Flurry of tax notices puts private companies' directors in a spot of bother

Section 179 of the Income Tax Act imposes vicarious liability on directors to recover tax dues of private firms

Directors of private limited companies are being slapped with tax notices, holding them liable for dues/disputes pending at the company’s end.

The number of such notices has risen exponentially over the past few weeks, said four people familiar with the matter. This is on the back of mounting pressure on tax officers, with the end of the financial year approaching.

The amount being demanded typically ranges from Rs 5 crore to Rs 20 crore. In many instances, the directors are being asked to pay up in 10-15 days. The flurry of notices may compel directors to quit and prompt a rethink among those seeking directorship positions.

Section 179 of the Income Tax Act imposes a vicarious liability on directors to recover tax dues of private firms. Such liabilities can be imposed by assessing officers without adjudication by a court. While the section deals with companies under liquidation, it also applies to all entities — whether in liquidation or not — said experts.

Current and former directors, as well as retired, nominee, and technical ones are covered under the section if they held the post during the period for which the tax demand has arisen. A tax notice makes the directors ‘assessees in default’, which means their bank account and property could be attached if they fail to pay up within the requisite time period.

“The only way out is if the director proves that the non-recovery cannot be attributed to any gross neglect, malfeasance, or breach of trust on their part.  However, in a closely held company where directors are involved in day-to-day affairs, it will be difficult to fall in the exception,” said Dilip Lakhani, a chartered accountant.

According to Indruj Rai, direct tax partner at Khaitan & Co, it is important for directors to prove they have discharged their duties judiciously. “It would be helpful to show opinions from consultants that back any position adopted by the company. Further, there is several jurisprudence where it has been held that the tax authorities must exhaust all measures to recover tax from the company and not seek any parallel recovery from the director,” he said.

Some experts believe the flaw is with the law which puts the onus on the accused to prove they are not guilty.

“The law is clear in that directors of closely held firms are liable to tax of the companies where they are directors, only if the non-recovery of demand is attributable misfeasance, neglect or breach of duty on the part of the director. The general presumption of the tax office that the director is automatically liable is incorrect, and contrary to provisions of the law,” said a tax expert.

“As a matter of principle, the burden of proof should be on the tax authority to prove that the director has been guilty of gross negligence or wilful misconduct,” added Abhay Sharma, partner at Shardul Amarchand Mangaldas.

Besides issuing notices to directors, the tax department is also trying to meet its targets by conducting recovery surveys at the premises of defaulters, and issuing garnishee notices on debtors who have to repay defaulters.

A garnishee order is an attachment of money against a third party who owes money to a debtor.

 “Where tax authorities seek to recover taxes from directors, they should take all steps to recover outstanding taxes, including by garnishee orders to debtors,” said Rai.

“However, such orders should not be passed in cases where an appeal is pending before any authority or court, or where a stay has been obtained,” he added.

Experts believe the increase in notices to directors will not help beyond a point. “How much money can you really recover? If a company owes you Rs 200 crore, you are not going to get it from individuals,” said an expert.

In FY19, direct tax collections reportedly fell short by Rs 82,000 crore at Rs 11.18 trillion, against a targeted Rs 12 trillion. A key reason behind the lower mop-up was lower collection from corporation taxes.