RESOLVING THE INSOLVENT

Taxation laws have always mingled with other regulatory laws and this interplay has resulted in better application of the tax laws. The intermingling of the GST law with the recently-enacted Insolvency & Bankruptcy Code, 2016 poses interesting facets of the GST law. Though both laws have a different orientation, they converge on the issue of tax recovery from a defaulter. The said laws also have an interesting commonality, i.e., they are claimed as reformist action carrying the same ‘magnitude of 1991’ (the year when economic reforms were carried out under the duo of PM Narasimha Rao and FM Manmohan Singh).

This article is an attempt to identify the points of convergence of these revolutionary laws in the context of corporate insolvencies.

Generally speaking, a defaulting / sick enterprise will also have statutory defaults (referred to as ‘Crown debts’). Under the erstwhile provisions, Crown debts were given priority over other financial / trade debts. Empirical evidence suggests that sick enterprises burdened with Crown debts impair the productivity of assets and deter the overall recovery of the enterprise. Permitting tax recoveries would defeat the ultimate motive of rejuvenating a sick enterprise and this has been expressed in the Bankruptcy Law Reforms Committee (BLRC) report in 2015:

‘2. Executive Summary
The key economic question in the bankruptcy process…
The Committee believes that there is only one correct forum for evaluating such possibilities and making a decision: a creditors’ committee, where all financial creditors have votes in proportion to the magnitude of debt that they hold. In the past, laws in India have brought arms of the Government (legislature, executive or judiciary) into this question. This has been strictly avoided by the Committee. The appropriate disposition of a defaulting firm is a business decision, and only the creditors should make it.’

The Insolvency and Bankruptcy Code, 2016 (IBC) is the bankruptcy law of India which aims at creating a single law for insolvency and bankruptcy for corporates and non-corporates. It is a comprehensive code for resolving insolvencies which erstwhile laws failed to achieve. Hitherto, the Sick Industrial Companies (Special Provisions) Act, 1985 (‘SICA’), the Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (‘RDDBFI’), the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI’) and the Companies Act, 2013 provided for insolvency of companies. The Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920 were made applicable to individuals and partnership firms. But the thrust of the IBC law is to identify sickness under a ‘liquidity approach’ rather than a ‘balance sheet approach’ at the earliest point of time, i.e., default in payment of any debt obligation.

At the end of it, the insolvency process results in two eventualities: (a) recovery of the enterprise through a Corporate Insolvency Resolution Process (CIRP); or (b) liquidation of the enterprise and distribution of assets to the stakeholders.

SUPREMACY OF THE CODE OVER ALL LAWS (INCLUDING GST)

The law was given teeth through blanket overriding provisions over all other Central and State laws. This was a learning from the erstwhile laws and the intent of the Legislature was to give corporate revival primacy over liquidation. Section 238 of the Code gives it supremacy over all other laws insofar as an insolvency resolution process is concerned and it cannot be eclipsed by resorting to remedies available under the ordinary law of the land. The IBC law has withstood the constitutional challenge in the famous Swiss Ribbons case (2019) 4 SCC 17 which gave further impetus to this legislation.

In terms of section 5(20) r/w/s 5(21) of IBC 2016, an operational creditor has been defined as a person to whom a debt in respect of goods or services is due and includes debt payable under any law to the Central and State Government. Contrary to the erstwhile laws which prioritised Crown debts, this law has relegated Government dues to the class of operational creditors. CBEC Circular 134/04/2020-GST, dated 23rd March, 2020 also clarifies that the GST dues would stand as ‘operational debt’ and no coercive action is permitted to be taken by the proper officer for recovery of debts due prior to the CIRP date. It would be seen under the IBC process that operational creditors have a limited power in revival of the enterprise. Section 30(1) only assures the liquidation value of the Corporate Debtor to operational creditors.

Participation in the insolvency resolution process – operational creditors

The insolvency process commences with an insolvency application filed by a financial creditor, operational creditor or corporate debtor (or its member) himself. Operational creditors are permitted to file for initiation of insolvency in case of default of any debts due to them. The date of admission of the application for insolvency by the NCLT acts as the ‘insolvency commencement date’. On and from this date, a blanket moratorium is announced against the institution and the continuation, execution of any suit or decree under any law against the Corporate Debtor. In addition, a complete bar is placed on transferring, encumbering, alienating, recovering, etc., of any assets or rights of the Corporate Debtor. This date serves as a reference point for ascertainment of debts / claims settled under the insolvency resolution process.

