The Bombay High Court (“BHC”) has in its judgement dated July 28, 2021, in the matter of M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer, Income-Tax Department and Others [Writ Petition (L) No. 7964 OF 2021], held that, the secured debt shall take priority over the ‘Government’ dues/tax dues.

Facts

M/s Classic Diamonds (India) Limited (“Borrower”), a company under liquidation, was sanctioned facility/debt (“Credit Facility”) by the State Bank of India (“SBI”) and IndusInd Bank (collectively referred to as “Lenders”) in 2003 and 2011 respectively. The Credit Facility was secured by way of an equitable mortgage created by way of deposit of title deeds in respect of various immovable properties including one office in Opera House, Mumbai (“Premises”). The Borrower defaulted in repayment of the Credit Facility. Consequently, the Lenders filed separate proceedings before the Debts Recovery Tribunals-II, Mumbai.

In the meanwhile, due to the non-payment of income tax dues by the Borrower, the Tax Recovery Officer, Income Tax Department (“ITD”), by its order dated January 17, 2013, levied attachment over the Premises prohibiting and restraining the Borrower from transferring or creating a charge on the Premises (“Attachment Order”).

M/s Edelweiss Asset Reconstruction Company (“EARC”) is a company registered as a securitization and asset reconstruction company pursuant to Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”). EARC, by two deeds of assignment dated March 19, 2014 and March 29, 2017, acquired all the rights, title and interest with respect to the Credit Facility (“Assignments”) granted by the Lenders to the Borrower. The Assignments were along with the benefits of security of equitable mortgages created by way of deposits of title deeds over the immovable properties of the Borrower including the Premises in favour of the banks. Thereafter, EARC, being the assignee, was substituted as the original applicant in two original applications filed by the Lenders because of the defaults committed by the Borrower in repayment of debts before the Debts Recovery Tribunals-II, Mumbai by orders dated November 17, 2014 and December 07, 2017, respectively.

On May 25, 2017, EARC called upon the Borrower to pay the balance of outstanding Credit Facility by initiation of proceedings under Section 13(enforcement of security interest) of the SARFAESI Act. However, on account of failure of repayment of debt, on November 08, 2017, EARC took possession of the Premises under Section 13(4) of the SARFAESI Act with an intention to sell the Premises. In December 2019, the EARC discovered that the ITD had prohibited the selling/transferring the Premises by virtue of the Attachment Order. Consequently, EARC repeatedly requested the ITD to vacate/lift the attachment on the Premises or grant a no objection certificate (“NOC”) for the sale of the Premises. On account of no response by the ITD and aggrieved by the Attachment Order, EARC filed this writ petition under Article 226 of the Constitution of India before the BHC seeking order and direction for ITD to raise the said attachment levied on the Premises and to issue an NOC permitting EARC to sell the Premises.

Issue

Whether the secured debt assigned in favour of EARC has a priority over Government dues/tax dues.

Arguments

Contentions raised by EARC:

EARC, inter alia, contended that it is a secured creditor and as per the provisions of Section 26-E (priority to secured creditors) of the SARFAESI Act, it has prior and superior charge over the Premises which cannot be disturbed because of the dues of ITD. EARC argued that Section 26-E of the SARFAESI Act provides a statutory recognition of the priority of claim of secured creditor over all other debts and all taxes, cess and other rates payable to ‘Central Government’ or ‘State Government’ or any local authority. Therefore, under the provisions of the SARFAESI Act, EARC was empowered to sell the assets of the Borrower and recover its dues over and above the attachment levied by ITD by virtue of the Attachment Order.

It was further contended that, the priority of the charge of EARC over the dues of the ITD also stood clarified by virtue of the Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016 (“SIRDLMP Amendment”). Section 41 (insertion of new section 31-B) of the SIRDLMP Amendment introduced Section 31-B (priority to secured creditors) under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“RDDB Act”). Section 31-B of the RDDB Act, similar to Section 26-E of the SARFAESI Act, provides a statutory recognition of the priority of claim of secured creditor over all other debts and all taxes, cess and other rates payable to Central Government or State Government or local authority.

