Janata Sahakari Bank Ltd., Vs Tax Recovery Officer VII, Income Tax Department - Thus, the mortgages, transactions or transfers are made during the pendency of the Income Tax proceedings, then all such transfers, mortgages, transactions are void under Section 281 of the Income Tax Act and any such mortgage or attachment made by the Bank during the pendency of the Income tax proceedings, cannot be a ground to claim priority based on the provisions of the SARFAESI Act or DRT Act.

HC Madras (19.07.2021) in Janata Sahakari Bank Ltd., Vs Tax Recovery Officer VII, Income Tax Department (W.P.No.15437 of 2014 and M.P.No.1 of 2014) held that;

• Thus, it is unambiguous that the transactions or transfers made during the pendency of the Income tax proceedings are void.

• Therefore, even before invoking the provisions of the SARFAESI Act and DRT Act, Section 281 of the Income Tax Act intervenes and declares the transactions or transfers as void, if any such transactions or transfers are made during the pendency of the Income Tax proceedings. In such circumstances, invoking the provisions of the SARFAESI Act or DRT Act for the purpose of claiming priority would not arise at all.

• In such cases, the Income tax proceedings are known only to the tax defaulter and not to the third party purchaser or the mortgagee Bank or otherwise.

• Thus, the void transfers or transactions made during the pendency of the Income tax proceedings cannot be the subject matter for any mortgage or further transfers or transactions etc., This being the possible perceptions, the Courts are bound to consider, which transaction will prevail over and which Act would be applicable with reference to the facts and circumstances.

• There is a consensus of judicial opinion on the question that the arrears of tax due to the State can claim priority over private debts. This position has not been seriously disputed.

• The doctrine may not apply in respect of debts due to the State if they are contracted by citizens in relation to commercial activities which may be undertaken by the State for achieving socio-economic good.

• Thus, the mortgages, transactions or transfers are made during the pendency of the Income Tax proceedings, then all such transfers, mortgages, transactions are void under Section 281 of the Income Tax Act and any such mortgage or attachment made by the Bank during the pendency of the Income tax proceedings, cannot be a ground to claim priority based on the provisions of the SARFAESI Act or DRT Act.

Blogger's Comments; If the above principle is adopted the secured creditor can never claim priority under SARFAESI or DRT Act.  due to overlapping income tax proceedings of different financial years at any given point of the time. This issue needs to be seriously examined. 

Excerpts of the Order;

The writ on hand is filed questioning the validity of the proceedings dated 27.12.2007 passed by the respondent.

Contention of the Petitioner;

# 2.The impugned proceedings reveals that it was issued for recovery of income tax arrears in the case of M/s.NEPC Agro Foods Limited and its Directors Shri.Raj Kumar Khemka, Shri.Ravi Prakash Khemka and Shri.Thirupathy Kumar Khemka. The respondent had noticed from the advertisement published in the daily newspaper 'Dinamalar' on 20.12.2007 that the Bank has taken possession of the property at Plot No.83 at Ambattur Industrial Estate, Chennai-53 for the loan amount of Rs.28,89,35,552/- due from M/s.NEPC Agro Foods Ltd., and its Directors Shri.Raj Kumar Khemka, Shri.Ravi Prakash Khemka and Shri.Thirupathy Kumar Khemka.

# 3.The impugned order further proceeds that the above defaulters M/s.NEPC Agro Foods Ltd. and its Directors Shri.Raj Kumar Khemka, Shri.Ravi Prakash Khemka and Shri.Thirupathy Kumar Khemka are in tax arrears to the Income Tax Department as below:

• 1.M/s.NEPC Agro Foods Ltd. Rs.20,37,11,265

• 2.Shri.Raj Kumar Khemka Rs. 51,08,289

• 3.Shri.Ravi Prakash Khemka Rs. 2,11,52,008

• 4.Shri.Thirupathy Kumar Khemka Rs. 59,35,011

# 4. In this connection, the respondent informed that the property mentioned in the newspaper, i.e. Plot No.83, Ambattur Industrial Estate, Chennai-53 was already attached in Form ITCP 16 by the Income Tax Department on 18.06.2003 and the same was served to the defaulter assessee company on 18.06.2003. A copy of the Form ITCP 16 also enclosed along with the impugned order which was communicated to Shri.A.S.Bapalt, the Authorised Officer, Janatha Sahakari Bank Ltd., Pune [the petitioner herein].

# 5.The petitioner Janata Sahakari Bank Ltd., made a submission that the attachment was made against M/s.NEPC Agro Foods Ltd. and they are neither a proper nor necessary party since the petitioner Bank was under lawful possession of the subject property since from 19.12.2007 which was affirmed by the Debt Recovery Tribunal, Debt Recovery Appellate Tribunal and the Madras High Court.

# 8.Before the Cooperative Court, NEPC Agro foods Ltd and NEPC India Ltd, admitted their joint liability and entered into duly recorded consent award dated 15.2.2007, wherein they agreed to repay a sum of Rs. 15,51,00,000/- on or before 15.3.2007 as full and final settlement of dues. It was an expressed term of the consent award that failing repayment the

petitioner could proceed with its remedies under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act [SARFAESI Act], 2002. Both NEPC Agro foods Ltd and NEPC India Ltd defaulted on the terms of the consent award and no payments were made.

# 9.The said default by these two Companies forced the petitioner to proceed and take possession of the property on 19.12.2007 in continuation of the action already initiated under the SARFAESI Act, 2002. It is contended that since 2007 the Petitioner is in possession of the schedule mentioned property.

# 10.The SARFAESI action initiated by the Petitioner Bank was challenged before the DRT-I, Chennai but the original stay was vacated by the High Court. On remand, DRT dismissed S.A. No. 68 of 2008. An Appeal was made before the Debts Recovery Appellate Tribunal, which was also dismissed. At the time of filing of the writ petition, no proceedings were pending relating to the loan agreement entered into between the petitioner bank and the NEPC Agro Foods Ltd. It is contended that the petitioner bank initiated winding up proceedings before the Madras High Court against M/s.NEPC Agro Foods Ltd. in C.P.No.247 of 2008. Meanwhile, the petitioner bank received the notice dated 27.12.2007 consequent to the advertisement dated 20.12.2007 in the Dinamalar newspaper from the respondent informing the petitioner of an Income Tax attachment by the respondent on the same schedule property vide Form ITCP6 dated 18.06.2003.

# 11.The petitioner states that the encumbrance certificate issued by the Inspector General of Registration reflects the charge created by the respondent vide Form ITCP 16 bearing reference No.T.R.No.130/CEN.I(1)/2003-04 dated 18.06.2003. The attachment was registered and started reflecting on the encumbrance certificate from 31.12.2007 as other charge after possession of the property was undertaken under SARFAESI Act by the petitioner. The petitioner bank's charge has been registered as a mortgage since 16.10.2002.

 

# 12.Based on the above facts as narrated, the learned senior counsel appearing on behalf of the petitioner has stated that, even before attachment by the Income Tax Department, the mortgage was in existence from 16.10.2002 onwards. However, it is clarified that the mortgage was registered between the petitioner and M/s.NEPC Agro Foods Ltd. on 11.12.1998 and the said mortgage was reflected in the encumbrance certificate also. Thus the petitioner bank holds priority over the charge and therefore the impugned order passed by the respondent is null and void.

# 13.The learned senior counsel for the petitioner strenuously contended that the actions of the Income Tax Department is absolutely untenable and not in consonance with the terms of priority as contemplated under the SARFAESI Act and Debt Recovery Tribunal Act. The learned senior counsel made a submission that M/s.NEPC Agro Foods Limited is an independent entity and absolutely unconnected with M/s.NEPC India Limited, who was the income tax defaulter as per the respondent. Thus the mortgage between the petitioner and the M/s.NEPC Agro Foods Limited is no way responsible for the income tax arrears due to the Department. The subject property mortgaged belongs to the M/s.NEPC Agro Foods Limited which is a separate entity and a company registered and therefore, the very initiation of proceedings under the Income Tax Act is untenable. The learned senior counsel in support of the said contention cited the judgments wherein the priority of the mortgage was upheld. The learned senior counsel cited the judgment of the Hon'ble Full Bench of this Court dated 10.11.2016 in W.P.No.2675 of 2011 [Assistant Commissioner (CT), Anna Salai-III Assessment Circle vs. The Indian Overseas Bank], wherein the Hon'ble Full Bench made an observation as under: 

• “2.We are of the view that if there was at all any doubt, the same stands resolved by view of the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016, Section 41 of the same seeking to introduce Section 31B in the Principal Act, Which reads as under:- “31B. Notwithstanding anything contained in any other law for the time being in force, the rights of secured creditors to realise secured debts due and payable to them by sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority. Explanation:-for the purposes of this Section, it is hereby clarified that on or after the commencement of the insolvency and bankruptcy Code, 2016, in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that code.”

• 3.There is, thus, no doubt that the rights of a secured creditor to realise secured debts due and payable by sale of assets over which security interest is created, would have priority over all debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or Local Authority. This Section introduced in the Central Act is with “notwithstanding” clause and has come into force from 01.09.2016.

• 4.The law having now come into force, naturally it would govern the rights of the parties in respect of even a lis pending.

• 5.The aforesaid would, thus, answer question (a) in favour of the financial institution, which is a secured creditor having the benefit of the mortgaged property. 

• 6.In so far as question (b) is concerned, the same is stated to relate only to auction sales, which may be carried out in pursuance to the rights exercised by the secured creditor having a mortgage of the property. This  aspect is also covered by the introduction of Section 31B, as it includes “secured debts due and payable to them by sale of assets over which security interest is created.

• 7.we, thus, answer the aforesaid reference accordingly.”

# 19. Under these circumstances, this Court is bound to examine the scope of Section 281 of the Income Tax Act as well as the priority conferred in favour of the Bank under the provisions of the SARFAESI Act and Debt Recovery Tribunal Act. The principles settled in the case of Corporation Bank vs. The Commissioner, Income Tax Department and others in W.P.No.27409 of 2019 dated 21.04.2012 is not in dispute and this Court is bound to consider the facts circumstances independently and the scope of the relevant provisions with reference to the provisions of the Income Tax Act.

“ANALYSIS:

# 30. Let us now consider the scope of Section 281 of the Income Tax Act. Chapter XXIII Section 281 of the Income Tax Act contemplates certain transfers to be void. Sub-clause (1) enumerates that “where, during the pendency of any proceeding under this Act or after the completion thereof, but before the service of notice under rule 2 of the Second Schedule, any assessee creates a charge on, or parts with the possession (by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever) of, any of his assets in favour of any other person, such charge or transfer shall be void as against any claim in respect of any tax or any other sum payable by the assessee as a result of the completion of the said proceeding or otherwise”. A close reading of the above provision would reveal that where during the pendency of any proceedings under this Act or after the completion thereof, but before service of notice under rule 2 of the Second Schedule, if any charge is created by an assessee in favour of any other person shall be void as against any claim in respect of any tax or any other some payable by the assessee. Therefore, it is unambiguous that, during pendency of the proceedings if any charge is created, then such charge created by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever shall be void.

