How to Recover from Director Actions Without Tracing Co. Assets?

Section 179 of the Income Tax Act, 1961, empowers the Tax Recovery Officer (TRO) to recover the tax dues of a private company from its directors, jointly and severally, if the company cannot pay its tax liability. However, this provision is not absolute and has certain conditions and limitations. One of the conditions is that the TRO must be satisfied that the non-recovery of tax dues from the company is attributable to any gross neglect, misfeasance or breach of duty on the directors’ part concerning the company’s affairs. Another limitation is that the directors must be allowed to be heard before passing an order under section 179. In this essay, we will discuss a recent case law where the Bombay High Court quashed an order under section 179 passed upon a deceased director, as there was no evidence to show that any notice was issued to him or that any steps were taken to trace the assets of the company.

Case Summary

The case in question is Manjula D. Rita v. Principal Commissioner of Income-tax – [2023] 153 taxmann.com 468 (Bombay). The facts of the case are as follows:

• The deceased assessee was a director of a company called M/s. Rita Enterprises Pvt. Ltd., which was engaged in the business of manufacturing and trading chemicals.
• An assessment order was passed for the assessment year 2019-20, making several additions to the company’s income and raising a tax demand of ₹1,18,75,260.
• The company filed a stay application before the TRO, which was rejected because there was no prima facie case in its favour, and it had not paid any part of the tax demand.
• Thereafter, an order under section 179 was passed upon the assessee on 30.03.2020, raising a tax demand of ₹1,18,75,260 from him as a company director.
• The assessee filed a revision petition under section 264 against the order under section 179, which the Principal Commissioner of Income Tax (PCIT) rejected on 29.05.2020.
• The assessee filed a writ petition before the Bombay High Court, challenging the orders passed by the TRO and the PCIT.

The main grounds raised by the assessee in his writ petition were:

• The order under section 179 was passed without issuing any notice or giving him any opportunity to be heard, violating the principles of natural justice and section 179(2).
• The order under section 179 did not satisfy any of the ingredients required to be met under section 179(1), i.e., that the non-recovery of tax dues from the company was attributable to any gross neglect, misfeasance or breach of duty on his part concerning the affairs of the company.
• The order under section 179 did not consider or mention any steps the TRO took to trace or recover the company’s assets before proceeding against him as a director.
• The order under section 179 did not consider that he had resigned as a company director on 31.03.2019 and had no control or involvement in its affairs thereafter.
• The order under section 179 did not consider that he had expired on 06.04.2020 and that his legal heirs had no knowledge or information about his director status or tax liability.

The main arguments advanced by the revenue in defence of the orders passed by the TRO and the PCIT were:

• The order under section 179 was passed after issuing letters through speed post to the assessee on 12.03.2020 and 16.03.2020, which were not returned undelivered.
• The order under section 179 was based on sufficient material and evidence to show that the non-recovery of tax dues from the company was attributable to gross neglect, misfeasance or breach of duty on his part as a director.
• The order under section 179 was justified as there was no response or compliance from the assessee or his legal heirs despite repeated reminders and notices.
• The order under section 179 was under the law and did not suffer from any illegality or arbitrariness.

The Bombay High Court favoured the assessee and quashed the orders passed by the TRO and the PCIT. The main reasons given by the court for its decision were:

