Corporate Veil Lifting: Court Emphasizes Due Process in Tax Recovery Case

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Case Name:

Ajay S. Patel vs Income Tax Officer (High Court of Gujarat)

Special Civil Application No. 12861 of 2014

Key Takeaways:

1. Lifting the corporate veil for public limited companies is possible, but requires proper justification and procedure.

2. Directors must be given notice and opportunity to respond before any decision to lift the corporate veil.

3. Orders lacking proper reasoning or violating principles of natural justice can be quashed.

4. The court's decision emphasizes the importance of due process in tax recovery cases.

Issue:

Can tax authorities recover outstanding tax dues of a public limited company from its director by lifting the corporate veil without following proper procedures?

Facts:

- Hirak Biotech Limited, a public limited company, was incorporated on 25.1.2015.

- The petitioner, Ajay S. Patel, was a director of the company for some time.

- On 11.10.2013, a show cause notice was issued under section 179 of the Income Tax Act, 1961.

- The petitioner replied on 17.10.2013, and another show cause notice was

issued on 4.9.2014.

- The petitioner filed a petition, and the court granted an interim stay on 16th September, 2014.

- During the pending petition, the petitioner received a copy of an order dated 19.11.2013, which he claims was never served to him earlier.

Arguments:

Petitioner's Arguments:

- The company is a public limited company, not a private limited company, so section 179 of the Income Tax Act (which applies to private limited companies) should not apply.

- The order is silent on the aspect of lifting the corporate veil.

- The petitioner was not given proper notice or opportunity to respond regarding the lifting of the corporate veil.

Revenue's Arguments:

- Relied on the case of Pravinbhai M. Kheni vs Assistant Commissioner of Income Tax (2013 (353) ITR 855 Gujarat) to argue that lifting the corporate veil is permissible for public limited companies under certain conditions.

Key Legal Precedents:

Pravinbhai M. Kheni vs Assistant Commissioner of Income Tax (2013 (353) ITR 855 Gujarat):

- Established that lifting the corporate veil can be justified for public limited companies under certain conditions.

- Emphasized the need for proper notice and opportunity for the director to respond before lifting the corporate veil.

Judgement:

The court quashed and set aside the impugned order dated 19.11.2013, stating that:

1. Lifting the corporate veil is not impermissible if facts are demonstrated and the competent officer is satisfied.

2. The person concerned must be given notice with tentative grounds for lifting the corporate veil.

3. The director should have the opportunity to show justifiable grounds against lifting the corporate veil.

4. The order passed without following these procedures would be in breach of principles of natural justice.

The court allowed the revenue to formulate grounds and give notice for treating the company as a private limited company by lifting the corporate veil, after which steps under section 179 of the Income Tax Act may be taken if appropriate.

FAQs:

Q1: Can tax authorities treat a public limited company as a private limited company for tax recovery?

A1: Yes, but only after following proper procedures and justifying the lifting of the corporate veil.

Q2: What rights does a director have when faced with potential lifting of the corporate veil?

A2: Directors must be given notice, opportunity to respond, and can present justifiable grounds against lifting the corporate veil.

Q3: Does this judgment prevent tax authorities from recovering dues from directors of public limited companies?

A3: No, it emphasizes the need for proper procedure rather than preventing recovery altogether.

Q4: What are the key considerations for lifting the corporate veil in such cases?

A4: Factors include the impossibility of recovering tax from the company and gross neglect or misfeasance by the director.

Q5: Can an order be quashed if proper procedures for lifting the corporate veil are not followed?

A5: Yes, as demonstrated in this case, orders can be quashed if they breach principles of natural justice.

1. The facts of the case appears to be that on 25.1.2015, a company in the name and style of Hirak Biotech Limited (hereinafter referred to as “the company”) was incorporated. Initially, there were three Directors. Thereafter, the Directors were added. The petitioner also remained as Director of the company for some time. On 11.10.2013, a show cause notice was issued under section 179 of the Income Tax Act, 1961 (hereinafter referred to as “the Act”) calling upon the petitioner to show cause as to why the outstanding tax dues of the company should not be recovered from the petitioner in capacity as the Director of the company. The petitioner submitted reply on 17.10.2013 and as per the petitioner, another show cause notice was issued dated 4.9.2014 calling upon the petitioner to pay the dues, failing which, coercive steps were to be taken. The petitioner replied to the show cause notice and as per the petitioner, when the present proceeding was going on before the officer concerned, the present petition was filed. As per the petitioner, this Court on 16th September, 2014, had entertained the petition and had granted interim stay so far as coercive actions are concerned. It appears that pending the petition, the petitioner received copy of order dated 19.11.2013 already passed by the officer concerned. The petitioner contends that though the order is dated 19.11.2013, it was never served to him and pending the petition since the order is received by him, the petition was amended challenging the said order dated 19.11.2013. It is under these circumstances, the present matter comes up for final disposal before this Court.

