Holding

Section 178 of the Income‑Tax Act creates a secured‑creditor claim that stands outside the winding‑up proceedings and does not alter the priority scheme of Section 530(1)(a) of the Companies Act.

Summary

Imperial Chit Funds Ltd., a company in liquidation, was served with a tax demand of Rs.1,027 by the Income Tax Officer after winding‑up proceedings had begun. The Official Liquidator argued that the tax claim could not be enforced until the claim was proved in the winding‑up process, invoking the Companies Act’s scheme of preferential payments. The Kerala High Court held that Section 178 of the Income‑Tax Act requires the liquidator to set aside the notified amount, treating the tax claim as a secured claim outside the winding‑up estate and giving it priority over other debts. On appeal, the Supreme Court examined the legislative intent of Section 178 and its non‑obstante clause, concluding that its scope is distinct from Section 530(1)(a) of the Companies Act and that the tax department is to be treated as a secured creditor. The Court affirmed that the amount set aside under Section 178 is outside the winding‑up proceedings and enjoys priority, and it rejected the appellant’s contention that Section 178 merely prescribes a procedural notice. Consequently, the appeal was dismissed.

Issues considered

The extent to which Section 178 of the Income‑Tax Act affects or overrides the priority scheme under Section 530(1)(a) of the Companies Act, 1956.
Whether the tax demand under Section 178 creates a secured‑creditor claim that stands outside the winding‑up estate.
The interaction between orders issued under the Income‑Tax Act and the Central Sales Tax Act in liquidation proceedings.

Legislation cited

Central Sales Tax Act, 1956s. 17
Companies Act, 1956s. 446, s. 447, s. 456, s. 511, s. 529, s. 530(1)(a)
Income Tax Act, 1961s. 178(1), s. 178(2), s. 178(3), s. 178(4), s. 178(5), s. 178(6)

Subjects

tax priorityliquidationSection 178Companies Actpreferential paymentsecured creditorwinding upcentral sales tax

Judgment

A IMPERIAL CHIT FUNDS (P) LTD.
v.
r
INCOME TAX OFFICER, ERNAKULAM

MARCH 19, 1996

B (B.P. JEEVAN REDDY AND K.S. PARIPOORNAN, JJ.]

Income-Tax Act, 1961: Section 178--Scope of

Companies Act, 1956: Section 53()-Scope of ..
c Company-Liquidation-Income-t~Recovery-Pre f ere 11tia1 pay-
ment-Liquidation proceedings-Notice for payment of tax to liquidato1-Tax ·
amount to be set apwt by liquidatoi-Held outside the winding up proceed-
ing.i-Held Section 178 of Income Tax Act does not affect the prio1ity scheme
of section 530 of Companies Act-Held scope of both sections is different.
D
Central Sales Tax Act, 1956: Section 17.

Company in liquidation-Tax recove1y-lnte1pretation of section 178 of
Income-Tax Act held applicable to section 17 of Central Sales Tax Act.

E Orders for recovery are sent to liquidator both by Income Tax and
Central Sales Tax AuthOJities-Precedence--Priority shall be decided accord-
ing to date of receipt of orders.

The question in this appeal is whether section 178 of the Income-Tax
Act affects or alters the existing law of priority or overrides the provisions
F of preferential payment provided in Section 530 of the Companies Act?
Connicting decisions have been rendered by High Courts on this point.
Kerala and Andhra Pradesh High Courts have taken the view that Section
178 of the Income-Tax Act does not affect the scheme of priority in Section
530 of the Companies Act, but, the amount "set aside" under Section 178
of the Income-Tax Act will not be available for distribution in accordance
G with the provisions of the ·companies Act and should be first applied to
the satisfaction of the tax liability and gets priority over other debts of the
Company, in the same way as a secured creditor, who stands outside the
winding up. On the other hand the High Court of Mysore, Calcutta,
Rajasthan, Gujarat and Delhi have taken a contrary view that the
H provisions of Section 178 of the Income-tax Act do not affect or alter the
640
IMPERIAL CHIT FUNDS v. I.T. OFFICER 641

existing law of priority and do not override the provision for preferential A
{ payment contained in Section 530 of the Companies Act.

