customers. 

Facts 

The petitioner, TASMAC, challenged the orders of the Income Tax Department wherein it was treated as an ‘assessee in default’ for failure to deduct tax at source under Section 206C, IT Act, 1961. The Income Tax Department contended that the petitioner should have deducted TCS on the amounts tendered by the successful bar licensee towards tax from sale of empty bottles by treating the sale of bottles as scrap. The petitioner has been given a statutory monopoly to sell – wholesale and retail – Indian Made Foreign Liquor (IMFL), in the State of Tamil Nadu. The petitioner invites tenders for running bars adjacent to its retail vending  liquor shops. It floats tenders to select third-party bar contractors to sell eatables and collect empty bottles from bars adjacent to its retail shops. As per the terms of bar licence, the licencee was allowed monetise empty bottles. The petitioner selected the winning tenders, used to retain 1% of the tender amount as agency commission and remit the remaining 99% to the State Government.  

The Income Tax Department contended that the petitioner fulfilled the conditions of being a seller under Explanation to Section 206C of the IT Act, 1961. The Department elaborated that the petitioner alone had the right over empty bottles as only it could award tenders for their sale and thus the awarding of tenders amounted to it selling scrap to winning bidders through the tendering process. 

The petitioners, on the other hand, contended that they only sold alcohol from distilleries and breweries to their ultimate customers via their retail outlets and they did not sell empty bottles to the customers. The petitioner clarified that the empty liquor bottles were sold by the licencees and they retained the entire consideration. Thus, the contention that the petitioner was seller of empty bottles and licencees the buyer was erroneous.  

High Court’s Interpretation of ‘Manufacture’ and ‘Scrap’ Proves Crucial    

The Madras High Court waxed eloquent and in a verbose manner about the role of petitioner in the State of Tamil Nadu. However, the issue that proved crucial to the fate of the case was the meaning of scrap. The Income Tax Department argued that empty bottles constituted scrap as per Explanation to Section 206C while the petitioner argued otherwise. Explanation (b) to Section 206C states that for the purpose of this Section – 

            Scrap means waste and scrap from the manufacture or mechanical working of materials which is definitely not usable as such because of breakage, cutting up, wear and other reasons; (emphasis added)

The Income Tax Department argued that the empty bottles were scrap since they were constituted via a mechanical process. The argument was that empty bottles were only generated when the liquor bottles are opened and consumed by the consumers and that the process of opening bottled liquor bottles involved them being subjected to external force beyond their yield strength to access contents of the bottle which was nothing but a mechanical process. (para 49) The petitioner described the above interpretation of the term mechanical process as absurd and unsustainable in law. (para 34)

The Madras High Court observed that while the term ‘manufacture’ had been defined under Section 2(29BA) of IT Act, 1961 the term ‘mechanical working of materials’ in the definition of scrap has not been defined separately. In the absence of a separate definition, the High Court noted that the doctrine of nocitur a sociis should be applied. The said doctrine, in its simplest version, means that when two or more words susceptible of analogous meaning are used together they must be understood in cognate sense as if they take their colour from each other. (paras 90-91) Relying on the above doctrine, the High Court opined that that an activity that does not amount to manufacture but resembles manufacture is the only activity that can be included in the expression ‘mechanical working of material.’ And accordingly, the High Court concluded that:

Mere opening, breaking or uncorking of a liquor bottle by mere twisting the seal in a liquor bottle will not amount to generation of “scrap” from “mechanical working of material” for the purpose of explanation to Section 206C of the Act. 

That apart, the activity of opening or uncorking of the bottle is also not by the petitioner. These are independent and autonomous acts of individual consumers who decides to consume liquor purchased from the Tasmac Shops of the petitioner which have a licensed premises (Bar) adjacent to them under the provisions of the Tamil Nadu Liquor Retail Vending (in Shops and Bars) Rules, 2003. (paras 99 and 100)

The Madras High Court further underlined its observations by stating that the empty water bottles were neither the property of the petitioners or of the licencees, and that the petitioner was merely regulating the sales of empty bottles and the same cannot be equated to sale of bottles by the petitioner. 

Conclusion 

The Madras High Court adopted a prudent approach in the impugned case by relying on and correctly applying the doctrine of nocitur a sociis. The said approach was a reasonable way of rebutting the Income Tax Department’s argument that opening of the liquor bottle amounted to a mechanical process, an interpretation that certainly stretched the limits of acceptable interpretation of expressions used in a tax statute.    

[1] M/s Tamil Nadu State Marketing Corporation Ltd v The Deputy Commissioner of Income Tax TS-798-HC-2023MAD. 

Citing DIN in Communication is Necessary: ITAT, Chandigarh

by

Income Tax Appellate Tribunal, Chandigarh (ITAT) in its recent decision[1] followed the decisions pronounced by the Delhi High Court and the Bombay High Court which had held that quoting DIN in the body of communication issued by the Income Tax Department is mandatory by strictly interpreting CBIC’s Circular. ITAT held that the Income Tax Department cannot take recourse to Section 293B, IT Act, 1961 and argue that the error of not quoting the DIN does not affect the validity of the communication. 

Facts 

The brief facts of case are: the assessee filed its return of income and the relevant assessment proceedings were completed. But subsequently after search proceedings in the assessee’s premises were completed, the Assessing Officer (‘AO’) stated that some of assessee’s income had escaped assessment due to assessee’s failure to fully and truly disclose certain materials. AO added additional income and passed a reassessment which was challenged by the assessee. One of the grounds of challenge before ITAT was that the AO did not follow the prescribed procedure, the assessment order was not uploaded on the e-filing portal of the assessee and was communicated via courier without mentioning the DIN. The ITAT noted that the ground relating to not mentioning the DIN was the heart of the matter and adjudicated on it on priority. And ITAT’s ruling on the said issue proved crucial to assessee’s success in the case. 

Arguments 

The arguments on the issue of DIN were simple: the assessee argued that not quoting DIN in the communication issued by the Income Tax Department was contrary to CBIC’s Circular and thus liable to be struck down. The assessee elaborated that DIN was mentioned in the demand notice, but not in the reassessment order. And both the notice and order are required to be issued under different provisions of the statute, are separate communications and thus require their own DIN. In essence, the assessee’s case was that omission to cite DIN in the body of the reassessement order was fatal and in direct contravention of the CBDT’s Circular and thus should be struck down. 

The Income Tax Department tried to justify the non-citation of DIN in the body of assessment on various grounds, two of which included: first, that the demand notice and assessment order were not two separate communications and thus the latter did not require a separate DIN; second, that the omission of DIN can be saved by Section 292B, IT Act, 1961. Section 292B states that any return of income, assessment, notice, summons or other proceedings issued or purported to have been issued under the provisions of IT Act, 1961 shall not be invalid merely by reason of any mistake, defect, or omission if such communication is in substance and effect in conformity with or according to the intent and purpose of IT Act, 1961. 