2. We have heard learned counsel Mr. Soparkar appearing for the petitioner and Mr. Manish Bhatt, learned counsel for the respondent.

3. As such, it is undisputed position that the company is a limited company and therefore, can be termed as public limited since it is not a private limited company. The language of section 179 provides for taking action for recovery of the outstanding tax of the private limited company from the Directors if the revenue finds that in spite of sincere attempts, it is not possible to recover the outstanding tax amount from the private limited company.

4. However, Mr. Manish Bhatt, learned counsel appearing for the revenue by relying upon the decision of this Court in case of Pravinbhai M. Kheni Vs. Assistant Commissioner of Income Tax reported at 2013 (353) ITR 855 (Gujarat), contended that it is not that no action can be taken against the Directors of the public limited company by lifting the corporate veil. He submitted that if the conditions are satisfied for lifting of the corporate veil as observed in the aforesaid decision of this Court, such is permissible. Therefore, he submitted that the order may not be quashed on such ground, but Mr. Bhatt could not point out to this Court as to whether at any point of time, the petitioner was put to notice on the aspects of lifting of the corporate veil and thereby to treat the Director of the public limited company at par with the Directors of the private limited company as provided under section 179 of the Act.

5. Mr. Soparkar, learned counsel appearing for the petitioner contended that the basic ingredients for lifting of the corporate veil could not be said as satisfied and in the impugned order, there is not a whisper about the lifting of such corporate veil and in his submission, the facts stated in the Affidavit-in-reply cannot be considered for supplementing the order for which there is complete silence.

6. We may record that in the above referred decision of this Court in case of Pravinbhai M. Kheni (supra), while considering the case under section 179 of the Act itself, this Court at page 23 had concluded thus:

“1) The respondent authorities did establish that it was not possible to recover the tax dues from the company.

2) The petitioner neither pleaded nor succeeded in establishing that such non recovery was not attributable to any gross neglect, misfeasance or failure in discharging duty on his part in connection with the affairs of the company.

3) Being a public company, ordinarily, provisions of section 179(1) of the Act cannot be applied. However, if the factors noted by the Assistant Commissioner in his impugned order dated 15.4.2002 and highlighted by us in this judgement are duly established, it would certainly be a fit case where invocation of principle of lifting of corporate veil would be justified.

4) We however, hold that the Assistant Commissioner proceeded to record such findings without giving sufficient opportunity of hearing to the petitioner and without disclosing the necessary materials for coming to such a conclusion.

5) The impugned orders dated 15.4.2002 and revisional order dated 9.4.2003 are quashed.

6) The proceedings are however, placed back before the Assistant Commissioner for proceeding further in accordance with law after giving a notice to the petitioner indicating his tentative grounds why he desires to invoke the concept of lifting of corporate veil, giving sufficient opportunity to the petitioner to meet with such allegations. After giving opportunity of hearing to the petitioner and following the principles of natural justice it would be open for the Assistant Commissioner to pass fresh orders in accordance with law as may be found appropriate on the basis of material on record.”

7. There is considerable force in the contention of the learned counsel for the petitioner that the impugned order is silent on the aspect of lifting of the corporate veil, but at the same time, in view of the aforesaid decision of this Court, it cannot be said that lifting of the corporate veil is impermissible if the facts are so demonstrated and the competent officer is satisfied for such purpose. But, in any case, as per the above referred conclusion No.6, the person concerned is required to be put to notice by formulation of the tentative ground as to why the concept of lifting of the corporate veil should not be invoked. The Director of the company may show justifiable ground to satisfy the authority that no case is made out for lifting of the corporate veil and thereafter, the competent officer may form an opinion whether to lift the corporate veil or not. But, in any case, as neither has happened in the present case, it can be said that the order passed based on the lifting of the corporate veil even if it is, would be in breach of the principles of natural justice and hence, cannot be sustained.

8. In view of the aforesaid observations and discussions, the impugned order dated 19.11.2013 at Exhibit 1 is quashed and set aside, but with the observations that it would be open to the respondent – competent officer to formulate the ground and thereafter, to give a notice for treating the company as private limited company by lifting of the corporate veil and thereafter, to take steps, if any, available in accordance with law under section 179 of the Act. At that stage, the petitioner may show cause by resisting the ground for contending that it is genuinely a public limited company and the corporate veil should not be lifted. Suffice it to observe that at that stage, rights and contentions of both the sides shall remain open.

The petition is partly allowed to the aforesaid extent. Rule is made absolute. Considering the aforesaid facts and circumstances, no order as to costs.

(JAYANT PATEL, J.)

(S.H.VORA, J.)