The appellant-company was wound up under orders passed by the
High C~urt. Subsequent to the commencement of winding up proceedings,
the Income Tax Officer sent a notice to the liquidator demanding an
amount of Rs. 1027 as tax due from the Company. The official liquidator B
tiled his report seeking directions of the Court that income tax claimed by
Revenue was not payable at that stage, and that the Income Tax Officer
should wait and prove his claim before the official liquidator when the list
of creditors would be settled. Rejecting the contention of the liquidator, a
Full Bench of the ·Kerala High Court held that the effect of Section C
178(3)(b) of the Income Tax Act was that the amount "set aside" by the
liquidator was marked off as outside the area of the winding up proceed-
ings and jurisdiction of winding up Court. In coming to this conclusion
the Full Bench of the High Court relied upon the judgment of a Single
Judge of the High Court in Income Tax Officer, Emakulam v. Indian Traders
Bank, (1968) K.L.T. 595· (later affirmed by Division Bench in A.S. No. D
225/1968) wherein the view stated herein before was taken.

In appeal to this Court it was contended for the appellant that (i)
Section 178 of the Income-Tax Act only provides for the procedure to be
followed by the person incharge of the company in liquidation and infor- E
mation to be given to appropriate persons regarding income tax dues, and
the said Section does not provide for priority of payments as provided in
Section 530 of the Companies Act; (ii) the view taken by the Kerala High
Court in its impugned judgment that Section 178 of the Income-Tax Act
provides for a preferential payment of income tax dues fails to give effect
).
to the relevant provisions of the Companies Act and the significance of the F
winding up proceedings in its proper context and (iii) the contrary view
taken by other High Courts that Section 178 of the Income Tax Act does
not provide for priority of payments regarding income tax lays down the
correct law.

Dismissing the appeal, this Court
G

HELD : 1. The judgment under appeal does not merit Interference
by this Court. It lays down the law correctly. The decision of the Mysore,
Calcutta, Rajasthan, Gujarat and Delhi High Court have failed to give due
importance to the legislative history and background that led to the H
642 SUPREME COURT REPORTS (1996] 3 S.C.R.

A e~actment of the section and the crucial words occurring in Sections
178(3) and 178(4) of the Income-tax Act to the effect that the Official
Liquidator "shall set aside" the amount notified by the Income Tax Officer
and if it is not so done, the Official Liquidator is personally liable to pay
the amount of tax which the company would be liable to pay. [655-E; C-D]

B 2. The scope of Section 530((1)(a) of the Companies Act, 1956 is
different from that of Section 178 of the Income-tax Act. Under Section
530(l)(a) all taxes which have become 'due and payable" alone are entitled
to preferential payment. The amount should have been crystalised into a
liability. Under Section 178(2) read with Section 178(3) of the Income-tax
C Act, provision should be made for any tax which is then or is likely
thereafter to become payable. Even the amounts which have not been
crystalised into a liability, but which are "likely to become due thereafter''
should be taken note.of. Further the non-obstante clause in Section 178(6)
of the Income-tax Act should also be kept in mind. On a total view of the
relevant statutory provisions in appears that the income Tax Department
D is treated as a "secured creditor". [652-B-C; 655-B]

3. Section 178 of the Income-tax Act occurs in Chapter XV of the Act.
The object sought to be achieved by the provisions in the said chapter is
'to fasten liability to pay the tax' on the income received and to catch the
E income at the earliest point of time and tax the same where it is found,
instead of waiting for long. [655-D]

4. The interpretation placed on Section 178 of the Income-tax Act
should govern cases arising under Section 17 of the Central Sales Tax Act,
1956 as well. But a situation may arise where the authorities under both
F the Acts • Income-tax Act as well as Central Sales Tax Act • seud similar
orders to the Official Liquidator, in which case the question of precedence
may arise. In such cases, the priority shall be with respect to the date of
receipt of the orders by the Official Liquidator. [655-F]

G Income Tax Officer, Emakulam v. Indian Traders Bank Ltd. (In
Liquidation) 1968 KLT 595; Income Tax Officer, B. Ward, Company Circle,
Hyderabad v. Official Liquidator, 101 ITR 470 and Imperial Chit Funds Ltd.
v. Income Tax Depanment, 116 ITR 1766(FB), approved.

illcome-Tax Officer, Company Circle, Bangalore v. Official Liquidator,
H Mysore High Coun and Ors., 63 ITR 810 (Mysore); Official Liquidator, High
IMPERIALCHITFUNDSv. l.T. OFFICER [PARIPOORNAN,J.] 643

Court, Calcutta v. Commissioner of Income Tax, 80 ITR 108 (Cal.); Com- A
missioner of Income Tax (Central), New Delhi and Anr. v. Official Liquida-
tor, Go/cha Properties) Pvt. Ltd. (In Liquidation) and Anr., 95 ITR 488
(Raj.); Baroda Board and Paper Mills Ltd. (In Liquidation) v. Income-Tax
Officer, Circle I, Ward-E, Ahmedabad and Ors., 102ITR153 (Guj.); Income-
Tax Officer Company Circle XVII New Delhi and Ors. v. Narula Finance (P) B
Ltd. (In Liquidation) 144 !TR 645; Income-Tax Office1; District 11(2) Addi-
tional, New Delhi v. Official Liquidator, National Conduits (P) Ltd. 128 ITR
228 (Delhi), disapproved.

