In case of a liquidation, a company must adhere to the procedures laid down under Chapter III of Insolvency and Bankruptcy Code, 2016 (‘IBC’). The process of liquidation may be voluntarily^[1] or through a Court / Tribunal order^[2]. However, the order and priority of distribution of proceeds from the sale of liquidation of assets among the stakeholders of a corporate person must be as prescribed under Section 53 of the IBC.

In a recent case,^[3] the challenge before the National Company Law Tribunal (‘NCLT’) by the applicant was in relation to set-off of income-tax refund (along with interest) by the Income-tax Department against the outstanding tax demands of earlier years, without filing the claim as mandated under the IBC. The NCLT observed that the refund set-off was against the tax demands that are pre-Corporate Insolvency Resolution Process (‘CIRP’) and held that, by virtue of Section 245(1) of the IT Act, the Income-tax Department being a secured creditor acquires a statutory right to set-off the refunds against the taxes in arrears under any proceedings. Accordingly, the set-off of refunds against the tax demands of pre-CIRP period was upheld.

In appeal,^[4] the National Company Law Appellate Tribunal (‘NCLAT’), distinguished between CIRP and liquidation proceedings by observing that, CIRP prohibits both institution and continuation of pending suits or proceedings, whereas only institution of new suit is a bar in liquidation proceedings. Thus, whilst interpreting Section 33(5) of the IBC, NCLAT held that continuation of proceedings by the Income-tax Department is permissible during the pendency of application for liquidation. The NCLAT then proceeded to examine the scope of liquidation under Regulation 29 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016, which allows mutual credits and set-off. In this context in a path breaking finding, though NCLAT concluded that there is no restriction, prohibition or embargo placed under IBC on the principle of set-off during liquidation proceedings, however, such action has been made subject to waterfall mechanism provided under Section 53 of IBC. Further, the NCLAT whilst taking cognizance of the recent decision passed by the Hon’ble Supreme Court,^[5] observed that Section 245(1) of the IT Act does not create any charge or security interest, therefore, the Income-tax Department cannot be treated as secured creditor. NCLAT also concluded that the Income-tax Department enjoys limited jurisdiction of continuing with assessment proceedings and in determining the quantum of income tax dues, but does not enjoy the jurisdiction and power to suo motu initiate recovery of dues or execute their claim unilaterally by setting off the refund amount with past tax dues.

The present ruling settles the legal position regarding set-off of refund by the Income-tax Department and goes a step further to clearly distinguish the difference between CIRP process and liquidation process. Further, while applying the principle of set-off, it must be kept in mind that no creditor ends up getting a share disproportional to their dues; and for recovery of the tax amount, the Income-tax Department is required to submit claims to the liquidator in the requisite form. Accordingly, the Income-tax Department, by unilaterally setting off the refund amount cannot put itself in a better footing than what is permissible as per their claim in the distribution matrix.

[1] Section 59 of Insolvency and Bankruptcy Code, 2016.

[2] Section 33 of Insolvency and Bankruptcy Code, 2016.

[3] Avil Menezes v. Principal Commission of Income-tax, Mumbai I.A. No. 2968 / (MB) / 2022 in CP (IB) No. 2295 / NCLT / MB / 2018 (NCLT).

[4] Avil Menezes v. Principal Commission of Income-tax, Mumbai, Company Appeal (AT) (Insolvency) No. 258 of 2024 (NCLAT).

[5] Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited,180 SCL 30 (SC).