ITAT’s Decision 

ITAT cited the CBDT Circular and arrived at the prudent conclusion that the CBDT Circular was clear in its mandate that the Income Tax Department shall not issue any communication without generating a DIN and quoting it in the body of the communication. No relaxation is provided in the Circular except when manual communication may be issued with prior approval of the Principal Commissioner. The ITAT also noted that the CBDT Circular clearly provided that in the absence of adherence to the conditions prescribed, it shall be presumed that the communication is invalid and deemed to have never been issued. 

The reassessment order, the ITAT held, was issued contrary to the conditions prescribed in the CBDT Circular, i.e., it did not cite the DIN in its body nor did it adhere to the conditions prescribed for issuing manual communication. Thus, it held the impugned communication to be invalid. 

ITAT did not accept any of the Income Tax Department’s arguments. It held that while the demand notice and the subsequent assessment order were part of the same assessment proceedings and their close connection cannot be denied. However, the demand notice is passed under Section 156, IT Act, 1961 while an assessment order is passed under Section 143 read with Section 147 of the IT Act, 1961. And more importantly it noted that no exception was provided in the CBDT Circular regarding issuance of successive communications to the same assessee, on the same date and regarding the same assessment year. ITAT concluded that: 

Therefore, in the instant case, we find that assessment order and notice of demand are two separate communications qua the assessee and carry separate physical existence and identity, even though issued on the same date by the same Assessing officer pertaining to same assessment year and therefore, necessarily have to carry separate DIN on the body of the said communications. In view of the admitted position that there is no DIN on body of the assessment order (even though there is DIN on body of the notice of demand), the same will continue to be non- compliant with paragraph 2 of the CBDT Circular no. 19/2019 and carry the same consequences in terms of paragraph 4 of the CBDT Circular and will be held as invalid and never been issued. (para 21) 

The Income Department was not allowed to take recourse to Section 292B as the ITAT relied on the relevant precedents to state that the language used in the CBDT Circular did not leave room for any alternate view or leeway and the said Circular is binding on the revenue as per Section 119, IT Act, 1961. The ‘phraseology’ used in paragraph 4 of the CBDT Circular which states that a communication shall be treated as never issued was relied on to conclude that Section 292B was inapplicable to the impugned case. 

Conclusion 

The ITAT’s decisions follow what is now a growing body of jurisprudence on the issue with several High Courts and ITATs deciding that not quoting DIN in the body of communication is fatal to the communication and contrary to CBDT’s Circular. The ITAT in this decision reiterates the earlier decisions with the additional input that demand notices and assessment orders cannot be treated as a single communication and are separate orders requiring their own DIN. As I stated in my recent post on ITAT Chennai’s decision on the same issue, decisions that strictly interpret CBDT’s Circular are welcome and hold them the Income Tax Department to standards that itself has prescribed for its officers.  

[1] M/s SPS Structures Ltd v The DCIT Central Circle-1, Chandigarh TS-791-ITAT-2023. 

CSR Expenses Can be Claimed under Section 80G: ITAT Mumbai

by

The ITAT Mumbai in a recent decision[1] clearly enunciated the tax treatment to CSR expenses under the IT Act, 1961. The ITAT held that while Explanation 2 to Section 37 disallows CSR expenses by way of business expenditure, but the import of the provision cannot be imported to CSR contributions which are otherwise eligible for deduction. Section 37 disallows mandatory CSR expenses referred to in Section 135, Companies Act, 2013 and not voluntary CSR expenses. The impugned case dealt with the former.  

Facts 

Principal Commissioner of Income Tax passed an order under Section 263 stating that the Assessing Officer’s assessment order was prejudicial to the interest of the revenue on the ground that assessee’s claim for deduction under Section 80G in respect of CSR expenses was allowed. The Principal Commissioner was of the view that any CSR expenditure incurred by an assessee shall not be deemed to be expenditure incurred for the purpose of business or profession and thus cannot be claimed as an expense even if part of the expense was spent on a trust/society which was otherwise eligible for deduction under Section 80G. The Principal Commissioner restored the matter to the Assessing Officer stating that the assessee’s claim under Section 80G be disallowed on CSR expenses. 

Against the said order, the assessee filed an appeal before the ITAT. 

ITAT’s Decision 

The ITAT’s decision in the impugned case is a good example of harmonious and strict interpretation of the tax statute. The Revenue’s argument was that if the sum satisfies the requirement of a CSR expense under Section 135, Companies Act, 2013 the sum gets exhausted and is no longer available for claiming the benefit under Section 80G of the IT Act, 1961. The ITAT noted that there is no provision in the IT Act, 1961 which satisfies the Revenue’s contention. The ITAT noted Section 80G barred claiming of CSR expenses if they were allocated to two funds i.e., Swach Bharat Fund and Clean Ganga Fund. While a similar restriction was not prescribed towards any other fund listed under Section 80G. This implied that if CSR expenses were allocated to any other fund listed under Section 80G, other than the two aforementioned funds there was no express prohibition of claiming deductions for donations made to other funds. ITAT noted: 

Out of so many entries under section 80G(2) of the Act, only donations in respect of two entries are restricted if such payments were towards the discharge of the CSR. The Legislature could have put a similar embargo in respect of the other entries also, but such a restriction is conspicuously absent for other entries. The irresistible conclusion that would flow from it is that it is not the legislative intention to bar the payments covered by section 80G(2) of the Act which were made pursuant to the CSR, and other than covered by section 80G(2)(iiihk) and (iiihl) of the Act. (para 6)

More pertinently, the ITAT noted that Explanation 2 to Section 37 disallowed deductions of CSR expenses only for the purpose of computing business under Chapter IV-D of IT Act, 1961 and it could not be extended or imported to CSR contributions which were otherwise eligible for deduction under Chapter VI-A of the IT Act, 1961. ITAT elaborated that the legislature intended to deny assessee the benefit under Chapter IVD pertaining to ‘Income under the head Business and Profession’. However, if the assessee is denied the benefit under Chapter VIA while computing ‘Total Taxable Income’, it would result in double disallowance to the assessee contrary to legislative intention. 

Conclusion The ITAT’s observations were founded on two pillars: first, that CSR expenses under Section 80G are only barred for two specific funds and thus donations to other funds can be claimed as expenses; second, the restriction under Explanation 2 to Section 37 was only for computing income under the head of income from business or profession and could not be used as a tool while computing total income under a separate Chapter of the IT Act, 1961. The latter observation relies on treating the two Chapters of IT Act, 1961, i.e., Chapter IVD and Chapter VI-A as independent and self-contained codes. This view is not unimpeachable, though in the impugned case the ITAT adopted a strict interpretation of the provisions and apart from the express disallowance for CSR expenses under Section 80G, it correctly held that assessee was allowed to claim expenses for other donations.    

