Income Tax Departments may no longer have first shot in NPAs

Income Tax Departments may no longer have first shot in NPAs

The Department of Financial Services in the finance ministry is considering to incorporate in the Sarfaesi Act the ‘principle of first to register’ a lien on the assets of defaulting companies.

The registration has to be with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (Cersai) set up to eliminate instances of multiple lending on the same property.

According to the changes proposed by the government in the Sarfaesi Act, whoever registers their charge on an asset first with the designated central registry will get priority over others in recovering the dues by attaching the assets. Since lenders practically are the first to do such registration (at the time of giving the loan), this would in most cases lead to their lien getting precedence.

The Income Tax Departments role in Recovery by lenders

Currently, the out-of-the-court mechanism under Sarfaesi Act allows secured creditors to take possession of the assets of a firm under liquidation if their dues are not paid within two months of raising demand. However, in practice, tax authorities and municipal corporations often attach the assets of a defaulting company beforehand, which comes in the way of lenders recovering their dues.

The tax departments draw the powers to attach from their respective laws – Income Tax Act, Central Excise Act and the like. As per the new proposal, the provisions of Sarfaesi Act of 2002, which is a relatively new law, will prevail over those of older statutes and will effectively protect the interest of lenders without any amendment to any other law.

The proposed amendments also include a provision to classify central and state authorities handling income tax, excise and value added tax as well as municipal corporations as secured creditors, so that the moment a taxpayer defaults, the authorities would need to register their charge on the assets. However, if the company has already taken a loan, the lender would have already registered his charge on the assets, giving the tax authorities only second charge on the assets.

Currently, secured creditors include banks, financial institutions, debenture trustees appointed by banks, securitisation companies, asset reconstruction companies and any other trustee holding security. “These changes to the Sarfaesi Act will be a huge leapfrog in terms of reforms in this area. States which agree to this provision may soon be perceived as more investor friendly and therefore would see greater lending by banks and financial institutions,” said an expert in bankruptcy laws.

The changes are in line with international best practices followed by the UK, US, Australia and Canada.