Supreme Court Clarifies Status of State Tax Dues under IBC: State Tax Officer vs. Rainbow Papers Limited (2022)

Date of the Judgment: 6th September 2022

Citation: (2022) INSC 807

Judges: Indira Banerjee, J. and A.S. Bopanna, J.

When a company faces insolvency, who gets priority in recovering their dues? The Supreme Court of India recently addressed this critical question in a case involving a conflict between state tax laws and the Insolvency and Bankruptcy Code (IBC). The core issue was whether the State Tax Department could claim a first charge over a company’s assets for unpaid taxes, or if the IBC’s provisions would take precedence. This judgment clarifies the interplay between state laws and the IBC, particularly concerning the status of government dues during insolvency proceedings.

The judgment was delivered by a two-judge bench comprising Justice Indira Banerjee and Justice A.S. Bopanna.

Case Background

Rainbow Papers Limited, the respondent, is a company engaged in manufacturing and selling crafts and oars since April 16, 1990. The State Tax Officer (1), the appellant, had assessed the respondent for Value Added Tax (VAT) and Central Sales Tax (CST) under the Gujarat Value Added Tax Act, 2003 (GVAT Act). The respondent owed ₹53,71,65,489 to the Sales Tax authorities.

On July 8, 2016, recovery proceedings were initiated against the respondent for dues from 2011-2012. The appellant attached the respondent’s land in Rajpur on October 8, 2018.

Meanwhile, Neeraj Papers Private Limited, an operational creditor of the respondent, filed a petition under Section 9 of the IBC on August 8, 2017, before the Ahmedabad Bench of the National Company Law Tribunal (NCLT), seeking to initiate the Corporate Insolvency Resolution Process (CIRP) against the respondent. The NCLT admitted the petition on September 12, 2017, and appointed George Samuel as the Interim Resolution Professional (IRP) on September 22, 2017.

After inviting claims from creditors, a Committee of Creditors (CoC) was formed on October 10, 2017. The CoC replaced the IRP with Ramachandra D. Choudhary as the Resolution Professional (RP), which was approved by the NCLT on November 6, 2017.

The appellant filed a claim with the RP for approximately ₹47.36 crores towards dues under the GVAT Act, but this claim was filed late. The RP informed the appellant that the entire claim had been waived off on October 22, 2018, which was conveyed by email on November 6, 2018.

The appellant challenged the Resolution Plan on December 20, 2018, arguing that government dues could not be waived off, and claimed to be a secured creditor. The NCLT rejected the application on February 27, 2019, stating it was not maintainable.

The appellant then appealed to the National Company Law Appellate Tribunal (NCLAT), which dismissed the appeal on December 19, 2019, upholding the NCLT’s decision that the government could not claim first charge over the Corporate Debtor’s property, and that Section 48 of the GVAT Act could not prevail over Section 53 of the IBC.

Timeline

Course of Proceedings

The Ahmedabad Bench of the NCLT rejected the appellant’s application, stating it was not maintainable. The NCLT noted that the Resolution Plan had been approved by the CoC with a 79.79% voting share and that the appellant’s claim was made at a much belated stage.

The NCLAT upheld the NCLT’s decision, observing that the appellant had not filed its claim within the stipulated time and approached the RP after the Resolution Plan had been approved. The NCLAT also held that the State Tax Officer’s claim was an operational debt and did not fall under the definition of a secured creditor. The NCLAT concluded that Section 48 of the GVAT Act could not prevail over Section 53 of the IBC.

Legal Framework

The key legal provisions in this case are:

• Section 48 of the Gujarat Value Added Tax Act, 2003 (GVAT Act):

  “Notwithstanding anything to the contrary contained in any law for the time being in force, any amount payable by a dealer or any other person on account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case maybe, such person.” This section states that tax dues are a first charge on the property of the dealer.

• Section 53 of the Insolvency and Bankruptcy Code, 2016 (IBC):

  This section outlines the order of priority for distributing assets in case of liquidation. It states, “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…” The section lists the order of priority for distribution of assets, with government dues being lower in priority compared to insolvency resolution costs, workmen’s dues, and secured creditors.

• Section 3(30) of the IBC:

  Defines “secured creditor” as “a creditor in favour of whom security interest is created.”

• Section 3(31) of the IBC:

  Defines “security interest” as “right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person…”

• Section 30 and 31 of the IBC:

  These sections deal with the submission and approval of resolution plans. Section 30(2) specifies the requirements for a resolution plan, including provisions for payment of operational and financial creditors. Section 31(1) states that the Adjudicating Authority shall approve the resolution plan if it meets the requirements of Section 30(2), and such plan shall be binding on all stakeholders.

