Income Tax Refund Cannot Be Unilaterally Set Off Against Pre-CIRP Dues During Liquidation Without Filing a Claim: NCLAT Delhi

Overview of the Dispute

The National Company Law Appellate Tribunal (NCLAT), Principal Bench, New Delhi, recently adjudicated a significant appeal in Avil Menezes (Liquidator) Vs PCIT (NCLAT New Delhi), arising from an order dated 22 November 2023 passed by the National Company Law Tribunal, Mumbai Bench-I. The central controversy revolved around whether the Income Tax Department could unilaterally appropriate refunds due to a corporate debtor under liquidation by adjusting them against pre-Corporate Insolvency Resolution Process (CIRP) tax arrears — without having filed any claim before the liquidator.

The corporate debtor in question, Sunil Hitech and Engineers Ltd., had been admitted into CIRP on 10.09.2018 and subsequently into liquidation on 25.06.2019, with Avil Menezes appointed as its liquidator. A public announcement inviting claims from all creditors was issued on 01.07.2019 under Regulation 12 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016.

Background Facts

Upon reviewing the Annual Information Statement of the corporate debtor, the liquidator discovered that:

  • The corporate debtor was entitled to an income tax refund of Rs. 5.84 crore for A.Y. 2021–22, along with interest of Rs. 11.46 lakhs
  • This refund had been adjusted on 12.11.2021 by the Income Tax Department against tax demands for A.Y. 2010–11 amounting to Rs. 2.98 crore and A.Y. 2011–12 amounting to Rs. 2.85 crore
  • Additionally, a refund of Rs. 60.79 lakhs for A.Y. 2020–21 had also been adjusted against pre-CIRP income tax dues

The liquidator contended that both refund amounts rightfully formed part of the liquidation estate under Section 36(3)(b) of the Insolvency and Bankruptcy Code, 2016 (IBC), and that the Income Tax Department had acted unlawfully by making a unilateral adjustment without lodging any claim in the liquidation proceedings.

The NCLT Mumbai, through its impugned order, dismissed the liquidator's application, holding that Section 245 of the Income Tax Act, 1961 granted the Income Tax Department a statutory right of set-off and that such a right effectively constituted a security interest under Section 3(31) of the IBC.

The NCLAT structured its analysis around two interconnected questions:

  1. Whether assessment proceedings initiated before liquidation could lawfully continue during the liquidation process
  2. Whether the Income Tax Department held secured creditor status under Section 245 of the Income Tax Act, 1961, and whether its unilateral appropriation of the income tax refund against pre-CIRP dues was legally valid

Issue 1: Continuation of Pending Proceedings During Liquidation

Distinction Between Section 14 and Section 33(5) of the IBC

The NCLAT undertook a careful statutory comparison between the moratorium provisions applicable during CIRP and those governing the liquidation phase.

Section 14 of the IBC, applicable during CIRP, explicitly prohibits both the institution of fresh suits or proceedings and the continuation of any pending suits or proceedings against the corporate debtor.

In contrast, Section 33(5) of the IBC, which governs the moratorium during liquidation, states:

"Subject to section 52, when a liquidation order has been passed, no suit or other legal proceeding shall be instituted by or against the corporate debtor: Provided that a suit or other legal proceeding may be instituted by the liquidator, on behalf of the corporate debtor, with the prior approval of the Adjudicating Authority."