[By KV Kailash Ramanathan]
The author is a student at the National University of Advanced Legal Studies, Kochi.
Introduction
In recent years, the legal fraternity has witnessed a befuddling tug-of-war between tax authorities on one hand and the Corporate Insolvency Resolution Process on the other. The battle runs for the recovery of taxes and dues payable by the corporate debtor. Taxation statutes like The Customs Act. 1962 provide for a recovery mechanism under the very legislation. Whereas under the Insolvency and Bankruptcy Code, 2016 ( “IBC” or “the Code”) once a moratorium is imposed, all other proceedings are suspended and recovery of debt can be done only by filing a claim with the resolution professional after which the process under the code will commence ending in liquidation or approval of the resolution plan.
Through its recent ruling in Sundaresh Bhatt, Liquidator ABG Shipyard vs Central Board of Indirect Taxes and Customs, the Supreme Court decisively upheld the precedence of the IBC over The Customs Act in the recovery of dues post imposition of moratorium. The ruling although made in the context of customs duty is likely to have a similar effect in its application to other tax statutes and pari materia provisions.
In this piece, the author seeks to analyse the ruling, and legislative intent behind the scope provided to the moratorium and explore the implications it is likely to have on the collection of taxes. The scope and extent of authority that shall henceforth be available to tax authorities post imposition of the moratorium shall also be discussed.
Factual Matrix
ABG Shipyard (“Corporate Debtor”) was a shipbuilding company prior to the initiation of the Corporate Insolvency Resolution Process (CIRP). As a part of its operations, the company imported goods that were used in the construction of ships to be exported. The corporate debtor stored some of these goods in the container freight stations in Maharashtra and custom-bonded warehouses in Gujarat. At the appropriate time, bills of entry for warehousing were submitted. The Corporate Debtor additionally benefited from an Export Promotion Capital Commodities Program (EPCG Scheme) and received an EPCG License for the aforementioned warehoused goods under the said scheme.
Later, the National Company Law Tribunal (“NCLT”) accepted a petition for initiation of CIRP against the corporate debtor and imposed a moratorium under Section 14 of the IBC. The Appellant was appointed as the Interim Resolution Professional. The Appellant then wrote to the respondents seeking custody of the corporate debtor’s goods in their warehouse asking them not to dispose of it. Upon receiving such communication from the Appellant, the Respondents sent notices to the Corporate Debtor for the first time regarding the non-fulfillment of export obligations in terms of the EPCG license and demanding customs duty of Rs. 17,13,989/- with interest.
Later, the NCLT passed an order commencing liquidation against the Corporate Debtor under Section 33(2) of the IBC. A fresh direction was also passed under Section 33(5) of the IBC prohibiting the institution of any suit or legal proceeding against the Corporate Debtor. Further, the NCLT also appointed the Appellant as the liquidator vide the same order. The liquidator filed an application under Section 60(5) of the IBC seeking direction to the respondents to release the warehoused goods.
The key question of law that is dealt with in this piece failed to receive the NCLAT’s consideration
Issues
The following issues were framed by the Court after considering the factual scenario of the case-
- Whether the provisions of the IBC would prevail over the Customs Act, and if so, to what extent?
- Whether the Respondent could claim title over the goods and issue notice to sell the goods in terms of the Customs Act when the liquidation process has been initiated?
Ruling and Analysis
The court pored through the provisions of both the Customs Act and IBC to determine which one would prevail over the other. The fundamental question involved here was that whether the charge over the goods for non-payment of customs duty, could be claimed and realized in accordance with the Customs Act, when a moratorium is in effect and order for liquidation under the code has already been made. The scheme of the IBC provides that once an order for liquidation is made, all creditors are required to realize their claims only as per the waterfall mechanism envisaged under Section 53 of the code. The mechanism explicitly provides for the order of priority in which different classes of creditors are repaid. In case of insufficient liquidation proceeds, repayment occurs to the complete exclusion of a lower-ranking class of creditors until the higher-ranking creditors’ claims are fully settled. Some of the aspects considered by the court are discussed below.
Proceedings under Customs Act precluded post-imposition of moratorium
While the Customs Act under Section 72 provides for a recovery mechanism, it is critical to note that the department had issued notice to the corporate debtor only after the imposition of moratorium under Section 14. Further, the moratorium continues as per Section 33(5) after the order for liquidation is made. The Court held that initiating such proceedings is in gross violation of the moratorium imposed.
When such a conflict exists the non-obstante clause under Section 238 of the IBC being the later provision applies and gives the code primacy over any other legislation.
Harmony between Section 142A of the Customs Act and the IBC’s Non-obstante clause
The overriding effect of the IBC over the customs act has been provided in the customs act itself. Section 142A of The Customs Act clearly notes that The Custom Authorities would have the first charge on an assessee’s assets under the Customs Act, with the exception of circumstances covered under, inter alia the IBC 2016. The NCLAT sidestepped Section 142A of the Customs Act and Section 238 of the Code by referring to the Calcutta High Court’s judgment in Collector of Customs v. Dytron (India) Ltd., which laid down that customs duty carry the first charge even during the insolvency process under Section 529 and 530 of The Companies Act, 1956.