[1] Societe Generale Securities India Pvt Ltd v PCIT TS-770-ITAT-2023. 

Quoting DIN in Body of Communication is Mandatory: ITAT Chennai 

by

The Income Tax Appellate Tribunal, Chennai (‘ITAT’) recently pronounced a decision[1] that strictly interpreted the CBDT’s Circular that all communication issued by the Income Tax Department relating to assessment, appeals, orders, statutory or otherwise issued on or after 1.10.2019 should carry a computer-generated Document Identification Number (DIN) duly quoted in the body of such communication. In this post, I will focus only on the DIN-related arguments and observations of ITAT, though there were a few ancillary issues that were discussed in this case.  

Impugned Circular

The impugned CBDT Circular states that while almost all notices and orders of the Income Tax Department are being generated electronically to maintain an audit trail of communication. However, some orders were being issued manually. To prevent instances of manual communication and improve the audit trail, the Circular mandated no communication shall be issued unless a computer-generated DIN is issued and ‘duly quoted in the body of communication.’ The Circular allowed manual communication only in exceptional circumstances with prior approval of the Chief Commissioner/Director General of Income Tax. Paragraph 4 of the Circular was clear about the implication of not following the Circular’s mandate – any communication issued in violation of the mandate would be deemed to have never been issued and shall be treated as invalid. 

Brief Facts 

The ITAT in the impugned case decided a batch of 54 appeals and only briefly narrated the facts one case. I will do the same. The communication that was the center of controversy was an instruction issued by the Dispute Resolution Panel (‘DRP’), an alternate body of dispute resolution created under the IT Act, 1961. DRP issued instructions to the Assessing Officer (‘AO’) under Section 144C(5) to complete the assessment of the assessee. The said instruction did not cite/contain a DIN in its body. The assessees contended that the instruction was invalid in law for being in contravention of the CDBT’s Circular and thus the subsequent assessment by the AO was also invalid since it was completed beyond the prescribed limitation period. The reason was that under Section 144C(13) the standard time limit for completing assessments by AO are extended to allow the AO to complete the assessment as per the DRP’s instructions. However, the assessees argued that if the DRP’s instructions to AO are invalid – because they did not cite the DIN – then the subsequent assessment completed by AO on such instructions are invalid since they were barred by limitation. 

The Income Tax Department adopted various arguments to persuade ITAT that the instructions issued by DRP were valid. The primary arguments were that the DIN of the relevant communication was generated on the same day or the next day and communicated to the relevant parties. The Income Tax Department also tried to defend the lack of DIN by arguing that instruction was an internal communication and thus it was not bound by the Circular’s mandate and further that DRP was not an income tax authority under IT Act, 1961 and only income tax authorities were obligated to follow the instructions contained in the CBDT Circular.   

ITAT Decides in Favor of Assessee

The ITAT was not persuaded by any of the Income Tax Department’s arguments. ITAT cited the CBDT Circular and noted that it is undoubtedly clear that any communication issued on or after 01.10.2019 without a valid DIN and quoted in the body of the order is invalid. ITAT noted the Income Tax Department’s argument that in each case before it, the DIN was communicated to the assessee by generating it on the same day or next day. ITAT, however, interpreted the conditions in the CBDT Circular strictly and noted that it contained two conditions: (i) generation of DIN; (ii) quoting the DIN in the body of communication. Thus, making it clear that the Income Tax Department had not complied with the two conditions of the CBDT Circular. 

The exception envisaged under the CBDT Circular wherein a manual communication could be issued without generating a DIN needs to state that the communication is being issued without generating a DIN and the approval of Chief Commissioner/Director General of Income Tax and the date of approval also needs to be mentioned. ITAT held that impugned communications did not satisfy the conditions provided in the exception either.

ITAT’s conclusion was unequivocal: 

In the present case, there is no dispute with regard to fact that mandatory requirement of generating a computer-based DIN has not been allotted and is duly quoted in the body of the order issued by the AO/DRP. Subsequent generation of DIN either on the same day or next day and intimated to the assessee or other person by way of separate communication does not satisfy the conditions of para 3 & 4 of said circular. Therefore, we are of the considered view that any communication issued by the income-tax authority, in the present case, the AO/DRP without a valid computer-generated DIN and is duly quoted in the body of the order is invalid, non-est and shall be deemed to have never been issued. (para 26)

ITAT also rejected the other arguments of the Income Tax Department that DRP’s instructions are internal communication and that DRP is not an income tax authority. As regards the former, ITAT held that the DRP’s instructions were to help AO complete the assessment and that was objective of the instructions, but the instructions were also communicated to the asssessee negating the argument that they constitute an internal communication. (para 27) For the latter, the ITAT held that DRP constituted a collegium of three Principal Commissioners or Commissioners of Income Tax and all three of them are income tax authorities under IT Act, 1961. Since DRP is an association/group of such income tax authorities, the argument that DRP is not an income tax authority does not hold water. (para 27)   

Conclusion 

ITAT concluded that once the DRP instructions are held to be bad in law and deemed to have never been issued, the AO could not have passed assessment orders under Section 144C(13) and thus the assessment orders were liable to be quashed. The ITAT adopted a cogent approach in adjudicating the matter and interpreted the conditions contained in CBDT Circular in a straightforward manner. The import of the Circular was clear, i.e., a DIN should be generated before issuing the communication and the same should be quoted in the body of the communication to maintain and enable a proper audit trail. Ex-post generation of DIN and communication of the same to the assessee amounted to ticking the box of communicating the DIN to the assessee, but not in accordance with the CBDT’s Circular.   

[1] M/s Sutherland Global Services, Inc. v The ACIT/DCIT, International Taxation Circle 2(2), Chennai TS-287-ITAT-2023CHNY

‘Prima facie’ Section 69A of IT Act, 1961 Inapplicable to Non-Residents: Delhi HC 

by

In a recent decision[1], the Delhi High Court heard an appeal from an order of the Income Tax Appellate Tribunal (‘Tribunal’) where the Tribunal had held that Section 69A, IT Act, 1961 was not applicable to the facts of the case. Accordingly, one of the questions of law that the High Court had to adjudicate was if the Tribunal was correct in holding that Section 69A was inapplicable to the facts of the case. The Revenue Department requested that the High Court may leave open the question for it to be deliberated upon in some other case. The High Court acceded to the request, but still made ‘prima facie’ observations on Section 69A and it is unclear if they will have precedential value. 