# 31. Schedule II Rule 11 of the Income Tax Act which contemplates investigation by Tax Recovery Officer. Sub-Clause (1) to Rule 11 states that “where any claim is preferred to, or any objection is made to the attachment or sale of, any property in execution of a certificate, on the ground that such property is not liable to such attachment or sale, the Tax Recovery Officer shall proceed to investigate the claim or objection”.

# 32. Sub-clauses (5) and (6) to Rule 11 of the Income Tax Act reads as under: (5) Where the Tax Recovery Officer is satisfied that the property was, at the said date, in the possession of the defaulter as his own property and not on account of any other person, or was in the possession of some other person in trust for him, or in the occupancy of a tenant or other person paying rent to him, the Tax Recovery Officer shall disallow the claim. (6) Where a claim or an objection is preferred, the party against whom an order is made may institute a suit in a civil court to establish the right which he claims to the property in dispute; but, subject, to the result of such suit (if any), the order of the Tax Recovery Officer shall be conclusive.

# 33. A perusal of the entire Rule would reveal that it is not an appeal or Revision. It is an investigation by the Tax Recovery Officer, which is contemplated. Therefore, any third person if involved in such transfer of property, which is declared as void under Section 281 of the Income Tax Act may submit an application for investigation by Tax Recovery Officer. Therefore, the statute does not assume that every third person is liable under the Income Tax Act. Schedule II Rule 11 of the Income Tax Act is a beneficial provision in respect of the person, who was otherwise cheated by any of the defaulter of tax arrears, who in turn can submit an application for further investigation in order to cull out the truth or genuinity with reference to the transactions or transfers. Therefore, the Tax Recovery Officer during the pendency found that the charge created in favour of the petitioner Bank is valid, then he can pass appropriate orders withdrawing the attachment made under the provisions of the Act. If the Tax Recovery Officer is of an opinion that the attachment made under the provisions of the Act was prior to the mortgage or otherwise, then he can pass appropriate orders confirming the attachment. However, the said Rule is not relatable to declaration or in the form of an appeal by any third person. It is only an enabling provision for effective adjudication of the actual facts and to find out the genuinity of certain transfers made during the pendency of the Income tax proceedings and with reference to the provision under Section 281 of the Income Tax Act.

# 34. Looking into the provisions of the SARFAESI Act, more specifically, Section 26E, which contemplates priority to secured creditors which reads that “notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any Secured Creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government of State Government or local authority”.

# 35. Let us now consider Section 31B of the Recovery of Debts and Bankruptcy Act, 1993 and the said section Section 31B was inserted by Act 44 of 2016 with effect from 01.09.2016. The said provision also deals with priority to secured creditors, which reads that “notwithstanding anything contained in any other law for the time being in force, the rights of secured creditors to realise secured debts due and payable to them by sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government  dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority”.

# 36. It is necessary to consider the conflicting provisions of the Income Tax Act, SARFAESI Act and Recovery of Debts and Bankruptcy Act, 1993.

# 37. On the one hand, the Income Tax Act states that, where during the pendency of any proceedings under the Income Tax Act or after completion thereof, any assessee creates a charge on or parts with the possession by way of mortgage, sale, etc. Shall be void against any claim in respect of any tax. So also, the SARFAESI Act states that Section 26E contemplates that the secured creditors shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government of State Government or local authority. Therefore, equal weightage is given in respect of the secured creditors. So also Section 31B of Recovery of Debts and Bankruptcy Act, 1993 states that sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority.

# 38. Thus, conflicting provisions in these three independent statutes are creating heart burning issues between the secured creditors as well as the Tax Department. Some of the decisions are in favour of the Tax Department and some of the decisions are in favour of the Banks. With reference to Section 26E of the SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, 1993, judgments are given in favour of the Banks in view of the fact that the said provisions contemplates priority over the Government dues is to be given to the Banks. The tenor of Section 281 of the Income Tax Act which contemplates that any such transaction made during the pendency of any proceedings under the Income Tax Act shall be void. Thus, the understanding would be that if the proceedings under the Income Tax Act are pending at the time of creating mortgage, sale, gift, etc., then Section 281 of the Income Tax Act would be pressed into operation. The next question is at the time of creation of mortgage, sale, gift etc., the Income Tax Proceedings are pending as contemplated under Section 281 of the Income Tax Act, such transactions became void. Thus, it is unambiguous that the transactions or transfers made during the pendency of the Income tax proceedings are void. This being the purposive interpretation to be adopted, all transfers, mortgages etc., made during the pendency of the Income tax proceedings shall became void under Section 281 of the Income Tax Act. Once Section 281 of the Income Tax Act was pressed into service and the transactions or transfers became void, any mortgage, transfer etc., thereafter would be of no validity. In other words, the transfer or transactions made against the void transactions under the Income Tax Act are invalid in the eye of law. Therefore, even before invoking the provisions of the SARFAESI Act and DRT Act, Section 281 of the Income Tax Act intervenes and declares the transactions or transfers as void, if any such transactions or transfers are made during the pendency of the Income Tax proceedings. In such circumstances, invoking the provisions of the SARFAESI Act or DRT Act for the purpose of claiming priority would not arise at all. Law expects that the parties to be prudent and careful. Before mortgage, transfer or transactions, an enquiry is required by the respective parties as the buyer must beware (caveat emptor) of the encumbrances or the statutory implications or the genuinity of the title etc., Thus, the principles of caveat emptor would be applicable in such circumstances, where a transactions or transfers are made during the pendency of the Income tax proceedings. In such cases, the Income tax proceedings are known only to the tax defaulter and not to the third party purchaser or the mortgagee Bank or otherwise. Thus, the void transfers or transactions made during the pendency of the Income tax proceedings cannot be the subject matter for any mortgage or further transfers or transactions etc., This being the possible perceptions, the Courts are bound to consider, which transaction will prevail over and which Act would be applicable with reference to the facts and circumstances.

# 39. More elaborately the facts at the first instance to be considered and then the application of law which is to be applied at the first instance also to be considered. For instance in the case where the income tax proceedings are pending under the Income Tax Act and if a mortgage is entered into by the tax defaulter with any Bank, then it is the duty of the Bank to ensure that no other proceedings are pending and it is the duty of the person who is borrowing loan to inform the same to the Bankers. Under these circumstances, the Income Tax Department is alien to the transaction of mortgage between the bank and the tax defaulter and therefore, the Act will automatically come to the rescue of the Income Tax Department declaring such transfers as void under Section 281 of the Income Tax Act.

# 40. Where the Bank entered into a mortgage well before the pendency of proceedings under the Income Tax Act, then Section 26E of the SARFAESI Act would be applicable and in such circumstances, the Bank will hold priority over all other claim including the Government dues. Even in such circumstances, this Court has to consider the other principles which all are to be followed in such cases. Admittedly, the SARFAESI Act and Recovery of Debts and Bunkruptcy Act, 1993 provides priority to the secured creditors and the Income Tax Act provides priority to the tax arrears to be recovered. Under these circumstances, this Court is inclined to consider the common law Doctrine of priority of crown debts.

# 41. The “doctrine of constitutional priority” will have precedence over the other priorities. If the priority clause is provided under various enactments, the question arises as to which priority is to be held precedence over the other priorities. The test of traceability and recognition under the constitutional provisions would be the proper procedure to form an opinion.

# 42. In the present scenario, the SARFAESI Act and the DRT Act provides priority to secured creditors, i.e. the banks hold priority. The Income Tax Act contemplates any such mortgage or sale during the pendency of any proceedings under the Income Tax Act shall be void. Thus, this Court has to test the supremacy on the basis of the constitutional recognition, which is supreme than the statutes enacted under the constitution. The taxation laws are constitutionally recognised with reference to the sovereignty and the policies of the Government. Thus the supremacy of the Constitution overtakes the statutes enacted and such enactments constitutionally recognised directly takes precedence over the other statutes.

# 43. The principles of ‘doctrine of constitutional priority’ is to be defined as, in the event of the similar provisions of priority under various enactments, then the statute which is recognised directly by the Constitution for the purpose of upholding the sovereignty and integrity of the Nation is to be considered as holding precedence over the other statutes providing priority.

# 44. The Constitutional Bench of the Hon’ble Supreme Court of India in the case of Builders Supply Corporation vs. Union of India [1965 AIR 1061] considered the principles laid down in the case of Kaka Mohamed Ghouse Sahib and Co. vs. United Commercial Syndicate and others [(1886) ILR 7 Mad. 434], wherein the Madras High Court has held that it is a settled principle of constitutional law that as between creditors of the same rank the Government is entitled to priority and the republican character of the Constitution of India has not abrogated this general doctrine of priority of State debts. In dealing with this question, Justice Ramamurti has referred to the relevant decisions in relation to the arrears of income tax due to the Government and has pointed out there is a consensus of judicial opinion on the question that the arrears of tax due to the State can claim priority over private debts. This position has not been seriously disputed.

# 45.Similarly, the basic justification for the claim of priority made by the Income Tax Department in the present case rests on the well recognised principle that the State is entitled to raise money by taxation, because unless adequate revenue is received by the State, it would not be able to function as sovereign Government at all. It is essential that as a sovereign the State should be able to discharge its primary governmental functions and in order to able to discharge such functions efficiently, it must be in possession of necessary funds and this consideration emphasizes the necessity and the wisdom of conceding to the State, the right to claim priority in respect of its tax dues.

# 46. In this context, Part XII of the Constitution of India, more specifically, Article 265 which states that tax not to be imposed save by authority of law; Article 266 speaks about Consolidated funds and public accounts of India and the States; Article 267 states Contingency fund; Article 268 states Duties levied by the Union but collected and appropriated by the States; Article 268A denotes service tax levied by Union and collected and appropriated by the Union and the States; Article 269 states taxes levied and collected by the Union but assigned to the States; Article 269A denotes levy and collection of goods and service tax in course of inter-state trade or commerce and Article 270 states that taxes levied and distributed between the Union and the States. The chapter deals with the taxes and its constitutional importance are to be considered by this Court. Undoubtedly, tax is the backbone of our Nation’s economy and it holds top priority. In this context, the tax collected goes to the welfare of the people in general, however the mortgage or sale transaction between the bank and the tax defaulter can be at no circumstances be compared with the constitutional importance of tax being collected from the people for the purpose of achieving the constitutional goals and perspectives. Therefore, the provisions of various Acts if there are conflicting provisions or grant of priority to various institutions, then the Constitution of India will be the guiding factor to form an opinion and confer priority. The nature of transaction, the implications, Constitutional importance and the other principles enunciated under the Constitution of India are the principal factors to be considered to form an opinion that, which claim shall be given priority over the other claims as various statutes enacted by the Parliament gives priority to such institutions irrespective of the fact that the other Acts are also providing similar priority to other institutions.

