CHETANMAL K RAMCHANDANI vs. INCOME TAX OFFICER

ORAL JUDGMENT

(PER : HONOURABLE MR.JUSTICE AKIL KURESHI) 1.Leave to amend. 2.These   petitions   are   taken   up   for   final   disposal.   The petitions involve identical questions of law and facts. We may record facts as mentioned in Special Civil Application No.2257/2014. 3.The petitioner is a director of one M/s. Flamingo Hotels Private Limited which, as its name suggests,  is a private limited company and would be here­in­after referred to as “the said company”. For the assessment year 2010­2011, the said company filed its return declaring total income of Rs.4.88   lakhs(rounded   off).   Such   return   was   taken   in scrutiny.   The   Assessing   Officer   framed   assessment   on 28.3.2013 and computed the long term capital gain after set off of business loss at Rs.4.14 crores(rounded off). The company filed appeal against the order of the assessment. Such appeal is pending before the CIT(Appeals). The said company also prayed for stay against the recovery of tax demand flowing from the order of assessment. CIT(Appeals) refused to grant stay. No further proceedings were carried by the company against such order of CIT(Appeals). As of now thus there is no stay against recovery of the tax. 4.The said company was unable to pay the taxes. The Tax Recovery Officer, Gandhidham, therefore, desired to invoke the provisions of section 179 of the Income Tax Act, 1961 (“the Act”  for short).  He therefore,  issued  a show  cause notice dated 27.9.2013 calling upon the petitioner, as the director   of   the   said   company,   why   the   tax   demand   of Rs.1.95 crores (rounded off) for the assessment year 2010­ 2011 due from the said company be not recovered from him in terms  of section  179 of the Act  by  holding  him jointly and severally liable for payment of tax, interest and penalty due from the company. 5.The petitioner replied to the show cause notice under a communication dated 5.10.2013 in which he pointed out inter­alia that provisions of section 179 of the Act can be invoked, unless the director proves that the non recovery could not be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company. The company was incorporated to run a five star hotel at Gandhidham. A hotel building for such purpose was   constructed   on   leasehold   land   acquired   by   the company. The inauguration of the hotel was planned in the first   week   of   February   2001. During   the   devastating earthquake of 26.01.2001, the hotel building was severely damaged.   On   account   of  this,   the   total   investment  was destroyed with no act of negligence or breach of duty on part   of   any   of   the   directors.   Despite   best   efforts,   the director could not even secure the insurance claim for the building  for  one  reason  or the other.  The company  has already filed suit against the insurance company which is still pending before the Civil Court at Gandhidham. The financial   institutions   however,   gave   one   time   settlement relief to enable the company to sell the property which was disposed   of   in   the   year   2009­2010. There   is   no   tax demand   outstanding   against   the   company   as   per   the return   filed.   However,   demand   arose   on   account   of   the assessment order. The income­tax department has raised an issue with respect to sale transaction of the property sold by the company. The company has already carried the matter   in   appeal.   It   was   further   pointed   out   that   the company is not having any property to pay the dues of the department, due to which the taxes cannot be recovered from the company. However, such non recovery from the company   cannot   be   attributed   to   any   gross   negligence. misfeasance or breach of duty on part of the  directors. 6.Ignoring   such   pleas   of   the   petitioner,   the   respondent passed   the   impugned   order   on   5.12.2013   declaring   the petitioner jointly and severally liable for payment of the tax, interest and penalties. He further directed the petitioner be treated as an assessee in default in respect of such dues of the   company.   He   observed   that   dues   had   become irrecoverable from the company as the company had no assets from which the recovery could be made. No efforts were   made   by   the   director   of   the   company   to   pay   the demands. While selling the properties, no provisions were made to pay the dues of the income tax out of the sale of the land. The directors were engaged in the daily affairs of the company. Adjustments as made by the company were not allowable under the law. The company was not entitled to carry forward any losses not allowed under the law and to   adjust   the   same   against   any   subsequent   gain.   He further observed that the destruction of the building  may be attributed to natural calamity, the director still had the responsibility   to   take   proper   measures   to   protect   the interest of the company like insuring the property against the earthquake. As far as matter of taxation is concerned, the   director   showed   gross   negligence   in   following   the applicable laws and thus tried to evade the due amount of taxes arising from the subsequent gains. Relevant portion of the impugned order which contains reasonings adopted by the Tax Recovery Officer reads as under : “The  dues  have  become   irrecoverable  from  the  assessee company   as   no   known   assets   are   there   to   recover   the same. Further no efforts have been made by the directors of the company to pay off the demands. While making the sale, no provisions were made to pay the due amount of income tax arising out of sale of land. It was the Directors of the company who were very well aware with the daily affairs of the company and they were also liable to obey the laws of the land in the periphery of the law only. The adjustments made by the company were not allowed by the law & thus the above person in the capacity   of   Director   of   the   assessee   company   was   not entitled to carry forward any losses which were not allowed by the law and to adjust any subsequent gain against the losses. It   may   be   a   truth   that   the   building   in   question   was destroyed   in   a   natural   calamity   which   was   beyond   the control of the Directors but on the other hand it was also the responsibility  to take proper  measure to protect  the interest of the company like insurance against earthquake and to take proper steps to follow the taxation rules in the matter.   As   far   as   taxation   matter   is   concerned,   the directors of the company have shown a gross negligence in following the applicable laws and thus has tried to evade the   due   amount   of   taxes   arising   out   of   from   any subsequent   gains.   Thus,   the   directors   have   remained negligent in discharging their duties in a proper manner. Further no provision was made by the company or any of its Directors to ensure payment of Government dues which were  bound to arise on account of deliberate and known acts of gross neglect and breach of duty by all directors of the company. The condition laid inn section 179 of IT Act for initiating proceedings against the Directors is therefore satisfied. In view of the above findings and detailed discussion every possible requirement of passing an order u/s179 has been met with  and consequently,  the above  named  person  is hereby   held   jointly   and   severally   responsible   and   liable u/s179 for payment of demand of all income­tax, interest, penalty  etc.  pertaining  to  AY  2010­11 which  have   been raised so far and may be further raised in future.” 7.It is this order which the petitioners has challenged in the petition. The facts in other petitions are identical. We may not therefore, separately record such facts. On the basis of facts   on   record,   learned   counsel   for   the   petitioners submitted that the tax demand had not become final. The order of the Assessing Officer is carried in appeal. Such appeal is still pending. At that stage, no recovery can be effected from the directors resorting to section 179 of the Act. In this respect he relied on decision of learned Single Judge   of   Kerala   High   Court   in   case   of  Khaders International   Construction   Ltd.   v.   Commissioner   of Income­tax  reported   in   (1998)   229   ITR   450. Counsel further submitted that even otherwise the requirements of section 179 of the Act were not fulfilled. The petitioners had demonstrated before the respondent that there was no negligence, misfeasance or breach of duty on their part in relation   to   the   affairs   of   the   company.   The   constructed property of the company was destroyed in an earthquake. The company therefore, could not set up and start its five star hotel as per its project and ran into heavy losses. The properties were sold and dues of the creditors were paid off as per the restructured  debts. 8.On   the   other   hand,   learned   counsel   Shri   Pranav   Desai opposed the petitions contending that the   company had set up a false claim of set off   of losses which were not allowable against the gains arising out of the sale of land. Sale   proceeds   were   utilised   for   paying   debts   of   other creditors without making provision for possible income tax liabilities. The directors had thus committed breach of duty in relation to the affairs of the company. 9.Few undisputed facts thus are : 1) The said company in order to set up a five star hotel at Gandhidham acquired a leasehold land and constructed a building thereon.  Before the hotel could be started,  the building   was   completely   destroyed   in   earthquake   which took place on 26.1.2001. The company could never recover from such set back and was unable to pay the dues of the creditors. 2) The insurance claim has still not been passed. Legal dispute between the company and the insurer is pending before the Civil Court. 2) Financial   institutions   restructured   the   debts   and allowed   the   company   to   dispose   of   the   land.   The   sale proceeds were utilised by the company to pay the debts. Though  the  precise  dates  of  such  payments  are  not  on record, it clearly emerges from the record that when such payments were made, the assessment was not yet framed by   the   Assessing   Officer   which   was   done   only   on 28.3.2013. The tax dues of the company arise out of order of   assessment.   Against   such   assessment   order,   the company has preferred appeal but stay pending appeal is refused.