Facts 

The assessee, a non-resident living in the United Arab Emirates filed the income tax returns for the Assessment Year 2017-18 declaring income which included savings bank interest and interest on income tax refund. During scrutiny proceedings, the Assessing Officer added additional sum under Section 69A, IT Act, 1961 on account of unexplained entries in the bank account and underreporting of income through interest. The assessee filed an appeal against the addition made by Assessing Officer which was partly allowed by the Commissioner of Income Tax. On second appeal, the Tribunal completely deleted the addition made under Section 69A. The Revenue filed an appeal against the Tribunal’s decision before the High Court. 

High Court’s Observations 

Before I mention that High Court’s observations, it is pertinent to mention Section 69A: 

            Where in any financial year the assessee is found to be the owner of any money, bullion, jewellery or other valuable article and such money, bullion, jewellery or other valuable article is not recorded in the books of account, if any, maintained by him for any source of income, and the assessee offers no explanation about the nature and source of acquisition of the money, bullion, jewellery or other valuable article, or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the money and the value of the bullion, jewellery or other valuable article may be deemed to be the income of the assessee for such financial year. (emphasis added)

The Tribunal noted that the ingredients of Section 69A were not fulfilled in the impugned case as the non-resident was not obliged to and had not maintained books of account, thereby a crucial ingredient of Section 69A was missing. Even on merits, the assessee’s explanation that the entries in the bank account were from his other account in Dubai and the money received on cancellation of a hotel booking and some money was deposited during demonetization was accepted by the Tribunal. The High Court noted that the Tribunal had meticulously examined the facts, the assessee’s explanation was held to be satisfactory and thus the additional money cannot be treated as unexplained money under Section 69A. The High Court refused to interfere in Tribunal’s findings on this matter. 

As regards applicability of Section 69A, the Revenue’s argument was that if the Tribunal’s observation is accepted, i.e., the provision is not applicable to non-residents, if would sanctify the non-maintenance of books by such assessees. (para 5) On this issue, the High Court opined as follows: 

Admittedly, in the present case, the respondent/assessee is a Non- Resident Indian and his source of income in India being from interest on bank accounts and interest on income tax refund, he is not obliged to maintain any books of account in India. It appears to us prima facie that the expression “if any” specifically used in Section 69A of the Act amplifies that where books of account are not maintained, it would not be possible to invoke this provision. But as mentioned above, learned counsel for appellant/revenue requested to keep this question open to be agitated in some better case. We accede to this request. (emphasis added) (para 7)

The Delhi High Court seems to have tentatively agreed to the Tribunal’s view, i.e., in the absence of books of account, Section 69A cannot be invoked. And a non-resident assessee is not obliged to maintain the books of account. This leads to the conclusion that Section 69A cannot be invoked against a non-resident assessee. This is the correct position of law. However, given that the Revenue expressly requested the High Court leave the question of applicability of Section 69A to the impugned case open and the High Court agreed to it, the above observations of the High Court should be treated as obiter dicta. Also, the preface of ‘prima facie’ to the High Court’s observations and the general tenor of the High Court’s observations supports the conclusion that the High Court’s opinion on applicability of Section 69A is not a fully reasoned opinion and should not be treated as a binding precedent.  

Conclusion 

Ideally, the Delhi High Court should have refrained from giving its ‘prima facie’ opinion on the scope and applicability of Section 69A in the impugned case since it agreed to the Revenue’s request to leave the question for deliberation in a subsequent case. However, even though the High Court has expressed it’s tentative opinion on the matter, it is important to treat the above observation as obiter dicta and not the final opinion on applicability and scope of Section 69A.  

[1] The Commissioner of Income Tax v Hersh Washesher Chadha 2023:DHC:8854-DB. 

Delhi HC Clarifies Powers of AO Under Section 142(2C), IT Act, 1961 

by

In a recent decision[1], the Delhi High Court clarified that the power granted to the Assessing Officer (‘AO’) under Proviso to Section 142(2C), IT Act, 1961 cannot be abdicated to a superior officer. Thus, the decision of the superior officer, even if it was arrived at on the recommendation of AO was not valid. 

Facts 

The brief facts of the case are that the assessee was subjected to a search action under Section 132, IT Act, 1961 on 19.02.2008 and thereafter the AO issued a notice to the assessee under Section 153A. Eleven months later, the AO issued a notice to the assessee seeking a response for conduct of special audit of its affairs in exercise of its powers under Section 142(2A). The objections of the assessee to the notice were rejected and thereafter the Commissioner of Income Tax (‘CIT’) approved the conduct of audit and appointed an auditor and the same was communicated to the assessee. The time frame of 120 days was also fixed for completion of the audit. 

The auditor so appointed thereafter requested for an extension and the request was forwarded by the AO to the Assistant CIT who in turn forwarded it to the CIT. On considering the request, the CIT granted an approval and the AO communicated the extension of time period to the auditors. 

The question before the Delhi High Court was whether the extension of time period for audit was lawfully granted by the CIT under Proviso to Section 142(2C), IT Act, 1961.

Arguments 

Before I summarise the arguments, the two relevant provisions for consideration are: 

Briefly put, Section 142(2A) states that if at any stage of the proceedings the AO is of the opinion that it is necessary to get the accounts of the assessee audited he may with the prior approval of the Principal Chief Commissioner or Chief Commissioner or Commissioner direct the assessee to get the accounts audited by an accountant nominated by the Principal Chief Commissioner or Chief Commissioner or Commissioner. The AO is required to form such an opinion based nature and complexity of accounts, volume of accounts, doubts about correctness of accounts and interests of the revenue. And once the auditor is nominated, the AO shall direct the assessee to get the accounts audited and furnish a report if such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as the AO may require. 

Proviso to Section 142(2C) states that:

… the Assessing Officer may, Suo motu, or on an application made in this behalf by the assessee and for any good and sufficient reason, extend the said period by such further period or period as he thinks fit; so, however, that the aggregate of the period originally fixed and the period or periods so extended shall not, in any case, exceed one hundred and eighty days from the date on which the direction under sub-section (2A) is received by the assessee.     

The recommendation for extension of time for the audit was made by CIT once the AO forwarded the auditor’s request letter to the CIT. The Revenue argued that the extension of time period was an administrative act and whatever functions a subordinate authority can perform a superior authority can also undertake on the administrative side. The Revenue further argued that the CIT had the power to appoint an auditor under Section 142(2A) and in doing so it exercises an administrative power. And in extension of the same power, the CIT can also amend the time within which the audit needs to be completed. The Revenue further added that if the prior approval of CIT is needed for appointment of an auditor under Section 142(2A), there is no infirmity in seeking the opinion of CIT for extension of the time for such audit under Proviso to Section 142(2C). The Revenue was trying to read the power to nominate an auditor under Section 142(2A) and the power to grant an extension for audit under Proviso to Section 142(2C) as the same or in a continuum.  