# 47. In support of the said observation, this Court would like to draw the attention with reference to the judgment of the Three Judges Bench of the Hon’ble Supreme Court of India in the case of Central Bank of India vs. State of Kerala and others [Civil Appeal No.95 of 2005 dated 27.02.2009], wherein the Apex Court considered the provisions of the DRT Act and SARFAESI Act and the following observations are made:

“33. The non obstante clauses contained in Section 34(1) of the DRT Act and Section 35 of the Securitisation Act give overriding effect to the provisions of those Acts only if there is anything inconsistent contained in any other law or instrument having effect by virtue of any other law. In other words, if there is no provision in the other enactments which are inconsistent with the DRT Act or Securitisation Act, the provisions contained in those Acts cannot override other legislations. Section 38C of the Bombay Act and Section 26B of the Kerala Act also contain non obstante clauses and give statutory recognition to the priority of State’s charge over other debts, which was recognized by Indian High Courts even before 1950. In other words, these sections and similar provisions contained in other State legislations not only create first charge on the property of the dealer or any other person liable to pay sales tax, etc. but also give them overriding effect over other laws. In Builders Supply Corporation v. Union of India [(1965) 2 SCR 289], the Constitution Bench considered the question whether tax payable to the Union of India has priority over other debts. After making a reference to the judgments of the Bombay High Court in Bank of India v. John Bowman and Ors., [AIR 1955 Bom. 305], Madras High Court in Kaka Mohammad Ghouse Sahib & Co. v. United Commercial Syndicate and others [(1963) 49 I.T.R. 25] and Manickam Chettiar v. Income-tax Officer, Madura, [(1938) 6 ITR 180], the Court held;

(i) “The Common Law doctrine of the priority of Crown debts had a wide sweep but the question in the present appeal was the narrow one whether the Union of India was entitled to claim that the recovery of the amount of tax due to it from a citizen must take precedence and priority over unsecured debts due from the said citizen to his other private creditors. The weight of authority in India was strongly in support of the priority of tax dues. 

(ii) The Common Law doctrine on which the Union of India based its claim in the present proceedings had been applied and upheld in that part of India which was known as `British India’ prior to the Constitution. The rules of Common Law relating to substantive rights which had been adopted by this country and enforced by judicial decisions, amount to `law in force’ in the territory of India at the relevant time within the meaning of Art. 372(1). In that view of the matter, the contention of the appellant that after the Constitution was adopted the position of the Union of India in regard to its claim for priority in the present proceedings had been alerted could not be upheld.

(iii) The basic justification for the claim for priority of Government debts rests on the well-recognised principle that the State is entitled to raise money by taxation, otherwise it will not be able to function as a sovereign government at all. This consideration emphasizes the necessity and wisdom of conceding to the State the right to claim priority in respect of its tax dues.” 34. In State Bank of Bikaner and Jaipur v. National Iron and Steel Rolling Corporation and others [(1995) 2 SCC 19], the Court again recognized the priority of the State’s statutory first charge under Section 11-AAAA of the Rajasthan Sales Tax Act, 1954 vis-`-vis claim of the bank to recover its dues from the borrower. 35. In Dena Bank v. Bhikhabhai Prabhudas Parekh & Co. and others [(2000) 5 SCC 694], the Court reviewed case law on the subject and observed: “The principle of priority of government debts is founded on the rule of necessity and of public policy. The basic justification for the claim for priority of State debts rests on the well-recognised principle that the State is entitled to raise money by taxation because unless adequate revenue is received by the State, it would not be able to function as a sovereign Government at all. It is essential that as a sovereign, the State should be able to discharge its primary governmental functions and in order to be able to discharge such functions efficiently, it must be in possession of necessary funds and this consideration emphasizes the necessity and the wisdom of conceding to the State, the right to claim priority in respect of its tax dues (see Builders Supply Corpn.). In the same case the Constitution Bench has noticed a consensus of judicial opinion that the arrears of tax due to the State can claim priority over private debts and that this rule of common law amounts to law in force in the territory of British India at the relevant time within the meaning of Article 372(1) of the Constitution of India and therefore continues to be in force thereafter. On the very principle on which the rule is founded, the priority would be available only to such debts as are incurred by the subjects of the Crown by reference to the State’s sovereign power of compulsory exaction and would not extend to charges for commercial services or obligation incurred by the subjects to the State pursuant to commercial transactions. Having reviewed the available judicial pronouncements their Lordships have summed up the law as under:

1. There is a consensus of judicial opinion that the arrears of tax due to the State can claim priority over private debts.

2. The common law doctrine about priority of Crown debts which was recognised by Indian High Courts prior to 1950 constitutes “law in force” within the meaning of Article 372(1) and continues to be in force.

3. The basic justification for the claim for priority of State debts is the rule of necessity and the wisdom of conceding to the State the right to claim priority in respect of its tax dues.

4. The doctrine may not apply in respect of debts due to the State if they are contracted by citizens in relation to commercial activities which may be undertaken by the State for achieving socio-economic good. In other words, where the welfare State enters into commercial fields which cannot be regarded as an essential and integral part of the basic government functions of the State and seeks to recover debts from its debtors arising out of such commercial activities the applicability of the doctrine of priority shall be open for consideration.”

# 48. One of the principles, which is impressive in the judgment cited supra, is that the basic justification for the claim for priority of Government dues rests on the well recognized principles that the State is entitled to raise money by taxation otherwise it will not be able to function as sovereign Government at all. This consideration emphasizes the necessity and wisdom of conceding to the State, the right to claim priority in respect of its tax dues. The importance of the above reading is to be considered regarding the present facts and circumstances.# 49. Let us consider the dispute raised in the present case. The Income Tax Department in their counter affidavit had stated that the assessee defaulter is in arrears to the tune of Rs.34,52,12,985/-. The demands were raised by the Income Tax Department prior to 31.03.1999, the date of mortgage to the petitioner bank. The Income Tax Department in other words claims that the proceedings under the Income Tax Act was pending even before the date of mortgage. The petitioner relying on the encumbrance certificate issued by the Registration Department of the State contends that the attachment is made after the mortgage by the petitioner bank. However, Section 281 of the Income Tax Act unambiguously states that during the pendency of any proceedings under the Income Tax Act. Thus, pendency of any proceedings is sufficient to treat any other transfer/mortgage as void.

# 50. Thus, the mortgages, transactions or transfers are made during the pendency of the Income Tax proceedings, then all such transfers, mortgages, transactions are void under Section 281 of the Income Tax Act and any such mortgage or attachment made by the Bank during the pendency of the Income tax proceedings, cannot be a ground to claim priority based on the provisions of the SARFAESI Act or DRT Act.

# 51. The disputed factors cannot be adjudicated by the High Court under Article 226 of the Constitution of India and it is for the petitioner to establish the details regarding the mortgage and the pendency of Income tax proceedings under the Income Tax Act. It is for the petitioners to produce the documents in original and adjudicate the same in the manner prescribed under Schedule II Rule 11 of the Income Tax Act. Thus, it would be improper to form an opinion regarding the disputed facts between the parties to the lis in the present case, which requires adjudication of facts based on the documents and evidences. High Court cannot conclude the disputed facts merely based on the affidavits and counter affidavits filed by the parties in a writ proceedings. However, this Court cannot conclude that the petitioner Bank holds priority over the Income tax arrears due to the Income Tax Department. The principles elaborately considered and discussed in the aforementioned paragraph would highlight the constitutional importance, which all are to be considered to grant priority to the institutions. Thus, this Court is inclined to pass the following orders: (1) The relief as such sought for in the present writ petition stands rejected. (2) The petitioner is at liberty to approach the Tax Recovery Officer by filing an appropriate application under Schedule II, Rule 11 of the Income Tax Act. In the event of filing any such application, the Tax Recovery Officer is directed to investigate the same with reference to the original documents and pass appropriate orders as expeditiously as possible.

# 52. With these directions, the writ petition stands disposed of. No costs. Consequently, connected miscellaneous petition is closed.”

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State Bank of India Vs. The Tax Recovery Officer, Income Tax Department - The orders of attachment passed by the Tax Recovery Officer / Income Tax Department were subsequent to the mortgage created in favour of the secured creditors and hence, the same will have no legs to stand, in view of the principles laid above by this court.

HC Madras (01,09.2022) in State Bank of India,Vs. The Tax Recovery Officer, Income Tax Department, [W.A. Nos.1512 of 2021, 60, 1249 and 1385 of 2022] held that; 

• Under common law, priority of crown debts would prevail only over unsecured creditors and would not have precedence over a secured debt.

• we do not find any provision under the Income Tax Act, which creates a charge in respect of tax or any sums that may become payable under the same. This aspect ought to be borne in mind for we find that both the learned Judges have proceeded on the basis that they had to decide the “priority of charge”

• Insofar as the first view is concerned, the law relating to the Government's right to recover dues commonly known as “Crown debt” stands resolved by a series of decisions, wherein, it has been consistently held that Crown/State would have preferential right to recover only over ordinary unsecured creditors but would not be entitled to precedence over a secured debt unless express provisions are incorporated.

• While in the case of a charge, there is no transfer of interest of property or any interest therein, but only the creation of a right of payment out of the specified property, a mortgage effectuates transfer of property or an interest therein.

• The practical distinction is that mortgage is good against subsequent transferees and a charge is only good against subsequent transferees with notice. A charge does not amount to a mortgage. In every mortgage, there is a charge, but every charge is not a mortgage.

• In any view, we find that the Income Tax Act does not create a charge towards recovery of dues. Section 281 only declares certain transactions to be void and cannot be understood as creating a charge in favour of the Income Tax Department in respect of dues arising under the same.

• In other words, nonobstante clause contained in Sections 34 and 35 would not come into play unless inconsistency is demonstrated between the provisions of the SARFAESI Act and Recovery of Debts and Bankruptcy Act and other enactments.

• It was found that there was nothing inconsistent between SARFAESI Act or Recovery of Debts and Bankruptcy Act vis-a-vis Bombay Act and Kerala Act and therefore, it was held that despite the non-obstante clause in Sections 34 and 35, the First charge under the Bombay Act and the Kerala Act would prevail.

• The orders of attachment passed by the Tax Recovery Officer / Income Tax Department were subsequent to the mortgage created in favour of the secured creditors and hence, the same will have no legs to stand, in view of the principles laid above by this court.

 

Excerpts of the order;.

