JASHVANTLAL NATVERLAL KANSARA vs. INCOME TAX OFFICER CO.WARD 4 (2)

C/SCA/6557/2004 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD SPECIAL CIVIL APPLICATION NO. 6557 of 2004

FOR APPROVAL AND SIGNATURE:

HONOURABLE MR.JUSTICE AKIL KURESHI

and HONOURABLE MS JUSTICE SONIA GOKANI

================================================================ 1 Whether Reporters of Local Papers may be allowed to see the judgment ? 2 To be referred to the Reporter or not ? 3 Whether their Lordships wish to see the fair copy of the judgment ? 4 Whether this case involves a substantial question of law as to the interpretation of the Constitution of India, 1950 or any order made thereunder ? 5 Whether it is to be circulated to the civil judge ? ================================================================ JASHVANTLAL NATVERLAL KANSARA & 2....Petitioner(s) Versus INCOME TAX OFFICER CO.WARD 4 (2) & 1....Respondent(s) ================================================================ Appearance: MR JP SHAH, ADVOCATE for the Petitioner(s) No. 1 - 3 MR MANISH J SHAH, ADVOCATE for the Petitioner(s) No. 1 - 3 MR TANVISH U BHATT, ADVOCATE for the Respondent(s) No. 1 - 2 MRS MAUNA M BHATT, ADVOCATE for the Respondent(s) No. 1 - 2 RULE SERVED for the Respondent(s) No. 1 - 2 ================================================================ Page 1 of 15

C/SCA/6557/2004 JUDGMENT CORAM: HONOURABLE MR.JUSTICE AKIL KURESHI and HONOURABLE MS JUSTICE SONIA GOKANI

Date : 19/02/2014

ORAL JUDGMENT (PER : HONOURABLE MR.JUSTICE AKIL KURESHI) 1. The petitioners have challenged the order dated July 01, 2003 passed by the Income­tax Officer under section 179(1) of the Income­tax Act, 1961 (hereinafter   referred   to   as   ‘the   Tribunal’)   as confirmed   by   an   order   dated   February   16,   2004 passed   by   the   Commissioner   of   Income­tax   in Revision Petition filed by the petitioners. 2. The facts are as under  : 2.1 The   petitioners   were   the   Directors   of   one M/s.K.N.   Minerals   Pvt.   Ltd.   (hereinafter referred   to   as   ‘the   Company’).   For   the assessment year 1998­1999, the return filed by the   petitioners   was   taken   in   scrutiny   and certain additions were made by the Assessing Officer.   The   assessment   order   though   was carried in appeal, the Commissioner of Income­ Page 2 of 15

C/SCA/6557/2004 JUDGMENT tax (Appeals) confirmed the order. No further appeal was carried by the Company. Arising out of such assessment proceedings, the Income­tax Department   had   to   recover   a   sum   of Rs.7,53,649/­   with   interest.   Despite   several efforts for recovery, such amount could not be recovered   from   the   Company.   The   Income­tax Officer, therefore, issued show cause notice to the Directors on June 24, 2002, calling upon the petitioners why in terms of section 179(1) of the Act recoveries should not be made from them. 2.2 In response to such notice, the petitioners replied under a communication dated July 11, 2002   and   raised   several   objections.   It   was pointed   out   that   the   Company   had   suffered losses.   The   Company   had   obtained   overdraft facility and also taken loans from the State Bank of India. The properties and the assets of the Company were mortgaged to the Bank. Since the Company was unable to pay outstanding dues to the Bank, the Bank had instituted recovery Page 3 of 15

