Treatment of Capital Gains Tax during liquidation process

M/s Shree Ram Lime Products Pvt. Ltd. Vs. Gee Ispat Pvt. Ltd
(CA-666/2019 in (IB) - 250(ND)/2017)
Order dated 22.10.2019
Sub: Treatment of Capital Gains Tax during liquidation process.

NCLT HELD THAT

We, therefore, hold that the tax liability arising out of the sale shall be distributed in accordance with the provisions of Section 53 of the Code. The applicability of Section 178 or 194 IA of the IT Act will not have an overriding effect on the water fall mechanism provided under Section 53 of the Code, which is a complete code in itself, and the capital gain shall not be taken into consideration as the liquidation cost. The Capital Gain will be treated as Operational Debts along with other dues of the government and will be paid according to water fall mechanism as referred above.

BRIEF FACTS

1. The learned Liquidator under Section 60(5) of the Insolvency & Bankruptcy Code, 2016, praying for directions/clarifications in respect of certain steps required to be taken after liquidating the assets of the Corporate Debtor.

2. Vide order dated 05.10.2018, liquidation of the assets of the Corporate Debtor had been directed as no resolution of the business of the Corporate Debtor was proposed.

3. Vide the present application, the learned Liquidator, Ms. Pooja Bahry, submits that the secured creditors had relinquished their charge over all properties of the Corporate Debtor which were mortgaged with them, upon which steps were taken by her to sell the same.

4. As per averments, auctions were held and a sum of Rs. 16,31,20,000/- has been realised so far. The liquidator proposes to proceed with distribution of the amounts in accordance with the waterfall mechanism prescribed in Section 53 of the Code.

5. However, she is faced with the issue as to whether capital gains tax would be attracted on sales of such secured assets to be included as liquidation cost. If so, she would be required to first make provision for the capital gains and accordingly after deduction of the amount, the balance shall be distributed amongst the claimants. The short point for clarification required by the Learned Liquidator therefore is whether in the present case she is required to deposit the capital gains and include it as liquidation costs to be defrayed in the first instance.

6. On notice being issued to the Income Tax Department, Ms. Lakshmi Gurung, Ld. Counsel appearing for them has of course claimed that the capital gain has to be deposited first as per the Income Tax Act. She submits that all dues towards realisable taxes have to be remitted in the first instance in the Liquidation process as per the provision of Section 178 of the IT Act and no exception can be carved out in cases under the Insolvency & Bankruptcy Code. Reliance has been placed on various judgments which have clearly ordained that capital gain tax is payable on sales whether the liquidation is voluntary or involuntary. Reliance is also placed on specific provisions for deduction of tax under Section 194 IA, mandating the purchaser of the property to deduct an amount equal to 1% of the sale consideration at the time of making payment and deposit it with Government as TDS.

7. To adjudicate the point in reference, we note that as per the provisions of Section 52 of the Code, a secured creditor has the option to:

a) Relinquish their security to the liquidation estate of the Corporate Debtor and allowed liquidator to sell the Secured Assets and apply the proceeds as per the liquidation waterfall under Section 53 of the Code.

b) Realise its security interest in the manner specified in this section.

8. In the present case had the secured creditors chosen option (b) they could have applied the entire proceeds received to recover their debts (without deduction on account of any capital gains tax) as tax on capital gains is not liable to be paid by the banks. However, instead of realising the Secured Assets on their own they have opted for proceeding under Section 52(a). The secured creditors of the Corporate Debtor have relinquished their security to the liquidator who proceeded to sell the Secured Assets in terms of the Code and the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 ("Liquidation Regulations").

Section 52: Secured creditor in liquidation proceedings.

(1) A secured creditor in the liquidation proceedings may—

(a) relinquish its security interest to the liquidation estate and receive proceeds from the sale of assets by the liquidator in the manner specified in section 53; or
(b) realise its security interest in the manner specified in this section.

9. Given the facts of the case we do not find favour with the arguments advanced on behalf of the Income Tax Department. This Bench is of the opinion that upon realisation of the liquidated estate of the Corporate Debtor, it has to be disbursed in accordance with the waterfall mechanism as per Section 53 of the Code.

10. Section 53(1)(e) provides for the liability towards government dues. As per Section 238 of the Code, the provisions of the Code shall have an overriding effect on any other enactment. The dues towards Government, be it tax on Income on or sale of properties, would qualify for being an operational debt and has to be dealt with accordingly. The provisions of Section 178 of the Income Tax Act have also been amended in view of the provisions of the Insolvency & Bankruptcy Code.

SECTION 53(1)

Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period and in such manner as may be specified, namely

(e) the following dues shall rank equally between and among the following:—

(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;

(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

11. Further, the asset liquidated are those released by the secured creditors under the Code. A secured creditor is entitled to effect sale under the SARFAESI Act and appropriate the entire amount towards its dues, without any liability to first pay the capital gain. It is only upon residual liquidity that the distribution of the assets has to be made according to the Operational Creditors (in this case the tax authorities) in terms of the provisions of Section of the Code. If the capital gain is first to be provided for, and then be included as liquidation cost, it would create an anomalous situation in the Secured Creditor getting a lesser remittance than what they could have realised had they not released the security into the common corpus. It is for this purpose that the provision of Section 178 of the Code has been amended giving priority to the waterfall mechanism over government dues.