\- CIVIL APPELLATE JURISDICTION Civil Appeal No. 1199
~~~. c
From the Judgment and Order dated 10.8.78 of the K;erala High
Court in Report No. 53 in C.P. No. 7 of 1973.

K. John Mathew and N. Sudhakaran for the Appellants.

J. Rarnamurthy, R. Salish and S.N. Terdol for the Respondents.
D

The Judgment of the Court was delivered by

PARIFOORNAN, J. 1. The appellant herein is M/s. Imperial Chit
Funds Private Limited, a company in liquidation, represented by the Offi- E
cial Liquidator, High Court of Kerala. The respondeni is .the Income Tax
Officer, Ernakulam (the Revenue). The Liquidator has filed this appeal
from the order passed by a Full Bench of the High Court of Kerala dated
19.8.1978 and rendered in report no. 53 in C.P. No. 7 of 1973. In the said
report the Official Liquidator prayed that orders may be passed holding
that income tax claimed by the revenue is not payable at that stage, and F
that the Income Tax Officer should wait and prove his claim before the
Official Liquidator when the list of creditors is settled. The Full Bench, by
the judgment appealed against, negatived the said prayer made by the
Official Liquidator in his report. It is against the aforesaid judgment the
Official Liquidator representing the Imperial Chit Funds Private Limited G
has come up in appeal

2. The Imperial Chit Funds Pvt. Ltd. is a private company. It was
wmmd up as per orders passed by the High Court dated 1.6.1973 in C.P.
No. 7 of 1973. After the comme.ncement of the winding up proceedings the
Income Tax Officer finalised the assessment of the company for the year H
644 SUPREME COURT REPORTS [1996] 3 S.C.R.

A 1972-73 by his order dated 31.3.1975. He assessed the company to income
tax in the sum of Rs. 934 and levied an interest of Rs. 93 payable under
Section 220(2) of the Income-tax Act. The total amount thus payable was
Rs. 1,027. The Official Liquidator intimated the Income Tax Officer by his
letter dated 8.5.1975 that the tax and interest constituted debt provable in
the winding up proceedings. He stated that he was not in a position to pay
B the amounts straightaway. According to the Liquidator, the tax was due
and payable within 12 months before the relevant date mentioned in
Section 530(8) (c) of the Companies Act and so, Section 530(1)(a) of the
....
said Act will not apply to the instant case. The Income Tax Officer ignored ,
the above intimation of the Official Liquidator. He issued a certificate to
C the Tax Recovery Officer and by his letter dated 8.12.1976 demanded a
sum of Rs. 1,027 to be paid immediately. A notice of demand was accord-
ingly issued. He also wrote to the Official Liquidator by communication
dated 15.1.1977 for payment of the amount as per the notice of demand.
Thereupon the Official Liquidator !iled report No. 53 dated 20.l.1977,
D seeking appropriate directions of the Court to the effect that the tax
claimed is not payable at that stage, and that the Income Tax Officer should •
wait and prove his claim, when the list of creditors is settled. The learned
Company Judge took the view that an important question arises for con-
sideration, namely, whether the legal effect of Section 178 of the Income-
tax Act is that the Income Tax Officer is entitled to the payment of the tax
E demanded otherwise than as provided in the Companies Act. He also
referred to an earlier Division Bench decision of the High Court of Kerala
rendered in A.S. No. 224/1968 wherein it was held that the amounts "set
aside" under section 178 of the Income-tax Act will not be available for
distribution in accordance with the provisions of the Companies Act and,
F therefore, there was no question of any priority in the distribution of assets.
In view of some subsequent decisions, the learned Company Judge felt
considerable doubt about the correctness of the aforesaid decision and
referred the matter for· being heard by a Division Bench. The Division
Bench of the High Court of Kerala before whom the matter came up, by
order dated 27th. June, 1977 referred the matter to a Full Bench for
G decision and accordingly the matter was finally heard and decided by a Full
Bench. The judgment of the Full Bench is reported in 116 !TR 176 (F.B.).

3. We heard Counsel for the appellant Mr. K. John Mathew and
Senior Counsel for the respondent-Revenue Mr. J. Ramamurthy. The sole
H question that arises for consideration in this case is, whether section 178
I
\

IMPERIALCHITFUNDSv. l.T. OFFICER [PARIPOORNAN,J.] 645

of the Income-tax Act affects or alters the existing law of priority or A
overrides the provisions of preferential payment provided in Section 530
of lhe companies Act. There are conflicting decisions on this point. A
learned single Judge of the High Court of Kerala, in Income tax Officer,
Emakulam v. Indian Traders Bank Ltd. (in Liquidation), 1968 KLT 595,
took the view that Section 178 of the Income-tax Act does not affect the
scheme of priority in Section 530 of the Companies Act, hut, the amount B
