S.178 of the Income-tax Act creates a first charge for the payment of tax, giving tax liability priority over other debts in winding up proceedings.

1. One wishes that S.178 of the Income-tax Act, 1961 were more explicit, but, as I read that provision, I do not think that it affects the scheme of priority in S.530 of the Companies Act although its effect no doubt is that the amount set aside under sub-section (3) thereof has first to be applied to the satisfaction of the tax liability and in that sense the tax liability gets priority over the other debts of the company in the same way as a secured creditor who stands outside the winding up, or whose security is redeemed under sub-section (4) of S.47 of the Provincial Insolvency Act read with S.529 of the Companies Act, gets priority to the extent of the value of his security. But, although sub-section (3) of S.178 of the Income-tax Act, which speaks of the liquidator making "payment to secured creditors whose debts are entitled under law to priority of payment over debts due to Government" the only payment I can think of by the liquidator to a secured creditor who has not relinquished his security is a payment under sub-section (4) of S.47 of the Provincial Insolvency Act, or to a creditor who, although he has not relinquished his security, has agreed to the liquidator selling the property free of his encumbrance on condition of his being given the same charge over the sale proceeds seems to regard these as cases of priority, they are really not so much cases of priority as of the particular asset not being available for distribution among the creditors in the winding up, They stand on the same footing as, for example, trust funds. What is really available for distribution are the assets which come into the hands of the Liquidator minus the trust monies, or the incumbrance of a secured creditor, or, in a case falling under S.178 of the Incometax Act, the amount set aside or earmarked for the payment of the tax. For, reading subsections (2), (3) and (4) of that section together there can be no doubt that what the section does is to create a first charge on the amount set aside by sub-section (3) thereof for payment of the tax that might be admitted to proof. To say as the liquidator has dons that the amount is set aside only for the purpose of paying the dividends that might be declared in respect of the tax liability and not the entire liability as proved In the winding up, so that the section serves only the limited purpose of ensuring that the assets of the company are not distributed beyond recall without reserving sufficient funds for the payment of dividends in respect of the tax liability which might not yet have been determined, and therefore not proved, is hardly in keeping with the wording of the section defective though it be. Sub-section (2) of the section, it may be noted, speaks of the tax payable by the company, and, sub-section (4), of the payment of the tax on behalf of the company, not of the dividends payable in respect of the tax liability. What the section contemplates is the payment of the tax eventually found due out of the amount set aside, not the payment of dividends in respect of the tax eventually found due. And, if this brings the section into conflict with S.530 of the Companies Act, the section must prevail by reason of sub-section (6) thereof - the question why income-tax alone of all Government dues should ride this high horse is not for me to answer. But, for the purposes of S.530 of the Companies Act, the tax liability is an ordinary and not a preferential claim and it is only out of the amount set aside under sub-section (3) of S.178 of the Incometax Act, that the Revenue can claim payment of its debt to the exclusion of other creditors.

2. I might add that the claim for priority under S.64 (1) (a) of the (Kerala) Insolvency Act real with S.529 (1) of the Companies Act is unsustainable - see In re Kerala Water Transport Corporation Ltd., (1967 KLT 358) where I have dealt with this matter at some length.

3. Subject to the liquidator's compliance with S.178 of the Income-tax Act,