Will secured creditor have priority over income-tax arrears? - V. K. Subramani - Article published in Business Advisor, dated October 10, 2016 - http://www.magzter.com/IN/Shrinikethan/Business-Advisor/Business/

1. Volume XVII Part 1 October 10, 2016 25 Business Advisor
Will secured creditor have priority over
income-tax arrears?
V. K. Subramani
The primary objective of income-tax is to garner resources
to the exchequer. Incidentally, the legal provisions
address various other socio-economic issues, such as (i)
tax rebate for senior citizens or super senior citizens; (ii)
reduction in chargeable income for premium paid on life
insurance and health insurance; (iii) deduction for
providing additional employment such as section 80JJAA;
(iv) deduction in respect of undertakings located in SEZ or
North-Eastern States as contained in sections 10AA and
10C; and (v) deduction for power-generating companies
and infrastructure undertakings as contained in section 80-IA besides many
other incentive provisions contained in the statute. Similarly, to tame the
taxpayers to have transparent transactions, there are some discouraging
legal provisions which could be found in sections 40A(3), 40A(2)(b), and 64,
in addition to various other penal provisions for contraventions and
omissions in compliance.
After the tax assessment is made, the taxpayer has to pay tax due to the
government or be eligible for refund of tax. It may so happen that a taxpayer
may not have adequate resources to pay the tax demand. He may appeal
against the tax assessment to reduce the tax liability or factually might have
incurred huge loss, such that the assets have to be disposed off for paying
the creditors which includes tax due to the government. It is at this point
that how the government can recover its tax dues vis-à-vis various other
creditors in the form of suppliers, lending institutions and employees
becomes an issue.
A taxpayer may transfer an asset by way of sale or gift or in any other
After the tax assessment is made, the taxpayer has to pay tax
due to the government or be eligible for refund of tax. It may
so happen that a taxpayer may not have adequate resources
to pay the tax demand.

2. Volume XVII Part 1 October 10, 2016 26 Business Advisor
manner. A tax demand may arise either before such transfer or after such
transfer. Such transfer may be an intentional transfer to defraud the
revenue or an innocent transfer. A transfer before an income-tax demand
crystallises cannot be declared void. On the other hand, a transfer made
after an income-tax demand notice is raised becomes debatable. Similarly, a
transfer of asset to settle the creditor who is secured over the asset cannot
be challenged. Only where an asset, free from being a security to the
creditor or lender, is transferred before or after the accrual of tax demand it
could become a controversy.
Legal provision
Section 281 says that where during the pendency of any proceeding under
the Income-tax Act or after the completion but before service of notice under
rule 2 of the Second Schedule to the Act if a taxpayer creates a charge or
parts with the possession of any of his assets, by way of sale, mortgage, gift,
exchange or any other mode of transfer in favour of any other person, such
transfer shall be void.
Such transaction shall be void as against any claim in respect of any tax or
any other sum payable by the assessee as a result of the completion of the
said proceeding or otherwise.
However, such transfer shall not be void in the following cases:
(i) When a transfer is made for adequate consideration and without notice of
the pendency of such proceeding or without notice of such tax or other
sum payable by the assessee; or
(ii) When a transfer is made with the previous permission of the Assessing
Officer.
Further, only where the amount of tax or other sum payable exceeds Rs
5,000 and the assets charged or transferred exceed Rs 10,000 in value this
provision would apply.
A transfer before an income-tax demand crystallises cannot
be declared void. On the other hand, a transfer made after an
income-tax demand notice is raised becomes debatable.

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The word „asset‟ means land, building, machinery, plant, shares, securities
and other fixed deposits in banks to the extent to which any of them do not
form part of the stock in trade of the business of the assessee.
Suresh Kumar Goyal’s case [2016] 139 DTR (Del) 362
The taxpayer by name Shiv Sareen acquired a property which he mortgaged
with IDBI Bank and got a cash credit limit of Rs 7.5 crore. Due to default of
loan payments the bank issued notice under section 13(2) of the SARFAESI
Act, 2002. The notice was issued in May 2012.
In November, 2013, the Tax Recovery Officer (TRO) issued an order
attaching the property in respect of arrears of income-tax owed by the
borrower. In December 2013, TRO also intimated the Sub-registrar about
the attachment and was asked not to undertake any transaction as regards
the said property.
The lender-bank took possession of the property in May 2014 and initiated
recovery proceedings under the SARFAESI Act. Having come to know of the
attachment of the property by the Income-tax authorities, the bank wrote a
letter to the TRO seeking authentication of the impugned order. The bank
also appraised the TRO about the mortgage of the property and based on
which the loan was given earlier and the fact of having taken possession of
the property by invoking the SARFAESI Act.
In January 2015, the IDBI Bank issued an advertisement for sale by public
auction and the buyer, i.e., plaintiff Suresh Kumar Goyal deposited earnest
money and subsequently the additional amounts and the balance of sale
consideration. The bank gave a sale certificate in respect of the property in
favour of the petitioner and also handed over the physical possession on
execution of sale deed.
Since the TRO objected to the sale of property and did not issue no objection
certificate to the petitioner, i.e., Suresh Kumar Goyal, he approached the
High Court. The Chief Commissioner was made the first respondent; the
Since the TRO objected to the sale of property and did not
issue no objection certificate to the petitioner, i.e., Suresh
Kumar Goyal, he approached the High Court.

