Treatment of Tax Dues under the Insolvency and Bankruptcy Code (IBC) Framework
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Tax Dues under the IBC constitute a significant category of claims asserted during insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC). The enactment of the IBC fundamentally altered the landscape for recovery of these dues by prioritizing the efficient resolution and revival of distressed companies. This shift has frequently created tension between the government’s interest in recovering tax claims and the rights of secured financial and operational creditors. To resolve these conflicts, courts and tribunas have provided substantial clarity regarding the position of tax authorities within the creditor hierarchy, especially under the waterfall mechanism under section 53 of the IBC, all which will be discussed in this blog.
Understanding Tax Dues in the Context of Insolvency
“Tax Dues under the IBC” encompasses direct taxes like income tax and corporate tax, which are levied directly on individuals’ earnings and company profits, respectively, and indirect taxes, such as Goods and Services Tax (GST), customs duty, and excise duty, which are imposed on the consumption of goods and services and collected by intermediaries. Under section 5(21) of the IBC, these Tax Dues under the IBC are classified as operational debts, meaning they arise from the provision of goods or services, including the supply of goods and services subject to GST, customs, and excise duties. This classification allows tax authorities to participate in the insolvency process as operational creditors, enabling them to claim dues from the corporate debtor’s estate during the resolution process. The implication for tax authorities is enhanced recovery prospects through the IBC, while for corporate debtors, it increases the risk of tax claims being prioritised in the resolution process, potentially affecting the viability of the resolution plan.
Position of Tax Authorities in the Priority Waterfall
Under section 53 of the IBC, the distribution of the proceeds from the sale of assets are listed as:
- Insolvency resolution costs
- Secured creditors and workmen’s dues
- Employee wages
- Government dues and remaining secured debt
- Unsecured creditors and shareholders
Hence, under the IBC, government tax claims are subordinated to secured creditors and employee claims, ranking secured creditors and workmen’s dues above government dues. This subordination reflects a deliberate legislative intent to prioritize secured and employee claims, although recent judicial interpretations, such as Rainbow Papers, have introduced complexity by recognising certain tax claims as secured if backed by a statutory charge.
Judicial Interpretation and Key Case Laws
The Supreme Court in Ghanashyam Mishra and Sons Pvt. Ltd. v. Edelweiss ARC held that all government dues, including tax and statutory liabilities, existing prior to the approval of a resolution plan, stand extinguished and cannot be claimed from the corporate debtor after the plan is sanctioned. This ruling established a clear priority for the commercial viability of a resolution over all prior sovereign claims. In Sundaresh Bhatt, Liquidator of ABG Shipyard v. Central Board of Indirect Taxes, the court reaffirmed the earlier position, reinforcing that once a resolution plan is approved, the tax authorities cannot continue to pursue claims against the corporate debtor. The court emphasised that the timely conclusion of the insolvency process is paramount and not subject to an open-ended process for government recoveries. The Rainbow Papers case introduced a complexity by analysing the classification of statutory dues, suggesting they could be considered secured debts and creating a debate that potentially allowed government claims to survive the insolvency process. This ambiguity was later resolved by subsequent decision clarifying that the ruling was specific to the facts of that case and did not override the principle of extinguishing prior sovereign dues upon plan approval. Through these judgments, the courts attempt to balance the legitimate interest of the government in recovering sovereign dues with the need to ensure the commercial viability of a resolution plan and provie a clean slate for the new management. Check out this Limited Insolvency Practice Exam
Issues and Challenges for Tax Dues under the IBC
There are certain procedural and statutory hurdles for tax authorities in insolvency cases, namely:
- Loss of revenue recovery rights after plan approval.
- Lack of coordination between tax departments and insolvency professionals.
- Difficulties in timely filing of claims during the CIRP.
- Absence of clear mechanisms for adjusting ongoing tax assessments post-resolution.
- Inconsistent interpretation across different forums (e.g., NCLT, ITAT, GST authorities).
Impact on Resolution Applicants and Corporate Debtors
The extinguishing of old Tax Dues under the IBC significantly enhances the attractiveness of distressed assets by providing potential buyers with a clean slate, free from the burden of financial obligations. This clarity allows bidders to accurately value the assets and focus on future profitability without the fear of past liabilities. However, uncertainty regarding pending tax assessments and potential future liabilities can still deter bidders, as the lack of finality introduces substantial risk. A clear, legally binding discharge of all prior claims under a court-approved resolution plan is therefore crucial for ensuring finality, providing business continuity, and encouraging competitive bidding for the distressed company’s assets.
Policy and Administrative Reforms Needed
For smoother integration between the IBC and tax framework, it is recommended to:
- Creation of a centralized government claim portal linked to IBBI and tax databases.
- Time-bound coordination between the RP/Liquidator and tax officers.
- Periodic clarifications from CBDT and CBIC aligning departmental recovery actions with IBC provisions.
- Training of tax officials in insolvency processes to ensure proper claim filing and compliance.
Conclusion
While the IBC has redefined the treatment of Tax Dues under the IBC by prioritizing revival over recovery, the approach must balance creditor rights, government interests, and procedural clarity. Judicial precedents have largely reinforced the supremacy of the IBC’s resolution process over central and state tax recovery efforts, ensuring that valid resolution plans are not undermined by past tax liabilities. Ultimately, stronger coordination between tax and insolvency frameworks will lead to a more predictable and transparent resolution ecosystem.
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