2026 (2) TMI 212 - HC - Income Tax

Attachment and mortgage of attached property under Second Schedule: mortgage not void ab initio; TRO may sell and appropriate proceeds.

Amended Section 281 removes the requirement to prove intent to defraud; therefore Section 281(1) operated only until service of the Rule 2 notice on the ... Scope and applicability of Section 281 of the I-T Act - Procedure for recovery under the Second Schedule (Rule 2, Rule 11, Rule 16, Rule 51) - Certain transfers to be void - Tax Recovery Officer's jurisdiction to determine claims under the Second Schedule - Effect of attachment relating back to date of service of Rule 2 notice HELD THAT:- As is noticeable from the text of the amended Section 281(1) in comparison to the pre-amended version, the qualification or condition that the transfer should be 'with the intention to defraud the revenue' has been deleted by the amendment. Consequently, it is no longer necessary for revenue to establish that the transfer was made with the intention to defraud the revenue. In the case at hand, the third respondent filed the return of income for AY 2011-12 on 08.02.2012. The case was selected for scrutiny and a notice under Section 143(2) of the I-T Act was issued to the third respondent on 31.07.2012. Since the self-assessment of the assessee was not accepted, a proceeding under the I-T Act had commenced. Pursuant thereto, the assessment order under Section 143(3) was issued on 31.03.2014 and the Rule 2 notice was issued on 24.02.2016 and served on the third respondent on 26.02.2016. Thus, Section 281(1) operated only up to 26.02.2016. Creation of mortgage in favour of the petitioner - The award records that all the respondents were set ex parte and that the entire claim of Rs. 42,94,056/- was allowed along with interest on the principal sum at 24% per annum from the date of claim until the date of realisation with costs of Rs. 2,19,480/-. The award also records that the immovable assets of the third respondent and second respondent therein, respectively, which are described in schedules, were attached by orders dated 05.05.2022 and 24.05.2022, respectively. The schedule of the property of the third respondent, as described therein, tallies with the schedule of the MoDT and with the property attached under order dated 21.04.2022 of the TRO. In order to enforce the award, it appears from documents filed by the petitioner that E.P. No.812 of 2023 was filed against the three judgment debtors. This execution petition is directed only against the property of E. Vimala Devi and has no bearing on these proceedings. Whether any separate execution petition was filed against the asset of the third respondent cannot be gleaned from the documents on record. Against this factual matrix, turn to the Second Schedule to the I-T Act and consider the implications of actions taken thereunder. Scope and applicability of the Second Schedule to the I-T Act - A combined reading of Rules 2 and 4 of the Second Schedule shows, the relevant date is the date of service of such notice and not the date of issuance thereof. Therefore, the contention of learned counsel for the petitioner cannot be countenanced. Because the mortgage was created after service of the Rule 2 notice, the mortgagor/third respondent was required to obtain the permission of the TRO before doing so as per Rule 16(1). In the absence of such permission, he was not competent to mortgage the property. The implications of such mortgage call for consideration next. Rule 16(2) provides that any private transfer or delivery of the property attached shall be void as against all claims enforceable under the attachment. Significantly, Rule 16(2) does not declare that any transfer of attached property is void ab initio or even void. Instead, the declaration is limited to being void as against claims enforceable under the attachment. The consequences would be clear from the following illustration. Assuming an assessee in default owes the Income Tax Department a sum of Rs. 6 crore, whereas the relevant property has a market value of Rs. 10 crore. If the transfer by way of mortgage is construed as being void ab initio, no interest in the property would pass to the mortgagee. Therefore, if the property were to be sold, the mortgagee would not be entitled to even the surplus over and above the Income Tax Department's dues of Rs. 6 crore. On the other hand, if the transfer were to be construed as void only against the claims enforceable under the attachment, the mortgagee would still be entitled to enforce the mortgage in respect of the available surplus of Rs. 4 crore. In my view, the text of Rule 16(2) leads to the conclusion that any transfer, including by way of mortgage, would be void only against claims enforceable under the attachment, but not otherwise. Adjudication of the validity of the mortgage - whether the TRO was entitled to adjudicate on the validity of the mortgage? - TRO has drawn reference to Rule 51 of the Second Schedule and concluded that the mortgage is void ab initio. Even after the amendment to Section 281(1), the TRO does not have the power to adjudicate on the validity of the instrument of transfer in favour of a third party. To that extent, the order impugned herein calls for interference. Consequently, the declaration that the mortgage in favour of the petitioner is void ab initio is set aside. The sequitur to the above conclusion is, however, not that the attachment by the revenue is invalid or that the proceedings by the TRO to recover arrears is invalid. Surplus, if any, shall be retained by the TRO and paid to the petitioner after confirming that proceedings under the Chit Funds Act, 1982 have attained finality. It should be borne in mind, in this regard, that the award was issued ex parte and that the statute provides for an appeal. The execution proceedings initiated by the petitioner before the civil court may be proceeded with because