How Does GST Liability Impact Bankruptcy Proceedings?

The treatment of GST liability during bankruptcy or insolvency proceedings under the Insolvency and Bankruptcy Code (IBC) is critical, as it affects how much the government can recover from a company undergoing financial distress. GST dues, as a form of tax liability, have a significant role in the resolution or liquidation process. The way these dues are treated determines how they rank compared to other claims during insolvency.

Impact of GST Liability on Bankruptcy Proceedings

GST as an Unsecured Operational Liability

GST dues, like other taxes, are typically treated as unsecured operational liabilities during the insolvency process under the IBC. This means that GST dues are ranked lower in terms of priority compared to secured creditors and financial creditors.

The Insolvency and Bankruptcy Code (IBC) treats these dues as part of the larger group of operational debts, which also include payments to suppliers, service providers, and other operational expenses.

Filing Claims in Insolvency Proceedings

During the insolvency proceedings, GST authorities are required to file their claims just like any other creditor. The Insolvency Resolution Professional (IRP) will verify the claims and include them in the list of creditors.

GST dues will be considered alongside other operational creditor claims, and the Committee of Creditors (CoC) will review and decide how to treat these dues within the resolution plan.

Priority of GST Dues

Under Section 53 of the IBC, the distribution of assets in a liquidation scenario follows a waterfall mechanism. In this process:

• Secured creditors are paid first, followed by financial creditors.
• Unsecured operational creditors, including GST liabilities, are paid next, after the above creditors have been satisfied.
• GST dues are considered unsecured unless they are linked to a secured asset, in which case they might have priority based on the nature of the debt.

GST Dues During the Moratorium Period

Once insolvency proceedings are initiated, a moratorium is imposed, which prohibits creditors, including GST authorities, from initiating any new recovery actions.

During this moratorium, no legal action can be taken to recover outstanding GST dues, but GST authorities can file their claims during the resolution process, and their dues will be handled according to the final approved resolution plan.

GST Recovery After Liquidation

In the event that the company undergoes liquidation due to failed resolution, GST liabilities are treated as part of the unsecured debts.

Liquidators will distribute the available assets according to the waterfall mechanism. If the company's assets are insufficient to meet all claims, GST dues will likely receive only a partial payment, depending on the remaining funds after satisfying higher-priority debts.

GST authorities may receive a reduced payment if the available assets do not cover the full liability.

GST Liabilities Post-Insolvency

Any GST liabilities that accrue after the insolvency process has started are considered post-insolvency liabilities. These dues are not part of the existing claims under the insolvency process and must be paid as they arise.

For example, if the company continues operations during the insolvency process and generates sales or incurs further taxable transactions, the GST for such transactions will be treated as a fresh liability and must be settled separately from the pre-existing dues.

Impact on Resolution Plan

In a resolution plan, the Committee of Creditors (CoC) can propose a settlement for GST dues as part of the overall restructuring plan. This may involve partial payments or a structured settlement. However, the GST authorities must approve the resolution plan for it to be effective.

The resolution plan must balance the claims of GST authorities and other creditors, taking into consideration the company’s ability to repay and the financial health of the business post-resolution.

Example

Let’s assume XYZ Pvt. Ltd. is undergoing insolvency proceedings and owes ₹3 crore in GST and ₹2 crore in unpaid supplier dues. The company has also defaulted on its loans to financial institutions.

• The GST dues will be treated as unsecured operational liabilities, and the company will need to file them as part of the claims in the insolvency resolution process.
• During the moratorium, the GST authorities cannot take action to recover the dues, but they can file their claims with the Insolvency Professional.
• If the company’s assets are insufficient, the GST authorities will receive payment after secured creditors and financial creditors are paid.
• If the company enters liquidation, the liquidator will sell off assets and distribute the proceeds, with GST dues ranked lower than secured and financial creditors in the distribution process.
• The company may also continue generating GST liabilities during the moratorium period, which will be treated as new liabilities.

Conclusion

GST liabilities impact bankruptcy proceedings by being categorized as unsecured operational debts under the Insolvency and Bankruptcy Code (IBC). These liabilities are typically paid after higher-priority debts, such as those of secured and financial creditors. While GST authorities cannot initiate recovery actions during the moratorium, they can file claims and be involved in the resolution plan. The treatment of GST dues depends on the stage of the insolvency and the available assets, with payment being made from the proceeds of asset sales in liquidation. Understanding the priority and treatment of GST liabilities helps creditors, including tax authorities, navigate the insolvency process effectively.