The NCLAT overlooked the fact that the above verdict has been legislatively overruled by the insertion of Section 142A in The Customs Act. A provision cannot be interpreted in a manner diametrically opposed to its explicit text that is clear, unambiguous, and has no absurdity whatsoever.[1] The literal rule of statutory construction needs to be followed here.
Hence it was conclusively held that in general the IBC and customs act operate in their specific spheres, and are to be interpreted harmoniously. However, in case of conflict, the IBC would prevail over the customs act.
Legislative Intent behind the scope of moratorium
In the ABG Shipyard case, the context specifically dealt with is the initiation of proceedings under the customs act after the imposition of a moratorium running under Section 14 and later under Section 33(5) of the code. All demand notices under the customs act were issued to the corporate debtor only when the moratorium period was in effect.
A moratorium period was conceived by the legislature to shield the corporate debtor from all forms of pecuniary attacks.[2] One of the lenses for interpretation of IBC is the reports by the Insolvency law Committees. The court took into account the pertinent section of the February 2020 Report, which clearly states that the purpose of a moratorium is to maintain the corporate debtor’s assets together during the insolvency resolution process, facilitate the orderly completion of the processes envisaged during the insolvency resolution process, and ensure that the business may continue as a going concern while the creditors consider a resolution of default.
Extent of the Customs Department’s powers.
It is imperative in the present discussion to delineate the extent of the authority’s powers once a moratorium is imposed. Issuing a legal notice under Section 72 is in the nature of initiating legal proceedings and is thereby barred as per Section 14 of the IBC. On this issue, the court relied on its earlier verdict in S.V. Kondaskar v. V.M. Deshpande, where the interplay between the bankruptcy provision of The Companies Act, 2013 and the Income Tax Act was dealt with. The court held that the customs authority would continue having the power to assess the quantum of dues payable as a duty. It is merely the initiation of recovery proceedings that stand prohibited. Determination of the levy and taxes, interest, and penalties thereon are permissible.
Striking such a balance ensures harmonious construction of the two legislations as the customs authority has limited jurisdiction to determine the quantum of operational debt, while its recovery falls squarely within the ambit of the code. Such an interpretation is in tune with the court’s earlier ruling in Gujarat Urja Vikas Nigam Ltd vs Amit Gupta and does not amount to a usurpation of the customs authority’s power by NCLT.
No Transfer of Title
The court declared in clear terms that the NCLAT’s prime reasoning was erroneous. The NCLAT argued that the Corporate Debtor’s default in paying customs duty and collecting the warehoused goods would cause a loss of title to those goods and cannot be considered as goods belonging to him. This contention was outright dismissed, as such deemed transfer of title to the customs authority under Section 72 would violate Sections 14, read with Sections 25 and 33(5) of the IBC. Further dispossessing property that way without due process of law would infringe upon article 300A of the constitution.
Implications on Indirect Tax Statutes
The impugned ruling in ABG Shipyard is certain to have serious implications on Tax collection. This would now act as a precedent in the operation of other tax statutes as well. Legislations like the Central Excise Act and the Goods and Services Act have provisions that are pari materia to the Customs Act. Tax authorities as operational creditors would have to go through the mechanism under the IBC to recover their dues, with their powers now restricted to the mere assessment of the quantum of total dues.
While the present case upholds the precedence of IBC only when proceedings are initiated for the first time after a moratorium is imposed, it is clear from the scope of the moratorium that proceedings initiated prior to it would be stayed by order of the adjudicating authority under Section 14. The same has been upheld by the supreme court in Pr. Commissioner Of Income Tax v. Monnet Ispat And Energy Ltd. where even the appeals by the income tax department at the Income Tax Appellate Tribunal were stayed.
Tax authorities also run the risk of being unable to realise the whole due under the waterfall mechanism as they rank only below other categories like liquidation cost. With the ruling of the supreme court in State Tax Officers vs Rainbow Papers Ltd, government dues are to be treated as secured creditors and thereby rank pari passu with workmen’s dues. Hence the recovery of the whole debt is a dicey affair.
Conclusion
Through its verdict, in the ABG Shipyard case the Supreme Court has clearly settled the question of law by holding that the IBC would prevail over The Customs Act, to the extent that once moratorium is imposed in terms of Sections 14 or 33(5) of the IBC as the case may be, the customs authority only has a limited jurisdiction to assess/determine the quantum of customs duty and other levies. The authority does not have the power to initiate the recovery of dues by means of sale/confiscation, as provided under the Customs Act.
The verdict is bound to have a huge precedential impact on the collection of indirect taxes, especially from distressed companies. Tax authorities as operational creditors would now have to seek remedy under the IBC, and in case of liquidation go through the waterfall mechanism under Section 53 which could cause them to forego a significant portion of their taxes.
[1] CIT vs T.V Sundaram Iyyengar (1975) 101 I.T.R 764 SC