The common question that arises for consideration in the batch of writ appeals, relates to the scope and ambit of Section 281 of the Income Tax Act, 1961 (hereinafter shortly referred to as “the Income Tax Act”) vis-a-vis, Section 26E of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (in short, “the SARFAESI Act”) and Section 31B of the Recovery of Debts and Bankruptcy Act, 1993.

 

# 2. There are four writ appeals viz., W.A.Nos.1512 of 2021, 60 of 2022, 1249 of 2022 and 1385 of 2022, out of which, W.A.Nos. 60 of 2022, 1249 of 2022 and 1512 of 2021 are filed by the Bankers/Financial institutions challenging the orders of a learned Judge in W.P.Nos.25325 of 2017, 15437 of 2014 and 5857 of 2018, wherein it was held that the dues of the Income Tax Department would take precedence over the dues of the secured creditor, though Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act, expressly provides/grants priority in payment of debts due to a secured creditor over all other debts including revenues, taxes, cesses, etc. The learned Judge proceeded on the basis that tax being an attribute of sovereignty and a necessity for attaining the constitutional goals and objectives, tax dues would prevail and take precedence over the rights of the secured creditors. To arrive at the said conclusion, reliance was placed upon the “doctrine of constitutional priority”.

 

# 3. On the other hand, it is the Tax Recovery Officer who has come up with W.A.No.1385 of 2022, challenging the order of another learned Judge in W.P.No.1251 of 2018, wherein, it was held that Section 281 of the Income Tax Act does not create a charge much less one preferential to the revenue overriding/prevailing over Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act. The learned Judge proceeded on the premise that the charge was created only when the property was attached by the Revenue / Income Tax Department and when a valid charge exists prior to the attachment, reliance on Section 281 of the Income Tax Act would not serve to disturb the right of the secured creditor under Section 26E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act.

 

# 4. There are conflicting views expressed by two learned Judges of this Court, while the first view being that the Revenue would have precedence over all other dues on the basis of the “Doctrine of constitutional priority”, (for the sake of ease of reference, we shall refer to this order as the “first view”), the other learned Judge has taken a view, which appears to be diametrically opposite (for the sake of ease of reference, we shall refer to this order as the “second view”) holding that Section 281 of the Income Tax Act by itself does not create a charge, in any view Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act, puts the issue of priority of charge beyond the pale of any doubt in favour of the secured creditors even where the competing claim is that of taxes, revenues etc. It may be relevant to note that the entitlement of the Bankers/ Financial Institutions in these four Writ Appeals to the benefit of priority in payment over other debts in terms of Section 31 B of Recovery of Debt and Bankruptcy Act and under Chapter IV A and more particularly, Section 26 E of the SARFAESI Act, remains undisputed. The only issue that has been raised for consideration is the impact of Section 281 of the Income Tax Act, 1961, vis-a-vis Section 31B of Recovery of Debt and Bankruptcy Act and Section 26 E of the SARFAESI Act.

 

# 6. In the above background, the following questions arise for consideration in these appeals:

• a) What is the nature of taxes and the right of the State to recover the same?

• b) Whether fiscal/tax legislations provide for a charge in respect of the taxes/revenues that are due; and if so, what are the kind/nature of charges created in fiscal/tax legislations and its status?

• c) Whether Section 281 of the Income Tax Act only contains a declaration of voidity in respect of transactions falling within its mischief or does it create a charge in respect of any sum payable under the Income Tax Act in favour of the Revenue and what is the scope of operation of Section 281 of the Income Tax Act and its input vis-a-vis Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act and whether the priority of charge created in favour of the secured creditors under the SARFAESI Act and the Recovery of Debts and Bankruptcy Act would prevail over the declaration of voidity contained in Section 281 of the Income Tax Act or any other recovery proceedings including attachment under the Income Tax Act?

 

# 7. We shall now proceed to answer the above questions in seriatim.

a)What is the nature of taxes and the right of the State to recover the same?

 

# 8.1. The above question has been the subject matter of consideration on numerous occasions including Constitution Benches of the Hon'ble SupremeCourt. We do not intend to multiply case laws as the legal position insofar as the above question is well settled. It is axiomatic that power to collect tax is an inherent attribute and an incident of sovereignty. The legislature of every State will possess the power to tax under the general grant of legislative power. Importantly, but for the limitation imposed under the Articles of the Constitution, the power to tax would be unfettered. In other words, the Articles under the Constitution are not the source of power to tax, but serve as limitation on the power to tax which would otherwise be unfettered.

8.2. Taxes are collected for public good and meant for being used by the Government in discharging its constitutional obligation for public welfare and common public good and to further the directive principles enshrined under the Constitution as held in Srinivasa Theatre and others v. Government of Tamil Nadu and others [1992(2) SCC 643]. In this regard, it may be relevant to refer to the following judgments to appreciate the status and purpose of tax under the Constitution. The relevance and importance of power to tax was examined by the Constitution Bench of 9 Judges in the recent case in Jindal Stainless Ltd v. State of Haryana [(2017) 12 SCC 1] while examining the validity of the Entry Tax and it was held as under:

• “67.1.………………… A tax is a compulsory exaction of money for general public good and is defined as under by Thomas M . Cooley in his book The Law of Taxation at p. 61 (Clark A. Nichols ed., 4th Edn. 1924) as: “Taxes are the enforced proportional contributions from persons and property, levied by the State by virtue of its sovereignty for the support of Government and for all public needs…………….”

• **

• ……………….The power of taxation is said to be an incident of sovereignty, and co-extensive with that of which it is incident.”

• “112.2. Secondly, because levy of taxes is both an attribute of sovereignty and an unavoidable necessity. No responsible Government can do without levying and collecting taxes for it is only through taxes that Governments are run and objectives of general public good achieved. Dealing with power of taxation, Cooley says:

• “Taxes are defined to be burdens or charges imposed by the legislative power upon persons or property, to raise money for public purposes. The power to tax rests upon necessity, and is inherent in every sovereignty. The legislature of every free State will possess it under the general grant of legislative power, whether particularly specified in the Constitution among the powers to be exercised by it or not. No constitutional government can exist without it, and no arbitrary Government without regular and steady taxation could be anything but an oppressive and vexatious despotism, since the only alternative to taxation would be a forced extortion for the needs of Government from such persons or objects as the men in power might select as victims.”

8.3. The above extract would clearly show that the power to tax is an inherent part and an attribute of sovereignty and is meant for being used for public welfare. Without taxes, the Government cannot run nor discharge its constitutional obligations set out in the form of Directive Principles of State Policy under Article 39 of the Constitution. In other words, taxes are collected in public interest and the taxes so collected cannot be used for any purpose other than common public good.

 

# 9.1. Having dealt with the status and purpose of tax under the Constitution, it may be relevant to examine the priority of collection of taxes. Doctrine of priority of Crown Debts Tax dues are normally referred to as “Crown Debt”. The position insofar as priority of Crown Debt could be summarised as under:

• a. The principle of priority of Government debts is founded on the rule of necessity and public policy.

• b. Between an unsecured creditor and crown debt, it is the crown debt which would prevail as held by the Constitution Bench in the case of Builders Supply Corporation reported in AIR (1965) SC 1061.

• c. Between a secured creditor and a crown debt, the secured creditor would have priority over the crown debt in the absence of any provision which provides for priority in favour of the State’s claim.

• d. If the legislation provides for a charge or a priority, then, if the crown debt and the private secured creditor concurs in point of time, the crown debt would prevail. If the private secured creditor is prior in time that would prevail. If the State’s charge is prior in time, then the State’s charge would prevail.

• e. If a “first charge” or a “priority” is provided/granted under the provisions of the Act or if it is expressly provided to override other claims including that of secured creditors, then it appears that it would be the State which would be entitled to preference even over secured creditors.

9.2. In this regard, it may be relevant to refer to the judgment of the Hon'ble Supreme Court in Dena Bank Vs. Bhikhabhai Prabhudas Parekh and Co. and others [(2000) 5 SCC 694], wherein the Crown's preferential right to recovery of debts over other creditors was explained as under:

• ''10.However, the Crown's preferential right to recovery of debts over other creditors is confined to ordinary or unsecured creditors. The common law of England or the principles of equity and good conscience (as applicable to India) do not accord the Crown a preferential right for recovery of its debts over a mortgagee or pledgee of goods or a secured creditor. It is only in cases where the Crown's right and that of the subject meet at one and the same time that the Crown is in general preferred. Where the right of the subject is complete and perfect before that of the King commences, the rule does not apply, for there is no point of time at which the two rights are at conflict, nor can there be a question which of the two ought to prevail in a case where one, that of the subject, has prevailed already. In Giles v. Grover [(1832) 131 ER 563 : 9 Bing 128] it has been held that the Crown has no precedence over a pledgee of goods. In Bank of Bihar v. State of Bihar [(1972) 3 SCC 196 : AIR 1971 SC 1210] the principle has been recognised by this Court holding that the rights of the pawnee who has parted with money in favour of the pawnor on the security of the goods cannot be extinguished even by lawful seizure of goods by making money available to other creditors of the pawnor without the claim of the pawnee being first fully satisfied. Rashbehary Ghose states in Law of Mortgage (TLL, 7th Edn., p. 386) — “It seems a government debt in India is not entitled to precedence over a prior secured debt.” '' (emphasis supplied)

9.3. The above position has been reiterated by the Hon’ble Supreme Court time and again and we do not intend to burden the judgment by multiplying case laws except to state that the above view has not been doubted much less a contrary view having been expressed.

 

b) Whether fiscal/tax legislations provide for a charge in respect of the taxes/revenues that are due and if so, what are the kind/nature of charges created in fiscal/tax legislations and its status?

# 10. Under common law, priority of crown debts would prevail only over unsecured creditors and would not have precedence over a secured debt. It appears that the legislature being conscious of the above limitation, while framing fiscal/taxing statutes, had incorporated provisions providing for a charge over the property of the defaulter, while also declaring that it shall have priority/preferential right for recovery through legislations, which has taken different forms. Barring a few tax legislations, the majority of fiscal/tax legislations have incorporated provisions providing for priority or creating a charge in respect of dues under the said enactment. In this regard, it may be relevant to refer to some of the provisions under the fiscal/tax laws which provide for charges in different forms. However, before that, it may be relevant to note that the provisions of the Central Excise Act, 1944 and the Customs Act, 1962 originally did not contain any provision creating a charge in respect of dues under the said enactments. A Full Bench of this Court in UTI Bank Ltd v. Deputy Commissioner Central Excise [(2006) 5 CTC 801] held that in the absence of any provision creating a charge, the Revenue's right to recovery, must yield to the right of a secured creditor to recover his dues. The relevant portion of the said Full Bench judgment reads as under:

• “26.In the light of the above discussion, we conclude,

• (i)Generally, the dues to Government, i.e., tax, duties, etc., (Crown's debts) get priority over ordinary debts.

• (ii)Only when there is a specific provision in the statute claiming “first charge” over the property, the Crown's debt is entitled to have priority over the claim of others.