"set aside" under Section 178 of the Income Tax Act will not be available
for distribution in accordance with the provisions of the Companies.Act
and should be first applied to the satisfaction of the tax liability and gets
priority over other debts of the company, in the same way, as a secured
creditor, who stands outside the winding up. The said decision was af- C
firmed in appeal by a Division Bench in A.S. No. 225 of 1968. A Division
Bench of the Andhra Pradesh High Court in Income lox Officer, B. Ward,
Company Circle, Hyderabad v. Official Liquidator, 101 ITR 470, has taken
the same view. On the other hand, the High Courts of Mysore, Calcutta,
Rajasthan, Gujarat and Delhi, in the decisions reported in Income-Tax D
Officer, Company Circle, Bangalore v. Official Liquidator, Mysore High Court
and Others, 63 !TR 810 (Mysore), Official Liquidator, High Court, Calcutta
v. Commissioner of Income-Tax, 80 !TR 108 (Calcutta), Commissioner of
Income-Tax (Central), New Delhi; and Another v. Official Liquidator, Go/-
cha Properties (Pvt.) Ltd., (In Liquidation), and Another, 95 !TR 488
(Rajasthan), Baroda Board & Paper Mills Ltd. (In Liquidation) v. btcome- E
Tax Officer, Circle l, Ward-E, Ahmedabad, and Others, 102 ITR 153
(Gujarat), Income-Tax Officer, Company Circle XVII, New Delhi, and
,. Others v. Narula Finance P. Ltd. (Jn Liquidation), 114 ITR 645 and Income-
Tox Officer, District 11(2) Additional, New Delhi v. Official Liquidator,
l
National Conduits (P) Ltd., 128 !TR 228 (Delhi) have taken a contrary view F
and have held, that the provisions of Section 178 of the Income Tax Act do
not affect dr alter the existing law· of priority and do not override the
provision for preferential payment contained in Section 530 of the Com-
panies Act. (Incidentially, we may state that the decision of Gujarat High
Court reported in 102 !TR. 153 was reversed by this Court in the decision
reported in 189 !TR 90, on some other aspect and the same is not relevant G
herein). The sole qnestion for our consideration is which of the rival views
is correct.

4. In order to appreciate the controversy in question, it will be useful
to bear in mind "the _relevant provisions of the Income-tax Act, 1961 and H
646 SUPREME COURT REPORTS (1996) 3 S.C.R.

A the Companies Act, 1956. The relevant provisions are extracted herein-
t
below:

Income-tax Act, 1961

"178. Company liquidation. - (1) Every person -
B
(a) who is the liquidator of any company which is being wound up,
whether under the orders of a court or otherwise; or
.-.
(b) who has been appointed the receiver of any assets of a company
(hereinafter referred to as the liquidator) shall, within thirty days '
c after he has become such liquidator, give notice of his appointment
as such to the Assessing Officer who is entitled to assess the income
of the company.

(2) The Assessing Officer shall, after making such inquiries or
calling for such information as he may deem fit, notify to the
D •
liquidator within three months from the date on which he receives
notice of the appointment of the liquidator the amount which, in
the opinion of the Assessing officer, would be sufficient to provide '
for any tax which is then, or is likely thereafter to become, payable
by the company.
E
(3) The liquidator -

(a) shall not, without the leave of the Chief Commissioner or
Commissioner, part with any of the assets of the company or the . '
A
properties in his hands until he has been notified by the Assessing
F Officer under sub-section (2); and

(b) on being so notified, shall set aside an amount equal to the
amount notified and, until he so sets aside such amou114 shall not
part with any of the assets of the company or the properties in his
hands:
G 'J
Provided that nothing contained in this sub-section shall debar the
liqnidator from parting with such assets or properties for the
purpose of the payment of the tax payable by the company or for
making any payment to secured creditors whose debts are entitled
H under law to priority of payment over debts due to Government
IMPERIAL CHIT FUNDS v. l.T. OFFICER [PARIPOORNAN, J.] 647

pn the date of liquidation or for meeting such costs and expenses A
of the winding up of the company as are in the opinion of the Chief
Commissioner or Commissioner reasonable.

(4) !f the liquidator fails to give the notice in accordance with
sub-section (1) or fails to set aside the amount as required by
sub-section (3) or parts with any of the assets of the company or B
the properties in his hands in contravention of the provisions of
that sub-section, he shall be personally liable for the payment of the
tax which the company would be liable to pay:

" . Provided that if the amount of any tax payable by the company is C
notified under sub-section (2), the personal liability of the liquida-
tor under this Sl!b-section shall be to the extr.nt of such amount.