The assessee, on the other hand, disputed that the power was an administrative power and argued that the audit proceedings are part of assessment proceedings which are judicial in nature. The assessee argued that the AO abdicated its powers under Proviso to Section 142(2C) in favor of CIT since AO did not seek approval of CIT for extension of the time but abdicated the entire decision to CIT. Further, it was pointed that the approval of CIT is not needed for extension of time under Proviso to Section 142(2C). The approval is only needed to appoint an auditor under Section 142(2A). The assessee was thus treating both the provisions are independent of each other and the powers so provided as distinct.  

Decision 

The Delhi High Court decided in favor of the assessee by strictly interpreting Proviso to Section 142(2C).  The High Court observed that the Proviso to Section 142(2C) makes it abundantly clear that the AO has the discretion to extend the initial timeframe allotted for submission of the audit report. And it noted that: 

Thus, it is evident from a plain reading of the provisions mentioned above that both the discretion to trigger the process for issuance of a direction to the assessee for getting the accounts audited within a specified timeframe and the extensions, if any, that are granted is that of the AO. Both sub-sections (2A) and (2C) read with the proviso appended to the latter make that abundantly clear. (para 11) 

The Delhi High Court correctly noted per Section 142(2A) the CIT or other authority was only the nominating authority for auditors. The time frame for submission of audit, the details in the audit reports, etc. were all to be decided by the AO. The High Court was categorical in its assertion that Section 142(2A) was ‘AO-centric’, since the AO was performing the dual role of an adjudicator and the inquisitor. (par 13.1)

The Delhi High Court concluded that the facts clearly show that the AO did not exercise its power to extend the timeframe, instead merely transmitted the request for extension to the CIT and made a recommendation which was not in accordance with Proviso to Section 142(2C). The High Court noted that ‘since the legislature vested the discretion to extend the timeframe solely in the AO, he could not have abdicated that function and confined his role to only making a recommendation to the CIT.’ (para 20) 

Finally, the Delhi High Court also agreed with the assesee’s contention that since the appointment of auditor was part of the assessment proceedings, it had civil consequences and it was clearly not an administrative power. Though the High Court did add that the distinction between administrative and quasi-judicial powers has been obliterated since they have civil consequences. 

Conclusion 

The Delhi High Court correctly interpreted the Proviso to Section 142(2C) wherein only the AO has the power to extend the timeframe for the audit though two things are worth mentioning: first, the fact that the AO decides the original time allotted under Section 142(2A) is not expressly provided in the provision though the High Court interpreted it to be so; second, the High Court’s opinion on the distinction between administrative and quasi-judicial powers and the obliteration of their difference is not entirely clear. While on one hand it termed the power as quasi-judicial while on the other hand it seemed to suggest that distinction between both kinds of powers had obliterated, making at least one observation redundant. 

[1] Pr. Commissioner of Income Tax Central v Soul Space Projects Ltd 2023:DHC:8835-DB. 

Delhi High Court Reiterates the Law on Interface of IBC and Tax

by

The Delhi High Court in a recent case[1] reiterated the legal position relating to outstanding tax of an entity which has or is undergoing the insolvency process under IBC, 2016. In the impugned case, the Revenue Department claimed that the petitioner owed it taxes despite such the Revenue Department’s claims not being part of the approved resolution plan. The High Court relying on relevant precedents stated that tax claims that were not part of the approved resolution plan stand extinguished and the Revenue Department is also bound by the resolution plan approved under IBC, 2016. 

Facts 

The petitioner, TUF Metallurgical Pvt Ltd, took over the management of the erstwhile corporate debtor in accordance with the terms of the resolution plan which was approved by the NCLT under Section 31(1), IBC, 2016 via order dated 05.11.2019. The public advertisement regarding commencement of the Corporate Insolvency Resolution Process (CIRP) was issued under Section 15, IBC, 2016 stating that the last date for filing of claims was 21.01.2019. But until the said date the Revenue Department did not submit any claim. It was on 12.12.2019 that the Revenue Department passed an order against the petitioner qua Assessment Year 2017-18. The petitioner’s claim was that the tax demand was barred after the approval of resolution plan was rejected by the Revenue Department which issued a Demand Notice and levied a penalty on the petitioner. Against the said order, the petitioner filed a writ petition before the Delhi High Court. 

Arguments 

The arguments of the petitioner and the Revenue Department were straightforward. The petitioners argued that the Revenue Department ignored the legal and factual ramifications which ensued on conclusion of any insolvency process. The petitioner stated that once the resolution plan was approved by the concerned authority, it was not open to the Revenue Department to open stale claims which were settled upon conclusion of the insolvency proceedings. The Revenue Department, on the other hand, argued that it stood on a ‘different footing’ from other creditors and that the tax claims of the Revenue Department would not be affected by the provisions of IBC, 2016. (para 4)

Decision 

Given that the argument of the Revenue Department did not have a legal leg to stand on, the decision of the Delhi High Court did not involve unravelling a complex legal web. The High Court’s conclusion rested on Supreme Court’s observations in Ghanshyam Mishra’s case[2], where the Supreme Court categorically observed that once the resolution plan has been approved by the adjudicating authority under Section 31(1), IBC, 2016, the claims as provided in the resolution plan shall stand frozen and shall be binding on the corporate debtor, its employees, members, Central Government, State Government, guarantors and other stakeholders. It was clarified by the Supreme Court that claims that are not part of the resolution plan shall stand extinguished and no person shall be entitled to initiate or continue proceedings in respect of claims which were not part of the resolution plan. It was further clarified that the said bar also applies to tax due to the Central or State Government. 

The conclusion, based on the findings in Ghanshyam Mishra case is that if the Revenue Department fails to respond to the public advertisement in time, its claims will not be part of the resolution plan. And subsequently, the Revenue Department cannot initiate proceedings in respect of taxes due prior to initiation of insolvency proceedings on the ground that it stands on a different footing than other creditors. Courts and IBC, 2016 do not acknowledge, and rightly so, that the Revenue Department is not bound by terms of the resolution plan. Accordingly, the Delhi High Court in the impugned case allowed the petitioner’s writ petition and set aside the demand and orders by the Revenue Department.     

Conclusion It is indeed a case of unending mystery that why does the Revenue Department does not respond to the public notices relating to commencement of insolvency process on time. And if it for some reason fails to respond to the notices on time, why does it initiate proceedings against the assessees, when the law clearly states that the provisions of IBC, 2016 shall override all other laws,[3] which of course also includes tax legislations. And more specifically, if the Revenue Department’s claim was not part of the approved resolution plan, the claim stands extinguished. The Revenue Department does not stand on a ‘different’ footing from other creditors. The IBC, 2016 certainly does not state so. It is a self-image that the Revenue Department has conjured with no legal basis.    