EARC also relied upon the decision of the Hon’ble Supreme Court (“SC”) in the case of Bombay Stock Exchange v. V. S. Kandalgaokar [(2015) 2 SCC 1] (“BSE Case”) and the decision of the BHC in the case of State Bank of India v. State of Maharashtra [(2020) SCC online Bom 4190] (“SBI Case”). It was submitted that in both the abovementioned judicial pronouncements, it was held that the Income Tax Act, 1961 (“IT Act”) does not provide for paramountcy of income tax dues. It was further submitted that in the SBI Case (supra), it was held that secured debt has priority over income tax dues and, therefore, EARC as secured creditor has a prior superior charge over the income tax dues.

Contentions raised by the ITD:

The ITD in an affidavit in reply dated July 09, 2021 submitted that, as the total ‘Income Tax’ demand against the Borrower was INR 58,64,54,659/-plus interest for different assessment years from 2006-2007 to 2013-2014, in the absence of any other means of recovery of the outstanding demand, the Premises of the Borrower was attached by virtue of the Attachment Order under the provisions of the IT Act.

The ITD submitted that during the recovery survey under Section 133A (power of survey) of the IT Act, the Borrower was summoned to produce various details including details of loans and advances, however, Borrower had nowhere mentioned about the mortgage over the Premises and, therefore, the Premises was attached. ITD also relied on the decision of the SC in the case of Central Bank of India v. State of Kerala [(2009) 4 SCC 94] (“CBI Case”) wherein it was held that, in case the statutory first charge is created in favour of State under Section 26B (tax payable to be first charge on the property) of the Kerala General Sales Tax Act, 1963 then, the said charge shall have primacy over the right of the bank to recover its dues.

Lastly, it was submitted that the Premises of the Borrower has been attached by the ITD in the interest of the ITD as per Sections 220 (when tax payable and when assessee deemed in default) to 232 (recovery by suit or under other law not affected) of the IT Act and Second Schedule (procedure for recovery of tax) thereof, and there is no provision in the IT Act to vacate/lift the attachment till the finalisation/recovery of the demand. Therefore, in the absence any such provision, the ITD itself cannot vacate/lift the attachment on the Premises pursuant to the Attachment Order and it would be for the BHC to pass appropriate orders.

Observations of the Bombay High Court

The BHC analysed the judicial pronouncement relied on by both the parties and observed that the SC in the BSE Case (supra), while considering the question whether the lien exercised by the stock exchange can be said to be a superior right to the income tax dues, held that the IT Act does not provide for any paramountcy of dues by way of income tax. The BHC further observed that the SC while giving the decision in the BSE Case (supra) also referred to its own decision in the case of Dena Bank v. Bhikhabhai Prabhudas Parekh & Co. [(2000) 5 SCC 694], where it was held that Government dues have priority only over unsecured debts. The BHC further assessed that in the SBI Case, the BHC also considered the question of priority between the charge of a secured creditor and tax/VAT dues under the Maharashtra Value Added Tax Act, 2002 and, after considering the provisions of SARFAESI Act as well as RDDB Act, it was observed that the mortgage of a secured creditor gets prior charge over the charge of the state for tax/VAT dues.

The BHC, with reference to the CBI Case (supra) relied on by the ITD, observed that the said decision was distinguished in the SBI Case (supra) wherein, the SC stated that, since Section 26E of the SARFAESI Act and Section 31- B of the RDDB Act were not in the statue book at the time of deciding the CBI Case (supra), the impact of the said sections did not come into consideration. In light of the abovementioned case laws and provisions, the BHC was of the view that EARC’s charge/mortgage over the Premises has priority over the dues of the ITD.

Decision of the Bombay High Court

The BHC allowed the petition and arrived at the conclusion that the EARC’s charge/mortgage on the Premises has priority over the dues of the ITD and directed the ITD to release the attachment levied pursuant to the Attachment Order on the Premises and issue a NOC permitting the EARC to sell the said premises.

VA View:

The BHC’s order deals with the doctrine of priority of crown debt. The common law doctrine of priority of crown debt pertains to a common law principle that the debt due to the state or the king claims priority before all other creditors. The basic justification for the said principle rests on the well-recognized principle that the State is entitled to raise money by taxation because unless adequate revenue is received by the State, it would not be able to function as a sovereign government at all.

Over the years, the SC, through various judgements mentioned above, and others, has created an exception to this doctrine by stating that a debt which is secured takes priority over the Government dues/tax. The BHC’s order rightly upholds what the SC has upheld in similar matters where the question of priority of secured debt over crown debt was raised.

For more information please write to Mr. Bomi Daruwala at [email protected]

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