(5) where there are more liquidators than one, the obligations and
liabilities attached to the liquidator under this section shall attach
to all the liquidators jointly and severally. D
(6) 17ie provisions of this section shall have effect notwithstanding
anything to the contrary contained in any other law for the time being
in force.11

(Emphasis supplied) E
Provisions of the Companies Act, 1956

"Suits stayed on winding up order.

446. {1) When a winding up order has been made or the Official F
Liquidator has been appointed as provisional liquidator, no suit or
other legal proceeding shall be commenced, or if pending at the
date of the winding up order, shall be proceeded with, against the
company, except by leave of the Court and subject to such terms
as the Court may impose. G

(2) The Court which is winding l!p the company shall, not-
withstanding anything contained in any other law for the time being
in force, have jurisdiction to entertain, or dispose of --

(a) Any suit or proceeding by or against the company; H
f
648 SUPREME COURT REPORTS [1996) 3 S.C.R.

A (b) any claim made by or against the company (including
claims by or against any of its branches in India);

(c) any application made under section 391 by or in respect
of the company;

B (d) any question of priorities or any other question what-
soever, whether of law or fact, which may relate to or arise
in course of the winding up of the company;

whether such suit or proceeding has been instituted, or 1s m-
stituted, or such claim or question has arisen or arises or such
c ~

application has been made or is made before or after the order
for the winding up of the company, or before or after the com-
'
mencement of the Companies (Amendment) Act, 1960.

(3) Any suit or proceeding by or against the company which is
D pending in any Court other than that in which the winding up of
the company is proceeding may, notwithstanding anything con-
tained in any other law for the time being in force, be transferred ,
to and disposed of by that Court."
....
"Effect of winding up order.
E
447. An order for winding up a company shall operate in favour
of all the creditors and of all the contributories of the company as
if it had been made on the joint petition of a creditor and of a
contributory."
F "Custody of company's property.

456. (1) Where a winding up order has been made or where a
"
provisional liquidator has been appointed, the liquidator or the
provisional liquidator, as the case may be, shall take into his
G custody or under his control, all the property, effects and ac-
tionable claims to which the company is or appears to be entitled."

"Distribution of property of company. ·-.)

511. Subject to the provisions of this Act as to preferential pay-
H ments, the assets of a company shall, on its winding up, be applied
IMPERJALCHITFUNDSv. LT. OFFICER [PARIPOORNAN,J.] 649

in satisfaction of its liabilities pari passu and, subject to such A
application, shall, unless the articles otherwise provide, be dis-
tributed among the members according to their rights and interests
in the company."

Inserted by the companies (Amendment) Act, 1985:
B
"Oveniding preferential payments.

529. (1) Notwithstanding anything contained in any other provision

.
.
of this Act or any other law for the time being in force, in the
winding up of a company
c
(a) workmen's dues; and

(b) debts due to secured creditors to the extent such debts
rank under clause (c) of the proviso to sub-section (1) of
section 529 pari passu with such dues.
D
shall be paid in priority to all other debts.

(2) The debts payable under clause (a) and clause (b) of sub-sec-
tion ( 1) shall be paid in full, unless the assets are insufficient to
meet them, in which case they shall abate in equal proportions."
E
"Preferential payments.

530. (1) In a winding up, subject to the provisions of Section 529A,
there shall be paid in priority to all other debts -

(a) all revenues, taxes, cesses and rates due from the com- F
1 pany to the Central or a State Government or to a- local
authority at the relevant date as defined in clause (c) of sub-
section (8), and having become due and payable within the
twelve months next before that date;"
G
(Emphasis supplied)

5. Counsel for the appellant Mr. JOhn Mathew laid stress on Sections
446, 447, 529(1) (b), 530(1)(a) besides Section 448A, 449 451, 456(2),
457(a), 511, 528 and 529 of the Companies Act to show that the Official
Liquidator is in full charge of the company in liquidation and that the H
f
650 SUPREME COURT REPORTS (1996] 3 S.C.R.

A properties and assets of the company are in the custody of the Court. It
was further contended that Section 530(1)(a) of the Companies Act
provides for preferential payment of revenues, taxes, cesses and rates due
from company to the Central or the State Government or a local authority,
and the Companies Act is a complete Code providing for all matters
B inclusive of the manner of payment of debts of the company in liquidation.