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IDBI bank as the second respondent; the Sub-registrar as the third
respondent; and the TRO as the fourth respondent.
The SARFAESI Act, 2002
Section 13(2) says that where any borrower who is under a liability to the
secured creditor makes any default in repayment of secured debt or any
installment thereof and his debt is classified as non-performing asset, the
secured creditor may require the borrower by notice in writing to discharge
his liability to the secured creditor within 60 days from the date of notice
failing which the secured creditor is entitled to exercise his rights under
section 13(4) of the Act.
Section 35 says that the provisions of SARFAESI Act shall override other
laws notwithstanding anything inconsistent therewith contained in any
other law for the time being in force or any instrument having effect by
virtue of any such law.
Contentions before the Court
The petitioner who paid the consideration in auction and eligible for transfer
of property contended that he is eligible for transfer of property in his
favour. It was contended that the SARFAESI Act being a special Act would
override the provisions of Income-tax Act.
In Asset Reconstruction Co India Ltd v. CIT (Special Civil Appln.No.2447 of
2011 decided on 27.09.2011), the Gujarat High Court made reference to its
earlier decision in the case of Baroda City Co-operative Bank Ltd v. State of
Gujarat 2010 (3) GLR 2132, where the legal position as regards the
SARFAESI Act was prescribed as under:
i. The arrears of tax due to the State can claim priority over the
unsecured debt;
ii. If first charge by way of priority is not claimed under the statute, the
said doctrine is not applicable;
iii. Normally, the doctrine of first charge/ priority of State will prevail over
the private debt which is an unsecured debt;
iv. In normal course, the doctrine of first choice/ priority cannot prevail
over secured debts, but if first charge of the State is over the secured
debts, both debts being equal, the State can claim priority even over
the secured debts; and
v. The secured debts under the Securitisation Act or debt under the
RDDB Act has no first charge and thereby cannot compete with first
charge/ priority claim of the State if made under the statute.

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Reference was also made to Supreme Court decision in the case of TRO v.
Gangadhar Vishwanath Ranade (1998) 149 CTR (SC) 90, where the Supreme
Court held that if a property is sold to third party with intention of
defrauding the revenue, the only remedy available to the Income-tax
Department is to file a suit under rule 11(6) of the Second Schedule to the
Income-tax Act to have the transfer declared void under section 281 of the
Act.
Again, the Supreme Court in Bombay Stock Exchange v. V.S.Kandalgaonkar
(2015) 2 SCC 1, while deciding whether the Income-tax Department could
require the Bombay Stock Exchange to deposit the sale proceeds of the
membership card of the deceased towards payment of income-tax dues, it
held that BSE was the owner of the membership card and no amount of tax
arrears due from the deceased could be paid on sale of such card. While
deciding the case the Supreme Court held that the „Crown has no
precedence over a pledgee of goods‟.
Conclusion
The Delhi High Court, taking note of the various precedents, held that the
notice under section 13(2) of the SARFAESI Act is not a show cause notice.
It, in effect, operates as an attachment/ injunction restraining the borrower
from transfer of secured assets. Also, such notice was issued after
classification of the debt as non-performing asset and issued much before
the order was passed by the TRO.
When the asset is already mortgaged in favour of the bank, such secured
creditor will have priority over the amounts due to the State. It directed the
Sub-registrar to register the sale deed executed by IDBI bank in favour of
the petitioner by holding that section 281 cannot be invoked based on the
facts of the case. Thus the decision was in favour of the assessee/
petitioner.
(V. K. Subramani is Chartered Accountant, Erode.)
When the asset is already mortgaged in favour of the bank,
such secured creditor will have priority over the amounts due
to the State.