What is the Treatment of Government Dues in Insolvency?

The treatment of government dues in insolvency is a crucial aspect of the Insolvency and Bankruptcy Code (IBC). Government dues, such as taxes, penalties, and other liabilities, are an essential consideration during insolvency proceedings because they can significantly impact the distribution of the company's assets among its creditors. Understanding how these dues are treated under the IBC helps clarify their priority and the rights of other creditors.

Treatment of Government Dues in Insolvency

Priority of Government Dues

Secured vs. Unsecured Government Dues: Government dues can be categorized into secured and unsecured liabilities. If the government holds any security interest (e.g., land, property), its dues may be treated as secured debts and paid out from the proceeds of the sale of those assets. Otherwise, government dues are usually considered unsecured debts.

Operational Creditors: Under the IBC, government dues related to operational creditors, such as unpaid taxes or penalties, fall under the category of unsecured creditors. Unsecured creditors typically rank lower than secured creditors in terms of repayment priority during insolvency proceedings.

Priority in Distribution of Assets

During the insolvency resolution process, the Insolvency and Bankruptcy Code (IBC) provides a clear framework for the distribution of assets. The priority of claims is based on a waterfall mechanism defined in Section 53 of the IBC.

The distribution follows this order of priority:

• Liquidation costs (such as fees for the Insolvency Resolution Professional (IRP))
• Secured creditors who have security interests
• Unsecured financial creditors (including banks and financial institutions)
• Operational creditors, including government dues
• Equity holders (shareholders) if anything remains

Therefore, government dues are generally placed in the fourth position after secured creditors and financial creditors, which means they receive payment after secured creditors are satisfied.

Tax Liabilities and Penalties

Tax Liabilities: Taxes owed to the government, such as income tax, GST (Goods and Services Tax), and custom duties, are typically treated as unsecured operational claims under the IBC. These are paid out only after the satisfaction of secured creditors and financial creditors.

Penalties and Fines: If a company owes penalties or fines to the government, these dues are also considered unsecured and fall under the category of operational creditors. In many cases, penalties are ranked lower in terms of payment priority compared to other government dues that may be related to taxes or dues arising out of statutory obligations.

Government's Role in Insolvency Resolution

Right to File Claims: The government, like any other creditor, has the right to file claims during the insolvency resolution process to recover its dues. These claims can be for taxes, penalties, or other government liabilities.

Regulatory Oversight: While the government is treated as a creditor, it may also have regulatory powers that influence the resolution process, particularly if the company is subject to regulatory frameworks or compliance requirements, such as environmental laws, or if the dues relate to public funds.

Impact of Insolvency on Government Dues

Waiver or Reduction: In some cases, during the resolution process, the government may be involved in discussions on the settlement of dues, and waiver or reduction of certain government dues (such as penalties or taxes) could occur as part of the resolution plan. This is typically part of the negotiations between the insolvency professional and creditors.

Tax Compliance: If the company is undergoing liquidation, outstanding tax dues may be partially paid based on the available assets after fulfilling the claims of higher-priority creditors.

Example

Let's say ABC Pvt. Ltd. is going through insolvency proceedings under the IBC due to its financial distress. The company owes the government ₹10 crores in unpaid GST, income tax, and penalties. In this case:

• The government will be treated as an unsecured creditor and will be paid after the repayment of dues to secured creditors and financial creditors.
• If the company undergoes liquidation, the available assets will first be used to pay the costs of the insolvency resolution process and secured creditors (such as banks or financial institutions that have security interests). Any remaining assets will be distributed among unsecured creditors, including the government.
• Tax dues may be prioritized over penalties, and in some cases, the government may reduce or waive some fines if the company presents a viable resolution plan.

Conclusion

Government dues, such as taxes and penalties, are treated as unsecured claims under the Insolvency and Bankruptcy Code (IBC) during insolvency proceedings. They are paid after secured creditors and financial creditors are satisfied, typically placing them in a lower priority for repayment. However, in certain cases, the government may agree to a waiver or reduction of these dues as part of the resolution plan. Understanding the priority of claims and the role of government creditors is vital in assessing the impact of insolvency on a company's financial recovery.