A public announcement is made of the CIRP containing the details of the insolvency and seeking submission of claims against the Corporate Debtor. Operational creditors are required to submit their claims for dues from the Corporate Debtor within the specified time frame. It is based on these claims that the resolution professional (RP) draws up the statement of debts due by the Corporate Debtor and the available assets against such claims. The RP is required to verify the claims, including contingent claims, for arriving at the creditors’ pool of the Corporate Debtor.

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1   For respective GSTIN registration

It is at this juncture that statutory authorities (including Central / State Governments1) have to enter the insolvency process and present their claim of unpaid taxes from the Corporate Debtor. Unless a claim is filed, Governments are not permitted to seek a share in the resolution plan of the creditor. These claims are subject to verification and admission by the IRP / RP. Therefore, if the merits of the claim itself are disputed, the IRP / RP may not consider the same as a valid claim. The Central / State Government being in the status of operational creditors, is not permitted to vote as part of the Committee of Creditors (COC) which is the prerogative of the financial creditors. They are mute spectators to the resolution process and would have to accept the decision of the COC as being in the overall interests of all stakeholders.

AGITATING THE RESOLUTION PLAN

Under the revived insolvency law, the financial creditors that comprise the COC are given supreme powers over the resolution of the Corporate Debtor. The law-makers believe that the financial creditors contributing risk capital stand to lose most in an insolvency and therefore would make all efforts to seek suitors who are willing to revive the company. In case a resolution plan is successfully drawn up and approved by the COC, the same would be approved by the NCLT and given statutory force. In terms of section 31 of the IBC, the approved resolution plan would be binding on all stakeholders, including Central / State Governments.

In all likelihood creditors (including Central / State Governments) would be aggrieved by the reduction in the settlement of dues under the resolution plan. Section 61(3) recognises that all resolution plans would entail some pain to stakeholders, yet the commercial wisdom of COC has been given statutory force. IBC limits the scope of any appeal against the order of NCLT (affirming the COC decisions) only in cases where:

* Approved resolution plan is in contravention of any law for the time being in force
* Material irregularity in exercise of powers by IRP / RP
* Debts owed to operational creditors have not been provided for in the resolution plan
* Insolvency costs are not provided for
* Or any other prescribed criteria.

The Supreme Court, in the case of Ghanshyam Mishra & Sons Private Limited vs. Edelweiss Asset Reconstruction Company Limited (2021) SCC Online SC 313, has unequivocally stated that the Legislature has consciously precluded any ground to challenge the ‘commercial wisdom’ of the COC before the NCLT and that decision is ‘non-justiciable’. Effectively, on approval of the plan by the NCLT, all operational creditors including the Central / State Governments, lose their right to claim any further dues on the fairness doctrine. Discretion on the rationing of the limited funds of the Corporate Debtors rests in the domain of the financial creditors jointly through the COC.

In the context of GST, though the Centre / State would have ascertained their respective dues, they can at the most stake their claims and it would be for the COC to ascertain the eligible claim and provide for the settlement of the said claim on a liquidation-value basis depending on the availability of assets of the Corporate Debtor and the proposal by the incoming resolution applicant. Despite the Centre / State having a self-assessed GST liability available on record, they are bound by the resolution plan and have to strictly abide by the same. Importantly, paragraph 67 of the above decision also states that debts in respect of the payment of dues arising under any law including the ones owed to Centre / State which do not form part of the resolution plan, stand extinguished. This conclusion seals the fate of all adjudicated / unadjudicated GST dues pertaining to the periods up to the CIRP date and the Centre / States cannot proceed to recover any amounts not provided in the resolution plan. Reference can also be made to the decision in Essar Steel India Ltd. Committee of Creditors vs. Satish Kumar Gupta (2020) 8 SCC 531,

‘107. For the same reason, the impugned NLCAT judgment [Standard Chartered Bank vs. Satish Kumar Gupta, 2019 SCC OnLine NCLAT 388] in holding that claims that may exist apart from those decided on merits by the resolution professional and by the Adjudicating Authority / Appellate Tribunal can now be decided by an appropriate forum in terms of section 60(6) of the Code, also militates against the rationale of section 31 of the Code. A successful resolution applicant cannot suddenly be faced with “undecided” claims after the resolution plan submitted by him has been accepted as this would amount to a hydra-head popping up which would throw into uncertainty amounts payable by a prospective resolution applicant who would successfully take over the business of the corporate debtor. All claims must be submitted to and decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the corporate debtor. This the successful resolution applicant does on a fresh slate, as has been pointed out by us hereinabove. For these reasons, NCLAT judgment must also be set aside on this count.’

