2022 (12) TMI 557 - HC - Income Tax

Doctrine of constitutional priority - Certain transfers to be void u/s 281 - Supremecy of attachment passed by the Tax Recovery Officer / Income Tax Department or to the mortgage created in favour of the secured creditors Dues of the Income Tax Department precedence over the dues of the secured creditor - Scope and ambit of Section 281 of the Income Tax Act, 1961 and Section 26E of SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, 1993 - Tax recovery proceedings - priority in payment of debts due to a secured creditor over all other debts including revenues, taxes, cesses, etc. - attribute of sovereignty and a necessity for attaining the constitutional goals and objectives, tax dues would prevail and take precedence over the rights of the secured creditors - What is the nature of taxes and the right of the State to recover the same? - HELD THAT - The power to tax is an inherent part and an attribute of sovereignty and is meant for being used for public welfare. Without taxes, the Government cannot run nor discharge its constitutional obligations set out in the form of Directive Principles of State Policy under Article 39 of the Constitution. In other words, taxes are collected in public interest and the taxes so collected cannot be used for any purpose other than common public good. Having dealt with the status and purpose of tax under the Constitution, it may be relevant to examine the priority of collection of taxes. Doctrine of priority of Crown Debts - The principle of priority of Government debts is founded on the rule of necessity and public policy. If the legislation provides for a charge or a priority, then, if the crown debt and the private secured creditor concurs in point of time, the crown debt would prevail. If the private secured creditor is prior in time that would prevail. If the State s charge is prior in time, then the State s charge would prevail. If a first charge or a priority is provided/granted under the provisions of the Act or if it is expressly provided to override other claims including that of secured creditors, then it appears that it would be the State which would be entitled to preference even over secured creditors. Whether fiscal/tax legislations provide for a charge in respect of the taxes/revenues that are due and if so, what are the kind/nature of charges created in fiscal/tax legislations and its status? - We find that the recovery mechanism under the Income Tax Act suffers from the above deficiency, in the absence of a provision creating a charge in respect of the property of the defaulter to enable recovery of their dues arising out of the above enactment. We say so, for in contrast to other tax enactments referred to above, we do not find any provision under the Income Tax Act, which creates a charge in respect of tax or any sums that may become payable under the same. This aspect ought to be borne in mind for we find that both the learned Judges have proceeded on the basis that they had to decide the priority of charge under the Income Tax Act vis-a-vis SARFAESI Act and Recovery of Debts and Bankruptcy Act, while the first view proceeds on the basis that priority must be granted to recovery of Government dues on the basis of doctrine of constitutional priority , the second view proceeds on the basis that attachment results in creation of charge and if the same is subsequent to mortgage, the right of the existing mortgagee would prevail. Insofar as the first view is concerned, the law relating to the Government's right to recover dues commonly known as Crown debt stands resolved by a series of decisions, wherein, it has been consistently held that Crown/State would have preferential right to recover only over ordinary unsecured creditors but would not be entitled to precedence over a secured debt unless express provisions are incorporated. Therefore, reliance on doctrine of constitutional priority for which we do not find any basis, is in any view unsustainable as it is contrary to the settled legal position. Coming to the second view, it has been held that a charge gets created only when the attachment is made. This view is again unsustainable since attachment would not constitute a charge. The broad distinction between a mortgage and a charge is that a charge only gives a right to payment out of a particular fund or particular property without transferring that fund or property, whereas a mortgage is in essence a transfer of an interest in specific immovable property. A mortgage is a jus in rem, a charge is a jus ad rem and the practical distinction is that mortgage is good against subsequent transferees and a charge is only good against subsequent transferees with notice. A charge does not amount to a mortgage. In every mortgage, there is a charge, but every charge is not a mortgage. Having examined the scope of charge , it may be relevant to note that the second view holding that an attachment creates a charge is unsustainable as attachment and charge are distinct and attachment does not by itself create a charge as stated supra. In any view, we find that the Income Tax Act does not create a charge towards recovery of dues. Section 281 only declares certain transactions to be void and cannot be understood as creating a charge in favour of the Income Tax Department in respect of dues arising under the same. Certain transfers to be void - Whether Section 281 of the Income Tax Act only contains declaration of voidity in respect of transactions falling within its mischief or does it create a charge in respect of any sum payable under the Income Tax Act in favour of the Revenue and what is the scope of operation of Section 281 of the Income Tax Act vis-a-vis Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act and whether the priority of charge created in favour of the secured creditors under the SARFAESI Act and Recovery of Debts and Bankruptcy Act would prevail over the declaration of voidity contained in Section 281 of the Income Tax Act or any other recovery proceedings including attachment under the Income Tax Act? - Section 281 of the Income Tax Act declares certain transactions to be void, now can it be understood that the declaration of voidity would prevail despite Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act conferring primacy in very wide terms. There is no doubt that Parliament's intention was to give priority to secured creditors which is to prevail over revenue, taxes, cesses, etc, in view of the express provisions contained in Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act. This is further reinforced by the Statement of Objects and Reasons (SOR) appended to the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016 which introduced sections 26E of the SARFAESI Act and 31B of the Recovery of Debts and Bankruptcy Act. According to the SOR, priority was accorded to secured creditors in repayment of debts in order to augment economic growth and ease of doing business. This gives a glimpse of the position earlier and what the amendment sought to remedy. Keeping the above background in mind, it does not seem that section 281 of the Income Tax Act and sections 26E of the SARFAESI Act and 31B of the Recovery of Debts and Bankruptcy Act can operate simultaneously without conflict. As applying the Heydon s Rule or Purposive construction, the non-obstante clause contained in Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act, which was introduced to give primacy to the secured creditors and expressly provides that it would prevail over all taxes, cesses etc., ought to be construed/interpreted in a manner that would promote and not defeat the object of the Parliament to protect and safeguard the interest of the secured creditors, intended in larger public interest and as a matter of policy. One more rule of construction is that when two competing Acts construed to further the purposes behind them produce a conflict; the court may resolve the conflict by taking into consideration as to which Act represents the superior purpose , as held in the case of Allahabad Bank v. Canara Bank 2000 (4) TMI 757 - SUPREME COURT Thus in view of the fact that the Parliament must be understood to have given priority to the secured creditors under Section 26E of the SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, fully aware and conscious of the status and importance that taxes enjoy under the Constitution. Therefore, with regard to operation of section 281 of the Income Tax Act vis-a-vis the operation of sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act, sections 26E and 31B according priority to secured creditors shall prevail and thus, the attachment by the Tax Recovery Officer is impermissible in the facts and circumstances of the case. We arrive at the following conclusion (i)Appellant is a secured creditor, who offered credit facilities to the Respondents 4 and 5, for which, mortgages were created in favour of appellant on 23.04.2013 vide document No.453 of 2013, on 18.08.2014 vide document No.2467 of 2014 and on 22.10.2015 vide document No.3168 of 2015. However, the Income Tax Department passed the order of attachment on 03.11.2015, for recovery of the tax dues, in respect of the properties over which mortgages were already created. (ii)Appellant sought to quash the communication of the Respondent dated 27.12.2007 with respect to recovery of income tax arrears of M/s.NEPC Agro Foods Limited and its Directors, on the premise that mortgage in respect of the property, was executed in favour of the Bank on 31.03.1999 itself, i.e., prior to the recovery proceedings. (iii)Writ petitioner / Bank challenged the attachment notice dated 27.03.2017 issued by the Income Tax Department, in respect of the properties which were offered to them as security by way of mortgage by deposit of title deeds for securing loans on 10.02.2014. The learned Judge allowed the writ petition on the ground that the mortgage preceded the attachment. (iv)Appellant / Bank sought a direction to the first respondent Tax Recovery Officer, Income Tax Department to remove the attachment made on 16.06.2017 and 23.07.2017 in respect of the properties, which were already mortgaged on 28.01.2016 and 07.02.2016, by the fourth and fifth Respondents to raise loan. In all these cases, the orders of attachment passed by the Tax Recovery Officer / Income Tax Department were subsequent to the mortgage created in favour of the secured creditors and hence, the same will have no legs to stand, in view of the principles laid above by this court. Therefore, the orders impugned in the writ appeals are quashed.

