FIRST RIGHT OF IT DEPARTMENT ON SOLD AND MORTGAGED PROPERTY TO RECOVER ITS DUES

Introduction

Section 281 of the Income-tax Act, 1961 (ITA) is one of such sections which may have a serious impact on taxpayers acquiring any right in a property. The crux of the section is that, in certain situations, transfer of an asset by an assessee can be held to be void.

To recover the dues from defaulting taxpayers, one of the methods is the attachment and sale of assessee’s movable and immovable property. The procedure for attachment and sale is specified in the Second Schedule of the ITA. The first step in this regard is the issue of notice by the Tax Recovery Officer (TRO) under rule 2 of the Second Schedule directing the defaulting assessee to pay the tax within the stipulated time. However, to defeat the recovery proceedings, the defaulting assessees sometimes create a charge on their assets or part with its possession. To cover up such situations, which may obstruct the recovery proceedings, section 281 provides that certain transfers shall be void against assessees.

Applicability of section 281 of the ITA

 The provisions of section 281 are applicable if the following conditions are satisfied:

  1. Any assessee creates a charge on or parts with the possession of any of his assets in favour of any other person. The parting of possession may be by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever.
  2. Such creation of charge or parting of possession takes place either:
    1. during the pendency of proceeding under this ITA, or
    2. after the completion of any proceedings, but before the service of notice under rule 2 of the Second Schedule of ITA.

If both of the above conditions are fulfilled, such charge or transfer shall be void against any claim in respect of any tax or any other sum payable by the assessee as a result of the completion of the said proceeding or otherwise.

  • Explanation to section 281: In this section, “assets” mean land, building, machinery, plant, shares, securities and fixed deposits in banks, to the extent to which any of the assets aforesaid does not form part of the stock-in-trade of the business of the assessee.
  • Exceptions to above rule- In the following situations, the charge created by or transfer made by the assessee shall not be treated as void:
  1. If the charge or transfer is made for adequate consideration and without notice of the pendency of such proceeding or, as the case may be, without notice of such tax or other sums payable by the assessee; or
  2. If the charge or transfer is made with the previous permission of the Assessing Officer (AO); or
  3. Where the amount of tax or other sums payable or likely to be payable does not exceed five thousand rupees; or
  4. The asset charged or transferred does not exceed ten thousand rupees in value.

IT department point of view

I.T. Authorities think that by passing an order under section 281 they could completely deprive the purchaser of his right and title to property purchased from an assessee against whom proceedings, as contemplated under section 281, were pending under the Act at the time of transfer/sale. In their hasty & unfortunate attempt, some officers even dare to serve a copy of the order passed by them under section 281 to the concerned Sub-Registrar with an instruction to cancel the transfer of the properties under question on the basis of their order.

Judicial precedents

It is now settled law that transfer during the pendency of proceedings is not void ab initio; it is void to the extent of tax due to the I.T. department. AO or TRO has no power to declare a sale/transfer as void. They have to file a civil suit to get the transaction declared as void.

In Tax Recovery Officer v. Gangadhar Vishwanath Ranade [1998] 234 ITR 188/100 Taxman 236 (SC), it has been held that—

If the Department desires to have the transaction of transfer declared void under section 281, the Department being in the position of a creditor will have to file a suit for a declaration that the transaction of transfer is void under section 281 of the Income-tax Act. The Tax Recovery Officer (or for that matter AO) cannot declare any transfer made by the assessee in favour of a third party as void”.

Section 281 does not prescribe any adjudicatory machinery for deciding any question which may arise under it; in order to declare a transfer fraudulent under section 281, appropriate proceedings have to be taken before the competent civil court. If the department finds that a property of the assessee is transferred by him to a third party with the intention to defraud the revenue, it will have to file a suit under rule 11(6) to have the transfer declared void under section 281.

Conclusion

Section 281 is a measure to safeguard the interest of the revenue, in situations where the department is not able to recover the tax from the existing assets in possession of the assessee. Thus, section 281 does not directly deal with the process of recovery as such, but it only seeks to protect the Revenue against transfers which may create obstructions in the recovery process. Therefore, it will always be in the interest of a buyer of the property to insist on the permission from the AO as above. Further, an occasion to obtain such permission invariably arises at the time of mortgaging a property to banks. In this context, it is also an important point for verification at the time of audit of advances portfolio of banks by Chartered Accountants.