SC ruling on IBC will have overriding effect over indirect tax recoveries

In a significant verdict, the Supreme Court (SC) has ruled that liquidation proceedings would have an “overriding effect” over indirect tax recoveries initiated, once the moratorium is imposed under the Insolvency and Bankruptcy Code (IBC).

The top court’s judgement came in an order related to a tax dispute between the Central Board of Indirect Taxes (CBIC), and ABG Shipyard, which owes Rs 22,842 crore to the creditors, is currently undergoing liquidation. The defunct firm’s promoters are also facing multi-agency probes for allegedly siphoning off bank loan amounts.

The top court held that to the extent of tax recoveries initiated by the Customs–a department under CBIC–after initiation of a moratorium period under the IBC, the department “should not” have first right of recovery from the distressed assets.

“While customs authorities have the power to assess the quantum of dues, they do not have the power to initiate recovery of dues under the Customs Act,” a three-bench judge held.

“We are of the clear opinion that the demand notices to seek enforcement of custom dues during the moratorium period would clearly violate the provisions of Sections 14 or 33(5) of the IBC, as the case may be. This is because the demand notices are an initiation of legal proceedings against the Corporate debtor (ABG Shipyard),” the bench added.

The move, according to the tax experts, would set a precedence in all tax recoveries matters. “Since the objective of the IBC is to get the recoveries for the various stakeholders (including government dues) in a transparent and timely manner or revive the distressed asset, the ruling would help in avoiding fresh tax disputes and provide certainty of taxation to the industry,” said Saurabh Agarwal, Tax Partner, EY.

The matter pertains to CBIC’s claims of its dues after the liquidation proceedings launched against the defunct firm in the National Company Law Tribunal (NCLT) Ahmedabad.

The company’s imported goods were lying in a customs bonded warehouse. CBIC had filed claims for customs duty recovery due to non-fulfillment of export obligations (ie 37.92 Cr, 151.33 Cr, 22.70 Cr) after the date of NCLT order of liquidation during May, 2019.

CBIC wanted to auction the goods to recover its dues against non-fulfilment of Export Promotion Capital Goods (EPCG) scheme obligations amounting to Rs 763.12 crore. The department had served the recovery notice in July the same year (that is, after liquidation order of NCLT).

Rejecting the claims, NCLT ordered customs to allow clearance of goods lying in bonded warehouses and asked to lodge their claims before the liquidator under the IBC. It had held that the claim of the department with respect to customs duty will be dealt with as government dues. Effectively, NCLT ordered that provisions of IBC shall have priority over customs recovery.

Subsequently, National Company Law Appellant Tribunal(NCLAT) set aside theorder of NCLT, and allowed the appeal of the CBIC and directed that goods can only be released or disposed of in line with the Customs Act.

This was following the CBIC argument that since the goods are lying in the customs property, it cannot be transferred,sold or recovered by liquidator of ABG Shipyard until duty being paid. The matter went to National Company Law Appellate Tribunal (NCLAT) which had too upheld the NCLT order.

The liquidator then moved to SC challenging the move.

The top court said that the customs dues to be settled strictly in accordance with the provisions of IBC and liquidator is the owner of the goods after initiation of IBC proceedings.

“Such an exception created under the Customs Act is acknowledged under Section 238 of the IBC as well,” the court said.

Clarifying that power of IBC, the apex court said that, in fact, Section 238 of the IBC overrides any provision of law which is inconsistent with it.

Observing that both the legislations work well in their own spheres, the court said that there should be no confusion in case of a conflict between the two bodies of law.

The court also broached the topic of moratorium under the insolvency law.

The moratorium is a period wherein no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can be instituted or continued against the borrower.