ROLE OF INSOLVENCY RESOLUTION PROFESSIONAL

The CIRP process involves appointment of an IRP / RP for management of the affairs of the Corporate Debtor. The powers of the board of directors stand suspended and vested in the hands of the RP (section 17/25). It provides that the IRP / RP would act and execute in the name and on behalf of the Corporate Debtor and keep the same as a going concern. In terms of section 148 of the CGST / SGST Act r.w. Notification 11/2020-CT dated 21st March, 2020, a special process has been identified for management of the affairs of the Corporate Debtor by the IRP / RP until conclusion of the insolvency resolution process. In terms of the proviso, this Notification would be applicable only to such class of persons who have defaulted in filing the outward supplies statement (GSTR1) or return (GSTR3B) under the GST law.

The IRP / RP would be deemed to be a ‘distinct person’ of the Corporate Debtor and is required to take separate registration numbers in each of the States where the Corporate Debtor was previously registered. In effect, a separate GSTIN (under the PAN of the Corporate Debtor) should be obtained by the IRP / RP and all inward / outward supply transactions from the date of appointment of the IRP / RP would have to be reported under the new GSTIN. This ensures that pre-CIRP dues would be governed by the resolution plan / liquidation order and an IRP / RP being a fiduciary, be responsible for acts done after its appointment under a fresh registration – refer Circular (Supra). Moreover, non-filing of prior period returns would not act as a bar on filing subsequent period returns and the new registration would facilitate regularising the compliance subsequent to the appointment of IRP / RP.

Recognising that the creation of a new registration would cause temporary technical challenges, the said Notification waives the time limit of section 16(4) and GSTR2A reflection under Rule 36(4) of the CGST law. Interestingly, as per the Circular (Supra), this waiver is permitted only for the first return filed by the IRP / RP after seeking the registration u/s 40. The IRP / RP is permitted to account for inward supplies which are received since its appointment and cannot expand the claim of credit to supplies prior to such date.

At the customer’s front, invoices raised by the Corporate Debtor during the interregnum (i.e., from the CIRP commencement date and date of registration by IRP / RP) would be eligible as input tax credit in the hands of the recipient despite the erstwhile GSTIN being reflected in such invoices. Separately, the said Notification also permits the RP to seek refund of the amounts lying in the electronic cash ledger in the erstwhile registration.

STATUS OF THE ERSTWHILE REGISTRATION

In terms of the Circular (Supra), the erstwhile registration is required to be placed under suspension by the proper officer after the CIRP date and cannot be cancelled by the proper officer. In case the registration is already cancelled, the proper officer has been directed to revoke the cancellation and bring the same to suspension status.

It may be noted that the new registration granted to the IRP / RP is for the limited timeframe from the CIRP date up to the approval / rejection of the resolution plan. In the event that the resolution plan of the resolution applicant is approved and the Corporate Debtor continues in the same legal form, the law appears to be silent on the continuation of the new registration or reverting to the erstwhile registration. On the basis that the law is silent and that IRP / RP registration is a temporary measure, it can be concluded that the Corporate Debtor would revert to the original registration and the proper officer would have to revoke the suspension placed on the original registration.

Naturally, section 39(10) and the GSTN portal may pose the technical challenge of prohibiting the Corporate Debtor from filing returns after the resolution date on account of default of prior period returns. Due to this hindrance and given the fact that the IRP / RP has filed the returns for the corresponding period, one may consider availing a third registration after the date of approval of the resolution plan by the NCLT. Of course, where the resolution plan involves an amalgamation or merger, the general GST provisions including transfer of input tax credit, would take over for this purpose.

