Secured Creditor Prevails: IT Department’s Claim as Second Mortgagor

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Case Name:

Commissioner of Income Tax Vs. Karnataka State Industrial Investment Development Corporation Ltd. (High Court of Karnataka)

Writ Appeal No. 3015 of 2013 (T-IT)

Date: 10th June 2015

Key Takeaways:

• The court upheld the rights of secured creditors over the claims of the Income Tax Department.
• Section 281 of the Income Tax Act was central to the case, which declares certain transfers void during tax proceedings unless specific conditions are met.
• The court found that the mortgage was made for adequate consideration and without notice of pending tax proceedings, thus not void under Section 281.

Issue

Can the Income Tax Department’s claim override the rights of a secured creditor when the mortgage was made without notice of pending tax proceedings?

Facts

• Veekay Developers obtained a loan from the Karnataka State Industrial Investment Development Corporation Ltd. and mortgaged properties as security.
• The Income Tax Department issued a notice for tax recovery from Veekay Developers.
• The Tax Recovery Officer attached the properties, but the Corporation challenged this attachment in court.

Arguments

• Corporation’s Argument: The mortgage was valid as it was made for adequate consideration and without notice of pending tax proceedings, thus not void under Section 281.
• IT Department’s Argument: The transfer was void under Section 281 as it occurred during pending tax proceedings.

Key Legal Precedents

• Section 281 of the Income Tax Act: Declares certain transfers void during tax proceedings unless made for adequate consideration and without notice of such proceedings.
• TAX RECOVERY OFFICER vs. INDUSTRIAL FINANCE CORPORATION OF INDIA AND ANOTHER (2012) 346 ITR 11 (Guj): Supported the view that transfers made without notice of pending proceedings are not void.
• TAX RECOVERY OFFICER vs. GANGADHAR VISWANATH RANADE (1998) 234 ITR 188 (SC): Emphasized the need to read Section 281 with Rule 11(1) of the Second Schedule.

Judgement

The court ruled in favor of the Karnataka State Industrial Investment Development Corporation Ltd., allowing it to proceed with the sale of the properties. The court found that the mortgage was made for adequate consideration and without notice of pending tax proceedings, thus not void under Section 281. The IT Department was treated as a second mortgagor, and any surplus from the sale was to be handed over to the Tax Recovery Officer for tax dues.

FAQs

Q1: Why was the IT Department’s claim considered secondary?

A1: The court recognized the Corporation as a secured creditor with the first charge over the properties, while the IT Department’s claim was secondary due to the timing and nature of the mortgage.

Q2: What does Section 281 of the Income Tax Act state?

A2: It declares certain transfers void during tax proceedings unless made for adequate consideration and without notice of such proceedings.

Q3: What was the significance of the court’s decision?

A3: The decision reinforced the priority of secured creditors over tax claims when the mortgage is made without notice of pending tax proceedings.

1. The respondent is a State owned Corporation. It is a financial institution governed by the State Financial Corporations Act, 1951. The respondent sanctioned a term loan to M/s Veekay Developers Private Limited (‘Veekay Developers’ for short) to establish a luxury hotel at Sy.No.32-2A, Bangra Kulur village, Mangalore city on 13.9.1995. However, the said term loan was transferred to V.K. Clubs and Homes Private Limited (‘V.K. Clubs’ for short) on 26.3.1997. The borrower created an equitable mortgage in favour of the respondent by deposit of title deeds on 28.4.1998. The title deeds of the properties so mortgaged are relating to portions of the land and buildings measuring about 4,390 square feet on the ground floor, 2100 square feet on the first floor, 3,515 square feet and 1020 square feet on the third floor and about 18,435 square feet on the 4th, 5th and 6th floors of the commercial building, together with common facilities thereof. By way of further security, the said borrower created equitable mortgage over free hold right in three shops measuring 325 square feet, 115 square feet and 535 square feet respectively in the building on the land mentioned supra. As aforementioned, the loan was sanctioned on 13.9.1995. The notice came to be issued under Section 143(2) of the Income Tax Act, 1961 (‘the Act’ for short) on 12.9.1995 to M/s Veekay Developers in respect of assessment year 1994-95 by the Assessing Officer. Subsequently, the Tax Recovery Officer, Mangalore Range passed an order dated 5.12.2000 attaching the immovable properties including the properties mortgaged by Veekay Developers and V.K. Clubs to the respondent invoking Rule 48 of Second Schedule to the Act to recover tax dues of Rs.80,03,276/- from Sri Vivian Kamath D’Souza, M/s Veekay Developers, M/s Shalimar Constructions and M/s Canara Builders. The order of attachment of immovable properties was issued on 5.12.2000. The said order of attachment of properties was called in question before this Court in Writ Petition No.46786/2012 by the respondent herein, which came to be allowed on 13.3.2013 and consequently the order attaching the immovable properties was quashed. The Revenue has questioned the order of the learned Single Judge passed in Writ Petition No.46786/2012 by filing this intra Court writ appeal.

2. Heard Sri Jeevan J. Neeralagi, learned advocate appearing on behalf of the appellants and Smt. Jinita Chaterjee, learned advocate appearing on behalf of the respondent.

