An ever-present concern for purchasers or transferees in any transaction, be it an acquisition of immovable property or a share purchase, is the furnishing of a 'no dues certificate' or No Objection Certificate ('NOC') by the seller or transferor under Section 281 of the Income-tax Act, 1961 ('IT Act'). The said NOC draws its importance on account of the far-reaching powers granted to the Income-tax Department under Section 281 of the IT Act.
In order to understand the context of the operation of Section 281, reference must first be made of Section 222 of the IT Act which lays down the mechanism for the recovery of taxes. The said provision lays down that where a taxpayer is in default or is deemed to be in default in making the payment of income-tax, the Tax Recovery Officer ('TRO') may draw up a 'certificate' for the recovery of the tax dues inter-alia by way of the attachment and sale of such defaulting taxpayer' property. The first step after the issuance of such 'certificate' under Section 222 of the IT Act is the issuance of notice under Rule 2 of the Second Schedule to the IT Act. Vide this notice issued under Rule 2 of the Second Schedule the defaulter is required to pay the amount specified in the 'certificate' issued by the TRO within fifteen days from the date of service of the notice and is intimated of the steps which would be taken to realise the tax dues.
To ensure that taxpayers are unable to frustrate the aforesaid tax recovery process by simply transferring the property owned by them for little or no consideration, the IT Act also contains Section 281. The said provision empowers the Department to declare a transfer as void where the transferor, during the pendency of any proceedings under the IT Act or completion thereof, but before the service of notice under the Second Schedule by a TRO, creates a charge on, or parts with the possession of any of his 'assets' in favour of another person. Such transfer can be by way of a sale, mortgage, gift, exchange, or any other mode of transfer whatsoever.
It is important to note that it is a settled law1 that the Department cannot unilaterally declare the transfer void without first obtaining a decree to this effect from a civil court.
The circumstances in which a transfer cannot be declared void under Section 281, are provided under the proviso to sub-Section (1) of the said provision:
(a) Where the transfer is carried out for adequate consideration and without notice of the pendency of such proceeding or without notice of the tax or other sums payable by the transferor under the IT Act; or
(b) Where NOC is issued by the jurisdictional Assessing Officer ('AO') of the transferor.
The procedure for obtaining NOC in relation to Section 281 is provided by CBDT in its Circular2. The Circular requires the transferor to, inter alia, seek stay for disputed demands and also indemnify the remaining outstanding demands. Considering the liabilities fastened in cases involving outstanding demands, while transferee may insist on NOC from AO as a matter of routine, the transferor may want to analyse their actual liability to obtain the certificate.
Given the far-reaching consequences of the provision for the transacting parties, the scope of Section 281 becomes a bone of contention in high stake transactions. In the subsequent paragraphs, we have sought to highlight a few practical issues that may be faced by the parties to a transfer in light of the said provision.
Whether NOC required in case of all transfers?
It is manifest from the plain reading of the provision that NOC is required to be obtained only in cases where there is any pendency of proceedings or where completion of such proceedings has resulted in a demand against the taxpayer.
As a natural corollary, where there are no proceedings or demand under the IT Act, the transferor may not be required to obtain any approval from the income-tax department. Practically, demonstrating this conclusion can be challenging. Given the sensitivity of the financial information, the transferor may not be forthcoming to allow the transferee to access to its income-tax portal. The parties in such cases can consider obtaining certification to capturing the status of proceedings and demands to decide the requirement of obtaining NOC from income-tax department.
Proviso to Section 281(1) - Bona fides must be established by transferees to avail protection of this provision
As stated above, the proviso to sub-section (1) of Section 281 of the IT Act provides a safeguard to genuine transactions by laying down that a transfer shall not be declared void if the following conditions are cumulatively satisfied:
(a) It is made for adequate consideration; and
(b) It is made 'without notice of the pendency of proceedings' under the IT Act or 'without notice of such tax payable or other sum payable' by the transferor.
With respect to the first condition, it may be noted that the expression 'adequate consideration' has not been defined. There are certain special provisions in the IT Act which provide fair market value in respect of certain properties for computation of income. As an illustration, reference may be made to the provisions of Section 56(2)(x) of the IT Act which provides a mechanism to compute fair market value for immovable property, shares and securities and certain other properties. It will be interesting to see if the taxman will accept fair market value as provided in similar provisions as 'adequate consideration'.
Regarding the second condition, what must be seen is who is the party to a transaction who must have notice of the pendency of proceedings or of tax liability in order for the said condition to be satisfied. Common sense would dictate that the said condition must be seen vis-à-vis the transferee and not the transferor, because the latter would be presumed to be aware of any proceedings or liabilities pending against them under the IT Act.
The said question has been conclusively answered by the High Court of Gujarat in its judgment in Karsanbhai Gandabhai Patel3. Therein, the High Court held that notice of pendency of proceedings must not only be served on the transferor but must also be served on the transferee. Furthermore, in Rekhadevi Omprakash Dhariwal4, the High Court of Gujarat held that a bona fide purchaser for an adequate consideration who has conducted due diligence cannot be made to suffer under Section 281 of the IT Act for tax dues in the name of transferor.
