SC throws caution to the Board

A two-judge Bench of the Supreme Court, in a case involving Madhumilan Syntex recently, held that defaulting companies and their directors can be prosecuted for delay in depositing the tax deducted at source (TDS).

The government's resolve to address the question of trial and punishment of tax-related economic offences dates back to the Direct Tax Enquiry Committee of the 70s. In that era, when maximum marginal rates of tax peaked over 95 per cent and tax evasion was rampant, the commission felt that monetary penalties were not enough and that prospect of conviction and sentence would act as a severe deterrent in the minds of erring tax payers.

Hence, the legislation to prosecute tax payers dates back to the mid-70s. A significant development occurred on April 1, 1989. Until then a technical failure to even withhold/ deduct tax could lead to prosecution. The rigours of law on prosecution became even more severe as a result of subsequent legislative amendment which took away the erring tax payer's right to put forth a 'reasonable cause' argument. Over the years, courts have held that mens rea is not a requisite ingredient for an offence.

In the Madhumilan Syntex case, the apex court was examining a petition on the revenue department's criminal complaint with respect to prosecution proceedings for non-payment of TDS. There was no doubt that the tax payer had failed to deposit a sum of Rs129,000 within the time limit. Further, the TDS was paid to the government alongwith interest before filing the return.

The revenue department made out a prima facie case for prosecution arguing that the tax payer (after withholding tax) acted as an agent of the government and was expected to fulfil the payment obligation within the time limit. Hence, the court's decision to negate the appellants argument that tax was indeed paid, albeit belatedly, was keeping in mind the spirit of the legislation.

The court, also relying on the Standard Chartered decision of 2005, held that a company not being a natural person was a 'legal' or 'juristic' person which did not mean that it is not liable for prosecution.

In that case, it was contended that where an offence was punishable with mandatory sentence of imprisonment, a company could not be prosecuted as the sentence of imprisonment could not be enforced on the company, the rationale being that a company was a juristic person and could not be awarded a prison term hence, could not be prosecuted.

The court rejected all arguments and held that the legislative intent to prosecute corporate bodies for the offence committed by them are clear and explicit, and the statute never intended to exonerate them from prosecution. The Stanchart judgment delivered in May 2005 reversed Velliappa Textiles decision delivered by the Supreme Court in September 2003. Interestingly, Finance (No.2) Act, 2004 inserted a fresh subsection to 'offences by companies,' clearly articulating that where an offence was committed by a company, the punishment for such offence was imprisonment and fine. In which case, the company will be punished with fine and every person who is charge of, and was responsible to, the company for the conduct of the business of the company or director, manager or secretary shall be liable to be punished.

Of course, a managing director or a director of a company cannot be held liable unless he is treated as a 'principal officer' or 'is in charge of' and 'responsible for' the business of the company.

On the issue whether a non-executive director can be held guilty, the Bombay High Court in the H Phiroze Raina's case had held that he could not be.

The Supreme Court decision seems to have partially unsettled the Bombay HC position since it seems to suggest that if the revenue treats the director as a 'principal officer', it is sufficient to prosecute him.

However, it would be bizarre to demonstrate that a non-executive director would satisfy the test of being 'in-charge' and 'responsible' for the business.

It is safe to conclude that the criminal liability can be fastened only on that (principal) officer connected with the management or administration of the company and whom the revenue department has served the notice (as emphasised by the Supreme Court in the recent decision).

The recent decision seems to have overridden the harmonious construction it took earlier in Velliappa Textiles case and several other high court decisions; predominantly relying on Stanchart's case. The Bench, while delivering the Stanchart judgment by a split verdict of 3:2, observed: "The court cannot act as a sympathetic caddie who nudges the ball into the hole because the putt missed the hole. Even a caddie cannot do so without inviting censure and more."

Whereas, it is the courts prerogative to interpret the law, the legilators have to ponder upon critical aspects and principles. While the court seems to have adhered to its conventional wisdom to interpret the law, its now up to the lawmakers to clarify the intent, which seems to have caused anxiety in the minds of several boards. 

The author is a partner with BMR & Associates and views are personal