Liability of directors of private company in liquidation

Dear Friends,

As you are aware that a private limited company is a legal entity and separate from its directors and members. It contains corporate veil behind which liability of its members and limited to the extent of subscribed share capital. But the operations of a company is managed by natural persons , called directors. They are responsible for management of affairs of the company and they are the true mind behind all decisions of the company.

In case of fraud, misfeasance or gross negligence by a company. The courts generally lift corporate veil to find out the main person behind the company. A private limited generally a family run or closely held company and managed by family members. It is duty to all persons to pay applicable taxes to the government accurately and within due date.

In case of company under liquidation the payment of " tax dues" will be recovered by the company and in case of non-recovery of "tax dues" the directors of company should be asked to pay the same.

In this article we are going to discuss important aspects of provisions of section 179 of the Income Tax Act, 1961.

The provisions of Section 179 of the Income Tax Act, 1961 provides that any tax due from a private company , in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered then , every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.

PLEASE NOTE THAT

For the purpose this section, the expression "Tax Due" ,includes penalty, interest or any other sum payable under the Act, 1961.

Section 179 of the Income Tax Act, 1961: Liability of directors of private company in liquidation;

(1) Notwithstanding anything contained in the Companies Act, 1956 (1 of 1956), where any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered, then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.

(2) Where a private company is converted into a public company and the tax assessed in respect of any income of any previous year during which such company was a private company cannot be recovered, then, nothing contained in sub-section (1) shall apply to any person who was a director of such private company in relation to any tax due in respect of any income of such private company assessable for any assessment year commencing before the 1st day of April, 1962.

LET'S CONSIDER SOME JUDGEMENTS

Paras S. Salva Vs. ACIT, Circle-8(2016) 389 ITR 336(Guj)- Assessee was director of a company. Notice was issued to recover unpaid taxes from directors of company. Assessee claimed that company was not a private limited company , but a public limited company. Revenue called upon the assessee to substantiate the claim. On appeal it was held that if revenue wanted to apply principle of lifting corporate veil in context of section 179 , it ought to have prima facie sufficient material to confront assessee on issue, revenue could not have questioned such a basic fact in such notice.

Pravinbhai M. Khem Vs. ACIT (2013)213 Taxman 81(Guj)- Although, provisions of section 179(1) cannot be applied to a public company but where a public was only a conduit for creation of unaccounted money and appropriating , its directors-cum-shareholders who were 7 in members and all of them being family members , it was held that if these facts are duly established , principle of lifting corporate veil should be applied and by application of Section 179 of the Act, 1961 , the recovery of tax due of the company can be sought from the directors.

Gul Gopaldas Daryani Vs. ITO (2014) 46 Taxman.com 35 (Guj)- A company was incorporated to run a five star hotel and a building for such purpose was constructed, however, during the devastating earthquake , hotel building was severely damaged. It was further found that insurance claim had been raised but the same was not passed by insurance company and civil disputes were still pending. During the relevant year , AO having completed assessment , raised a tax demand against the company. In view of failure of the company to pay taxes, TRO passed an order in terms of Section 179 holding the directors jointly and severally liable for payment of tax. On facts, it was held that it is not a case where director i.e. assessee , failed to take measures for protecting property or interest of company and therefore impinged order passed by TRO was quashed.

Sadhna Ramchandra Jeswani V/s Income Tax Officer, Special Civil Application Nos. 5354 & 5355 of 2018, High Court of Gujarat, Date of Decision: 27.08.2018, Coram: Akil Kureshi & B.N. Karia, JJ., it was observed that:

"At the outset, we may notice that Section 179 of the Act would enable the Revenue to recover the unpaid tax dues of a private company from its director, unless he proves that the non-recovery cannot be attributed to any gross negligent, misfeasance or breach of duty on his part in relation to the affairs of the company. Of course, this requirement is cast in the negative and the burden is on the person who was a director of the company at the relevant time to establish the relevant facts. Nevertheless, it would be the onus of the Assessing Officer to draw the primary facts to the notice of the assessee on the basis of which, he proposes to invoke powers under Section 179 of the Act. Essentially, this statutory provision provides for lifting of corporate veil and enable the Revenue to recover the unpaid tax dues of a private company from its directors, provided the requirements referred to in Sub-section (1) of Section 179 of the Act are satisfied."

PLEASE NOTE THAT

1. For applicability of the provisions of Section 179 of the Income tax Act, 1961 ,first and foremost requirements of applicability of Section 179 ,is that director from whom such recovery is sought to be made is director of a private company.
2. Where it was established from materials on record that there was no gross neglect , misfeasance or breach of duty on the part of director to the affairs of the company. It was held that in given situation , revenue can not be made him liable.
3. Liability of directors for the tax dues of a private limited company arises only when the arrears cannot be recovered from the company. The AO should record reasons of his believe that the tax and arrears will not be recovered from the company ,only in that case recovery from director should be made. It means that the Revenue is required to establish that they have taken all steps to recover dues from the company but not succeeded.
4. For invoking section 179 it is not necessary that all three ingredients , viz ,gross neglect, misfeasance and breach of duty are satisfied; it is sufficient if it is held that there is gross neglect or misfeasance or breach of duty on part of directors in relation to affairs of company. Thus where a company did not file its return of income for more than 10 years and was not in a position to pay tax depended, it could be said that there was a gross neglect on the part of directors of the company and hence, all ingredients of Section 179 were satisfied.
5. The "Income Tax" for the purpose of Section 179 does not include penalty, therefore , directors of the company cannot be called upon to pay the penalty of the company under provisions of Section 179 of IT Act, 1961.
6. Please note that for the purpose of section 179 of the Act, 1961 the notice of recovery should be given to all directors ,whether they are executive or non-executive , professional or non-professional. All directors are jointly and severally responsible.
7. In case where notices are issued for payment of "tax dues" to the company and not to the director attachment of bank account and recovery of dues from directors is not permissible [Susan Chacko Perumal V/s Asstt. CIT, (2017) 399 ITR 74 (Guj)].
8. Please note that the director should be given an opportunity to show and prove that non-recovery of tax due is not due his negligence , misfeasance or fraud.

CONCLUSION

From above it is clear that for applicability of provisions of Section 179 of the Act, 1961 it is necessary that revenue should prove that they have taken all steps and not able to recover tax from the company and director of the company is responsible for gross negligence, misfeasance and fraud in a private limited company. It should be noted that Section 179 is applicable only on Private (closely held) company and not on Public Companies. But a provisions of Section 179 is applicable on a Public Company also in case it is managed y a family or it is family business. The main purpose of Section 179 is to lifting of corporate veil to find the main person behind the management of the company.

DISCLAIMER: The above write up is only for information and knowledge of readers.