12. We therefore hold that the tax liability arising out of the sale shall be distributed in accordance with the provisions of Section 53 of the Code. The applicability of Section 178 or 194 IA of the IT Act will not have an overriding effect on the water fall mechanism provided under Section 53 of the Code, which is a complete code in itself, and the capital gain shall not be taken into consideration as the liquidation cost.

COMPANY IN LIQUIDATION- SECTION 178

(1) Every person—

(a) who is the liquidator of any company which is being wound up, whether under the orders of a court or otherwise; or
(b) who has been appointed the receiver of any assets of a company(hereinafter referred to as the liquidator) shall, within thirty days after he has become such liquidator, give notice of his appointment as such to the Assessing Officer who is entitled to assess the income of the company.

(2) The Assessing Officer shall, after making such inquiries or calling for such information as he may deem fit, notify to the liquidator within three months from the date on which he receives notice of the appointment of the liquidator the amount which, in the opinion of the Assessing Officer, would be sufficient to provide for any tax which is then, or is likely thereafter to become, payable by the company.

(3) The liquidator—

(a) shall not, without the leave of the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner, part with any of the assets of the company or the properties in his hands until he has been notified by the Assessing Officer under sub-section (2) ; and
(b) on being so notified, shall set aside an amount, equal to the amount notified and, until he so sets aside such amount, shall not part with any of the assets of the company or the properties in his hands :

Provided that nothing contained in this sub-section shall debar the liquidator from parting with such assets or properties for the purpose of the payment of the tax payable by the company or for making any payment to secured creditors whose debts are entitled under law to priority of payment over debts due to Government on the date of liquidation or for meeting such costs and expenses of the winding up of the company as are in the opinion of the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner reasonable.

(4) If the liquidator fails to give the notice in accordance with sub-section (1) or fails to set aside the amount as required by sub-section (3) or parts with any of the assets of the company or the properties in his hands in contravention of the provisions of that sub-section, he shall be personally liable for the payment of the tax which the company would be liable to pay :

Provided that if the amount of any tax payable by the company is notified under sub-section (2), the personal liability of the liquidator under this sub-section shall be to the extent of such amount.

(5) Where there are more liquidators than one, the obligations and liabilities attached to the liquidator under this section shall attach to all the liquidators jointly and severally.

(6) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other law for the time being in force except the provisions of the Insolvency and Bankruptcy Code, 2016.

PAYMENT ON TRANSFER OF CERTAIN IMMOVABLE PROPERTY OTHER THAN AGRICULTURAL LAND- SECTION 194-IA

(1) Any person, being a transferee, responsible for paying (other than the person referred to in section 194LA to a resident transferor any sum by way of consideration for transfer of any immovable property (other than agricultural land), shall, at the time of credit of such sum to the account of the transferor or at the time of payment of such sum in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct an amount equal to one per cent of such sum as income-tax thereon.

(2) No deduction under sub-section (1) shall be made where the consideration for the transfer of an immovable property is less than fifty lakh rupees.

(3) The provisions of section 203A shall not apply to a person required to deduct tax in accordance with the provisions of this section.

Explanation.—For the purposes of this section,—

(a) "agricultural land" means agricultural land in India, not being a land situate in any area referred to in items (a) and (b) of sub-clause (iii) of clause (14) of section 2;
(b) "immovable property" means any land (other than agricultural land) or any building or part of a building.

13. That apart, we are also unable to comprehend what capital gains would accrue when the extremely stressed assets of the Corporate Debtor are being liquidated and the situation presumably gives way to larger capital losses.

CONCLUSION

One important aspect which escaped the attention of the Ld. Liquidator & the bench is that there is no provision in the Code for consideration of claim of any party including govt. dues, falling due after the liquidation commencement date. Liquidator can only consider the claims as on the date of commencement of Liquidation.

SECTION 53 OF IBC, 2016

SECTION 53: DISTRIBUTION OF ASSETS

(1) Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period and in such manner as may be specified, namely :—

(a) the insolvency resolution process costs and the liquidation costs paid in full;
(b) the following debts which shall rank equally between and among the following :—

(i) workmen's dues for the period of twenty-four months preceding the liquidation commencement date; and
(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;

(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;
(d) financial debts owed to unsecured creditors;
(e) the following dues shall rank equally between and among the following:—

(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

(f) any remaining debts and dues;
(g) preference shareholders, if any; and
(h) equity shareholders or partners, as the case may be.

(2) Any contractual arrangements between recipients under sub-section (1) with equal ranking, if disrupting the order of priority under that sub-section shall be disregarded by the liquidator.

(3) The fees payable to the liquidator shall be deducted proportionately from the proceeds payable to each class of recipients under sub-section (1), and the proceeds to the relevant recipient shall be distributed after such deduction.

Explanation.—For the purpose of this section

(i) it is hereby clarified that at each stage of the distribution of proceeds in respect of a class of recipients that rank equally, each of the debts will either be paid in full, or will be paid in equal proportion within the same class of recipients, if the proceeds are insufficient to meet the debts in full; and

(ii) the term "workmen's dues" shall have the same meaning as assigned to it in section 326 of the Companies Act, 2013.

Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016

Regulation 12. Public announcement by liquidator.

(1) The liquidator shall make a public announcement in Form B of Schedule II within five days from his appointment.
(2) The public announcement shall-
(a) call upon stakeholders to submit their claims or update their claims submitted during the corporate insolvency resolution process, as on the liquidation commencement date; and
(b) provide the last date for submission or updation of claims, which shall be thirty days from the liquidation commencement date.