[1] TUF Metallurgical Pvt Ltd v Union of India & Anr 2023:DHC:8856-DB.

[2] Ghanshyam Mishra & Sons Pvt Ltd v Edelweiss Asset Reconstruction Co Ltd (2021) 9 SCC 657. 

[3] Section 238, IBC, 2016. 

Delhi High Court Holds Explanations 6 and 7 Added to Section 9 in 2015 are Retrospective in Nature

by

In a recent decision[1], the Delhi High Court has held that the Explanations 6 and 7 added to Section 9, IT Act, 1961 via Finance Act, 2015 are retrospective in nature despite the amendment not expressly stating so. A brief recall to the Finance Act, 2012 which inter alia amended Section 9 along with adding Explanation 5 to it, to overcome the effect of Supreme Court’s decision in Vodafone International Holdings.[2] The amendment clearly stated that Explanation 5 would have effect w.e.f. 1.04.1962. However, such an express declaration was missing when Explanations 6 and 7 were added in 2015. Nonetheless, the Delhi High Court held that Explanations were retrospective in nature by referring to their legislative history. 

Facts 

The respondent, August Capital PTE Ltd, was a company incorporated in Singapore in 2011. Between January 2013 and March 2014 the respondent invested in equity and preference shares of Accelyst Pte Ltd (‘APL’), incorporated in Singapore. In March 2015 the respondent sold its investment to an Indian company. In the return of the income for the particular Assessment Year, i.e, 2015-16, the respondent showed its income as nil. The respondent was issued a showcause notice as to why its income from the sale of shares should not be taxed in India. The respondent’s explanation was that it had only acquired 0.05% of ordinary share capital and 2.93% of preference share capital and had no rights of management and control concerning the affairs of APL and thus the capital gains arising out of the transfer of shares was not taxable in India. 

The Assessing Officer, Dispute Resolution Panel decided in favor of the Revenue Department wherein the respondent’s taxable income was pegged at a little more than Rs 36 crores. The tribunal ruled in favor of the respondent and directed deletion of the income and against the tribunal’s decision, the Revenue filed an appeal before the Delhi High Court. 

The respondent was sought to be taxed under Explanation 5 that was added to Section 9, IT Act, 1961 via the Finance Act, 2012. Explanation 5 added via Finance Act, 2012 with retrospective effect stated that:

            … an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India;     

The above Explanation was unambiguously added to tax Vodafone like transactions. However, immediately after its insertion there were specific concerns about the uncertain nature of the terms ‘share and interest’ and ‘substantially’. A Committee chaired by Mr. Parthsarthy Shome recommended that the term ‘substantially’ used in Explanation 5 be defined precisely to avoid interpretive difficulties. The narrow concern was that Explanation 5 may also include within its scope small investors wherein even if a single share of a company is transferred – and such company derived its value substantially from assets located in India – it would result in taxable gains under the Explanation 5. 

Explanations 6 and 7 were added to address the above concerns and effectively provided a benefit to small investors. For example, Explanation 6 states that for the purpose of this clause, it is hereby declared that the share of interest, referred to in Explanation 5 shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India, if, on the specified date, the value of the assets exceeds the amount of ten crore rupees and represents at least fifty per cent of the value of all the assets owned by the company or entity, as the case may be. A minimum threshold was prescribed to indirectly define the term ‘substantially’ used in Explanation 5.  

Similarly, Explanation 7 inter alia states that for the purposes of this clause no income shall be deemed to accrue or arise to a non-resident from transfer, outside India, of any share of, or interest in, a company or an entity, registered or incorporated outside India referred to in Explanation 5 if the such company or entity directly owns the assets situated in India at any time in the twelve months preceding the date of transfer, neither holds the rights of management or control in relation to such company or entity, nor holds voting power or share capital or interest exceeding five per cent of the total voting power. 

Arguments and Decision

The respondent in the reply to showcause notice had clearly stated that it had no control and management rights in APL and further argued before the Delhi High Court in the same vein. The respondents argued that the Explanations 6 and 7 should have retrospective effect since Section 9(1)(i) read with Explanations 4,5,6, and 7 form a complete code. They referred to the context and reason for introductions of Explanations 6 and 7 and argued that the reason for introduction of these Explanations was to cure the unintended effect of Explanation 5 and given this context, Explanations 6 and 7 should also be given a retrospective effect even if Finance Act, 2015 did not expressly state that these Explanations would have retrospective effect. 

The Revenue, on the other hand, argued that Explanations 6 and 7 brought a substantial change in the law and were not merely clarificatory amendments. And added that even a clarificatory amendment need not necessarily have a retrospective effect. 

The Delhi High Court cited the Shome Committee recommendations and the text of Finance Minister’s speech while explaining the introduction of Explanations 6 and 7. Both these sources led to the straightforward conclusion that the Explanations 6 and 7 were added to cure the limitations of Explanation 5, and thus the Delhi High Court concluded that the insertion of Explanations 6 and 7 was a curative step to cure the vague expressions used in Explanation 5. The High Court noted that: 

The argument advanced on behalf of the appellant/revenue, shorn of gloss, boils down to the fact that the insertion of Explanations 6 and 7 via FA 2015 was to take effect from 01.04.2016 and could only be treated as a prospective amendment. The argument advanced in support of this plea was that Explanations 6 and 7 brought about a substantive amendment in Section 9(1)(i) of the Act. In our view, this submission is misconceived because Explanations 6 and 7 alone would have no meaning if they were not read along with Explanation 5. Therefore, if Explanations 6 and 7 have to be read along with Explanation 5, which concededly operates from 01.04.1962, they would have to be construed as clarificatory and curative. (para 20)

The Delhi High Court reasoned that the legislature took recourse to the mischief rule else Explanation 5 offered no legislative guidance to the assessing officer and was in danger of being struck down as arbitrary. The High Court concluded that though the Finance Act, 2016 stated that the Explanations 6 and 7 were to take effect from 01.04.2016, the legislative history provides authority to conclude that they could be treated as retrospective. 

Conclusion The Delhi High Court relied almost solely on legislative history and context of the introduction of Explanations 6 and 7 to Section 9 to hold that the Explanations had a retrospective effect. This is novel territory because the Finance Act, 2015 clearly does not state that the Explanations 6 and 7 will have retrospective effect. Alternately, one could also argue that the Delhi High Court adopted holistic approach in interpreting the effect of Explanations 6 and 7. It is undoubtedly true from the legislative history, as the High Court cited, that the Explanations 6 and 7 were intended to overcome the shortcomings of Explanation 5. And as standalone, Explanations 6 and 7 do not contain much substance. Thus, if Explanations 6 and 7 are to be read in tandem with Explanation 5, there is little reason to suggest that only Explanation 5 should have a retrospective effect while Explanations 6 and 7 operate prospectively.   