According to Counsel, Section 178 of Income-tax Act, only provides for
the procedure to be followed by the person incharge of the company in
li1uidation and information to be given to appropriate persons regarding
income tax dues, and the said Section does not provide for priority of
payments. It was contended that Section 178 of the Income-tax Act is only
c limited in its operation, and does not provided for preferential payments •
or priority of payments, as provided in Section 530 of the Companies Act.
The argument was that Section 178 of the Income-tax Act and the relevant
provisions of the Companies Act referred to herein are distinct and provide
for different contingencies. If it is not so understood, and Section 178 of
D the Income-tax Act is interpreted as one providing for preferential payment
also, it will lead to disastrous consequences and completely set at naught
the scheme and the relevant provisions of the Companies Act with regard
to the winding up proceedings. Since the stage for deciding for preferential
payment has not reached, the Income Tax Officer had not right to call upon
E the liquidator to pay the amount and should wait for the stage when he
can prove the claim in the winding up proceedings. The interpretation
placed by the High Court on Section 178 of the Income-tax Act as if it
provides for a preferential payment of income tax dues, has failed to give
effect to the relevant provisions of the companies Act and the significance
of the winding up proceedings in its proper context. The High Courts of
F
Mysore, Calcutta, Rajasthan, Gujarat and Delhi have understood Section
178 of the Income-tax Act as not in any way providing for priority of
payments regarding income tax dues and the view expressed by the Kerala
and the Andhra Pradesh High Courts to the .contrary does not lay down
the correct law. On the other hand, Counsel for the revenue submitted that
G the decisions of the Kerala and the Andhra Pradesh High Courts have
given due importance to the legislative history and background leading to
the enactment of Section 178 of the Income-tax Act and the crucial words
contained in the section to hold that Section 178 of the Income-tax Act is
a special provision and the amount which is to be set aside as per the said
H section stands outside the winding up proceedings and is not available for
+'
IMPERIALCHITFUNDSv. l.T. OFFICER [PARIPOORNAN,J.] 651

distribution in accordance with the provisions of the Companies Act at all. A
Counsel for the revenue further argued that the preferential payment
specified in Section 530 (l)(a) of the Companies A.ct and the mandate
under Section 178 of the Income-tax Act behaving the Liquidator to set
aside the amount notified by the Income Tax officer, sufficient to provide
for any tax which is then or is likely thereafter to become due and payable B
by the Company are of different import and the view taken by the Kerala
and Andhra Pradesh High Courts that Section 178 of the Income-tax Act,
mandating that the amount "set aside" should be first applied to the
satisfaction of the tax liability, and is outside the winding up proceedings,
is justified in law. It was further contended that except the Kerala and
Andhra Pradesh High Courts, the other High Courts have failed to give C
due importance to the legislative history and background which led to the
enactment of Section 178 of the Income-tax Act and the language used in
the section.

6. In the judgment under appeal the High Court has referred to the D
legislative history and background that led to the enactment of Section 178
of the Income-tax Act, 1961. The High Court has referred to report of the
Company Law Reforms Committee which has been referred to in the
decision of the Andhra Pradesh High Court, wherein the plea for priority
+t of tax demands, particularly income tax, was dealt with and it was observed
that preferential right without limit should not be conferred. The E
committee's recommendations were not completely accepted by the legis-
lature. That apart, the report of the Direct Taxes Administration Inquiry
Committee was referred to (Srinivasan's book on Income Tax Volume II,
page 345), wherein necessity was pointed out, for the Liquidator to obtain
tax clearance certificate or to compel him to set aside the amounts to cover
(-
F
the amounts due under income tax or amounts which may become due,
1 and it was thereafter, Section 178 of the Income-tax Act, 1961 was enacted
in the present form. After referring to the above materials in paragraph
No. 4 of the Judgment, the Full Bench of the High Court observed, thus :

"With respect, these decisions (Decisions of other High Courts) G
fail to take note of the object and purpose with which Section 178
of the Income-tax Act was put into the statute book; and the
significance and the implications of "setting as_ide" of an ap·
proximate amount needed to meet tax liability of the company.
