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28 May 2019

Director’s liability under the Income tax law – An insight

by Bharathi Krishnaprasad

It may be enticing to hold a directorship position in a corporate house. However, should the roofs descend someday, it becomes equally undesirable. The same tag potentially becomes an albatross around the neck. In such scenarios, while the liability of a shareholder is limited to the sums invested in the company or the sums agreed to be invested, in certain instances, the liability of a director can become unlimited.  The fiction of ‘separate legal entity’ of a corporate form, sometimes, by legislation to contrary, does very little to shield the men and women behind its veil. Legislations in India impose various liabilities on the director for any wrongdoing by a company, fairly enough, since those at the helm of decision making cannot be left scot-free, leaving government remediless.

The Income Tax Act, 1961 (‘IT Act’), vide Section 179, imposes joint and several liabilities on every director of a private company[see endnote 1] for recovery of tax dues, should the same not be recoverable from the hands of the company. Upon the section becoming applicable, the directors would step into the shoes of the company as an Assessee for the purposes of payment of all taxes due under the IT Act from the company[see endnote 2]. Thereafter, the provisions of the IT Act, specifically, those relating to recovery would apply on the director as they were applied on the assessee company.

Such a provision was introduced for the first time in the IT Act, from 1st April, 1962, there being no pari materia provision present in its predecessor legislation.[see endnote 3] When the section was first introduced, it was only made applicable to companies that were being wound up, in that, only directors of companies that were liquidated were covered by the Section. With effect from 1st October, 1975[see endnote 4], applicability of the section was extended to all private companies in scenarios where recovery of tax demands against such companies did not yield results. This Article addresses certain aspects relating to liability of directors under the IT Act.

 

Scope of the section - public company v. deemed public company v. private company

From a plain reading of Section 179 of the IT Act, it appears that directors of public companies are not covered by the rigors of the section. Even companies that are deemed to be public companies under the Companies Act[see endnote 5] would be outside the purview of application of Section 179 of the IT Act[see endnote 6]. However, where the affairs of a company, incorporated as public limited company are arranged in such a way so as to defraud the revenue and the surrounding circumstances merit disregarding the legal structure, then, the Income tax authorities would have the power to lift the corporate veil and treat the directors of such a company as liable under Section 179 of the IT Act[see endnote 7]. With the enacting of anti-avoidance provisions[see endnote 8] in the statute, such a power now flows to the Income tax authorities, from the provisions of the statute itself.

 

Who can be made liable?

The liability under Section 179 will lie on every person who was, at any point in time, a director of that company for the previous year in respect of which the taxes are sought to be recovered.  To illustrate, if Mr A was a director during the financial year 2018-19, and additional tax demand in respect of that financial year is raised pursuant to a tax assessment that is completed in 2021, Mr A can be held liable under Section 179, even if he had resigned from directorship in 2020.  Further, even those individuals who have resigned from directorship during the relevant previous year or those individuals who were inducted into the directorship during the year would be covered by the provision.  The provisions would equally apply to nominee directors or directors appointed by interested parties like lender/ technology partner, etc.

 

When would the liability trigger?

Suffice it is to say, that the directors’ liability would get triggered only in scenarios where the Income tax authorities establish that attempts made to recover from the company have gone in vain[see endnote 9]. Where no attempt was made to recover the tax due from the debtors of and shares held by the company, it was held by the Hon’ble Allahabad High Court that seeking to make the director liable under Section 179 of the IT Act would not be valid.[see endnote 10]

It is also to be noted that private contracts would not override the statutory requirement.  The Managing Director assuming all responsibilities under section 179 of the Act in a contract with the other directors will not absolve the directors from liability under the section. The Revenue Authorities will have recourse to recover the tax dues from all the directors, irrespective of the agreement amongst them.

 

Section not to apply when duty performed with due diligence

The charge created on the directors vide Section 179 is however, not sacrosanct, in that, should any director be able to demonstrate that non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to affairs of the company, then, there will not be any liability cast on the director. Needless to say, this would depend largely on the surrounding facts and circumstances of the case and the factors giving rise to the demand of tax.  Though the responsibility to establish that the non-recovery of dues from the company cannot be attributable to the gross neglect, misfeasance or breach of duty by the director is on the director himself[see endnote 11], the Gujarat High Court[see endnote 12] had held the Revenue Authorities hold an equal responsibility to prima facie form a belief that the non-recovery is attributable to the gross neglect, misfeasance or breach of duty by the directors[see endnote 13]. 

The section, strangely, does not restrict its applicability to directors in charge of accounting or finance, but casts the net wide.  The Hon’ble Gujarat High Court[see endnote 14] held that merely because an individual is a technical director, that would, ipso facto, not mean that liability cannot be enforced on that director under Section 179 of the Act.  It is imperative on every director to establish that there was no gross neglect, misfeasance or neglect of duty on this part.  Even director who is a foreign citizen can be held liable under the section. 

However, where the recovery of taxes from the company was impossible due to the assets of the company being under the possession of lender,[see endnote 15] or where civil disputes relating to recovery of dues of the company are pending before judicial forums,[see endnote 16] a director cannot be held liable for non-recovery of taxes of the company. 