it pertains to the asset of E. Vimala Devi, but no civil court shall issue any process against the attached property. Any such process for the execution of a decree would contravene Rule 16(1) of the Second Schedule of the I-T Act. This writ petition is disposed of on the following terms: (i) The order dated 21.04.2022 is set aside partly to the extent that it declares that the mortgage in favour of the petitioner is void ab initio. (ii) The TRO is entitled to bring the attached immovable property for sale in accordance with the Second Schedule of the I-T Act. (iii) The TRO is entitled to appropriate the sale proceeds towards the amount mentioned in the certificate issued under Section 222 of the I-T Act. (iv) If a surplus were to be available after the above mentioned appropriation, the TRO shall pay such surplus to the petitioner or the third respondent, as the case may be, on the basis of the final, conclusive and binding verdict in proceedings initiated by the petitioner against inter alia the third respondent under the Chit Funds Act, 1982. (v) It is open to the petitioner to take steps to enforce the award in ARC No.377 of 2021 against the assets of Vimal Enterprises or E. Vimala Devi, but not against the assets of the third respondent, including the attached asset. Issues: (i) Whether the Tax Recovery Officer (TRO) had power to declare the mortgage in favour of the petitioner as void ab initio; (ii) Whether a mortgage created after service of the Rule 2 notice operates against claims enforceable under attachment and the consequences for sale proceeds; (iii) Whether the petitioner may enforce its claim against the attached property of the defaulting assessee.Issue (i): Whether the TRO had power to declare the mortgage in favour of the petitioner as void ab initio.Analysis: Section 281(1) as amended and the Second Schedule's rules were analysed to determine the TRO's powers. The text of Section 281(1) renders certain transfers void as against claims in respect of tax, and the Second Schedule (including Rules 11, 16 and 51) prescribes recovery procedure and investigatory powers for the TRO. Rule 11 provides the TRO with a mechanism to investigate claims or objections; Rule 16(2) declares private transfers void as against claims enforceable under attachment; Rule 51 makes attachment relate back to the date of service of the Rule 2 notice. The statutory scheme does not vest the TRO with power to finally adjudicate and declare a third-party transfer wholly void ab initio; instead the TRO determines entitlement for purposes of attachment and sale, leaving final determination of proprietary rights and surplus to competent civil or arbitral fora.Conclusion: The TRO lacked power to declare the mortgage void ab initio; that declaration is set aside.Issue (ii): Whether a mortgage created after service of the Rule 2 notice operates against claims enforceable under attachment and the consequences for sale proceeds.Analysis: The Rule 2 notice was served on 26.02.2016. Evidence establishes that the memorandum of deposit of title deeds was executed on or before 16.11.2016 and was not shown to have been created prior to service of the Rule 2 notice. Rule 16(1) prohibits the defaulter from dealing with property after service of Rule 2 notice without TRO permission; Rule 16(2) renders private transfers void as against claims enforceable under attachment but does not render such transfers completely unenforceable. Rule 51 causes attachment to relate back to service of Rule 2 notice, enabling the TRO to proceed with sale and appropriate proceeds towards arrears; any surplus is to be dealt with subject to final orders of civil court or arbitral forum.Conclusion: A mortgage created after service of the Rule 2 notice does not operate against claims enforceable under the attachment; the TRO is entitled to sell the attached property and appropriate sale proceeds towards the certificate amount, with any surplus payable only pursuant to a final conclusive determination in competent proceedings.Issue (iii): Whether the petitioner may enforce its claim against the attached property of the defaulting assessee.Analysis: The petitioner's alleged debt relates to transactions arising in January 2018 and an arbitral award issued ex parte in May 2022. The Second Schedule bars civil process for execution against attached property after service of Rule 2 notice (Rule 16(1)). The TRO may proceed with sale and appropriate proceeds; enforcement of the petitioner's claim against the attached asset requires a final, conclusive determination (civil court or final arbitral/appeal outcome) and, absent TRO permission or such finality, the petitioner cannot execute its award against the attached property. The petitioner may, however, pursue enforcement against assets of other judgment debtors not subject to the attachment.Conclusion: The petitioner is not entitled to enforce the award against the attached property of the third respondent; it may enforce the award against other assets or persons not affected by the attachment, and any surplus from sale of the attached property shall be released only pursuant to final conclusive proceedings.Final Conclusion: The TRO's declaration that the mortgage was void ab initio is set aside, but the TRO remains entitled to proceed with attachment, sale and appropriation of sale proceeds under the Second Schedule; entitlement to any surplus is subject to a final conclusive determination in appropriate civil or arbitral proceedings.Ratio Decidendi: The statutory scheme of Section 281(1) and the Second Schedule grants the TRO powers to attach, investigate and sell attached property and to treat transfers as void only insofar as they are adverse to claims enforceable under the attachment; it does not empower the TRO to adjudicate and declare third-party transfers absolutely void ab initio, which requires final determination by a civil court or other competent forum.