How Income Tax Dues Are Treated Under the IBC

Income tax dues in a Corporate Insolvency Resolution Process rank as government dues under Section 53(1)(e) of the Insolvency and Bankruptcy Code, 2016, pari passu with operational creditors only for the two years before liquidation and subordinate to secured creditors and workmen at every other stage. The Supreme Court has confirmed that Section 238 of the Code overrides the Income Tax Act, 1961, and that any tax claim not filed with the Resolution Professional before a resolution plan is approved stands extinguished once the National Company Law Tribunal sanctions the plan. This post examines that waterfall, CBDT's claim-filing circulars, and NCLAT rulings on delayed tax claims.

Section 53 and the Waterfall Mechanism

Section 53 of the IBC prescribes the order of priority in which the proceeds from the sale of liquidation assets are to be distributed. The hierarchy, in descending order of priority, is: (1) CIRP costs and liquidation process costs; (2) workmen's dues for 24 months preceding the liquidation commencement date, pari passu with secured creditors; (3) wages and unpaid dues to employees for 12 months; (4) financial debts owed to unsecured creditors; (5) government dues for a period of two years preceding the liquidation commencement date, pari passu with operational creditors' dues; (6) remaining secured and unsecured debts; (7) preference shareholders; and (8) equity shareholders.

Government dues, including income tax arrears, do not enjoy priority over secured financial creditors or workmen. The IBC's waterfall is a self-contained code on priority, and the Income Tax Act, 1961, the CGST Act, 2017, and analogous statutes do not override it.

Supreme Court Decisions

Ghanashyam Mishra and Sons v. Edelweiss Asset Reconstruction Company Limited [(2021) 9 SCC 657]

The Supreme Court held in this case that once a resolution plan is approved under Section 31 of the IBC, all claims not included in the plan stand extinguished. The court confirmed that this extinguishment applies to tax dues that were not filed as claims during the CIRP. The income tax department, like any other creditor or authority, is required to file its claim before the Resolution Professional within the prescribed time. Failure to do so results in extinguishment of the claim against the corporate debtor under new management.

Priority of Tax Dues and the 2-Year Window

Under the waterfall in Section 53(1)(e), government dues for two years preceding the liquidation commencement date rank pari passu with operational creditor dues. Older government dues fall even lower in priority. This means income tax arrears for periods beyond two years before liquidation commencement are subordinated to operational creditors. The Supreme Court has confirmed that this waterfall applies to liquidation distributions under Section 53 and that the IBC prevails over tax statutes by virtue of the non-obstante clause in Section 238 of the IBC.

What Do CBDT Circulars Require of Field Officers Filing Tax Claims?

The CBDT has issued internal instructions directing field officers to file tax claims in CIRP proceedings within the prescribed time. The IBBI's model CIRP timeline and regulations require the Resolution Professional to publicise the process of filing claims widely, including to government departments. Despite these measures, late filing by the income tax department has remained a recurring problem, partly because CIRP timelines are tight and partly because coordination between NCLT proceedings and tax department offices at different hierarchical levels is imperfect.

The NCLAT has directed the CBDT to address what it termed 'frivolous tax litigation' where the tax department continued to litigate the priority question despite clear NCLT and NCLAT orders consistent with the Supreme Court's position. The NCLAT's observations underline that the tax department's position in insolvency proceedings is that of an operational creditor ranked below secured financial creditors.

Income Tax Dues in Resolution Plans

Where the CIRP ends in a resolution plan rather than liquidation, the plan must address the treatment of income tax claims admitted by the Resolution Professional. The resolution plan is binding on all creditors under Section 31, including the income tax department, once approved by the NCLT. The department cannot, after plan approval, seek recovery from the corporate debtor of dues that were not included in the plan, provided the department had notice of the CIRP and an opportunity to file its claim.

Plans must, at minimum, provide for payment of admitted tax claims in accordance with the liquidation waterfall value, and preferably address them specifically to avoid post-approval disputes. Several resolution applicants have included a specific provision in their plans offering the tax department an amount equal to what it would receive under Section 53 in liquidation, with a capped lump-sum payment. This approach has been approved by NCLTs as commercially sensible.

What Tax Compliance Obligations Continue During and After CIRP?

Income tax obligations arising after the insolvency commencement date are not affected by the CIRP. The Resolution Professional (and post-plan approval, the successful resolution applicant) must ensure that the corporate debtor files tax returns, deducts and deposits TDS, and pays advance tax obligations for the period of the CIRP and thereafter. These are CIRP costs to the extent they fall within the CIRP period and are payable in full as first priority under Section 53(1)(a).

How Are Tax Assessment Orders and Refund Adjustments Handled During CIRP?

Assessment orders passed by the income tax department against the corporate debtor after the insolvency commencement date, without permission of the NCLT, may be challenged as violations of the moratorium under Section 14. Courts have taken differing views on whether tax assessment (as distinct from recovery) constitutes an action against property of the corporate debtor. The safer practice is for the Resolution Professional to inform the jurisdictional Income Tax Officer of the CIRP commencement and seek a stay of assessment or completion of assessment before the NCLT after lifting of moratorium.

Tax refunds due to the corporate debtor for periods before insolvency commencement form part of the assets available to the Resolution Professional. The income tax department's practice of setting off such refunds against outstanding demands may violate the moratorium. The Resolution Professional may apply to the NCLT to compel the department to release the refund.

Frequently Asked Questions

Can the Income Tax Department recover dues from the new owner after a resolution plan is approved?