Summary

Issues involved:

1. Scope and ambit of Section 281 of the Income Tax Act, 1961 vis-à-vis Section 26E of the SARFAESI Act, 2002 and Section 31B of the Recovery of Debts and Bankruptcy Act, 1993.
2. Priority of tax dues versus secured creditors' dues.
3. Impact of non-obstante clauses in Sections 26E and 31B.
4. Validity of mortgage during pending tax proceedings.
5. Applicability of amendments to pending cases.

Detailed Analysis:

1. Scope and Ambit of Section 281 of the Income Tax Act, 1961 vis-à-vis Section 26E of the SARFAESI Act, 2002 and Section 31B of the Recovery of Debts and Bankruptcy Act, 1993:

The judgment addresses the conflict between Section 281 of the Income Tax Act and Sections 26E of the SARFAESI Act and 31B of the Recovery of Debts and Bankruptcy Act. Section 281 declares certain transfers void during pending tax proceedings, while Sections 26E and 31B grant priority to secured creditors over all other debts, including tax dues. The court examined whether Section 281 creates a charge or merely declares voidity and concluded that it does not create a charge but only declares certain transactions void.

2. Priority of Tax Dues versus Secured Creditors' Dues:

The court reiterated that the priority of Crown debts (tax dues) over unsecured creditors is well-established. However, between secured creditors and Crown debts, the secured creditors' rights prevail unless a specific statutory provision grants priority to the Crown debts. The judgment emphasized that the SARFAESI Act and the Recovery of Debts and Bankruptcy Act, through Sections 26E and 31B, expressly grant priority to secured creditors over tax dues.

3. Impact of Non-Obstante Clauses in Sections 26E and 31B:

The court highlighted the significance of the non-obstante clauses in Sections 26E and 31B, which are intended to give overriding effect to the rights of secured creditors over all other debts, including taxes. The non-obstante clauses in these sections are broader than those in Sections 34 and 35 of the respective Acts, ensuring that secured creditors' rights take precedence in the event of any conflict with other laws.

4. Validity of Mortgage during Pending Tax Proceedings:

The court examined various cases where mortgages were created during pending tax proceedings. It was held that if a mortgage was created before the attachment by the Tax Recovery Officer, the secured creditors' rights would prevail. The court clarified that Section 281 does not create a charge but only declares voidity, which does not affect the priority granted to secured creditors under Sections 26E and 31B.

5. Applicability of Amendments to Pending Cases:

The court addressed the applicability of Sections 26E and 31B to pending cases. It was held that these sections apply to pending cases, as affirmed by the Full Bench of the court. Even if recovery proceedings were set aside, the secured creditors could invoke Sections 26E and 31B, making the examination of this issue largely academic.

Conclusion:

The court concluded that the orders of attachment by the Tax Recovery Officer were subsequent to the creation of mortgages in favor of secured creditors and thus invalid. The non-obstante clauses in Sections 26E and 31B grant priority to secured creditors over tax dues, ensuring their rights prevail. The court quashed the orders impugned in the writ appeals and upheld the priority of secured creditors as per the SARFAESI Act and the Recovery of Debts and Bankruptcy Act.