What Happens to Pending Tax Disputes in Case of Insolvency?

When a company enters insolvency or bankruptcy, the treatment of pending tax disputes becomes a significant issue in the resolution process. Under the Insolvency and Bankruptcy Code (IBC), tax disputes and tax liabilities are handled according to specific provisions, and the process for resolving them differs based on whether the company is undergoing a Corporate Insolvency Resolution Process (CIRP) or liquidation.

The tax authorities and creditors, including the government, play a vital role in determining how outstanding tax disputes are treated in insolvency proceedings.

Impact of Insolvency on Pending Tax Disputes:

Tax Liabilities in CIRP:

When a company enters insolvency and the CIRP is initiated, the tax authorities may file their claims as part of the overall creditor claims. The treatment of these claims depends on whether they are considered operational debts or financial debts.

Operational debts, including tax dues, are typically given priority over unsecured financial debts but are subject to the decision-making process of the Committee of Creditors (CoC), which decides whether the company should undergo a resolution or liquidation.

Pending tax disputes are typically put on hold during the CIRP. This means that no further action will be taken by the tax authorities to recover the disputed amount until the insolvency process has been resolved. However, this does not mean the tax dispute is dismissed.

Resolution Plan and Tax Disputes:

The resolution plan developed during the CIRP may address how pending tax disputes should be handled. The Committee of Creditors (CoC) may negotiate with the tax authorities to settle the tax liabilities as part of the resolution plan.

The resolution plan can include provisions for payment or settlement of the disputed tax claims. If the company is revived through a resolution plan, part of the agreement could involve the compromise or settlement of pending tax disputes.

Tax disputes that are unresolved and pending for adjudication during the resolution process may continue to be litigated, but the IBC framework provides a timeline for resolving such disputes to avoid unnecessary delays in the process.

Tax Claims During Liquidation:

If the company enters liquidation, the liquidator takes control of the company’s assets and is responsible for settling all outstanding liabilities, including tax claims. In liquidation, the tax authorities can file their claims as part of the process.

Tax liabilities, including the amounts disputed but not yet settled, are treated as unsecured claims in the liquidation process. These claims are ranked along with other unsecured creditors.

The liquidator may try to reach a settlement with the tax authorities to resolve the disputes. If an agreement is reached, the disputed taxes could be paid as part of the liquidation process.

Effect of Ongoing Tax Litigation:

Even during insolvency, pending tax litigation can continue, especially if the disputes involve the valuation of assets or interpretation of tax laws. However, the IBC does not prevent the tax authorities from pursuing litigation.

If the tax dispute has reached a certain stage of litigation, such as a high court or appellate court case, the resolution of the dispute may need to be completed before the final settlement of the company’s liabilities under the IBC.

In such cases, the Resolution Professional (RP) will work with the tax authorities and creditors to ensure that the resolution plan accounts for potential tax liabilities or judgments resulting from the ongoing litigation.

Tax Claims as Part of the Resolution Process:

Tax claims are usually treated as operational debts, and their settlement will be part of the negotiations during the CIRP. This includes disputes over corporate tax liabilities, GST claims, and other pending tax-related matters.

The Resolution Professional may have to negotiate with the tax department to include pending tax disputes as part of the resolution plan and may seek to reach a settlement or compromise for these claims.

Priority of Tax Claims:

Under the IBC, tax liabilities, including penalties or interest, are treated as operational debts and typically ranked lower than secured financial creditors. However, the tax authorities may still claim priority over some other debts depending on the nature of the liability.

Tax authorities may also participate in the CoC and have the right to vote on the resolution plan.

Stay on Tax Recovery:

The IBC provides for a moratorium during CIRP, which halts any collection efforts, including recovery by tax authorities. This moratorium prevents the tax authorities from pursuing recovery of dues during the resolution process.

However, the moratorium does not cancel the tax disputes or liabilities; it simply stops the collection actions during the ongoing insolvency resolution process.

Example:

Example 1:

A company facing insolvency has several pending tax disputes regarding unpaid GST and income tax claims. During the CIRP, the tax authorities file their claims with the Resolution Professional. The Committee of Creditors (CoC) reviews these claims and negotiates with the tax authorities to settle the disputed amounts. The resolution plan is approved, and the tax liabilities are restructured as part of the resolution process.

Example 2:

A company enters liquidation after failing to resolve its tax disputes. The liquidator takes over the company’s assets and settles various creditor claims, including those of the tax authorities. The disputed tax claims are treated as unsecured debts and are settled based on the available assets. If the dispute is still unresolved in court, the tax authorities and the liquidator work together to resolve the litigation.

Conclusion:

Pending tax disputes in an insolvency case are handled with due regard to the IBC’s framework. These disputes are typically suspended during CIRP under the moratorium and can be addressed as part of the resolution plan. In liquidation, tax disputes are treated as unsecured claims and settled in accordance with the liquidation process. The tax authorities can continue pursuing litigation, but the insolvency proceedings take precedence in determining the final settlement of the company’s liabilities.