C/SCA/6557/2004 JUDGMENT proceedings before the Debts Recovery Tribunal. The Debts Recovery Tribunal in its order dated February 26, 1997 recorded that the petitioners were to pay Rs.26 lakh by way of full and final settlement towards the dues of the Bank. The land and building of the Company was valued at Rs.18 lakh. The remaining amount was brought by the   directors   of   the   Company   from   their personal resources. The Company had also filed an   application   before   the   Registrar   of Companies to strike off the name of the Company since the Company had no assets and was not carrying on any business. In order to ensure the strike off of the name of the Company, the Company   had   to   give   a   guarantee   from   the creditors i.e. directors themselves, that they have no objection to forgo the amount due to them by the Company. The directors, thus, had forgone   an   amount   of   Rs.17,85,729/­   in   the process.   The   petitioners   also   contended   that the recovery can be made under section 179(1) of   the   Act   only   if   the   petitioners   fail   to prove that non­recovery cannot be attributed to Page 4 of 15

C/SCA/6557/2004 JUDGMENT any   gross   neglect,   misfeasance   or   breach   of duty on their part in relation to the affairs of the Company. The petitioners contended that in view of the facts narrated above, there was no gross neglect, misfeasance or breach of duty on their part in relation to the affairs of the Company.   It   was   also   pointed   out   that   the Company   had   suffered   total   loss   of   Rs.20.85 lakh and the Company had obtained loans from three   directors   to   the   tune   of   more   than Rs.17.85 lakh. 2.3 Second reply was filed by the petitioners on October 21, 2002 before the Income­tax Officer in which similar contentions were taken. 2.4 The   Income­tax   Officer,   however,   was   not convinced by such explanation and he passed the order   dated   July   01,   2003,   holding   that   the provisions of section 179(1) of the Act would be applicable in the present case. He held that being   the   directors   of   the   Company,   it   was their duty to pay tax due from the Company. Page 5 of 15

C/SCA/6557/2004 JUDGMENT They   failed   to   discharge   such   duty,   hence, provisions   of   section   179(1)   of   the   Act  are attracted. He, therefore, directed recovery of the outstanding dues of the Company from the petitioners along with interest and penalty. 2.5 The petitioners challenge such order before the   Commissioner   of   Income­tax   (Appeals)   by filing a revision petition under section 264 of the Act. In such application, the petitioners reiterated their stand that there was no gross neglect, misfeasance or breach of duty on their part   in   the   affairs   of   the   Company   and, therefore, the order under section 179 of the Act was bad in law. 2.6 The   Commissioner,   however,   dismissed   such revision petition by his order dated February 16, 2004. Hence, this petition. 3. Having heard the learned counsel for the parties and having perused the documents on record, we find that the basic facts are not in dispute. To Page 6 of 15

C/SCA/6557/2004 JUDGMENT recapitulate such facts, the petitioners were the directors of a private company. The Company had tax dues towards the Department. Despite efforts by   the   Department,   such   dues   could   not   be recovered.   The   Income­tax   Officer,   therefore, proceeded against the petitioners under section 179(1)   of   the   Act.   Section   179(1)   of   the   Act provides as under : “Liability of directors of private company in liquidation : 179.(1) Notwithstanding   anything   contained in   the   Companies   Act,   1956   (1   of   1956), where any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income   of   any   previous   year   during   which such   other   company   was   a   private   company cannot be recovered, then, every person who was a director of the private company at any time during the relevant previous year shall be   jointly   and   severally   liable   for   the payment of such tax unless he proves that the non­recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.” Page 7 of 15

C/SCA/6557/2004 JUDGMENT 4. Sub­section   (1)   of   section   179,   thus,   empowers the Department to recover unpaid tax dues of a private company from its directors under certain circumstances when such dues cannot be recovered from the Company. Such recovery, however, can be avoided   if   the   director   concerned   proves   that non­recovery   cannot   be   attributed   to   any   gross neglect,   misfeasance   or   breach   of   duty   on   his part in relation to the affairs of the Company. In the case of  Maganbhai   Hansrajbhai   Patel   v. Assistant   Commissioner   of   Income­tax   and another,  reported in 353 ITR 567, the Division Bench   of   this   Court   in   the   context   of   such provision observed as under : “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 Page 8 of 15

C/SCA/6557/2004 JUDGMENT 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 Page 9 of 15

C/SCA/6557/2004 JUDGMENT 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 Page 10 of 15