Arguments

Appellant’s Arguments:

• The appellant argued that Section 48 of the GVAT Act provides for a first charge on the property of the dealer for tax dues, making the State a secured creditor under Section 3(30) and 3(31) of the IBC.
• The appellant contended that the NCLAT erred in holding that the State is not a secured creditor and that Section 48 of the GVAT Act cannot prevail over Section 53 of the IBC. The appellant clarified that it was not claiming that Section 48 of GVAT Act prevails over Section 53 of IBC, but that the State is a secured creditor.
• The appellant submitted that the Resolution Professional (RP) failed to examine the books of accounts, verify the dues to the State, and include them in the information memorandum and the Resolution Plan.
• The appellant argued that the time period for submitting claims under Regulation 12 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (2016 Regulations) is directory, not mandatory.
• The appellant relied on Swiss Ribbons (P) Ltd. v. Union of India [(2019) 4 SCC 17], arguing that the RP’s duty is only to receive, verify, and collate claims, not to adjudicate them.
• The appellant argued that the Resolution Plan did not meet the requirements of Section 30(2) of the IBC, as it did not provide for the payment of dues to the State.
• The appellant submitted that the Adjudicating Authority should have examined whether the Resolution Plan met the requirements of Section 30(2) of the IBC, and not approved it as a mere formality.

Respondent’s Arguments:

• The respondent argued that the appellant’s claim was made at a much belated stage, after the approval of the Resolution Plan by the Committee of Creditors (CoC).
• The respondent contended that the appellant’s claim was an operational debt and did not fall within the meaning of a secured creditor under the IBC.
• The respondent argued that Section 53 of the IBC overrides Section 48 of the GVAT Act, and therefore, the government cannot claim first charge over the property of the Corporate Debtor.
• The respondent submitted that the Resolution Professional (RP) had no jurisdiction to entertain the claim of the appellant as it was filed at a belated stage.

Submissions

Issues Framed by the Supreme Court

The Supreme Court addressed the following key issue:

1. Whether the provisions of the IBC, and in particular, Section 53 thereof, overrides Section 48 of the GVAT Act which provides for first charge on the property of a dealer in respect of any amount payable by the dealer on account of tax, interest, penalty etc. under the said GVAT Act.

The Court also dealt with the sub-issue of whether the State Tax Department can be considered a secured creditor under the IBC.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

How each authority was viewed by the Court?

• Swiss Ribbons (P) Ltd. v. Union of India [(2019) 4 SCC 17]: The Court cited this case to emphasize that the Resolution Professional’s (RP) duty is only to receive, verify, and collate claims, not to adjudicate them.
• Ghanshyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd. [(2021) 9 SCC 657]: The Court cited this case to highlight that the Adjudicating Authority must ensure that the Resolution Plan meets the requirements of Section 30(2) of the IBC.
• Ebix Singapore Private Limited v. Committee of Creditors of Educomp Solutions Limited and Another [(2022) 2 SCC 401]: The Court cited this case to affirm that Resolution Plans must conform to the statutory provisions of the IBC.
• Section 48 of the Gujarat Value Added Tax Act, 2003: The Court interpreted this section to establish that the State has a first charge on the property of the dealer for tax dues, creating a security interest.
• Section 53 of the Insolvency and Bankruptcy Code, 2016: The Court interpreted this section to clarify that it deals with the distribution of assets in liquidation and does not override the security interest created by Section 48 of the GVAT Act.
• Section 3(30) of the Insolvency and Bankruptcy Code, 2016: The Court interpreted this section to define “secured creditor” as a creditor in whose favor a security interest is created.
• Section 3(31) of the Insolvency and Bankruptcy Code, 2016: The Court interpreted this section to define “security interest” as including a charge created by law, such as under Section 48 of the GVAT Act.
• Sections 30 and 31 of the Insolvency and Bankruptcy Code, 2016: The Court interpreted these sections to outline the requirements for a valid Resolution Plan and the Adjudicating Authority’s role in approving it.
• Regulation 12 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016: The Court interpreted this regulation to determine that the time period for submitting claims is directory, not mandatory.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following:

• Statutory Interpretation: The Court emphasized a harmonious interpretation of the IBC and the GVAT Act. It held that Section 48 of the GVAT Act creates a statutory charge, which falls within the definition of “security interest” under Section 3(31) of the IBC, thus making the State a secured creditor under Section 3(30) of the IBC.
• Importance of Statutory Dues: The Court stressed that statutory dues owed to the government or governmental authorities cannot be ignored in a resolution plan. It noted that the Committee of Creditors (CoC) cannot secure their dues at the cost of statutory dues.
• Resolution Plan Compliance: The Court highlighted that a resolution plan must comply with Section 30(2) of the IBC, which mandates provisions for payment of dues to operational creditors, including the government. The Adjudicating Authority has a duty to ensure such compliance before approving a plan.
• Directory Nature of Time Limits: The Court reiterated that the time limits for submitting claims under the 2016 Regulations are directory and not mandatory. It noted that the Resolution Professional (RP) is obligated to consider claims even if they are submitted late.
• Role of the Resolution Professional: The Court emphasized that the RP’s role is to receive, verify, and collate claims, not to adjudicate them. The RP should examine the books of accounts and include all valid claims in the information memorandum.