These have been notified in the Kerala and the Andhra decisions H
.j
I

652 SUPREME COURT REPORTS [1996] 3 S.C.R.

A to which we shall refer. Before we do so, we may briefly indicate
that the effect of Section 178(3)(b) is that the amount "set aside"
by the Liquidator is marked off as outside the area of the winding
up proceedings and the jurisdiction of the winding up court. This
is the view taken by the Kerala High Court and we are in agreement
with it;"
B
We would only add that the scope of Section 530(1)(a) is different from
that of Section 178 of the Income-tax Act. Under Section 530(1)(a) all taxes
which have "become due and payable" alone are entitled to preferential
payment. The amount should have been crystalised into a liability. Under
C Section 178(2) read with Section 178(3) of the Income-tax Act, provision •
should be made for any tax which is then or is likely thereafter to become
payable. Even the amounts which have not been crystalised into a liability,
but which are "likely to become due thereafter" should be taken note of.
And, we should also bear in mind, the non-obstante clause-Section 178(6)
D of the Income- tax Act.

7. In the judgment under appeal, the Full Bench has followed the
judgment of a learned single Judge of the Kerala High Court in J.T.O., "'
Emakulam v. Indian Traders Bank Ltd., (1968) KLT 595. In the said
decision Raman Nair, Acting Chief Justice, a judge with considerable
E experience in company law, dealt with section 178 of the Income-tax Act
and Sections 529 and 530 of the Companies Act, and observed in his
characteristic style, thus :

"One wishes that Section 178 of the Income-tax Act, 1961 were
F more explicit, but, as I read that provision, I do not think that it
affects the scheme of priority in section 530 of the Companies Act
although its effect no doubt is that the amount set aside under
sub-section (3) thereof has first to be applied to the satisfaction of
the tax liability and in that sense the tax liability gets priority over
the other debts of the company in the same way as a secured
G creditor who stands outside the winding up, or whose security is
redeemed under sub-section (4) of section 47 of the Provincial
Insolvency Act read with section 529 of the companies Act, gets
priority to the extent of the value of his security. But, although
sub-section (3) of section 178 of the Income-tax Act, which speaks
H of the liquidator making "payment to secured creditors whose
IMPERIAL CHIT FUNDS v. I.T. OFFICER [PARIPOORNAN, J.] 653

debts are entitled under law to priority of payment over debts due A
to Government" - the only payment I can think of by the liquidator
to a secured creditor who has not relinquished his security is a
payment under sub- section (4) of section 47 of the Provincial
Insolvency Act, or to a creditor who, although he has not relin-
quished his security, has agreed to the liquidator selling the proper- B
ty free of his incumbrance on condition of his being given the same
charge over the sale proceeds - seems to regard these as cases of
priority they are really not so much cases of priority as of the
particular asset not being available for distribution among the
I creditors in the winding up. They stand on the same footing as, for
.) example, trust funds. What is really available for distribution are C
the assets which come into the hands of the Liquidator minus the
trust monies, or the_ incu1nbrance of a secured creditor, or, in a·
case falling under section 178 of the Income-tax Act, the amount
set aside or earmarked for the payment of the tax. For, reading
subsections (2), (3) and (4) of that section together there can be D
no doubt that what the section does is to create a first charge on
the amount set aside by sub-section (3) thereof for payment of the
tax that might be admitted to proof. To say as the liquidator has
done that the amount is set aside only for the purpose of paying
the dividends that might be declared in respect of the tax liability E
and not the entire liability as proved in the winding up, so that the
section serves only the limited purpose of ensuring that the assets
of the company are not distributed beyond recall without reserving
sufficient funds for the payment of dividends in respect of the tax
liability which might not yet have been determined, and therefore
F
not proved, is hardly in keeping with the wording of the section
defective though it be. Sub-section (2) of the section, it may be
noted, speaks of the tax payable by the company, and, sub-section
(4), of the payment of the tax on behalf of the company, not of the
dividends payable in respect of the tax liability. What the section
contemplates is the payment of the tax eventually found due out G
of the amount set aside, not the payment of dividends in respect
of the tax eventually found due. And, if this brings the section into
conflict with section 530 of the Companies Act, the section must