“21. To   our   mind,   the   authority   completely   failed   to appreciate in proper perspective the requirement of section 179(1)   of   the   Act.   We   may   recall   that   said   provision provides for a vicarious liability of the director of a public company   for   payment   of   tax   dues   which   cannot   be recovered from the company. However, such liability could be   avoided  if  the   director   proves   that  the   non   recovery cannot be attributed to any gross negligence, misfeasance or breach of duty on his part in relation to the affairs of the company.   It   is   ofcourse   true   that   the   responsibility   of establishing such facts is cast upon the director. Therefore, once it is shown that there is a private company whose tax dues   have   remained   outstanding   and   same   cannot   be recovered,   any   person   who   was   a   director   of   such   a company at the relevant time would be liable to pay such dues. However, such liability can be avoided if he proves that the non recovery  cannot  be attributed  to the three factors   mentioned   above.   Thus   the   responsibility   to establish such facts are on the director. However, once the director   places   before   the   authority   his   reasons   why   it should be held that non recovery cannot be attributed to any of the the three factors, the authority would have to examine such grounds and come to a conclusion in this respect.   Significantly,   the   question   of   lack   of   gross negligence, misfeasance or breach of duty on part of the director is to be viewed in the context of non recovery of the tax dues of the company. In other words, as long as the director establishes that the non recovery of the tax cannot be attributed to his gross neglect, etc., his liability under section 179(1) of the Act would not arise. Here again the legislature advisedly used the word gross neglect and not a mere neglect on his part. The entire focus and discussion of the Assistant Commissioner in the impugned order is with respect to the petitioner's neglect in functioning of the company when the company was functional. Nothing came to be stated by him regarding the gross negligence on part of   the   petitioner   due   to   which   the   tax   dues   from   the company could not be recovered. In absence of any such consideration, the Assistant Commissioner could not have ordered recovery of dues of the company from the director. We would clarify that in the present case the petitioner had putforth a strong representation to the proposal of recovery of tax from  him  under  section  179 of the  Act.  In such representation, he had detailed the steps taken by him and the circumstances due to which non recovery of tax cannot be   attributed   to   his   gross   neglect.   It   was   this representation and the factors which the petitioner had put forth before the Assistant Commissioner which had to be taken into account before the order could be passed. It is not even  the case of the department  that  the petitioner paid   the   dues   of   other   creditors   of   the   company   in preference to the tax dues of the department. It is not the case   of   the   department   that   the   petitioner   negligently frittered away the assets of the company due to which the dues of the department could not be recovered. To suggest that the petitioner did not oppose the GSFC's auction sale is begging the question. GSFC had sold the property after several attempts through auction. It is not the case of the department that proper price was not fetched.”