3. We do not find any ground to interfere in the impugned order. Section 281 of the Act declares certain transfers to be void. Section 281 of the Act states that where, during the pendency of any proceeding under the Act or after the completion thereof, but before the service of notice under rule 2 of Second Schedule, any assessee creates a charge on, or parts with the possession (by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever) of, any of his assets in favour of any other person, such charge or transfer shall be void as against any claim in respect of any tax or any other sum payable by the assessee as a result of the completion of the said proceeding. Based on the wordings of Section 281 of the Act, Sri Neeralagi, learned advocate appearing on behalf of the appellant submits that the transfer by way of mortgage in favour of the respondent - Corporation by Veekay Developers is void ab initio and therefore the respondent – Corporation has no locus standi to question the order of attachment.

4. The above submission cannot be accepted having regard to the proviso to Section 281 of the Act. Section 281 of the Act will have to be read in its entirety and homogeneously. On reading the said provision, it is clear that Section 281 of the Act lays down that charge or transfer of property during the pendency of the Income Tax proceedings shall be void. However under the proviso to sub-section (1) of Section 281 of the Act, charge or transfer shall not be void if it is made – (a) for adequate consideration and without notice of the pendency of such proceeding or (b) without notice of tax or other sum payable by the assessee.

5. In the matter on hand, there cannot be any dispute that the transfer was for adequate consideration. The records reveal that the term loan obtained by Veekay Developers and subsequently transferred to V.K. Clubs is to the tune of Rs.211.00 lakhs. Whereas the notice under Section 143(2) of the Act by the Income Tax Department is for recovery of Rs.80,03,376/-. Hence it is clear that the transfer was for adequate consideration. It is also clear from the records that, while the transfer by way of mortgage is effected, there was no notice of pendency issued to transferee, of the proceedings initiated by the department. As aforementioned, the notice was issued to the assessee by the Assessing Officer one day prior to sanctioning of the loan. The notice was issued on 12.9.1995, whereas the loan was sanctioned by the respondent – Corporation to V.K. Developers on 13.9.1995. Therefore it is clear that the transfer by way of mortgage was also without notice of pendency of the assessment proceedings. In view of the same, the transfer cannot be held to be void. For the aforementioned finding, we are supported by the judgment of Gujarath High Court in the case of TAX RECOVERY OFFICER .vs. INDUSTRIAL FINANCE CORPORATION OF INDIA AND ANOTHER reported in (2012)346 ITR 11 (Guj).

In yet another judgment in the case of TAX RECOVERY OFFICER .vs. GANGADHAR VISWANATH RANADE reported in (1998) 234 ITR 188 (SC), the Apex Court has observed that Section 281 will have to be read homogeneously with the Rule 11(1) of Second Schedule to Act. The Apex Court in the said judgment has observed thus:

In the present case, the Tax Recovery Officer could not have examined whether the transfer was void under section 281 of the Income-tax Act. His adjudication of the transfer as void under section 281 is without jurisdiction. The Tax Recovery Officer has relied upon the earlier order of the Income-tax Officer dated May 9, 1974, declaring that the transaction is void under section 281 of the Income-tax Act. In the earlier proceedings, however, although the High Court has not set aside this order of the Income- tax Officer, the High Court has expressly held that the order amounted only to an intention or declaration on the part of the Department to treat the transaction as void under Section 281. Such a declaration cannot affect the legal rights of the parties affected under rule 11. The High Court expressly held that the rights of the parties under rule 11 were not affected in any way by this declaration. The Department, therefore, cannot proceed on the assumption that the transaction is void under section 281, nor can the Tax Recovery Officer, while proceeding under rule 11, declare a transaction of transfer as void under section 281 by relying on the order of May 9, 1974, or otherwise. His jurisdiction relates to examining possession, and only incidentally, any question of right to possession as claimed by the objector. The High Court has, therefore, rightly set aside the order of the Tax Recovery Officer.

However, the right of the Department to have the transfer declared as void under section 281 of the Income-tax Act, as it stood at the relevant time, is not thereby taken away. We are informed that the property continues to be under attachment by virtue of interim orders passed in this appeal. The Department may, if it so desires, take appropriate proceedings in accordance with law for having the transfer declared as void under section 281 of the Income-tax Act.

Be that as it may, as aforementioned, on facts, it is clear that the transfer by way of mortgage by V.K.Developers in favour of the respondent – Corporation was for adequate consideration and was without notice of pendency of the assessment proceedings. Hence the same cannot be declared as void. In view of the same, the learned Single Judge has rightly set aside the order passed by the Tax Recovery Officer attaching the immovable properties for the purpose of sale.

6. Undisputedly, the respondent is a secured creditor. Hence it is needles to observe that even the Crown debt could be discharged only after the debt of secured creditors stand discharged. In that regard, consciously the concerned Tax Recovery Officer by his letter dated 27.1.2006 has clearly stated that the respondent – Corporation can proceed for sale of the properties involved as the respondent - Corporation has first charge over the properties and to treat the Income Tax Department as second mortgagor. It is also clearly stated in the said letter that after appropriation of sale proceeds towards dues of the respondent – Corporation, surplus, if any has to be handed over to Tax Recovery Officer, Range-2, Mangalore for appropriation of Income Tax dues. In view of the same, no interference is called for.

Appeal fails and the same stands dismissed.

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JUDGE

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JUDGE