SCENARIO ON LIQUIDATION

Where the COC fails to draw up a resolution plan within the specified / extended time lines or the resolution plan is rejected or contravened, the NCLT would direct that the company be liquidated and the assets be distributed to the stakeholders under a waterfall mechanism. The liquidation order shall be deemed to be a notice of discharge to the officers, employees and workmen of the Corporate Debtor and the liquidator takes charge of all the matters of the Corporate Debtor. In terms of section 53 of the IBC, the distribution of assets / liquidation value to workmen, secured creditors and unsecured creditors would be made prior to meeting the Crown debts. In all likelihood, a Corporate Debtor would not have sufficient assets and the dues would have to be written off by the Central / State Governments.

Unlike the Notification issued w.r.t. the resolution process, the GST law has not provided for the continuation or creation of a new registration in the eventuality of the company entering into liquidation. A liquidator appointed u/s 34 of the IBC law may inherit a going concern and would have to perform a piecemeal liquidation of the Corporate Debtor. The liquidation process may entail GST implications which the official liquidator may be liable to discharge. The law appears to be silent
on the status of the IRP / RP registration or the erstwhile pre-CIRP registration during such process and the Board should clarify this practical issue faced by liquidators.

SIGNIFICANCE OF DISTINCT PERSON REGISTRATION

Section 168 of the law mandates a fresh registration by the IRP / RP in fiduciary capacity and such registration has been treated as a distinct person. Curiously, this Notification, though procedural in nature, raises concerns on the substantive provisions of section 25 which define distinct person. The assets / inventory which are in possession under the older GSTIN are now to be considered the property of the new IRP / RP GSTIN as being ‘distinct person’ under law. While one may be tempted to invoke Schedule I and deem a notional supply among these GSTINs, we should be conscious of the purpose of the Notification. The said Notification is directed towards procedural aspects and not alteration of substantive rights / liabilities of the taxpayer. The rights and liabilities under law would continue under the supervision of the IBC process and GST should not treat this registration as a distinct person in the strict sense. Under the IBC law, sections 17, 18, 24 and 25 define the role and responsibilities of the IRP / RP as being responsible for the management of affairs and ensuring compliance of legal requirements under the IBC and other laws. The Supreme Court in Arcellor Mittal (India) Ltd. vs. Satish Kumar Gupta (2019) 2 SCC 1, states that the RP is taking over the Corporate Debtor in an ‘administrative capacity’ and not in an adjudicatory capacity. This conclusion should put at rest any doubts on the distinct person concept which has been introduced through section 168 of the law.

INTERESTING FACETS OF INPUT TAX CREDIT AT CUSTOMER’S END

GST dues which are collected and payable by the Corporate Debtor may remain unpaid or would be settled at a reduced value under a resolution / liquidation plan. This may result in violation of section 16(2)(c) of the GST law requiring the recipient to establish that input tax has been paid to the Government. Does the settlement of the resolution plan by the Corporate Debtor have any bearing on the ITC claim of the recipient? One theory would claim that the debt due by the Corporate Debtor (i.e., output tax) itself would stand ‘extinguished’ on approval of the resolution plan and thus the taxes are not ‘unpaid taxes’ to the Government causing invocation of the said provision. Section 16(2) pre-supposes a legally sustainable claim and non-payment of such claim would result in denial of ITC. But where the claim itself has been extinguished one may say that section 16(2) stands complied with. Moreover, Government being a stakeholder of the resolution plan, has accepted the haircut (though by statutory force whose validity has not been challenged at appellate forums), it should be estopped from now staking a new claim at the recipient’s end.

The alternative theory would claim that taxes which are not realised by the Government are not ITC and this makes it justifiable for the Revenue to deny the claim. The fallout of this approach would be that the recipient of input from the Corporate Debtor would be under double jeopardy – having paid the tax portion to the Corporate Debtor it would still be denied the ITC by the Government.

INPUT TAX CREDIT LYING IN BALANCE / REFUNDS DUE AS ON CIRP DATE

The Corporate Debtor may be entitled to the ITC lying unutilised as on the CIRP date [for example, Input – 100; Input as per 2A – 150; Output – 350]. The question for consideration is whether the Government’s claim would be 250 or 350? Government in every likelihood may proceed to confirm its demand (vide an order) for gross amount of 350 and this poses a question on the ‘debt’ which is due to the Government. Claim u/s 2(6) refers to a ‘right to payment’ whether or not such right is disputed / undisputed, etc. Debt has been defined u/s 2(11) as being a ‘liability or obligation’ in respect of a claim which is due from any person. Regulation 9-14 places the responsibility of verification of the claims and ascertainment of the ‘best estimate’ on the IRP / RP.