• (iii)Since there is no specific provision claiming “first charge” in the Central Excise Act and the Customs Act, the claim of the Central Excise Department cannot have precedence over the claim of secured creditor, viz., the petitioner Bank.

• (iv)In the absence of such specific provision in the Central Excise Act as well as in Customs Act, we hold that the claim of secured creditor will prevail over Crown's debts.”

• In view of our above conclusion, the petitioner UTI Bank, being a secured creditor is entitled to have preference over the claim of the Deputy Commissioner of Central Excise, first respondent herein.”

 

# 11. At this juncture, it may be relevant to note that a specific provision creating a first charge in respect of the dues under the Central Excise Act, 1944 and the Customs Act, 1962, was inserted after the above order of the Full Bench of this Court. The said provision under the Customs Act reads as under, similar provision introduced under the Central Excise Act is not extracted to avoid being repetitive as the provision under the Central Excise Act is identical.

• “142A. Liability under Act to be first charge.—Notwithstanding anything to the contrary contained in any Central Act or State Act, any amount of duty, penalty, interest or any other sum payable by an assessee or any other person under this Act, shall, save as otherwise provided in section 529A of the Companies Act, 1956 (1 of 1956), the Recovery of Debts Due to Banks and the Financial Institutions Act, 1993 (51 of 1993) and the Securitisation and Reconstruction of Financial Assets and the Enforcement of Security Interest Act, 2002 (54 of 2002) and the Insolvency and Bankruptcy Code, 2016 (31 of 2016).]

 

# 12.1. It may also be relevant to take note of some of the other tax legislations, wherein, a statutory charge has been created in respect of the tax dues under the respective enactment, which are as follows:

Madhya Pradesh General Sales Tax Act, 1958:

“33-C. Tax to be first charge.— Notwithstanding anything to the contrary contained in any law for the time being in force, any amount of tax and/or penalty, if any, payable by a dealer or other person under this Act shall be a first charge on the property of the dealer or such person.”

Section 11-AAAA was introduced in the Rajasthan Sales Tax Act, 1954 by way of an amendment in 1989 and the same reads thus:

“11-AAAA. Liability under this Act to be the first charge.— Notwithstanding anything to the contrary contained in any law for the time being in force, any amount of tax, penalty, interest and any other sum, if any, payable by a dealer or any other person under this Act, shall be the first charge on the property of the dealer, or such person.”

Section 42 of TNVAT Act creates a charge subject to exceptions, reads as follows:

42. Payment and recovery of tax, penalty, etc.-

(1) Save as otherwise provided for in Section 21, the tax assessed or has become payable under this Act from a dealer or person and any other amount due from him under this Act shall be paid in such manner and in such instalments, if any, and within such time as may be specified in the notice of assessment, not being less than thirty days from the date of service of the notice. The tax under Section 21 shall be paid without any notice of demand. In default of such payment, the whole of the amount outstanding on the date of the default shall become immediately due and shall be a charge on the properties of the person or persons liable to pay the tax or penalty or interest under this Act.

(2) Any tax assessed on or has become payable by, or any other amount due under this Act from a dealer or person and any fee due from him under this Act, shall, subject to the claim of the Government in respect of land revenue and the claim of the Agriculture and Rural Development Bank in regard to the property mortgaged to it under sub-section (2) of Section 28 of the Tamil Nadu Co-operative Societies Act, 1983 (Tamil Nadu Act 30 of 1983), have priority over all other claims against the property of the said dealer or person and the same may without prejudice to any other mode of collection be recovered,-

(a) as land revenue, or

(b) on application to any Magistrate, by such Magistrate as if it were a fine imposed by him:

12.2. We may note that while the Madhya Pradesh and Rajasthan Sales Tax Acts provide for “first charge” in favour of the tax dues, the TNVAT Act, while providing for a “charge”, does not create a first charge rather makes it subject to certain claims. Now, a first charge has been held to prevail even over existing charges/mortgages, which would apply to the Madhya Pradesh and Rajasthan enactments, but not to the TNVAT Act as it merely creates a charge, which, as stated above, is subject to other claims mentioned therein. In this regard, it may be relevant to refer to the judgment of the Hon'ble Supreme Court in State Bank of Bikaner and Jaipur v National Iron and Steel Rolling Corporation, reported in (1995) 2 SCC 19, wherein, the scope of 1st charge was explained as under: 

• “10. The section creates first charge on the property, thus clearly a statutory charge mortgage. created by The giving priority to the property statutory including first a charge over all other charges submission, therefore, on that the section 11AAAA the Rajasthan of Sales Tax Act operate only over the equity of redemption, cannot can be accepted. The charge operates on the entire property of the dealer including the interest of the mortgage therein.”

12.3. Thus, it is evident that the legislature has provided provisions for creating charge over the property of the defaulter in tax enactments, some of which has been extracted above, with a view to enable recovery of the tax dues. The above legislative device/practice also reflects legislative recognition of the fact that in the absence of provision providing for statutory charge, the recovery mechanism may suffer from inadequacy/deficiency, when pitted against secured creditors.

 

# 13. We find that the recovery mechanism under the Income Tax Act suffers from the above deficiency, in the absence of a provision creating a charge in respect of the property of the defaulter to enable recovery of their dues arising out of the above enactment. We say so, for in contrast to other tax enactments referred to above, we do not find any provision under the Income Tax Act, which creates a charge in respect of tax or any sums that may become payable under the same. This aspect ought to be borne in mind for we find that both the learned Judges have proceeded on the basis that they had to decide the “priority of charge” under the Income Tax Act vis-a-vis SARFAESI Act and Recovery of Debts and Bankruptcy Act, while the first view proceeds on the basis that priority must be granted to recovery of Government dues on the basis of “doctrine of constitutional priority”, the second view proceeds on the basis that attachment results in creation of charge and if the same is subsequent to mortgage, the right of the existing mortgagee would prevail.

 

# 14. Insofar as the first view is concerned, the law relating to the Government's right to recover dues commonly known as “Crown debt” stands resolved by a series of decisions, wherein, it has been consistently held that Crown/State would have preferential right to recover only over ordinary unsecured creditors but would not be entitled to precedence over a secured debt unless express provisions are incorporated. Therefore, reliance on “doctrine of constitutional priority” for which we do not find any basis, is in any view unsustainable as it is contrary to the settled legal position. 

 

# 15. Coming to the second view, it has been held that a charge gets created only when the attachment is made. This view is again unsustainable since attachment would not constitute a charge. In this regard, it may be relevant to refer to the decision of the Hon'ble Supreme Court in Kerala State Financial Enterprises Ltd. v. Official Liquidator [(2006) 10 SCC 709], which reads as under:

• “9....An attachment itself does not create any charge in the property.

• 10. The expression `attachment' has no definite connotation. An order of attachment is passed for achieving a limited purpose. It is subject to further orders as also provisions of other statute.

• 11. The word `attachment' would only mean `taking into the custody of the law the person or property of one already before the court, or of one whom it is sought to bring before it. It is used for two purposes : (i) to compel the appearance of a defendant; and (ii) to seize and hold his property for the payment of the debt. It may also mean prohibition of transfer, conversion, disposition or movement of property by an order issued by the court.”

 

# 16.1. While, on the correctness of the divergent views expressed by the learned judges, to appreciate as to what would constitute “charge”, we may have to look to the Transfer of Property Act, 1882, in particular, Section 100 of the same, which reads as under:

• “100. Charges.— Where immoveable property of one person is by act of parties or operation of law made security for the payment of money to another, and the transaction does not amount to a mortgage, the latter person is said to have a charge on the property; and all the provisions hereinbefore contained which apply to a simple mortgage shall, so far as may be, apply to such charge. Nothing in this section applies to the charge of a trustee on the trust-property for expenses properly incurred in the execution of his trust, and, save as otherwise expressly provided by any law for the time being in force, no charge shall be enforced against any property in the hands of a person to whom such property has been transferred for consideration and without notice of the charge.

The charges that have been dealt with in the above section are:

• (1) Charges created by act of parties.

• (2) Charges arising by operation of law.

16.2. The above provision has come up for consideration before the Hon’ble Supreme Court in JK (Bombay) Private Ltd v. New Kaiser-I-Hind Spinning and Weaving Co. Ltd [1970 AIR 1041] and the expression “charge” has been explained as under:

• “While in the case of a charge, there is no transfer of interest of property or any interest therein, but only the creation of a right of payment out of the specified property, a mortgage effectuates transfer of property or an interest therein. No particular form of words is necessary to create a charge and all that is necessary is that there must be a clear intention to make a security for payment of money in presenti.”

16.3. The broad distinction between a mortgage and a charge is that a charge only gives a right to payment out of a particular fund or particular property without transferring that fund or property, whereas a mortgage is in essence a transfer of an interest in specific immovable property. A mortgage is a jus in rem, a charge is a jus ad rem and the practical distinction is that mortgage is good against subsequent transferees and a charge is only good against subsequent transferees with notice. A charge does not amount to a mortgage. In every mortgage, there is a charge, but every charge is not a mortgage. 

 

# 17. Having examined the scope of “charge”, it may be relevant to note that the second view holding that an attachment creates a charge is unsustainable as ‘attachment’ and ‘charge’ are distinct and attachment does not by itself create a charge as stated supra. In any view, we find that the Income Tax Act does not create a charge towards recovery of dues. Section 281 only declares certain transactions to be void and cannot be understood as creating a charge in favour of the Income Tax Department in respect of dues arising under the same.

 

c)Whether Section 281 of the Income Tax Act only contains declaration of voidity in respect of transactions falling within its mischief or does it create a charge in respect of any sum payable under the Income Tax Act in favour of the Revenue and what is the scope of operation of Section 281 of the Income Tax Act vis-a-vis Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act and whether the priority of charge created in favour of the secured creditors under the SARFAESI Act and Recovery of Debts and Bankruptcy Act would prevail over the declaration of voidity contained in Section 281 of the Income Tax Act or any other recovery proceedings including attachment under the Income Tax Act?

18.1. To answer the above question, it may be relevant to extract Section 281 of the Income Tax Act, which reads as under:

Certain transfers to be void.

281. (1) Where, during the pendency of any proceeding under this Act or after the completion thereof, but before the service of notice under rule 2 of the Second Schedule, any assessee creates a charge on, or parts with the possession (by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever) of, any of his assets in favour of any other person, such charge or transfer shall be void as against any claim in respect of any tax or any other sum payable by the assessee as a result of the completion of the said

proceeding or otherwise : Provided that such charge or transfer shall not be void if it is made-

(i) for adequate consideration and without notice of the pendency of such proceeding or, as the case may be, without notice of such tax or other sum payable by the assessee; or

(ii) with the previous permission of the Assessing Officer.

