In Collecting Dues, Taxmen Can Jump Queue

When a firm starts sinking, creditors start queuing up to recover their dues. Though the government is by nature slow its departments have shown that they can get their act together and claim their dues on grounds of sovereign power and public interest. They have succeeded, as the courts have accepted these strong arguments.

The Supreme Court last month affirmed the right of the revenue authorities to recover sales tax arrears from a sick firm ahead of other secured creditors. Neither the private debtors nor even the nationalised banks can take precedence over the taxmen, according the judgment in Dena Bank vs Bhihabhai Parekh.

 

In this case, Dena Bank filed a suit for recovery of a sum due to it from the firm on a mortgage. Meanwhile, the Karnataka sales tax department tried to attach and sell the mortgaged properties. The receiver appointed for the firm resisted the attempt of the authorities. The government then bought the mortgaged properties in auction. The bank in turn impleaded the government in its suit against the firm. The district court ruled that the bank will have priority in recovering the dues. But the high court reversed the finding. Therefore, the bank appealed to the Supreme Court.

The bank argued that the claim of the ST authorities cannot precede its charge on the properties as it was a secured creditor. It further argued that the property belonged to the partners while the ST arrears were the burden on the firm, which is a separate entity.

The Supreme Court held that the doctrine of priority of state's debt has been recognised by the courts from the British days. This also has the approval of Article 372(1) of the Constitution which says that the laws in force at the time of the coming into force of the statute will continue to be operative. The principle is founded on the rule of necessity and public policy. The basic justification for the claim for priority rests on the well-recognised principle that the state is entitled to raise money by taxation.

"Unless adequate revenue is received by the state, it would not be able to function as sovereign government at all," the court explained. "It is essential that as a sovereign, the state should be able to discharge its primary governmental functions efficiently. It must be in possession of necessary funds and this consideration emphasises the necessity and wisdom of conceding the state the right to claim priority in relation to its tax dues."

The court, however, laid down an exception. The principle would not apply in the case of debts due to the state if they are contracted by citizens in relation to commecial activities which may be undertaken by the state for socio-economic good. In other words, welfare activities, not basic to governmental functions, are not covered by this principle.