Author: Urishtha Bhatnagar, Manipal University Jaipur
To the Point
In SBI v. Tax Recovery Officer, the Madras High Court clarified the interplay between the Income Tax Act, 1961, the SARFAESI Act, 2002, and the Recovery of Debts and Bankruptcy Act, 1993. The Court held that tax recovery by the State, being a sovereign function, enjoys constitutional priority over private debts. Consequently, any mortgage created during the pendency of income tax proceedings is void under Section 281 of the IT Act, irrespective of the rights claimed by secured creditors under SARFAESI.
Abstract
This case arose from a challenge to the order of the Tax Recovery Officer declaring a subsequent mortgage by the borrower in favour of the State Bank of India as void. The mortgage had been created after the attachment of the property for tax default.
The High Court examined whether SARFAESI provisions granting overriding powers to secured creditors could supersede Section 281 of the IT Act, which invalidates transfers made during pending income tax proceedings. Justice S.M. Subramaniam upheld the IT Department’s stance, emphasising the doctrines of priority of crown debts and constitutional priority. The Court reiterated that recovery of taxes is a sovereign obligation recognised under the Constitution and thus takes precedence over private debt recovery mechanisms.
Use of Legal Jargon
Section 281, Income Tax Act, 1961 – Invalidates any transfer or creation of an interest in property during the pendency of income tax proceedings, unless with prior permission.
Caveat Emptor – Imposes a duty on secured creditors to verify the existence of pending tax claims before accepting security.
Doctrine of Priority of Crown Debts – Grants the State priority in recovering debts owed to it over other creditors of equal standing.
Doctrine of Constitutional Priority – Recognises debts traceable to constitutional provisions (like taxes) as superior to statutory claims under other enactments.
Sections 34 RDDB Act & 35 SARFAESI Act – Provide overriding effect, but only in case of inconsistency with other laws.
The Court clarified that sovereign tax claims do not conflict with SARFAESI provisions but instead operate in a different domain, giving them primacy.
The Proof
The borrower’s property was attached for tax default by the IT Department.
SBI accepted a mortgage over the same property after the attachment.
The Tax Recovery Officer declared the mortgage void under Section 281 IT Act.
SBI argued that SARFAESI’s overriding provisions protected its secured creditor rights.
The Court held that since the mortgage was created after tax proceedings commenced, Section 281 rendered it void.
Secured creditors are expected to conduct due diligence and cannot claim ignorance of pending tax liabilities.
Case Laws
Builders Supply Corporation v. Union of India (1965) – Constitution Bench held that the Government enjoys priority for recovery of tax dues over other unsecured creditors.
Union of India v. Somasundaram Mills (1985) – Reiterated the priority of crown debts in Indian jurisprudence.
Central Bank of India v. State of Kerala (2009) – Clarified that secured creditors’ rights are subject to statutory charges for government dues unless specifically excluded.
Conclusion
The Madras High Court reaffirmed that tax recovery holds constitutional supremacy over private debt enforcement. Section 281 IT Act operates as an absolute bar against creating mortgages during pending tax proceedings. This judgment underscores the obligation of banks and financial institutions to exercise due diligence before accepting property as security, thereby reinforcing the sovereign character of tax claims.
FAQs
What does Section 281 IT Act prohibit?
It prohibits transfers or creation of interests in property during pending income tax proceedings without prior approval from the tax authorities.
Does SARFAESI override tax recovery provisions?
No. SARFAESI overrides only where there is inconsistency; sovereign tax claims operate independently and enjoy priority.
What is the doctrine of priority of crown debts?
It is a common law principle granting the State first claim over debts owed, particularly taxes, ahead of private creditors of equal rank.
What duty do banks have before accepting mortgage security?
They must follow caveat emptor, ensuring no statutory dues or pending proceedings exist against the property offered as collateral.
