High Court Of Gujarat
Gul Gopaldas Daryani Vs. ITO
Section : 179
Assessment Year : 2010-11
Akil Kureshi And Ms. Sonia Gokani, JJ.
Special Civil Application Nos. 2257 To 2259 Of 2014
April 29, 2014
Akil Kureshi, J. – 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 2010-2011, the said company filed its return declaring total income of Rs.4.88 lakh (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 crore (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 crore (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 inter alia 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 2009-2010. There is no tax demand outstanding against the company as per the return filed. However, demand arose on account of the assessment order. The income-tax 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 down in 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/s 179 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 income-tax, interest, penalty etc. pertaining to AY 2010-11 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. CIT  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.
10. Section 179 of the Act pertains to the liability of the directors of private company in liquidation. Sub-section(1) thereof which is relevant for our purpose reads as under :
“(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 non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.”
11. In terms of sub-section (1) of section 179, thus when any tax dues from a private company cannot be recovered, then every person who was a director of the private company during the previous year when the tax dues arose, would be jointly and severally liable for payment of tax, unless he proves that non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.
12. Under sub-section (1) of section 179, thus what can be recovered from a director of a private company is the tax dues of the company which cannot be recovered from the company in which he is the director. In that view of the matter, we see no mandate under sub-section (1) of section 179 that the income tax department must await the outcome of appeal or further appeals by the assessee against any order of assessment which gives rise to such tax dues of the company. If the stay pending such appeal is refused, the tax becomes recoverable from the company, of course, subject to outcome of the pending appeal. If such tax is not paid by the company, it becomes its tax due. Under section 156 of the Act, when any tax, interest, penalty, fine or other sum is payable in consequence of any order passed under this Act, Assessing Officer would serve a notice of demand on the assessee. As per section 220(1), the assessee would have to pay the amount specified in the demand notice issued under section 156 within 30 days unless this period is curtailed under the proviso. Under section 220(3), the Assessing Officer has the power to extend the period. As per section 220(4), if the amount is not deposited within time allowed under sub-section(1) or extended under sub-section(3), the assessee shall be deemed to be in default. The decision of Kerala High Court in case of Khaders International Construction Ltd. (supra) was rendered in peculiar facts of the case where the original tax demand by the Assessing Officer was Rs.21.61 lakh (rounded off). The directors of the company challenged the order of assessment before various authorities and the tax demand was reduced to Rs. 2 lakh. It was in this background the learned Judge observed that it cannot be stated that non-recovery of tax was due to negligence of the directors. The first contention of the counsel for the petitioners therefore, cannot be accepted.
13. The second contention pertains to the very validity of exercise of powers under section 179(1) of the Act by the Tax Recovery Officer. In context of such contention, we have to ascertain whether the respondent was correct in coming to the conclusion that non-recovery of the tax from the company could be attributed to any gross negligence, misfeasance or breach of duty on part of the directors. Taking note of the provisions of section 179 of the Act, in case of Maganbhai Hansrajbhai Patel v. Asstt. CIT  353 ITR 567/ 211 Taxman 386/26 taxmann.com 226 (Guj.), Division Bench of this Court 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 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 of course 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 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 put forth 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.”
14. It can thus be seen that once it is established that the taxes of a private company cannot be recovered from the said company, the directors of the company at the relevant time would be jointly and severally liable for payment of such taxes, unless, it is proved that non-recovery cannot be attributed to any gross negligence, misfeasance or breach of duty on their part in relation to the affairs of the company. The burden cast by statute is thus in the negative and is on the director concerned as is observed in case of Maganbhai Hansrajbhai Patel (supra). However, once in defence, the director places necessary facts before the Tax Recovery Officer to establish that non-recovery cannot be attributed to gross negligence, misfeasance or breach of duty on his part, the Tax Recovery Officer is required to apply his mind and come to definite findings. In the present case, the directors pointed out to the Tax Recovery Officer that the entire project ran into heavy losses due to devastating earthquake. Before the hotel could be inaugurated, the building was destroyed. The project therefore, never took off. This resulted into heavy losses to the company. The financial institutions restructured the debts and permitted sale of its property. Out of the sale proceeds, the creditors were paid off proportionately. When such payments were made, assessment order was still not passed. The insurance claim is not passed by the insurance company and civil disputes are still pending. In such facts and circumstances, the Tax Recovery Officer committed a serious error in applying section 179 of the Act against the directors.
15. We may recall that in order to come to conclusion that non-recovery was due to gross negligence, misfeasance or breach of duty on part of the directors, he relied on the following factors :
(1)While making the sale, no provisions were made for payment of income tax arising out of the sale of land. The company should have been aware of the tax liabilities. The director should have known that the company could not carry forward losses which were not eligible in law and to adjust the same against subsequent gains arising out of sale of land.
(2)The building may have been destroyed due to natural calamity, the directors ought to have taken proper measures to protect the interest of the company by insuring the property against earthquake etc.
(3) By not making any provisions for government dues, the directors acted deliberately in gross negligence and in breach of duty.
16. In our opinion, all the three grounds are not sustainable. Firstly, the dues were paid to the creditors at the time when assessment order was yet to be passed. The assessee made a bona fide claim of set off. It may be that according to the Assessing Officer such claim was not maintainable. The issue however, has not yet achieved finality and is pending before the appellate authority. There is nothing on record to suggest that the company raised such a claim wholly mala fide. Under the circumstances, the ground that while paying all other creditors, the company made no provision for income tax liability, was not a valid ground. On the date when the creditors were paid off, there was no outstanding liability towards the income tax department.
17. The second ground that the directors should have taken appropriate measures to protect the property of the company is neither maintainable in law nor in fact. The company had insured its property. However, the insurance claim ran into disputes. It was therefore, not a case where the directors failed to take measures for protecting the property or interest of the company as suggested by the Tax Recovery Officer. Even otherwise, whether to insure a property against any loss and if done against which risks, would be a purely commercial decision of a company. Depending on the threat perception in the area and insurance premium, the company would be taking appropriate decision. Such decision may turn out to be wise or in some case unwise. That by itself would not mean that the directors were negligent in performing their duties or they committed breach of duty in affairs of the company.
18. The last ground being deliberately false claim raised by the company is not borne out from any material on record. In a given case, if the company raises a completely bogus and mala fide claim of tax deduction, with the sole purpose of defrauding the Revenue, it may still be open for the Revenue to argue that provisions of section 179 of the Act would be applicable. Before the same however, can be done, there has to be material on record and which material must be disclosed to the director who is likely to face the adversity of the order. In the present case, in the show-cause notice, no such averments or suggestions were made. Nor in the impugned order any material from the record is referred to which would enable the Tax Recovery Officer to draw such conclusions
19. In the result, impugned order on 5.12.2013 is quashed. All the petitions are allowed and disposed of.
20. Before, closing in facts of the case, it is provided that if at any stage the company receives any amount from the insurance company for the destruction of hotel building, the petitioners shall intimate this to the income tax department in writing within four weeks from the date of receipt of such amounts and in any case before utilising such amount for any purpose.
[Citation : 367 ITR 558]