When a company goes into liquidation, an important question that arises is whether statutory liabilities such as income-tax have preference over the rights of the secured creditors and workers? The Courts have to decide the interesting question whether Section 178 of the Income-Tax Act, 1961 (the Act), makes the claim for income-tax dues a preferential right over the rights of creditors under Section 529-A of the Companies Act, 1956.

Considering the proviso to Section 178(3) of the Act, the Official Liquidator is not debarred from making any payment to secured creditors whose debts are entitled under the law to priority of payment over debts due to Government on the date of liquidation. Thus, the provision provides that payment can be made to secured creditors having priority in law over the Government.

If Section 529-A of the Companies Act is considered, it is clear that it has an overriding effect. The Section makes it clear that notwithstanding anything contained in any other provision of this Act or any other law for the time being in force, dues of the workers and the debts due to secured creditors to the extent such debts rank under clause (c) of the proviso to Section 529(1) pari passu with such dues shall be paid in priority to all other debts.

It is to be noted at this stage that so far as the dues of the company towards the tax liabilities are concerned, the same would come within Section 530(1)(a) of the Companies Act. As per Section 530(1) of the Companies Act, the dues as envisaged under Section 530(1)(a), would be subject to the provisions of Section 529-A and the dues are to be paid in priority to all other debts subject to the provisions of Section 529-A of the Companies Act.

Therefore, first the amount realised is to be disbursed to the creditors as mentioned under Section 529-A of the Companies Act and they would have a preferential right. Considering Sections 529-A and 530(1)(a) of the Companies Act read with proviso to Section 178(3) of the Act, workmens dues and the debts due to secured creditors to the extent such debts rank pari passu under section 529(1)(c) will be paid in priority to all other debts.

This point was considered by the Gujarat High Court in C.I.T. vs. O. L. of Minal Oil & Industries Ltd. (163 Taxman 1). The facts in this case were that the company was ordered to be wound up. A committee was constituted and upon realisation of the sale proceeds, the same was to be paid to Export Import Bank of India (Exim Bank) after deducting expenses.

Thereafter, the sale in favour of one Karnak for Rs 23.80 crore came to be confirmed by the Court order dated February 20, 2004 specifying the schedule of payment of sale consideration of Rs 23.80 crore. As per the order, an amount of Rs 10 crore was to be paid to Exim Bank in two instalments of Rs 5 crore, subject to the deduction as stated in the order and the balance payment was required to be made within a period of five years in five annual instalments after a moratorium of two years.

The Commissioner of Income-Tax preferred an application for directing the Official Liquidator of the company in liquidation to set aside the amount of tax dues as per the provisions of Section 178(2) of the Act by contending, inter alia, that the applicant is the Assessing Officer of the company in liquidation and the block assessment order under Section 158-BC, read with Section 144 was passed on October 16, 2003 and the undisclosed income was determined at Rs 65.49 crore.

The assessee filed an appeal before the C.I.T.(A) and he deleted the addition to the extent of Rs 48.81 crore. The net undisclosed income was determined at Rs 16.67 crore and the tax liability was fixed at Rs 10.32 crore.

For recovery of the demand, the applicant notified the Official Liquidator as per the provisions of Section 178(2) and the Official Liquidator informed the applicant that the factory site including land, building and machinery were sold through a public auction for Rs 23.80 crore in pursuance of the orders passed by the Court and that the entire sale proceeds received in this regard were to be disbursed to Exim Bank.

The Official Liquidator informed the applicant that as per the provisions of the Companies Act, the secured creditors, i.e., all secured banks/ institutions and workers would have first charge over the assets and their claim would be settled in priority to tax dues. The tax department filed a writ petition against this order relying on the decision of the Supreme Court in Imperial Chit Funds (P.) Ltd. v. Income-tax Officer (219 I.T.R. 498).

The Gujarat High Court held that the applicant was not entitled to any relief as prayed for and the application was required to be dismissed. The Court held that the dues of the Income-tax Department would not have any preference and/or priority over the claims of the workmen and/or secured creditors as envisaged under Section 529-A of the Companies Act. Section 178 of the Act provides that the liquidator of any company which is being wound up, whether under an order of a Court or otherwise, is bound, within thirty days of his appointment, to give notice thereof to the Assessing Officer who in his turn is bound within three months to intimate to the liquidator the estimated amount of tax liability of the company.

Until the liquidator has set aside an amount to meet the tax liability, he should not part with any of the assets except for paying secured creditors entitled to priority over Government dues. However, this section does not confer on the Government any higher priority than that enjoyed under the company law, as decided in the aforesaid cases.

If the liquidator fails to set aside the amount notified by the Assessing Officer, he would be personally liable for the companys tax to the extent of that amount. Where there are more liquidators than one, their liabilities are joint and several under this Section.

Contravention of this section is punishable as an offence under Section 276-A read with Section 278-AA.

H. P. Ranina