prevail by reason of sub-section (6) thereof ' the question why
income-tax alone of all Government dues should ride this high H
654 SUPREME COURT REP.ORTS [1996] 3 S.C.R.

A horse is not for me to answer. But, for the purposes of section 530
of the Companies Act, the tax liability is an ordinary and not a
prefereptial claim and it is only out of the amount set aside under
sub-section (3) of section 178 of the Income-tax ·Act, that the
Revenue can claim payment of its debt to the exclusion of other
11
creditors.
B
And the Division Bench in A.S. No. 225/1968, affirming the above decision,
observed thus :

"...................... we cannot ignore the provision in sub-section (2) of
c section 178 that the amount to be notified is not only the amount '
for which preference is given under Section 530 of the Companies
Act, 1956 but the entirety of the income-tax dues of the company
including that which may thereafter become payable. When we
read this provision with the provision in sub-section (4) of section
178 of the Act which makes Liquidator personally liable for the
D
payment of the Tax which the company would be liable to pay if
the Liquidator failed to give notice in accordance with sub-section
(1) of Sec. 178, it appears to us that the provision in Sec. 178(3)
imports much more than that was contended by Counsel for the
appellant. This is the view that has been taken in the judgment
E under appeal which, if we may say with great respect, deals with
all aspects in a few sentences. We respectfully agree with the view
taken by the learned Judge."

Approving the above dicta, the Full Bench has further laid stress on the
F crucial words occurring in Section 178 (2), 178 (3) (b) of the Income-tax
Act, which behoves the Official Liquidator to "set aside the amount" equal
to the amount notified by the Income Tax Officer and held that these words
mean "keeping separate for special purpose" and the words "set aside" or
11
set apart" are synonymous with the word "appropriate 1\ T~e Full Bench
has observed in paragraph 6 of the judgment thus :
G
"The shades of meaning thus attached to the expression 'set aside'
convey the idea of an appropriate or an allocation of the income-
tax dues; with the result, that it stands outside the winding up by
the Company Court - an idea suggested in the judgment of Ag. Chief
H Justice Raman Nayar, confirmed by the Division Bench."
IMPERIAL CHIT FUNDS v. LT. OFFICER [PARIPOORNAN, J.] 655

The Andhra Pradesh High Court in the decision reported in l.T.O. v. A
Official Liquidator, 101 !TR 470, has taken a similar view. We are of the
·opinion that the judgment of the learned single Judge of the Kerala High
Court in l.T.O. v. Indian Traders Bank Ltd., (1968) KLT 595, affirmed in
AS. No. 225/68 and approved by the Full Bench in the judgment under
appeal as also the decision of the Andhra Pradesh High Court in I.T.O. v. B
Official Liquidator, 101 !TR 470, lay down the law correctly. On a total
view of the relevant statutory provisions, it appears to us, that the Income
Tax Department, is treated as a "secured creditor''. The decisions of the
) Mysore, Calcutta, Rajasthan, Gujarat and Delhi High Courts have failed
to give due importance to the legislative history and background that led
to the enactment of the section and the crucial words occurring in Sections C
178(3) and 178(4) of the Income-tax Act to the effect that the official
liquidator "shall .set aside" the amount notified by the income Tax Officer
and if it is not so done, the Official Liquidator is personally liable to pay
the amount of tax which the company would be liable to pay. It ·should be
remembered that Section 178 of the Income-tax Act occurs in Chapter XV D
of the Act. The object should to be achieved by the provisions in the said
Chapter is "to fasten liability to pay the tax" on the income received and to
catch the income at the earliest point of time and tax the same where it is
found, instead of waiting for long. We, therefore, hold that the judgment
under appeal does not merit interference by this Court.
E
8. During the course of hearing, our attention was drawn to Section
17 of the Central Sales Tax Act, 1956 which is similar to Section 178 of the
Income-tax Act, 1961. We are of the view that the interpretation placed by
.i us on Section 178 of the Income-tax Act, should govern cases arising under
Section 17 of the Central Sales Tax Act, 1956 as well. But, a situation may F
arise where the authorities under both the Acts, (Income-tax Act as well
as Central Sales Tax Act) send similar order to the Official Liquidator, in
which case the question of precedence may arise. In our opinion, in such
cases, the priority shall be with respe~t to the date of receipt of the orders
by the Official Liquidator.
G
9. We affirm the judgment under appeal. This appeal is without merit
and is, therefore, dismissed. There shall be no orders as to costs.

T.N.A. Appeal dismissed;