(2) This section applies to cases where the amount of tax or other sum payable or likely to be payable exceeds five thousand rupees and the assets charged or transferred exceed ten thousand rupees in value.

Explanation.—In this section, "assets" means land, building, machinery, plant, shares, securities and fixed deposits in banks, to the extent to which any of the assets aforesaid does not form part of the stock-in-trade of the business of the assessee.

18.2. On a reading of section 281 of the Income Tax Act, the following  position emerges:

a) The provision is intended to operate during the pendency of any proceeding or after the completion thereof and before the service of notice under Rule 2 of the Second Schedule to the Income Tax Act.

b) Any charge/transfer that is created during the pendency of any proceeding or after its completion under the Act and before service of notice under Rule 2 of the Second Schedule shall be “void to the extent of any sum payable as a result of completion of the said proceedings”.

c) The provision is a statutory declaration of any charge/transfer created by an assessee during the pendency of any proceeding or after its completion under the Act and before service of notice under Rule 2 of the Second Schedule, being void in respect of the tax or any sum payable as a result of completion of the said proceeding or otherwise.

d) The voidity though is with reference to and governs transfers during the pendency of any proceeding or after its completion under the Act and before service of notice under Rule 2 of the Second Schedule, but appears to become operational only on completion of the proceeding consequent to which sums become payable under the Act. This is apparently for the reason that there could be instances where on completion of the proceeding, there may be no liability for the voidity to operate. However, once sum becomes payable on completion of proceeding, the declaration of voidity would relate back and cover any transfer made prior to the completion of any proceeding under the Act.

e) Section 281 of the Income Tax Act does not create a charge. It is a negative declaration in the sense that certain transactions, viz., any charge or transfer made during the pendency of the proceeding and on completion thereof and before issuance of notice under Rule 2 of the Second Schedule are declared void to the extent of sums payable on completion of such proceeding.

f) The declaration of voidity under Section 281 of the Income Tax Act, is not absolute, but comes with exceptions, viz., that the charge/transfer though made during the pendency of proceedings under this Act or after completion but before issuance of notice, the charge/transfer, may still not be void if the same is made for adequate consideration and without notice of pendency of such proceedings or notice of such tax or sum being payable by the assessee or if the transfer is made with the previous permission of the Assessing Officer.

g) The declaration of voidity under Section 281 of the Income Tax Act, is not absolute but only in respect of any tax or sum payable by the assessee as a result of completion of proceedings under the Income Tax Act. h) It may be relevant to note that Section 281 of Income Tax Act as it originally stood provided that charge/transfers would be void only if the same “is with an intent to defraud revenue”. In other words, unless the intent behind the charge or the transfer was to defraud the revenue, the same would not be covered by Section 281 of the Income Tax Act, as it then stood. While examining Section 281 of the Income Tax Act, as it then stood, it was held by the Hon’ble Supreme Court in TRO v. Gangadhar Vishwanath Ranade [1998 (234) ITR 188 (SC)], as under:

• “If the Department desires to have the transaction of transfer declared void under Section 281, the Department being in the position of a creditor, will have to file a suit for a declaration that the transaction of transfer is void under Section 281 of the Income Tax Act. 

• .....

• 14. However, the right of the Department to have the transfer declared as void under Section 281 of the Income Tax Act, as it stood at the relevant time, is not thereby taken away. We are informed that the property continues to be under attachment by virtue of interim orders passed in this appeal. The Department may, if it so desires, take appropriate proceedings in accordance with the law for having the transfer declared as void under Section 281 of the Income Tax Act.”

18.3. Section 281 of the Income Tax Act has since been amended whereby, the expressions “intent to defraud revenue” was omitted. Consequently, any transfer during the pendency of any proceeding under the Act or after completion thereof before service of notice under Rule 2 of the Second Schedule shall be void against any claim in respect of any tax or any other sum payable by the assessee as a result of completion of the said proceeding. In other words, the need to examine/enquire the intent of such transfer, viz., whether the charge/transfer is to defraud revenue is done away with.

 

# 19.1. There is yet another aspect which may have to be borne in mind. As stated above, the operation of Section 281 of the Income Tax Act is during the pendency of the proceeding and on completion thereof and before issuance of notice under Rule 2 of the Second Schedule, if any sum becomes payable as a result of completion of the said proceeding. This is in view of the fact that once a notice is issued under Rule 2, the Rules of the Second Schedule kicks in and governs the recovery mechanism.

19.2. To appreciate the compartmentalization of the recovery mechanism between Section 281 and the Rules of the Second Schedule of the Income Tax Act, it may be useful to refer to the decision of the High Court of Andhra Pradesh, in ICICI Bank Limited v. Tax Recovery Officer and others [(2019) 411 ITR 518], wherein, while dealing with the scope of Section 281 and the Rules under the Second Schedule of the Income Tax Act, it was held as under:

• 29. Therefore, it is clear that the proviso (i) to sub-section (1) of Section 281 provides an escape route for innocent third parties, to whom the property of the assessee is transferred during the pendency of the proceedings, but before an attachment is ordered. This compartmentalization is very important to be noted, in view of the fact that during the pendency of the proceedings for assessment, an assessee does not become an assessee in default. Section 281(1) cannot be interpreted to mean that every assessee is likely to become an assessee in default and therefore, all transfers effected by him even before he becomes a defaulter are null and void.

19.3. The High Court of Andhra Pradesh as a matter of fact found that the return of income for the relevant period was filed on 31.07.2009 and notices under Section 143(2) were issued on September 2010 and February 2011, the order of assessment was passed on 27.12.2011 and the demand notice under Section 156 was also issued on 27.12.2011. The assessee therein would have become an assessee in default on 26.01.2012. It was only thereafter that notice could have been issued under Rule 2. The Tax Recovery Certificate was issued on 09.01.2014 and the order of attachment was on 14.03.2018. Importantly, the mortgage has been created on 11.07.2011 much before the order of assessment. It was thus held that the rights of the mortgagee would prevail. The relevant portion of the judgment reads as under:

• “31.But the mortgage was created by the third respondent in favour of the petitioner-bank on July 11, 2011, much before the order af assessment was passed under section 143(3) on December 27, 2011. In other words, the assessee was nowhere near the point of being declared as an assessee-in default on the date of creation of the mortgage. Hence, the creation of the mortgage cannot be said to have automatically become void in terms of section 281(1) merely because of the pendency of the proceedings under Sections 143 and 142, It required something more to be done, but the same was not done in this case. As a matter of fact even an investigation, under rule 11 was not carried out in this case. Therefore, the order of attachment is clearly illegal. On the date on which the order of attachment was passed, the property had already been sold by the petitioner-bank, in exercise of the power conferred upon the bank under the Securitisation Act, 2002.

• 32. It is important to note one more aspect. Section 281(1), by its very nature operates only up to the stage of service of notice under rule 2 of the Second Schedule. Therefore, section 281(1) obviously deals with a situation, which can be compared to fraudulent preferences dealt with by the insolvency laws. Therefore, what is applied to an assessee (or an insolvent under the Insolvency laws) cannot be applied to a secured creditor like the bank. 

• 33. There appears to be no provision in the Income-tax Act. by which a first charge is created automatically on the properties of the assessees. There is no provision in the Income-tax Act, similar to section 16C of the Andhra Pradesh General Sales tax Act, 1957.”

 

21. Thus, the judgment of the Andhra Pradesh High Court in the case of ICICI Bank Limited (supra) looked to the fact of declaration of the assessee as an assessee in default vis-a-vis the date on which the mortgage was created and the Hon’ble Supreme Court looked to issuance of notice under Rule 2 of the Second Schedule to the Income Tax Act vis-a-vis the date of creation of mortgage to resolve the question of priority. In other words, both the Andhra Pradesh High Court and the Hon’ble Supreme Court held that the secured creditor has priority since the mortgages were found as a matter of fact to have been created prior to

the assessee being treated as an assessee in default or notice having been issued under Rule 2 of the Second Schedule to the Income Tax Act. Impact of Section 281 of the Income Tax Act vis-a-vis Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act:

 

# 22.1. To understand the impact of Section 281 of the Income Tax Act visa- vis section 26E of the SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, it may be necessary to extract the said provisions, which reads as under:

Section 26E: Priority to secured creditors.

26E. Notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any secured creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority. 

Explanation.—For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.

31B. Priority to secured creditors.— Notwithstanding anything contained in any other law for the time being in force, the rights of secured creditors to realise secured debts due and payable to them by sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority.

Explanation.—For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.

22.2. The most important aspect of the above provisions and one which would help to resolve the controversy, viz., the impact of Section 281 of the Income Tax Act vis-a-vis Section 26E of the SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, is the effect and extent of the non obstante clause contained in Section 26E and 31B of the SARFAESI Act and the Recovery of Debts and Bankruptcy Act, respectively. This is not the first time that the SARFAESI Act had employed non-obstante clause with a view to override other laws, even prior to Section 26E of the SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, there were Sections 35 and section 34 of the SARFAESI Act and the Recovery of Debts and Bankruptcy Act which provided for provisions with non-obstante clauses intended to override other laws.

 

# 23.1. Before we proceed to examine the manner in which the non obstante clauses contained in the SARFAESI Act and the Recovery of Debts and Bankruptcy Act has been understood judicially, it may be relevant to set out broadly the scope of non obstante clause in general. In this regard, it may be relevant to refer to the following judgments: 

Woodward Governor India P. Ltd Vs. Commissioner of Income Tax and others reported in (2002) 253 ITR 745:

“A clause beginning with “notwithstanding anything” is sometimes appended to a section in the beginning with a view to give the enacting part of the section in case of conflict an overriding effect over the provision of Act mentioned in the non obstante clause (see Orient Paper and Industries Ltd. v. State of Orissa, 1991 Supp (1) SCC 81 : AIR 1991 SC 672). A non obstante clause may be used as a legislative device, to modify the ambit of the provision of law mentioned in the non obstante clause, or to override it in specified circumstances, (see T.R. Thandur v. Union of India, (1996) 3 SCC 690 : AIR 1996 SC 1643). The true effect of the non obstante clause is that in spite of the provision or Act mentioned in the non obstante clause, the enactment following it will have its full operation or that the provisions embraced in the non obstante clause will not be an impediment for the operation of the enactment (see Smt. Parayankandiyal Eravath Kanapravan Kalliani Amma v. K. Devi, (1996) 4 SCC 76 : AIR 1996 SC 1963).”

Jay Engineering Works Limited v. Industry Facilitation Council and another reported in AIR 2006 SC 3252: In ICICI Bank Ltd. v. Sidco Leathers Ltd. and Others (2006) Scw

2361) 5 SCALE 27] the law is stated in Para 38) the following terms:

"The non obstante nature of a provision although may be of wide amplitude, the interpretative process thereof must be kept confined to the legislative policy. Only because the dues of the workmen and the debt due to the secured creditors are treated pari passu with each other, the same by itself, in our considered view, would not lead to the conclusion that the concept of inter se priorities amongst the secured creditors had thereby been intended to be given a total go-by. A non obstante clause must be given effect to, to the extent the Parliament intended and not beyond the same."