 

Sums that can be recovered - ‘tax due’ meaning of

Another interesting aspect to note is that the provisions Section 179, until its amendment vide Finance Act, 2013, did not contain any definition for the term “taxes due”. In the absence of definition for the term “taxes due”[see endnote 17], the Courts opined that the director’s liability is limited only to income tax due and that it cannot extend to interest and penalty[see endnote 18]. To plug this loophole, the Finance Act, 2013 amended the Section to include a definition of the term “taxes due”. Taxes due, with effect from 1st June, 2013[see endnote 19] includes penalty, interest and any other sum due under the Act. It is pertinent to note that there was no express retrospective application of the said amendment. A question that needs to be deliberated here is whether this amendment will apply for qua any orders passed after that date or whether this amendment would apply only with respect to assessment years after that date i.e AY 2014-15 onwards.

In a question before the Hon’ble Kerala High Court[see endnote 20] on whether Section 179 would have application for previous years prior to coming into force of that Section and when no pari materia provision existed in the predecessor legislation, it was ruled that no liability under Section 179 can be invoked on the directors for any previous year prior to coming into force of the Act of 1961 from 1st April, 1962.

When Section 179 was amended with effect from 1st October, 1975 to include all companies and not just companies that are wound up, a question arose before the Hon’ble High Court of Calcutta.[see endnote 21] as to whether director of a company that is not in liquidation during assessment years 1968-69 to 1974-75 can be fastened with liability to pay tax. The Court answered in the negative and held that no liability would arise on the director, absent retrospective effect given to the Section, for financial year 1974-75 or any earlier year. A different view was, however taken by the Bombay High Court, which held the amendment from 1st October, 1975 would have a retrospective application. The Court ruled so upon a combined reading of subsection (1) and (2) to Section 179[see endnote 22] and held that while provisions of sub-section (2) were expressly made applicable from 1st April, 1962, one cannot, sans harmony read that sub-section (1) would operate only prospectively.  That ruling by the Hon’ble High Court of Bombay was weighed, therefore, by the specifics of the amendments made with effect from 1st October, 1975.

It is an accepted principle that the law that exists on the beginning of the Assessment Year would prevail for making assessment qua that year. Section 179 is in itself a charging section that creates liability on the directors for tax dues by a company. Earlier such a liability was existing only qua the tax component and it was only by an amendment from 1st June, 2013 that it has been extended to levy of penalty and interest as well. This amendment has not been expressly made retrospective and has been expressly made applicable only from 1st June, 2013. Section 179 is also not like provisions of tax deducted at source which are transaction based and can apply from any given date. As such, it is not only logical but also within the spirit of law, to interpret that the Section would apply only qua assessment years that begin on or after 1st June, 2013 i.e. only from AY 2014-15.

 

Precautions to be taken by directors

Therefore, as already stated, proving the director as not liable under Section 179 would largely depend on the facts and circumstances of case. But, such reasons need to be built after identifying the reasons that have led to the company’s financial position and after analysing the underlying causes that give rise to tax demand. The extent of actual participation by the director in decision making, the assent or dissent given for any resolutions at the Board meeting and the specific roles and responsibilities assigned to and actually carried on by the Director would be relevant. It should be kept in mind that what is required to be demonstrated is the fact that the non-recovery was not due to gross neglect, misfeasance or breach of duty on part of director. Therefore, identifying the factors for the inability of the company to not pay the tax dues and addressing the same would be crucial.

[The author is a Principal Associate, Direct Tax Practice in Lakshmikumaran & Sridharan, Chennai]

Endnotes:

  1. As defined in Section 2(68) of the Companies Act, 2013.
  2. Section 2(7) of the Act defines an assessee to mean a person by whom any tax or any other sum of money is payable under this Act
  3. The Indian Income Tax Act, 1922
  4. Taxation Laws (Amendment Act), 1975
  5. The Companies Act provides that any private company that is a subsidiary of a public company will be deemed to be a public company.
  6. M.Rajamoni Amma v. Dy CIT [1992] 195 ITR 873 (SC); Suresh Narain Bhatnagar v. ITO [2014] 367 ITR 254 (Guj)
  7. Ajay Surendra Patel v. DCIT [2017] 394 ITR 321 (Guj.)
  8. Anti-avoidance provisions are contained in Chapter XA of the Act
  9. Madhavi Kerkar v. ACIT [2018] 403 ITR 157 (Bom.)
  10. Smt.Prathiba Garg v. CIT [2014] 264 CTR 520 (All.)
  11. M.R. Sundararaman v. CIT [1995] 215 ITR 9 (Mad.)
  12. Ram Prakash Singeshwar Rungta v. ITO [2015] 370 ITR 641 (Guj.)
  13. It may be noted that order making a director liable under Section 179 is not an appealable order
  14. Suresh Narain Bhatnagar v. ITO [2014] 367 ITR 254 (Guj.)
  15. Jashvantal Natverlal Kansara v. ITO [2014] 367 ITR 254 (Guj.)                                                           
  16. Gul Gopaldas Daryani v. ITO [2014] 367 ITR 558 (Guj.)
  17. The term “tax” is defined in Section 2(43) of the Act to mean income tax and super tax chargeable under the provisions of the Act.
  18. Maganbhai Hansrajbhai Patel v. ACIT [2013] 353 ITR 567 (Guj.); Hemendra Sakarlal Gandhi v. ITO [2013] 216 Taxman 98 (Guj.)
  19. Memorandum to Finance Bill, 2013 specifies that this amendment will take effect from 01.06.2013
  20. Ratanlall Murarka v. ITO [1984] 145 ITR 433 (Bom)
  21. Smt. Bidya Devi v. CIT [2000] 113 Taxman 378 (Cal)
  22. UoI v. Manik Dattatreya Lotlikar [1987] 35 Taxman 526 (Bom)

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