[1] The Commissioner of Income Tax, International Taxation-I v Augustus Capital Pte Ltd 2023:DHC:8521-DB. 

[2] Vodafone International Holdings B.V. v Union of India & Anr (2012) 1 SCR 573. 

Bombay High Court Upholds Amendment to Definition of Income under IT Act, 1961 

by

In a significant decision[1], the Bombay High Court upheld the amendment made to definition of income in Income Tax Act, 1961 (IT Act, 1961) via which all forms of subsidy granted by the Central or State Government, in cash or kind, are now considered income and taxable under the IT Act, 1961. The petitioner’s core challenge to the amendment was that it removed the distinction between revenue and capital subsidy while latter had been held by Courts to be non-taxable. The Bombay High Court did not engage with several arguments of the petitioners that traversed issues of legislative competence and fundamentals of income tax jurisprudence, but instead reasoned that the challenge was because of petitioner’s reduced profits and therefore was unwarranted. 

Facts 

Petitioner was a biotechnology company and had a manufacturing plant in Hadapsar, Pune. It was eligible for concessions on electricity duty and VAT/GST/ subsidy under the State of Maharashtra’s ‘Package Scheme of Incentives, 2013’ which came into effect from 1 April 2013. Petitioner was entitled to the subsidies from 1 January 2015 to 31 March 2045, having fulfilled the eligibility conditions prescribed under the Scheme. 

The Finance Act, 2015 amended the definition of income under Section 2(24), IT Act, 1961 wherein clause (xviii) was added. The clause stated: 

            assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee; 

other than, –

  • The subsidy or grant or reimbursement  which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43; or 
  • The subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or a State Government, as the case may be;  

Clearly, any incentives in the form of subsidies or otherwise provided to companies or assessees in general were included in the definition of income and made exigible to tax. The significance of this amendment can be appreciated through a brief understanding of the history of income tax under which revenue receipts are by default taxable, but capital receipts are taxable only if there is an express provision to that effect. Income tax laws have evolved in the past few decades in such a manner that a large variety of capital receipts have been expressly made taxable and the distinction between revenue and capital receipts though still in existence, has been blurred to a large extent. The above cited clause is another step towards rendering the distinction between revenue and capital receipts otiose. 

The petitioner’s case was built on this distinction which has been upheld by Indian Courts in numerous decisions.[2] The petitioner’s arguments also raised important issues of legislative competence and arguments that alluded to fiscal federalism, which unfortunately went unaddressed by the Bombay High Court. Some of the petitioner’s arguments were: the amendment does not create any distinction between capital and revenue subsidy though only the latter is taxable under Sections 4 and 5 of IT Act, 1961; that IT Act, 1961 levies tax only on ‘real’ income and the definition of income cannot be extended to include every kind of subsidy especially when it is received on capital account; the subsidy given by a State Government is by forsaking its own revenues and taxing the same in the hands of the petitioner amounts indirect tax on revenue of the State in violation of Article 289; the amendment was also challenged as violative of Article 14 for being arbitrary and discriminatory as well as Article 19(1)(g) of the Constitution for causing unreasonable hardship on the petitioner as it had made a huge investment in a backward region on the promise of subsidy and now the Union may take away 30-40% of the subsidy via income tax. 

The petitioner’s cited a bevy of cases to underline the fact that the distinction between subsidy received on revenue and capital account has been acknowledged by Courts and only the former has been held to be taxable and not the latter. The Revenue, on the other hand, invoked the argument that Courts should be deferential in matters of economic law as it involves complex decision-making impinging on economic and fiscal policy of the country. Accordingly, it argued that the legislature has wide leeway in drafting provisions on taxation of income and can choose to levy tax on certain persons and Article 14 cannot be invoked against tax laws casually. Similarly, reduction of profits of the petitioner, the Revenue argued, cannot be a ground to invoke violation of Article 19(1)(g).  

Bombay High Court Focuses on Reduced Profits 

The spectrum of issues highlighted by the petitioner were ultimately futile, as the Bombay High Court upheld the amendment by relying on and focusing on one strand, i.e., Article 19(1)(g) and reduction of profits of the petitioner. The High Court did cite the relevant judicial precedents that distinguished capital and revenue receipts and the ‘purpose test’ enunciated by the Supreme Court in various cases, but only for ornamental reasons. (para 17-21) The High Court used the well-entrenched doctrine in Indian jurisprudence that in matters of economic laws – by extension tax laws – the legislature has a wide latitude. It cited the relevant precedents on this point as well to underline its agreement with the approach that courts cannot intervene unless there is manifest arbitrariness and violation of Article 14 or if the restrictions were unreasonable thereby contravening Article 19(1)(g) of the Constitution. (paras 24-25) 

The latter particularly was conclusive in influencing the Bombay High Court’s conclusion that the amendment to definition of income was constitutional. The High Court noted that the petitioner’s argument about withdrawal of fiscal incentives tends to conflate the issue with fiscal immunity. And that the profits as well as incentives are subject to fluctuation and the amendment reflects a recalibration of fiscal advantages in tune with the broader economic policy considerations. And that diminution or even drastic reduction in profits cannot amount to violation of Article 19(1)(g) of the Constitution. (para 31) The High Court concluded that: 

The policy of tax in its effectuation, might, of course, bring in some hardship in some individual cases. That is, inevitable. Every cause, it is said, has its martyrs. Mere excessiveness of a tax or even the circumstances that its imposition might tend towards the diminution of the earnings or profits of petitioner, per se and cannot constitute violation of constitutional rights. If in the process a few individuals suffer severe hardship that cannot be helped, for individual interests must yield to the larger interests of the community or the country as indeed every noble cause claims its martyr. (para 38) 

The doctrine of deference in matters of economic law proved decisive in the Bombay High Court finally upholding the amendment to the definition of income. While the merits of this doctrine are beyond the scope of this post, it is crucial to mention that the sacrosanct status accorded to this doctrine is preventing Courts from engaging in a fundamental analysis of the violation of Fundamental Rights and other well established doctrines in taxation law in this case the well founded distinction between revenue and capital receipts and the promise of IT Act, 1961 to only tax ‘real’ income. The High Court was especially remiss in interlinking the two aspects, i.e., if subsidy on capital account did not constitute ‘real’ income, then is it still within legislative competence to levy tax on such subsidy?    

