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Recovery of tax arrears of company from directors

Subject : Income Tax Law
Month-Year : Aug 2005
Author/s : Pradip Kapasi
Gautam Nayak
Chartered Accountants
Topic : Recovery of tax arrears of company from directors
Article Details :

1. Issue for consideration :

1.1 S. 179 of the Income-tax Act provides for liability of directors of a private company. It provides that where any tax due from a private company in respect of any income of any previous year cannot be recovered, then every person who was a director of the private company at any time during the relevant previous year is jointly and severally liable for the payment of such tax, unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company. It, therefore, provides for a joint and several liability of the directors of a private company for its tax dues.

1.2 The question arises as to whether the tax authorities can proceed against the directors of the company, even where the company has certain assets, as they may find it easier to recover money from the directors rather than from the company ? In other words, is it essential for the tax authorities to first exhaust all avenues of recovery against the company before proceeding against the directors ?

1.3 While the Bombay High Court, Andhra Pradesh High Court and Gujarat High Court have held that the directors can be made personally liable to pay arrears of tax of the company only if the Income-tax Department was unable to realise the arrears from the company, the Madras High Court has taken a contrary view and held that the recovery of arrears of the company from the directors can be initiated before exhausting the remedies against the company.

2. Praveen Desai’s case :

2.1 The issue recently came up for consideration before the Gujarat High Court in the case of Indubhai T. Vasa (HUF) v. ITO, 196 CTR 15. The Gujarat High Court followed its earlier ratio in the case of Bhagwandas J. Patel v. Dy. CIT, 238 ITR 127, where the issue had come up earlier before the Gujarat High Court for consideration. The issue had however first come up for consideration before the Bombay High Court in the case of Union of India v. Praveen D. Desai, 173 ITR 303.

2.2 This was an appeal to the Division Bench against the single judge decision in the case of Praveen D. Desai v. ITO, 149 ITR 187 (Bom.), where the single judge had set aside the order of the Income-tax Officer holding that the director of a private company in liquidation was liable to pay taxes due by the company under the provisions of S. 179(1) of the Income-tax Act, 1961.

2.3 While conceding the main issue about the liability of a director of a private company to pay taxes of a private company u/s.179(1), on behalf of the assessee, it was argued that a sale proclamation had been issued by the Tax Recovery Officer for sale of immovable property of the company, and that the director could be made liable to personally pay the arrears only if the Department was unable to realise the arrears by the proposed auction sale.

2.4 The Bombay High Court agreed with the assessee’s contention, that the liability of the director arose only if the Department was unable to recover the arrears of tax from the assets of the company.

2.5 A view similar to that taken by the Bombay High Court was also taken by the Andhra Pradesh High Court in the case of K. V. Reddy v. ACIT, 232 ITR 306.

3. Sundararaman’s case :

3.1 The issue also came up before the Madras High Court in the case of M. R. Sundararaman v. CIT, 215 ITR 9.

3.2 In this case, the petitioner was one of the directors of a private company till 1951, when he resigned from his post as a director of the company. The company was wound up in January 1969. In 1970, the tax authorities called upon the petitioner to pay the income-tax arrears of the company for A.Ys. 1948-49 and 1949-50 u/s.179, and proposed to adjust the tax refund due to him against such arrears.

3.3 The petitioner filed a writ petition before the High Court challenging the proposed recovery of taxes of the company from him. Among other contentions, it was argued on behalf of the petitioner that the Department could initiate action against the petitioner only after exhausting its remedies against the company and its assets.

3.4 The Madras High Court dismissed this argument of the petitioner on the ground that S. 179(1) made the liability of the company and the petitioner joint and several. The Court accordingly dismissed the petition, holding that the tax could be recovered from the petitioner.

4. Observations :

4.1 The Madras High Court seems to have misinterpreted the provisions of S. 179 of the Act. According to the Court, the company and the directors had a joint and several liability to pay the taxes. The language of the Section however seems to indicate that the liability of the directors is joint and several inter se. As analysed by the Andhra Pradesh High Court in Reddy’s case (supra), it is not a joint and several liability of the directors with the company, but with each other. As held by the Court in that case, it is not a liability co-extensive with the liability of the company, unlike a principal debtor and the surety. In the case of a principal debtor and surety, the liability of the surety is co-extensive with that of the principal debtor, and therefore both the principal debtor and the surety can be proceeded against simultaneously.

4.2 The Madras High Court also does not seem to have appreciated that the Section comes into application only where any tax due from a private company cannot be recovered from the company. It has no application in a situation where there is the possibility of recovery of taxes from the company and recovery action is continuing in its case. The Assessing Officer can, therefore, assume jurisdiction u/s.179 against the directors only where he gives a finding that the income-tax dues cannot be recovered from the company. This aspect has been rightly highlighted by the Andhra Pradesh High Court in Reddy’s case (supra).

4.3 As rightly pointed out by the Gujarat High Court in Bhagwandas Patel’s case (supra), before recovery in respect of dues from the private company can be initiated against the directors, to make them jointly and severally liable for such dues, it is necessary for the Revenue to establish that such recovery cannot be made against the company and then and then alone, it can reach the directors who were responsible for the conduct of business in the previous year in relation to which such liability exists.

4.4 It is also worth noting that the Madras High Court’s decision is a decision of a single judge whereas the decisions of the Bombay High Court, Andhra Pradesh High Court and Gujarat High Court are all decisions of Division Benches of those Courts.

4.5 Therefore, it appears that the decision of the Madras High Court needs reconsideration, as it does not appear to lay down the correct interpretation of law as analysed by the other High Courts. The better view is that the directors of a private company can be made liable only after all recovery proceedings against the company and assets of the company are exhausted, and not until then.

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