While it may be tempting to conclude on the basis of the said decisions that even in the absence of NOC the Department would be left without a recourse under Section 281 of the IT Act by simply pleading that the transferee did not have knowledge of the proceedings or income-tax liabilities of the transferor, it is advisable that transferees should maintain the proper documentation evidencing that:
(a) The consideration paid by them for the transfer is 'adequate'. This may be done by obtaining valuation reports from experts; and
(b) Proper due diligence was indeed carried out by them to ascertain whether there were any pending proceedings or income-tax liabilities of the transferor.
Section 281(2) - Transferees should operate cautiously for the determination of transferor's potential liability
As per its sub-section (2), Section 281 of the IT Act only applies when inter-alia the amount of tax or other sums payable or likely to be payable exceeds INR 5,000. While the threshold provided under Section 281(2) regarding the 'amount of tax or other sum payable or likely to be payable' is low, a question which still arises is how the potential tax liability may be determined when proceedings are pending against the transferor.
For instance, if proceedings are pending against the transferor, wherein the issues under consideration by the authorities may be covered by judicial precedents in favour of the transferor, the transferor may be of the view that the said proceedings would end up in a favourable outcome. The said view may also be corroborated by legal opinions.
However, even in such circumstances, especially keeping in mind the low threshold of tax liability under Section 281(2) of the IT Act, a transferee may want to insulate itself from the risk under Section 281 by insisting on an NOC issued by the AO.
Creation of charge or transfer of property - Determination of whether charge is created or not in case of transferable development rights
As discussed above, Section 281 is attracted when a taxpayer 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 their assets. Thus, a question which may arise is what happens when possession is handed over or charge is created in an asset which, per se, may not result in transfer of title in the asset.
An instance of this may be where a landowner may have transferred developmental rights to a real estate developer under an agreement ('Development Agreement'). In such a situation, while the land itself may not be transferred in the first instance, the landowner may part with the possession in favour of the developer.
In such instances, where the landowner does not pay its tax dues, the Department may invoke Section 281 to declare the Development Agreement as void under by claiming that the landowner had parted with the possession during the pendency of proceedings under the IT Act. Thus, in addition to other tax considerations, the Development Agreement should also be drafted keeping in mind the implications under Section 281 of the IT Act.
Meaning of 'asset' - Slump sale transactions
Keeping in mind its simplicity from a regulatory perspective, a common mode utilized by parties for a business transfer is a 'slump sale', which is defined in Section 2(42C) of the IT Act to mean 'the transfer of one or more undertaking, by any means, for a lump sum consideration without values being assigned to the individual assets and liabilities in such transfer.'
The term 'undertaking' is in turn defined in the Explanation to Section 2(19AA) to include 'any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.' As is clear from the above-mentioned definition of 'undertaking' and the numerous judicial precedents regarding 'slump sale', individual assets such as land, building, plant and machinery etc. would not constitute an 'undertaking' for the purposes of the IT Act and rather, all of such assets taken together along with the liabilities, if any, of a business would constitute an 'undertaking'.
However, as per the Explanation to Section 281, the term 'asset' is defined to mean '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 taxpayer. Hence, the definition of the term 'asset' under Section 281 of the IT Act is an exhaustive one.
Therefore, a question which arises in the light of the aforesaid definitions is whether Section 281 would apply in the case of a slump sale where an 'undertaking' is transferred as a going concern.
The scheme of taxation of transfer of an undertaking by way of slump sale was introduced vide Finance Act, 1999 with effect from 1 April 2000. Prior to this amendment, the Courts had understood slump sale as a sale of business as a whole-lock, stock and barrel without values being assigned to individual assets5. Even post amendment, the transfer by way of slump sale is understood to be transfer of an undertaking as opposed to transfer of individual assets.
Given the aforesaid, the transferor may want to explore the possibility of arguing that 'undertaking' is not included as a class of asset and ergo there is no requirement to obtain NOC in case of business transfer. Per contra, transferee may want to safeguard its interest and may contest that requirement to obtain NOC is triggered by transfer of specified assets. It may be contested that such transfers may be a result of individual asset transfer or a business transfer. However, the inclusion of such assets in any scheme of transfer may trigger the requirement to obtain NOC.
Conclusion
In light of the aggressive approach adopted by the tax authorities to collect their fair share of taxes, the taxpayers may want to ensure their compliance with the requirement of Section 281 of the IT Act. While there may be various contractual safeguards to protect the interest of acquirers, the powers available under Section 281 may have the effect of unsettling the contractual rights and may have far reaching consequences for the contracting parties. Given the multi-faceted issues surrounding Section 281 of the IT Act, the parties may want to tread with caution before taking any legal position in relation to the said provision.
Footnotes
1.TRO v. Gangadhar Vishwanath Ranade, 1998. 234 ITR 188 (SC)
2. Circular No. 4 of 2011
3. Karsanbhai Gandabhai Patel v. TRO, 2014. 43 taxmann.com 415(Gujarat)
4. Rekhadevi Omprakash Dhariwal v. TRO, 2018. 96 taxmann.com 84 (Guj.)
5. West Coast Chemicals and Industries Ltd., 1962. 46 ITR 135, 142 (SC)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.