No. Once a resolution plan is approved under Section 31 and the corporate debtor comes under new management, the income tax department cannot recover pre-CIRP dues not included in the plan from the corporate debtor. The Supreme Court confirmed this in Ghanashyam Mishra and Sons v. Edelweiss Asset Reconstruction Company Limited [(2021) 9 SCC 657].

Where do income tax dues rank in the Section 53 waterfall?

Government dues including income tax rank at position (e) in Section 53(1), pari passu with operational creditor dues, for the two years preceding liquidation commencement. Older tax dues rank even lower, below all other dues covered in the waterfall.

What should the Resolution Professional do if the tax department fails to file a claim?

The Resolution Professional should record that the tax department was notified and did not file a claim within the prescribed time. Post-approval, the RP and the resolution applicant may rely on the clean-slate principle to resist any recovery attempt, supported by NCLT orders if necessary.

Are tax assessment proceedings stayed by the moratorium under Section 14?

Courts have differed on this. Recovery proceedings are clearly stayed. Assessment proceedings have been treated differently in different jurisdictions. The Resolution Professional should seek legal advice and proactively coordinate with the jurisdictional Income Tax Officer.

Can a resolution plan include a lump-sum payment to settle all pre-CIRP tax dues?

Yes. Resolution applicants frequently include a lump-sum settlement for admitted tax claims. The plan must offer at least the amount the department would receive under Section 53 in liquidation. Any payment above this is at the commercial discretion of the resolution applicant.

Does the IBC override the Income Tax Act on priority of claims?

Yes. Section 238 of the IBC provides a non-obstante clause that overrides any inconsistent provision in any other law, including the Income Tax Act. The Supreme Court confirmed this in multiple rulings upholding the Section 53 waterfall.

Is there a deadline for the Income Tax Department to submit its claim to the Resolution Professional?

Yes. Once a public announcement is made under the CIRP Regulations, creditors including the Income Tax Department are invited to submit claims within the period stated in that announcement, ordinarily fourteen days from the insolvency commencement date. NCLAT has permitted late claims where filed before the resolution plan is approved and the delay is adequately explained, but there is no right to file a claim after CoC approval of the plan.

Are GST dues treated the same way as income tax dues in the Section 53 waterfall?

Yes. GST dues, like income tax dues, fall within the definition of government dues under Section 53(1)(e) of the Insolvency and Bankruptcy Code, 2016, and rank pari passu with operational creditors for the two years preceding liquidation commencement, with older dues ranking lower. The Central Board of Indirect Taxes and Customs follows a similar claim-filing process to the CBDT.

Does penalty on unpaid tax rank the same as the principal tax amount in liquidation?

Penalties and interest components of a tax demand are generally treated as part of the government dues admitted in the CIRP or liquidation, and rank at the same point in the Section 53 waterfall as the underlying tax, provided the Resolution Professional has verified and admitted the full quantum, including penalty and interest, as part of the claim.

What forum hears a dispute over the Income Tax Department's claim in a CIRP?

Disputes over admission, rejection, or quantum of the Income Tax Department's claim are ordinarily raised before the National Company Law Tribunal seized of the CIRP, with an appeal lying to the National Company Law Appellate Tribunal and, on a question of law, to the Supreme Court under Section 62 of the Insolvency and Bankruptcy Code, 2016.

Can the Income Tax Department initiate fresh recovery proceedings once the moratorium under Section 14 is lifted?

Once the moratorium ends, whether on approval of a resolution plan or on liquidation, the department may pursue recovery only in accordance with what the resolution plan or the liquidation distribution provides. It cannot revive a claim that was not filed during CIRP and stands extinguished under the clean slate principle recognised by the Supreme Court.

Is advance tax payable by the corporate debtor during the CIRP period?

Yes. Advance tax and TDS obligations arising during the CIRP period are current obligations of the corporate debtor as a going concern, payable in the ordinary course, and typically treated as CIRP costs under Section 53(1)(a) when incurred by the Resolution Professional in running the business, giving them first priority in the waterfall.

What happens if the Resolution Professional admits the tax claim at a lower amount than assessed?

The Income Tax Department may challenge the admitted quantum before the National Company Law Tribunal by filing an application disputing the Resolution Professional's determination. Until that challenge is decided, the Resolution Professional generally proceeds on the basis of the admitted figure for voting and distribution purposes, subject to the tribunal's directions, and any shortfall the department later establishes is addressed as the tribunal directs rather than reopening completed distributions.

Does a change in ownership after a resolution plan affect the corporate debtor's future tax filings?

No. The corporate debtor's obligation to file returns and comply with the Income Tax Act, 1961 continues under the new management exactly as it did before, since the corporate entity survives the resolution process. Past-year losses and tax attributes may carry forward subject to conditions under the Income Tax Act, including approvals applicable to companies undergoing insolvency resolution.

Vikrant D. Shetty | Vikrant D. Shetty leads the Insolvency and Arbitration Practice at Vikrant D. Shetty & Associates, Advocates & Solicitors. The firm advises financial creditors, operational creditors, and corporate debtors in proceedings before the National Company Law Tribunal (NCLT), Mumbai Bench, and represents parties in domestic and international commercial arbitrations seated in India and abroad, including enforcement and challenge proceedings before the Bombay High Court.

Related reading: Interest on Arbitral Awards in India: Pre-Award, Post-Award and Compounding Under Section 31(7).

See also: GST Input Tax Credit Reversal When a Vendor Undergoes Liquidation.

This article is for general informational purposes only and does not constitute legal advice. For advice specific to your situation, please seek direct consultation with an advocate.