• No evidence indicated any notice was issued to the assessee before passing the order under section 179. The affidavit filed by the revenue stated that only letters were issued through speed post but did not annex any proof of such letters or their delivery status. The court observed that a letter sent by speed post cannot be equated with a notice under section 179(2), which requires personal service or affixation in a conspicuous place. The court also noted that the revenue did not produce any postal receipt or tracking report to show that the letters were delivered to the assessee. Thus, the court concluded that no notice or opportunity of being heard was given to the assessee, a mandatory requirement under section 179(2) and a violation of the principles of natural justice.
• There was nothing to indicate what steps the TRO took to trace or recover the company’s assets before proceeding against the assessee as a director. The court observed that section 179(1) is not a blanket provision that empowers the TRO to recover the tax dues of a company from its directors without any regard to the availability or otherwise of the company’s assets. The court held that before invoking section 179(1), the TRO must make reasonable efforts to locate and seize the assets of the company and must record his satisfaction that such efforts have failed or are likely to fail. The court also held that the TRO must give reasons for his satisfaction and disclose the steps he took to trace or recover the company’s assets. The court found that, in this case, there was no such satisfaction or disclosure by the TRO in his order under section 179, which rendered it unsustainable in law.
• The order under section 179 did not make out any case as required under section 179(1) that the non-recovery of tax dues from the company was attributable to any gross neglect, misfeasance or breach of duty on the part of the assessee as a director. The court observed that section 179(1) is not a penal provision that imposes vicarious liability on the directors for the company’s default but a remedial provision that enables the recovery of tax dues from the directors responsible for the default. The court held that before passing an order under section 179(1), the TRO must establish that there is a nexus between the non-recovery of tax dues from the company and the gross neglect, misfeasance or breach of duty on the part of the directors about the affairs of the company. The court also held that gross neglect, misfeasance or breach of duty must be viewed in the context of non-recovery of tax dues and not to the general functioning of the company. The court found that, in this case, no such nexus or context was established by the TRO in his order under section 179, which made it arbitrary and unreasonable.

The implications and consequences of the Bombay High Court’s judgment for the taxpayers and the revenue authorities

The Bombay High Court’s judgment in the case of Manjula D. Rita v. Principal Commissioner of Income-tax has significant implications and consequences for both the taxpayers and the revenue authorities about section 179 of the Income Tax Act, 1961. Some of them are as follows:

• For the taxpayers, especially the directors of private companies, the judgment may provide relief and protection from arbitrary and unreasonable orders passed by the Tax Recovery Officers under section 179. The judgment may also safeguard their rights to natural justice and fair hearing before being held liable for the tax dues of the company. The judgment may also enable them to challenge such orders on valid grounds, such as lack of notice, lack of steps to trace or recover the assets of the company, lack of nexus or context between the non-recovery of tax dues and their gross neglect, misfeasance or breach of duty, etc. The judgment may also prevent them from being harassed or coerced by the revenue authorities to pay the tax dues of the company without any justification or evidence.
• For the revenue authorities, especially the Tax Recovery Officers, the judgment may provide guidance and clarity on exercising their discretion and authority under section 179 fairly and reasonably. The judgment may also ensure that they comply with the procedural and substantive requirements of the provision, such as issuing notice and allowing being heard to the directors, take steps to trace or recover the assets of the company, making out a case of gross neglect, misfeasance or breach of duty on their part, etc. The judgment may also improve their efficiency and effectiveness in recovering the tax dues from private companies and their directors, as it may require them to be more diligent and evidence-based in their approach.

In this case, the Bombay High Court’s judgment has upheld the rule of law and the principles of natural justice in relation to section 179 of the Income Tax Act, 1961. The judgment has also balanced the interests and rights of taxpayers and the revenue authorities concerning the recovery of tax dues from private companies and their directors. The judgment has also set a precedent for future cases involving similar issues and circumstances.

Conclusion

The Bombay High Court, in this case, has reiterated and reinforced the principles and safeguards governing the application of section 179 of the Income Tax Act, 1961. The court has emphasized that section 179 is not a draconian provision invoked indiscriminately against any director of a defaulting company but a discretionary provision that can be invoked judiciously against those directors culpable for the default. The court has also stressed that section 179 is subject to certain conditions and limitations, such as issuing notice and allowing being heard to the directors take steps to trace or recover the assets of the company and make out a case of gross neglect, misfeasance or breach of duty on their part. The court has quashed an order under section 179 passed upon a deceased director, as there was no evidence to show that any notice was issued to him or that any steps were taken to trace or recover the company’s assets.

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