The Insolvency and Bankruptcy Code (IBC) has been in force for over 5 years now and has, by and large, been a successful piece of legislation. However, as expected, given that IBC is a relatively new law, there have been teething issues stemming from a lack of synchronisation with other laws such as tax laws.

For example, to reduce the burden of conflicting claims and compliances under various laws, IBC provides a moratorium regarding various actions against the corporate debtor (i.e. the company undergoing insolvency) during the corporate insolvency and resolution process (CIRP).

Further, the IBC also provides that the code's provisions will override other laws. Thus, while in normal circumstances, the tax authorities are empowered to adjust a refund due to a taxpayer against any other pending tax demands of such taxpayer, such adjustment should not be allowed when the taxpayer is undergoing CIRP.

As per the IBC, a moratorium is imposed, among other things, on the execution of any judgment, decree, or order in any court of law, tribunal, arbitration panel, or other authority. Thus, no recovery should be made by the tax authorities by execution of any order.

However, in practice, since the tax authorities are often unable to recover tax dues from corporate debtors, the tax authorities have set off the refunds due to the corporate debtors against any pending tax demands, rejecting the stay application filed by the corporate debtors.

Under the IBC, amounts due to the government are treated as operational debts, which rank below-secured debts in the distribution waterfall. The purpose is lost if the tax authorities do not file for claims with a resolution professional unilaterally set off the refunds.

The idea behind the moratorium period is to pause/suspend the initiation/continuation of litigation against the corporate debtor. However, in practice, things are often quite different.

Suppose a lower authority has passed an order against the corporate debtor. In that case, the corporate debtor is at times under pressure to file an appeal against the same during the moratorium period since the fear is that:

(a) if the tax demand is treated as crystallised by the tax authorities, they may set off the refunds due to the corporate debtor; and

(b) the issues under consideration in the tax order decided against the corporate debtor may set an adverse precedent for future assessment years.

On the flip side, if an order has been passed favouring the taxpayer, the corporate debtor typically argues the tax authorities should file no appeal against the corporate debtor during the moratorium period. This puts the tax authorities in a difficult position as they cannot pursue a case that may finally result in a tax demand.

Post-approval of the resolution plan, the option to file a claim under IBC gets extinguished. However, all stakeholders, including tax authorities, are bound by the resolution plan, which allows the resolution applicant to run the company with a fresh slate.

Thus, if any tax is assessed to be payable after approval of resolution process by the corporate debtor as per assessment orders for which the tax authorities had not filed a claim with resolution professional, such tax claims should not be maintainable. In these cases, tax authorities have set off the refunds due to the corporate debtor against the tax demands.

While the introduction of IBC was certainly a step in the right direction, one hopes that in the forthcoming budget, some of the creases are ironed out to smoothen the insolvency process further.

—Abhay Sharma Abhay is a partner and Priyanka Jain is a senior associate in the tax practice at Shardul Amarchand Mangaldas & Co

Stay tuned for more union budget-related updates