GST being a VAT model, the references to output tax and input tax are made to ascertain the net value addition. Though they are distinct and independent concepts, the scheme of the legislation is to arrive at the net tax liability after reduction of amounts lying as credit. The scheme of section 49 of the GST law (also refer ‘self-assessed tax’) and returns also depict that the ‘liability or payment’ to the Government would be computed after deduction of the ITC eligible to the Corporate Debtor. But the answer may be different to the extent of input which is eligible but lying unclaimed by the Corporate Debtor (50). This is because the statutory scheme requires that ITC should be claimed for it to be eligible for a deduction against output tax. Where the claim is not made by the Corporate Debtor or its representative (IRP / RP), in all likelihood that amount would stand lapsed and cannot be claimed as a set-off in ascertaining the debt due to the Government.

Where refunds are due by the Government, it may be within its statutory right to internally adjust these amounts. Section 54(10) of the GST law empowers the officer to recover the said amounts. Where such adjustments are made prior to the moratorium, the Government would be within the framework to justify the adjustment. But once a moratorium is declared, section 14(1)(a) bars any transfer, encumbrance, alienation or disposal of the assets of the Corporate Debtor. The Government may be barred from adjusting the refunds due to the Corporate Debtor with outstanding dues. In such scenarios, the IRP / RP would have to pursue the refund claim from the Government and transfer the outstanding dues to the decision of the COC under the resolution plan. But in case of liquidation, Regulation 29 expressly permits mutual credits or set-off prior to ascertainment of the net amount payable by the Corporate Debtor.

FATE OF ALTERNATIVE RECOVERIES – JOINT & SEVERAL LIABILITY OF DIRECTORS, ETC.

GST law has amply empowered authorities to recover their tax dues from refund adjustments, garnishee proceedings, etc. Whether these provisions which can be invoked in the normal course of business operations have a bearing on the Corporate Debtor? The moment the CIRP process is initiated, the moratorium shields the Corporate Debtor from any further liabilities and also protects all its assets from alienation from the Corporate Debtor. This effectively restricts the taxman from approaching banks / debtors and recovering the taxes forcefully. Under general law, the right of the creditor in invoking the personal guarantees granted by directors was under consideration before the Court in SBI vs. V. Ramakrishnan & Ors. (2018) 17 SCC 394, wherein it was held that the moratorium does not insulate the guarantors of the debt and their independent and co-extensive liability would continue unhindered. On these lines, the liability of directors under GST would also stand on an independent footing.

Section 88 provides for joint and several liabilities over the directors of the company unless they prove that such non-recovery was not on account of any gross neglect, misfeasance or breach of duty in relation to the affairs of the company. While this provision is specific to cases involving liquidation, it does not specifically provide for cases where the Corporate Debtor is taken over by a resolution applicant. Therefore, Centre / State may not be in a position to invoke the said provision in case of reduction of debt due to the respective Governments.

In the alternative, the taxman would like to go after the transferee of business (especially in case of a takeover / merger by resolution applicant) u/s 85 which provides for recovery action against the transferee of the business for recovery of taxes from such transferee. While the said provisions are open-ended, it would be contrary to the IBC provisions which give finality to dues to the resolution applicant and hence any such claims would have to be eclipsed into the resolution plan (refer Arcellor Mittal’s case, Supra). Another viewpoint would be that the resolution plan would have the effect of determination of tax dues and no other forum or civil authority is permitted to alter these dues from the Corporate Debtor.

Implications over criminal or personal penalties against directors, etc.
Parallel proceedings such as prosecution, personal penalties are permitted to be invoked against the directors of Corporate Debtors. The said proceedings would not form part of the insolvency process and would remain unaffected by the resolution plan. The affected persons would have to contest these matters at the appropriate forum on merits and cannot take shelter under the resolution scheme.

CONCLUSION

The taxman should appreciate the macro-economic aspects of introducing this legislation. It is here where the taxman should don the entrepreneur hat and swallow the bitter pill for a better future of the enterprise and of the economy as a whole. It was stated by the Court that ‘What is important is that it is the commercial wisdom of this majority of creditors which is to determine, through negotiation with prospective resolution application, as to how and in what manner the corporate resolution process is to take place’. It is only when such an approach is adopted that the IBC resolution process would yield the desired results.