C/SCA/6557/2004 JUDGMENT 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.” 3. Reverting to the facts of the case, the Company had run into losses. The Company had substantial dues towards the State Bank of India from which it   had   taken   loans   and   also   enjoyed   overdraft facility. Certain properties of the Company were also mortgaged to the Bank. To realise its dues, the   Bank   filed   a   petition   before   the   Debts Recovery   Tribunal.   Before   the   Debts   Recovery Tribunal, the parties agreed to settle the total dues of the Bank for Rs.26 lakh. The properties of   the   Company   were   valued   at   Rs.18   lakh.   The balance   was   supplied   by   the   directors   of   the Company

from

their

personal

resources. Additionally, in order to strike off the name of Page 11 of 15

C/SCA/6557/2004 JUDGMENT the Company from the Registrar of Companies, the directors   agreed   to   forgo   their   loans   to   the Company which were in excess of Rs.16 lakh. When such facts were established, in our opinion, the Assessing   Officer   ought   to   have   held   that   the petitioners   had   succeeded   in   establishing   that non­recovery of the tax dues of the Company could not be attributed to gross neglect, misfeasance or breach of duty on the part of the directors in relation to the affairs of the Company.  In the impugned order in this respect, it had observed as under : “5.1 ..   ..   ..   As   a   director   of   the company it was duty bound on the part of the directors of the company to pay tax due from the   company   and     the   directors   failed   to discharge   that   duty,   hence   provisions   of Section   179(1)   are   clearly   attracted. Reliance is placed on the decision of Union of India vs Praveen D. Desai (1988) 173 ITR 303. 5.2 On verification of the relevant details it is found that there is gross negligence on the part of the directors in the day to Page 12 of 15

C/SCA/6557/2004 JUDGMENT day affairs of the company. In the auditor's report special remark is put which read as under :

“.. .. .. The company has sold all its assets in settlement of bank outstanding and earned

capital

gain

of Rs.16,52,293/­ .. .. ..”

From the above remarks and also on the   basis   of   the   facts   of   the   case   the directors   of   the   assessee   company   were   in knowledge   of   incidence   of   income   tax. Furthermore, the affairs of the company are audited by leading Chartered Accoutant firm M/s.C. Patel and Co.. Hence the directors of the   company   are   fully   aware   of   their liability to pay tax on behalf of assessee company. Hence, the director's contention as non   negligence   on   their   part   is   not sustainable and accordingly rejected.” 4. It may be that the assets of the Company may not have   been   mortgaged   to   the   Bank.   Nevertheless, the Debts Recovery Tribunal in its order dated November 11, 1997 provided as under : “27. ..   ..   ..   The   plaintiff   bank   is entitled to recover the suit dues by sale of Page 13 of 15

C/SCA/6557/2004 JUDGMENT said   hypothecated   machineries   and   movables including the goods etc. That the  defendant No.1 had agreed to create equitable mortgage on   the   fixed   assets   including   land   of factory   premises   towards   the   security   for repayment   of   suit   financial   facilities. Hence   the   plaintiff   bank   shall   also   be entitled to realise the suit dues by sale of said immovable property.” 5. We   have   perused   the   said   order   of   the   Debts Recovery Tribunal. It does not appear that the petitioners had consented that the Bank dues may also be recovered from such fixed assets. It was the Debts Recovery Tribunal which had given such liberty to the Bank. That being the position, the contention of the counsel for the Revenue that the   petitioners   should   have   offered   the   said properties   for   recovery   to   the   Department,   can still   not   bring   the   action   of   the   petitioners within   the   said   expression   of   gross   neglect, misfeasance or breach of duty on their part. 6. In the result, the impugned orders dated July 01, 2003 and February 16, 2004 passed by the Income­ Page 14 of 15

C/SCA/6557/2004 JUDGMENT tax   Officer   and   Commissioner   of   Income­tax respectively   are   quashed.   The   petition   stands disposed of. Rule is made absolute accordingly. There shall be, however, no order as to costs. (AKIL KURESHI, J.) (MS SONIA GOKANI, J.) Aakar Page 15 of 15