The Madras High Court has clarified that the Tax Recovery Officer (TRO) lacks the jurisdiction to adjudicate the validity of a mortgage and declare it void ab initio. Essentially, the Second Schedule to the Income Tax Act is a procedural mechanism for tax recovery and does not confer judicial power upon the TRO to decide the rights of third parties.
The Court said that a mortgage created after the service of a notice under Rule 2 of the Second Schedule to the Income-tax Act, without the TRO’s permission is, under Rule 16(2) of the Second Schedule, void only as against the claims enforceable under the tax attachment. It is not void ab initio, and the mortgagee’s rights over any surplus proceeds from a tax sale remain intact, subject to determination by a competent court or arbitrator.
The High Court, therefore, partly set aside the TRO’s order to the extent that it declared the mortgage in favour of the petitioner void ab initio. The Court also permitted the TRO to proceed with the sale of the attached immovable property to recover the tax arrears in accordance with the Second Schedule of the Income Tax Act.
Simultaneously, the Court held that the TRO is entitled to appropriate the sale proceeds to satisfy the tax dues mentioned in the certificate. Further, any surplus amount remaining after settling the tax dues shall be retained by the TRO and paid to the petitioner or the third respondent based on the final verdict in the proceedings initiated by the petitioner under the Chit Funds Act, 1982.
The petitioner is free to enforce its arbitral award against the assets of other parties involved in that dispute, but not against the attached property of the third respondent, added the Court.
A Single Judge Bench of Justice Senthilkumar Ramamoorthy observed that Section 281(1) of the Income Tax Act, which deems certain transfers void, is only applicable to transfers made before the service of a Rule 2 notice. Since the mortgage in favour of the petitioner was created on 16 November 2016, which was after the Rule 2 notice was served on 26 February 2016, Section 281(1) and its proviso (protecting bona fide transfers for adequate consideration) do not apply to this case.
Emphasising that the validity of the mortgage must be tested against the provisions of the Second Schedule to the Income Tax Act, the Bench noted that under Rule 16(1) of the Second Schedule, once a Rule 2 notice is served, the defaulter is not competent to mortgage their property without the TRO’s permission.
However, Rule 16(2) clarifies that any private transfer of an attached property is “void as against all claims enforceable under the attachment”, and not void ab initio. This means the transfer is invalid only to the extent of the tax department’s claim, and a mortgagee could still have a claim on any surplus sale proceeds, added the Bench.
The Bench further observed that the Second Schedule is a procedural framework for tax recovery and does not empower the TRO to adjudicate the validity of a transfer in favour of a third party. While referring to the Supreme Court’s decision in Tax Recovery Officer v. Gangadhar Vishwanath Ranade [(1998) 234 ITR 188 (SC)], the Bench noted that even after the amendment to Section 281, the TRO cannot declare a transfer void; such a declaration must be sought from a civil court.
Briefly, the case involves an immovable property purchased by the third respondent, who had an outstanding tax demand of Rs. 3.21 Crores, which was certified by the TRO. Accordingly, a notice under Rule 2 of the Second Schedule to the Income-tax Act, was issued to the third respondent.
Subsequently, the third respondent created a mortgage by deposit of title deeds on the said property in favour of the petitioner, Sree Gokulam Chit and Finance Co. P. Ltd., as security for amounts due up to Rs. 50 Lakh. Later, the TRO attached the property and scheduled an auction sale. The petitioner objected to the auction, citing its mortgage, but the TRO declared the mortgage void ab initio.
Appearances:
Advocates A.S. Sriraman and S. Sridhar, for the Petitioner/ Taxpayer
Senior Standing Counsel B. Ramanakumar and Junior Standing Counsel Avinash Krishnan Ravi, for the Respondent/ Revenue