Conclusion 

The Bombay High Court’s decision falls short primarily on not engaging with the various arguments put forth by the petitioners. In my view, there is considerable merit in determining the scope of income and whether IT Act, 1961 can be amended by the Union to include any form and kind of receipt as income. Historically, capital receipts have not been taxed under IT Act, 1961 but there is no express bar in including such receipts within the fold of income. However, the related concern in this case was that a portion of subsidy benefits extended by the State Government, would end up being paid as taxes to the Union. Apart from a constitutional question, this issue also raises the point of efficacy of such subsidies and grants provided by the State Government. It is unlikely that any Court will read a limitation on the Union’s legislative power on that ground, but it is worth examining from the perspective of efficacy of policies providing tax exemptions. Finally, it is worth noting that though the distinction between revenue and capital receipts has been significantly blurred via numerous provisions expressly taxing the latter, the question of whether it amounts to ‘real’ income as opposed to hypothetical income has not been answered conclusively in this context. Courts have opined that mere accounting entries cannot be relied on to state that the assessee has received income, ‘real’ income that can be taxed. A similar analysis in the context of revenue and capital receipts is amiss, as it is possible to suggest that not every capital receipt amounts to a ‘real’ income taxable under the IT Act, 1961.   

[1] Serum Institute of India Pvt Ltd v Union of India TS-723-HC-2023-BOM. 

[2] See, for example, CIT v Chapalkar Brothers 400 ITR 279 (SC); CIT v Shree Balaji Alloys 7 ITR-OL 50 (SC). 

High Court Quashes Tax Notice Citing ‘Clean Slate’ Principle under IBC, 2016

by

In a recent judgment, the Delhi High Court[1] emphasised and reiterated the ‘clean slate’ principle under the Insolvency and Bankruptcy Code, 2016 (‘IBC, 2016’). The High Court held that the notices issued by the Revenue Department after the Resolution Plan had been approved by the National Company Law Tribunal (‘NCLT’) were bad in law. The clean slate principle, as per the High Court, does not admit of any exceptions for the Revenue Department and the tax dues have to be paid as per the Resolution Plan, else they the tax claims will be considered as extinguished.  

Facts 

The Revenue Department’s impugned notice dated 28.08.2018 called upon Tata Steel Ltd, petitioner, to deposit tax for the assessment years 2001-02, 2009-10, 2010-11, and 2013-14. Via the same notice the petitioner was also asked to justify as to why a penalty under Section 221(1), IT Act, 1961 should not be levied. The petitioner challenged the notice broadly on the ground that the notices were issued after the approval of the Resolution Plan by the NCLT and fell within the ambit of ‘clean slate’ principle. In other words, once the Resolution Plan had been approved by the NCLT, all creditors were bound by the terms of the Resolution Plan and the Revenue Department could not claim an exception from the said principle. 

The arguments advanced on behalf of the petitioner also mentioned that the Revenue Department was an operational creditor and tax due to it was operational debt within the meaning of Sections 5(20) and 5(21), IBC, 2016. And the claims that were made by the Revenue Department were the subject matter of the Resolution Plan while those claims that were not part of the Resolution Plan were extinguished and could not be recovered. And since the claim relating to penalty was not lodged by the Revenue Department before the Resolution Professional, it was not provided in the Resolution Plan and thus could not be recovered from the petitioner. 

Delhi High Court Decides 

The Delhi High Court enlisted the timeline of the Revenue Department’s claims and the insolvency process via which the petitioner became the successor entity to Bhushan Steel. The Delhi High Court noted the dates on which various assessment orders and other orders were passed by the CIT(Appeals) and held that it was clear that the demands for the Assessment Years in question were certainly outstanding on the date the Resolution Plan was approved. The High Court noted that for the Assessment Years 2009-10, 2010-11, and 2013-14 the claims were certainly filed by the Revenue Department before the Resolution Professional. While for the Assessment Year 2001-02 and claims for penalty there was a failure to lodge the relevant claim. In view of these facts, the High Court observed that the failure to lodge the claim within the prescribed time framework cannot result in such claims being placed on a better footing compared to other claims that were considered while finalizing the Resolution Plan. 

The Delhi High Court correctly concluded that the demand qua Assessment Year 2001-02 which was communicated via an additional notice after approval of the Resolution Plan ordinarily would stand extinguished under IBC, 2016. However, since an appeal for the Assessment Year 2001-02 was pending before the Supreme Court, the High Court concluded that recoveries for the said Assessment Year would have to be made as per the decision in that appeal. (paras 26 and 32.1) 

The Delhi High Court reiterated that qua claims of the Revenue Department filed before the Resolution Professional, i.e., before finalizing the Resolution Plan, they could only be satisfied as per the terms of the Resolution Plan. The Delhi High Court observed: 

Notwithstanding the aforesaid argument advanced on behalf of the revenue, we are of the opinion that dues payable to creditors, including statutory creditors, for the periods which precede the date when the RP is approved, can only be paid as per the terms contained in the RP. (para 27) 

Thus, if claims were filed by the Revenue Department after the approval of the Resolution Plan, they could not be satisfied since they were presumed to have been extinguished as per the clean slate principle. Though it is important to note here that the said claims should be pending when the proceedings under IBC, 2016 are initiated. Thus, to the extent the pending claims were lodged before the Insolvency Professional and are incorporated in the Resolution Plan approved by NCLT they will be satisfied in the terms incorporated in the said plan; for pending claims that were not incorporated they stand extinguished.    

IBC, 2016 Overrides IT Act, 1961 

The Delhi High Court also noted, in no ambiguous terms, that IBC, 2016 overrides IT Act, 1961. The fact that IBC, 2016 overrides IT Act, 1961 is a straightforward conclusion when one reads Section 238, IBC, 2016 as it states that the provisions of this law shall have effect notwithstanding anything contained in any other law for the time being in force, which by a reasonable interpretation also includes IT Act, 1961. Clarifying the same, the Delhi High Court observed that: 

Thus, where matters covered by the 2016 Code are concerned [including insolvency resolution of corporate persons] if provisions contained therein are inconsistent with other statutes, including the 1961 Act, it shall override such laws. If such an approach is not adopted, it will undermine the entire object and purpose with which the Legislature enacted the 2016 Code. (para 29) 

Conclusion 

The Delhi High Court’s two observations that: first, pending tax claims against a company which underwent the insolvency process under IBC, 2016 can only be recovered as per the Resolution Plan; second, that IBC, 2016 overrides all other laws including IT Act, 1961 seem obvious and straightforward in hindsight. However, the aggressiveness of the Revenue Department to seek its claims despite the law saying otherwise requires that the law be laid in clear terms and perhaps repeatedly to thwart such tax claims that can cast a shadow on an insolvency process that seeks to revive a debt-laden company.   

[1] Tata Steel v Deputy Commissioner of Income Tax 2023: DHC: 7855 – DB. 

LinkedIn