High Court quashes tax recovery fastened on the Director of a delinquent company
 

In a recent case¹, the Hon’ble Bombay High Court quashed the order passed by the Income-tax Authority under Section 179(1) of the Income-tax Act, 1961 (ITA) (the Act) against the Ex-director (petitioner or ex-Director) of the assessee company. The impugned order by the Income-tax department sought to recover the tax payable by the assessee company from the petitioner as per Section 179(1) of the Act. This alert summarizes the key aspects of the aforesaid judgment in the paragraphs below:
 

Facts of the Case

 

• The Income-tax department passed an order against the Ex-director of the assessee company, namely, Kaizen Automation Private Limited, on 18 March 2019 under Section 179(1) of the Act holding the Ex-director liable for taxes allegedly due from the assessee company for assessment years 2008-2009 and 2009-2010.
• The Petitioner, i.e., Ex-director, submitted that the management and the real control of the assessee company were in the hands of the six Directors appointed by the joint venture partner (who held 74% stake) and the other two Directors being the petitioner and his wife.
• The petitioner also submitted that the decision regarding the assessee company’s accounts and/or audits was solely in the control of the Board of Directors appointed by the majority joint venture partner.
• The petitioner also submitted that the joint venture agreement and the other antecedent documents provided that the joint venture partner had not only reserved the absolute right, power, and control over the decision taken in respect of its 74% shareholding in the assessee company but had also taken a right over power, control, and authorization of the petitioner and his wife’s shareholding in the company, aggregating to 26%.
• The petitioner submitted that he and his wife were name-sake Directors and were removed from directorships in January 2009. Thereafter they had no access to the assessee company’s books, accounts, and affairs.
• The Income-tax department submitted that the assessee company during the assessment years under consideration, the assessee company, being a private company, had received large sums of money as share application money or share premium, which would not have been possible without the involvement of its Directors. Therefore, they further submitted that the petitioner being Director of the private company at the relevant assessment years, was jointly and severally liable for the tax payment to the assessee company.

 

Hon’ble High Court Judgment

 
After hearing the submissions made by Petitioner and Respondents, the division bench of the Hon’ble High Court held as follows:  

• The Hon’ble Court noted the judgments of Satish D. Sanghavi vs Union of India (2012) 25 taxmann.com 328 (Bombay) and Narinder Singh vs Union of India 2019 (367) ELT 775, according to which it is settled position of law that in the absence of any specific provisions in the statute, duty, or penalty liability of the company cannot be recovered from its Director, who is not personally liable towards the liability of the company. However, a perusal of Section 179(1) of the Act shows that it provides an escape route to the Director. It says that where a director proves that non-recovery of tax dues cannot be attributed to any gross neglect, misfeasance, or breach of duty on his part in relation to the affairs of the company, he shall not be liable for payment of tax dues.
• The Hon’ble Court noted that the legislature, in its wisdom, had used the words “gross neglect” and not mere neglect on the part of the Director. The Hon’ble Court referred the judgment² by the Hon’ble Gujarat High Court on a similar issue, wherein it was held that gross negligence etc., is to be viewed in the context of non-recovery of tax dues of the company and not with respect to the general functioning of the company.
• The Hon’ble Court noted that the Income-tax department had not demanded the tax dues when the petitioner was Director of the assessee company. Moreover, a perusal of records shows that the Income-tax department merely proceeded on the basis that the petitioner was a Director during the assessment years and failed to really consider whether there was any gross neglect or misfeasance for breach of duty on his part in relation to affairs of the company, “in the context of the non-recovery of tax dues.” In such a situation, it is difficult to sustain the impugned order of tax recovery passed by the Income-tax department against the Ex-director.
• The Hon’ble Court held that having brought on record material to show the lack of financial control, lack of decision-making power, and having a very limited role in the assessee company even as Director and the entire decision-making process being with the Directors appointed by the controlling shareholder (being the single largest shareholder of the assessee company), in our opinion, petitioner has sufficiently discharged the burden cast upon him in terms of Section 179(1) of the Act to absolve him from the liability thereunder.
• The Hon’ble Court also stated that the state’s action must be conducted within a reasonable period. Delay in adjudication defeats the very purpose of the legal process, and the assessee as a taxable person must know where he stands and if there is no action from the departmental authorities for a long time, such delayed action would be in contravention of procedural fairness and thus will violate the principles of natural justice. In the present case, the Income-tax department has initiated action after a long period of about eight years. Therefore, the said action, resulting in impugned orders, vitiated the touchstone of procedural fairness too.