23.2. It thus appears that non-obstante clause is a legislative device intended to give an overriding effect and ensure that the provisions have its full operation. As stated above, prior to introduction of Sections 26E and 31B of the SARFAESI Act and the Recovery of Debts and Bankruptcy Act, Section 35 of the SARFAESI Act and Section 34 of the Recovery of Debts and Bankruptcy Act provided that the provisions of these Acts would override other laws. For a better appreciation of the width of the non- obstante clause in Section 26E of the SARFAESI Act and section 31 B of the Recovery of Debts and Bankruptcy Act, it may be relevant to contrast the same with Section 35 of the SARFAESI Act and Section 34 of the Recovery of Debts and Bankruptcy Act. The following table is relevant:

 

SARFAESI Act Section 26E: Priority to secured creditors. 26E. Notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any secured creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority. Explanation.—For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.] Recovery of Debts and Bankruptcy Act Section 35. Provisions of this Act to override other laws. 35. The provisions of this Act shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

Recovery of Debts and Bankruptcy Act Section 35. Provisions of this Act to override other laws. 35. The provisions of this Act shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law. Section 37. Application of other law not barred 37. The provisions of this Act or the rules made thereunder shall be in addition to, and not in derogation of, the Companies Act, 1956 (1 of 1956), the Securities Contracts (Regulation) Act, 1956 (42 of 1956), the Securities and Exchange Board of India Act, 1992 (15 of 1992), the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993) or any other law for the time being in force.”

Recovery of Debts and Bankruptcy Act: 31B. Priority to secured creditors.— Notwithstanding anything contained in any other law for the time being in force, the rights of secured creditors to realise secured debts due and payable to them by sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority. Explanation.—For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.

Recovery of Debts and Bankruptcy Act: 34. Act to have overriding effect. (1) Save as provided under sub-section (2), the provisions of this Act shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force or in any instrument having effect by virtue of any law other than this Act. (2) The provisions of this Act or the rules made thereunder shall be in addition to, and not in derogation of the Industrial Finance Corporation Act, 1948 (15 of 1948), the State Financial Corporations Act, 1951 (63 of 1951), the Unit Trust of India Act, 1963 (52 of 1963), the Industrial Reconstruction Bank of India Act, 1984 (62 of 1984), the Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986) and the Small Industries Development Bank of India Act, 1989 (39 of 1989).”

 

23.3. A question arose before the Hon’ble Supreme Court in Central Bank of India v. State of Kerala and others [(2009) 4 SCC 94] as to whether Sections 34 and 35 of the Recovery of Debts and Bankruptcy Act and SARFAESI Act which give overriding effect to the provisions of those Acts against other laws, would prevail over Section 38-C of the Bombay Act and Section 26-B of the Kerala Act, which provided for non obstante clause and created a first charge in favour of the State with regard to the dues arising under those enactments. The  Hon’ble Supreme Court held that the non obstante clause contained in Sections 34 and 35 would get attracted only in the event of conflict in the light of the language employed therein which provided that the provisions of the said enactments will prevail in the event of any inconsistency. In other words, nonobstante clause contained in Sections 34 and 35 would not come into play unless inconsistency is demonstrated between the provisions of the SARFAESI Act and Recovery of Debts and Bankruptcy Act and other enactments. It was found that there was nothing inconsistent between SARFAESI Act or Recovery of Debts and Bankruptcy Act vis-a-vis Bombay Act and Kerala Act and therefore, it was held that despite the non-obstante clause in Sections 34 and 35, the First charge under the Bombay Act and the Kerala Act would prevail. In this regard, it may be relevant to refer to the judgment of the Supreme Court which reads as under:

“111. However, what is most significant to be noted is that there is no provision in either of these enactments by which first charge has been created in favour of banks, financial institutions or secured creditors qua the property of the borrower.

112. Under Section 13(1) of the Securitisation Act, limited primacy has been given to the right of a secured creditor to enforce security interest vis-à-vis Section 69 or Section 69-A of the Transfer of Property Act. In terms of that sub-section, a secured creditor can enforce security interest without intervention of the court or tribunal and if the borrower has created any mortgage of the secured asset, the mortgagee or any person acting on his behalf cannot sell the mortgaged property or appoint a Receiver of the income of the mortgaged property or any part thereof in a manner which may defeat the right of the secured creditor to enforce security interest. This provision was enacted in the backdrop of Chapter VIII of the Narasimham Committee's Second Report in which specific reference was made to the provisions relating to mortgages under the Transfer of Property Act.

113. In an apparent bid to overcome the likely difficulty faced by the secured creditor which may include a bank or a financial institution, Parliament incorporated the non obstante clause in Section 13 and gave primacy to the right of secured creditor vis-à-vis other mortgagees who could exercise rights under Sections 69 or 69-A of the Transfer of Property Act. However, this primacy has not been extended to other provisions like Section 38-C of the Bombay Act and Section 26-B of the Kerala Act by which first charge has been created in favour of the State over the property of the dealer or any person liable to pay the dues of sales tax, etc. Sub-section (7) of Section 13 which envisages application of the money received by the secured creditor by adopting any of the measures specified under sub-section (4) merely regulates distribution of money received by the secured creditor. It does not create first charge in favour of the secured creditor.

....116. The non obstante clauses contained in Section 34(1) of the DRT Act and Section 35 of the Securitisation Act give overriding effect to the provisions of those Acts only if there is anything inconsistent contained in any other law or instrument having effect by virtue of any other law. In other words, if there is no provision in the other enactments which are inconsistent with the DRT Act or the Securitisation Act, the provisions contained in those Acts cannot override other legislations. Section 38-C of the Bombay Act and Section 26-B of the Kerala Act also contain non obstante clauses and give statutory recognition to the priority of the State's charge over other debts which was recognised by Indian High Courts even before 1950. In other words, these sections and similar provisions contained in other State legislations not only create first charge on the property of the dealer or any other person liable to pay sales tax, etc. but also give them overriding effect over other laws.

....126. While enacting the DRT Act and the Securitisation Act, Parliament was aware of the law laid down by this Court wherein priority of the State dues was recognised. If Parliament intended to create first charge in favour of banks, financial institutions or other secured creditors on the property of the borrower, then it would have incorporated a provision like Section 529-A of the Companies Act or Section 11(2) of the EPF Act and ensured that notwithstanding series of judicial pronouncements, dues of banks, financial institutions and other secured creditors should have priority over the State's statutory first charge in the matter of recovery of the dues of sales tax, etc. However, the fact of the matter is that no such provision has been incorporated in either of these enactments despite conferment of extraordinary power upon the secured creditors to take possession and dispose of the secured assets without the intervention of the court or Tribunal. The reason for this omission appears to be that the new legal regime envisages transfer of secured assets to private companies.

...128. If the provisions of the DRT Act and the Securitisation Act are interpreted keeping in view the background and context in which these legislations were enacted and the purpose sought to be achieved by their enactment, it becomes clear that the two legislations, are intended to create a new dispensation for expeditious recovery of dues of banks, financial institutions and secured creditors and adjudication of the grievance made by any aggrieved person qua the procedure adopted by the banks, financial institutions and other secured creditors, but the provisions contained therein cannot be read as creating first charge in favour of banks, etc."

23.4. The above judgment proceeds on the basis that though there is a nonobstante clause, the same would become operational and get triggered only in the event of inconsistency with provisions of other enactment. In other words, the non-obstante clause was found to be inadequate and may not operate unless there is inconsistency with any other law. With a view to get over the deficiency in the non-obstante clause which was contained in Sections 34 and 35, Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act has been introduced. If one contrasts the non-obstante clauses contained in Sections  26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act vis-a-vis Sections 34 and 35, it would be evident that the non-obstante clause in Section 26E and Section 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act is not limited in its operation only in the event of inconsistency, but is intended to give primacy to the rights of secured creditors to recover over all other debts and expressly includes revenues, taxes, cesses or other rates payable to Central Government or State Government or local authority. Parliament intended to give primacy to Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act, as evident from the nonobstante

clause contained therein which is couched in very wide terms as to its scope and operation. Section 281 of the Income Tax Act declares certain transactions to be void, now can it be understood that the declaration of voidity would prevail despite Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act conferring primacy in very wide terms. There is no doubt that Parliament's intention was to give priority to secured creditors which is to prevail over revenue, taxes, cesses, etc, in view of the express provisions contained in Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act. This is further reinforced by the Statement of Objects and Reasons (SOR) appended to the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016 which introduced sections 26E of the SARFAESI Act and 31B of the Recovery of Debts and Bankruptcy Act. According to the SOR, priority was accorded to secured creditors in repayment of debts in order to augment economic growth and ease of doing business. This gives a glimpse of the position earlier and what the amendment sought to remedy.

 

# 24. Keeping the above background in mind, it does not seem that section 281 of the Income Tax Act and sections 26E of the SARFAESI Act and 31B of the Recovery of Debts and Bankruptcy Act can operate simultaneously without conflict. In other words, the conflict is inevitable. Application of section 281 could result in two possible outcome:

• (i) the transfer / charge can either be saved under the proviso (or)

• (ii) transfer / charge could come under the mischief of section 281 and its declaration of voidity.

In the first case, if the transfer / charge falls under the proviso, Section 281 of the Income Tax Act would not get attracted and the secured creditor will be entitled to enforce in view of its priority. If the transfer / charge falls within the mischief of Section 281 of the Income Tax Act as discussed supra, it would suffer from the declaration of voidity. ‘Void’ as explained by the Hon’ble Supreme Court in Kalawati v. Bisheshwar [AIR 1968 SC 261] and State of Kerala v. M.K.Kunhikannan Nambiar Manjeri Manikoth [(1996) 1 SCC 435 : AIR 1996 SC 906], would mean ‘non-existent from its very inception’ and ‘nullity’. Sections 26E and 31B presuppose an existence of a valid charge / mortgage and if the declaration of voidity in section 281 of the Income Tax Act destroys the very foundation on which sections 26E and 31B exists, it appears doubtful that a banker or a financial institution can take advantage of the priority provided therein. In this regard, it may be necessary to bear in mind the Maxim sublato fundamento, cadit opus, meaning, “if the foundation is removed, the superstructure falls” [See: Kalabharati Advertising v. Hemant Vimalnath Narichania and others, (2010) 9 SCC 437 : 2010 SCC Online SC 970 at page 447].