Sentiment Analysis of Reasons Given by the Supreme Court:

Fact:Law Ratio:

Logical Reasoning:

Final Decision

The Supreme Court allowed the appeal, setting aside the orders of the NCLT and NCLAT. The Court held that:

• The State Tax Department is a secured creditor under the IBC due to the first charge created by Section 48 of the GVAT Act.
• Section 53 of the IBC does not override Section 48 of the GVAT Act, as Section 53 deals with the distribution of assets in liquidation, while Section 48 creates a security interest.
• The Resolution Plan did not meet the requirements of Section 30(2) of the IBC, as it did not provide for the payment of dues to the State.
• The Adjudicating Authority was required to examine whether the Resolution Plan met the requirements of Section 30(2) of the IBC, and not approve it as a mere formality.

The Court remanded the matter back to the Adjudicating Authority (NCLT) to consider the Resolution Plan afresh, keeping in view the observations made in the judgment.

Key Takeaways

• State Tax Dues as Secured Debt: State tax dues, secured by a statutory first charge, are treated as secured debts under the IBC. This means that state tax departments have a higher priority in repayment compared to operational creditors.
• Harmony Between State Laws and IBC: The judgment emphasizes that the IBC does not override state laws creating a security interest. Instead, it seeks to harmonize these laws, ensuring that state dues are not ignored during insolvency proceedings.
• Importance of Resolution Plan Compliance: Resolution Plans must adhere to the requirements of Section 30(2) of the IBC, which includes provisions for payment of dues to all creditors, including the government.
• Role of Adjudicating Authority: The Adjudicating Authority (NCLT) has a duty to scrutinize Resolution Plans to ensure they comply with the IBC, and not approve them as a mere formality.
• Directory Nature of Time Limits: The time limits for submitting claims under the IBC are directory, not mandatory. This means that the Resolution Professional (RP) must consider claims even if they are submitted late.

Implications

The judgment has significant implications for various stakeholders:

• State Tax Departments: The judgment reinforces the position of state tax departments as secured creditors, ensuring that their dues are given priority in insolvency proceedings. This provides a significant boost to state revenues.
• Resolution Professionals: RPs must be more diligent in examining the books of accounts of corporate debtors to identify and verify statutory dues. They must also ensure that Resolution Plans comply with Section 30(2) of the IBC.
• Committee of Creditors (CoC): The CoC cannot secure their dues at the cost of statutory dues. They must ensure that Resolution Plans provide for the payment of all valid claims, including those of the government.
• Adjudicating Authorities: NCLTs must be more vigilant in scrutinizing Resolution Plans to ensure they comply with the IBC. They cannot approve plans as a mere formality.
• Corporate Debtors: Corporate debtors must be aware that statutory dues cannot be waived off easily. They must ensure that their books of accounts are accurate and that all dues are properly accounted for.
• Financial and Operational Creditors: Financial and operational creditors must be aware of the higher priority given to secured creditors, including state tax departments.

Critical Analysis

Strengths:

• Clarity on Security Interest: The judgment provides much-needed clarity on the definition of “security interest” under the IBC, specifically including statutory charges created by state laws.
• Protection of Government Dues: The judgment ensures that government dues are not ignored during insolvency proceedings, which is crucial for maintaining fiscal stability and public interest.
• Harmonious Interpretation: The Court’s approach of harmonizing the IBC with state laws is commendable, as it avoids unnecessary conflicts between federal and state legislation.
• Emphasis on Compliance: The judgment reinforces the importance of compliance with the mandatory provisions of the IBC, particularly those relating to Resolution Plans.
• Flexibility in Claim Submission: The Court’s recognition of the directory nature of time limits for submitting claims provides flexibility and ensures that all valid claims are considered.

Weaknesses:

• Potential for Delays: The judgment may lead to delays in the resolution process, as RPs and Adjudicating Authorities will need to be more thorough in examining statutory dues.
• Increased Burden on RPs: The judgment places an increased burden on RPs to identify and verify statutory dues, which may require additional resources and expertise.
• Complexity in Resolution Plans: The need to accommodate statutory dues may make Resolution Plans more complex, potentially reducing their attractiveness to prospective resolution applicants.
• Potential for Litigation: The judgment may lead to an increase in litigation, as stakeholders may dispute the validity and priority of statutory dues.
• Impact on Resolution Efficiency: The priority given to statutory dues may reduce the recovery prospects for other creditors, potentially impacting the overall efficiency of the resolution process.

Conclusion

The Supreme Court’s judgment in State Tax Officer vs. Rainbow Papers Limited is a landmark ruling that clarifies the status of state tax dues under the IBC. By recognizing the first charge created by state laws as a security interest under the IBC, the Court has ensured that state tax departments are treated as secured creditors, with a higher priority in repayment. The judgment emphasizes the importance of compliance with the IBC, particularly the requirement that Resolution Plans must provide for the payment of all valid claims, including statutory dues. This ruling has significant implications for various stakeholders, including state tax departments, Resolution Professionals, the Committee of Creditors, and the Adjudicating Authorities. While the judgment may lead to increased complexity and potential delays in the resolution process, it is a crucial step towards ensuring a fair and equitable insolvency regime that protects the interests of all stakeholders, including the government.