 

# 25. Thus, once the security interest is declared a nullity, it will be non-est and there is no question of applying SARFAESI or Recovery of Debts and Bankruptcy Act and consequentially, no question of priority. This would essentially lead to a conflict, as in the present case, primacy to section 281 will render the priority accorded to secured creditors nugatory. We must thus examine, whether section 281 of the Income Tax Act or sections 26E and 31B of the SARFAESI and Recovery of Debts and Bankruptcy Act would prevail. It appears that the non-obstante clause in Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act would prevail over the declaration of voidity contained in Section 281 of the Income Tax Act, for unless it is nullified, the primacy contained in the provisions of Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act would stand nullified, thereby defeating the object of Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act.

 

# 26. While interpreting the scope of the non-obstante clause contained in Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act, we may take guidance from the Heydon’s Rule, commonly known as “Purposive Construction”, which provides that when the material words are capable of bearing two or more constructions, the most firmly established rule for construction of such words of all statutes in general (be they penal or beneficial, restrictive or enlarging of the common law) is the rule laid down in Heydon's case which has now attained the status of a "classic"1. The rule which is also known as "purposive construction" or "mischief rule" enables consideration of four matters in construing an Act: (i) What was the law before the making of the Act, (ii) What was the mischief or defect for which the law did not provide, (iii) What is the remedy that the Act has provided, and (iv) What is the reason of the remedy. The rule then directs that the courts must adopt that construction which "shall suppress the mischief and advance the remedy”. Four things are to be discerned and considered:

• Firstly, what was the common law before the making of the Act,

• Secondly, what was the mischief and defect for which the common law did not provide,

• Thirdly, what remedy the Parliament hath resolved and appointed to cure the disease of the commonwealth, and

• Fourthly, the true reason of the remedy,

Then to make such construction as shall suppress the mischief, and advance the remedy, and to suppress subtle inventions and evasions for continuance of the mischief, and pro priuate commodo, and to add force and life to the cure and remedy, according to the true intent of the makers of the Act, pro bone publico. 

 

# 27. Applying the mischief or Heydons Rule to Sections 26E and 31B of the SARFAESI and Recovery of Debts and Bankruptcy Act, we can infer the following:

The Mischief - Inadequacy of the non-obstante clause in Section 34 and 35 of the Recovery of Debts and Bankruptcy Act and SARFAESI Act, which was found to be limited in operation to grant to primacy only in case of inconsistency with other laws.

The remedy - To get over the above mischief of Section 26E and 31B of theS ARFAESI and Recovery of Debts and Bankruptcy Act, containing nonobstante clause was introduced. The said non-obstante clause is very wide in scope and operation and grants primacy against any other law, which is not confined to circumstances, wherein, there is inconsistency between the SARFAESI Act and Recovery of Debts and Bankruptcy Act. Thus, applying the Heydon’s Rule or Purposive construction, the non-obstante clause contained in Sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act, which was introduced to give primacy to the secured creditors and expressly provides that it would prevail over all taxes, cesses etc., ought to be construed/interpreted in a manner that would promote and not defeat the object of the Parliament to protect and safeguard the interest of the secured creditors, intended in larger public interest and as a matter of policy.

 

# 28. One more rule of construction is that when two competing Acts construed to further the purposes behind them produce a conflict; the court may resolve the conflict by taking into consideration as to which Act represents "the superior purpose”, as held in the case of Allahabad Bank v. Canara Bank [(2000) 4 SCC 406], which reads as under:

• “34. While it is true that the principle of purposive interpretation has been applied by the Supreme Court in favour of jurisdiction and powers of the Company Court in Sudarsan Chits (I) Ltd. case [(1984) 4 SCC 657], and other cases, the said principle, in our view, cannot be invoked in the present case against the Debts Recovery Tribunal in view of the superior purpose of the RDB Act and the special provisions contained therein. In our opinion, the very same principle mentioned above equally applies to the Tribunal/Recovery Officer under the RDB Act, 1993 because the purpose of the said Act is something more important than the purpose of Sections 442, 446 and 537 of the Companies Act. It was intended that there should be a speedy and summary remedy for recovery of thousands of crores which were due to the banks and to financial institutions, so that the delays occurring in winding-up proceedings could be avoided.”

If the above rule is applied, then there is no room for doubt that Section 26 E of the SARFAESI Act and Section 31 B of the Recovery of Debts and Bankruptcy Act which was introduced with a specific purpose to override and grant priority to recovery of debts due to secured creditors over all other debts, taxes, cesses etc., must be understood as prevailing over Section 281 of the Income Tax Act, in the event of conflict of priority. This is also in view of the fact that the Parliament must be understood to have given priority to the secured creditors under Section 26E of the SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, fully aware and conscious of the status and importance that taxes enjoy under the Constitution. Therefore, with regard to operation of section 281 of the Income Tax Act vis-a-vis the operation of sections 26E and 31B of the SARFAESI Act and Recovery of Debts and Bankruptcy Act, sections 26E and 31B according priority to secured creditors shall prevail and thus, the attachment by the Tax Recovery Officer is impermissible in the facts and circumstances of the case.

 

# 29. Now coming to the question of whether the amendments by way of Section 26E of the SARFAESI Act and Section 31B of the Recovery of Debts and Bankruptcy Act, would be applicable to the Bankers in the present case in view of the fact that Section 31B was inserted with effect from 01.09.2016, while Section 26 E was inserted and notified to come into force on 24.01.2020. The above question need not detain us long for the following reasons:

a) Firstly, the Full Bench of this Court in W.P.No.2675 of 2011 etc. batch, dated 10.11.2016 has held that it would govern the rights of the parties even in respect of a pending lis. The relevant portion of the same reads as under:

• "3. There is, thus, no doubt that the rights of a secured creditor to realise secured debts due and payable by sale of assets over which security interest is created, would have priority over all debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or Local Authority. This section introduced in the Central Act is with "notwithstanding" clause and has come into force from 01.09.2016. The law having now come into force, naturally it would govern the rights of the parties in respect of even a lis pending."

The Special Leave Petition is stated to be pending before the Apex Court and there is an order of “Status Quo” in SLP (Civil) No.20471 of 2021 dated 16.03.2018. In view thereof, the Full Bench Order of this Court would continue to bind/govern.

b) Secondly, we would think the examination of the above question may be academic, in view of the fact that even if the recovery proceeding is setaside for any reason, the same may not serve any purpose. The claim of the Bankers/ Financial Institutions is admittedly still outstanding, hence it is open for the Bankers/ Financial Institutions on proceeding being set-aside to invoke Section 26 E of the SARFAESI Act and Section 31 B of theRecovery of Debts and Bankruptcy Act as it is applicable presently in any view. In similar circumstances, the Hon'ble Supreme Court in the case of Dena Bank v. Bhikhabhai Prabhudas Parekh and Co. [(2000) 5 SCC 694] while examining the question whether the State would have precedence to recover the tax dues over that of secured creditors after clarifying the position on the above issue, proceeded to examine the further contention that the petitioners therein who were partners of a firm that Section 15(2-A) of the Karnataka Sales Tax Act, which provided that where any firm is liable, the firm and each of the partners would be jointly and severally liable was introduced only with effect from 18.11.1983, however the taxes that were sought to be recovered related to periods prior to 1964-65 i.e., prior to the insertion of the above provision. The Apex Court after holding that it would be prospective, however proceeded to hold that even if the recovery proceedings were to be set aside, it may not serve any purpose since it was open for the State to resort to the amended Section 15(2-A) of the Karnataka Sales Tax Act which would prevail over the right of the appellant Bank. The following portion is relevant and thus extracted:

• 21.....Even if we were to set aside the sale held by the State, it will merely revive the arrears outstanding on account of sales tax to which further interest and penalty shall have to be added. The amended Section 15(2-A) of the Karnataka Sales Tax Act shall apply. The State shall have a preferential right to recover its dues over the rights of the appellant Bank and the property of the partners shall also be liable to be proceeded against. No useful purpose would, therefore, be served by allowing the appeal which  will only further complicate the controversy. "

The position here is no different. Apart from the fact that the Full Bench has while considering the applicability of Section 31 B of the Recovery of Debts and Bankruptcy Act has held that it would apply even to lis pending, which would be the position in respect of Section 26E of the SARFAESI Act as well. Even if this Court were to set aside the recovery proceedings for any reason, the Bankers/ Financial Institutions right to claim priority in terms of Section 31 B of the Recovery of Debts and Bankruptcy Act and Section 26 E of the SARFAESI Act would be available and the right to recover under the Income Tax Act, 1961 must yield to the provisions under the SARFAESI Act and the Recovery of Debts and Bankruptcy Act and thus, the above exercise may not serve any useful purpose. Therefore, the above issue appears to be a mere academic exercise and we do not intend to examine the question any further.

 

# 30.1. In view of the legal position explained above and applying the same to the facts of the present case, we arrive at the following conclusion: 

• (i)In WA.No.60 of 2022, the appellant is a secured creditor, who offered credit facilities to the Respondents 4 and 5, for which, mortgages were created in favour of appellant on 23.04.2013 vide document No.453 of 2013, on 18.08.2014 vide document No.2467 of 2014 and on 22.10.2015 vide document No.3168 of 2015. However, the Income Tax Department passed the order of attachment on 03.11.2015, for recovery of the tax dues, in respect of the properties over which mortgages were already created.

• (ii)In W.A.No.1249 of 2022, the appellant sought to quash the communication of the Respondent dated 27.12.2007 with respect to recovery of income tax arrears of M/s.NEPC Agro Foods Limited and its Directors, on the premise that mortgage in respect of the property, was executed in favour of the Bank on 31.03.1999 itself, i.e., prior to the recovery proceedings.

• (iii)In WA.No.1385 of 2022, the writ petitioner / Bank challenged the attachment notice dated 27.03.2017 issued by the Income Tax Department, in respect of the properties which were offered to them as security by way of mortgage by deposit of title deeds for securing loans on 10.02.2014. The learned Judge allowed the writ petition on the ground that the mortgage preceded the attachment.

• (iv)In WA.No.1512 of 2021, the appellant / Bank sought a direction to the first respondent – Tax Recovery Officer, Income Tax Department to remove the attachment made on 16.06.2017 and 23.07.2017 in respect of the properties, which were already mortgaged on 28.01.2016 and 07.02.2016, by the fourth and fifth Respondents to raise loan. 

30.2. In all these cases, the orders of attachment passed by the Tax Recovery Officer / Income Tax Department were subsequent to the mortgage created in favour of the secured creditors and hence, the same will have no legs to stand, in view of the principles laid above by this court. Therefore, the orders impugned in the writ appeals viz., WA Nos.1512/2021, 60/2022 and 1249/2022 and in the writ petitions, are quashed. Regarding WA No.1385 of 2022 filed by the Revenue, there is no necessity to interfere with the order passed by the

learned Judge.

 

# 31. Accordingly, all the Writ Appeals are disposed of. There shall be no order as to costs. Consequently, connected miscellaneous petitions are closed.

 

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