Avoid Headaches by Checking Tax Clearance Certificate Before Buying an asset.

tax clearance certificate

The tax clearance certificate in relation to a property may not be that much important for a seller as it is for a buyer because that tax certificate is a guarantee that there will not be a legal tussle over the validity of the transfer of property in the name of the buyer. This post is going to do a thorough analysis of section 281 of income tax act .

Once you finish the article, you will get answers to common questions like why a tax clearance certificate needed or , what are types of assets covered under section 281 or how to apply for obtaining permission for the transfer of property, what is the format of a certificate under section 281 of income tax act, and case laws on section 281 of income-tax act that will clarify many controversial issues.

Why a tax clearance certificate needed ?

This is because of a provision of law under the Income Tax Act. Section 281 of Income Tax Act basically declares any transfer of assets of a person after being served with a notice. The exact wording of the said provision is as under :

281. (1) Where, during the pendency of any proceeding under this Act or after the completion thereof, but before the service of notice under rule 2 of the Second Schedule, any assessee creates a charge on, or parts with the possession (by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever) of, any of his assets in favour of any other person, such charge or transfer shall be void as 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

So, basically the intention of this law is to prohibit a person who has been issued any income tax notice -say scrutiny notice u/s 143(2) or notice u/s 147 for reassessment and against whom some tax demand may arise or there is already demand notice, from selling or gifting or transferring the assets.

The tax clearance certificate issued by the AO will derrick your purchase as the certificate may save you harassment to fight with income tax department over ownership of the bought property!

What are types of assets covered under section 281 ?

tax clearance certificates

What type of assets?

The meaning of assets for section 281 means following types of assets which are investments for the owner and not stock-in-trade of any business carried on by him/her

  1. land,
  2. building,
  3. machinery and plant,
  4. shares, securities and fixed deposits in banks,

Significance of Tax Clearance Certificate

Section 281 of the Income Tax Ac, in its proviso, states that the transfer of the assets may not be treated as null and void if the owner of the property has obtained permission to transfer from the income tax authority (a tax clearance certificate.) The other exception is if the asset is transferred for adequate consideration and the owner has no pending proceeding or tax demand.

How to Obtain Tax Clearance Certificate ?

It is a fact that the department is fully digital and therefore you may expect that the application can be done through the income tax portal. Unfortunately, you will have to apply for the issue of a tax clearance certificate or permission of AO manually only. Income Tax Rule does not prescribe any form for this purpose, however, CBDT issued a circular no. 4/2011 [f. no. 402/69/2010-itcc], dated 19-7-2011 for obtaining permission u/s 281 in which a form is given. So, fill it out and submit the form to your assessing officer.

Form for Application U/s 281

Format of certificate under section 281 of income tax act
is given the circular . Download the form and instruction (below) for application to AO for obtaining the no objection from department as per section 281 of the Income tax Act.

What to do when your application u/s 281 rejected ?

There can be two types of rejection. One is a well reasoned order in which the AO cites factual reason for rejecting the application . But if the application is rejected arbitrarily and without assigning any reason , there are two options available . Please note that you can not appeal before CIT(Appeal ) because order passed by the AO u/s 281 is not listed as appealable order in section 246A of the I t Act. In my opinion, the two options available to you in such case are :

  • File a petition u/s 264 before commissioner -because provision u/s 264 mentions word “any order ” and that will cover the order of rejection u/s 281.
  • Writ in High Court is also available because there is no alternative remedy available.

Okay! What happens if Tax Clearance Certificate is not obtained prior to transfer ?

Let us now discuss legal issues for various situations that may arise concerning the purchase and sale of assets. Does the law under section 281 of the Income Tax Act override other central laws like the Transfer of Property Act or Registration Act? Whether the AO, in absence of failure to obtain the Tax Clearance Certificate, has the power to attach the asset even though it is not in possession of the original owner (seller)? All these issues are discussed with the help of case laws on section 281 of income-tax act , in the subsequent paragraph below :

Can AO declare your transfer as void citing violation of section 281 ?

The answer to this question was settled by the Supreme Court in TRO v. Gangadhar V. Ranade (1998) 234 ITR 188 (SC), wherein the Apex Court affirmed the decision of the High Court by holding that if the Department desires to have the transaction of transfer declared void under section 281, the Department is 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 Assessing Officer) cannot declare any transfer made by the assessee in favour of a third party as void”.

But, the above ruling was based on law u/s 281 effective before the passing of the amendment to section 281 in 1975 in which the heading of section 281 was “Transfers to defraud revenue void.” After the 1975 amendment to the I T Act , the heading of section 281 was “Certain transfers to be void.

This deletion of the words “transfers to defraud revenue ” was interpreted in several decisions of High Courts to rule that the Apex Court decision in Ranade Case by which it was held that the Revenue must file a suit with the court if it wants to declare a transfer void, will not be necessarily applicable to all cases.

SC judgments in Ranade case distinguished by Madras HC, Andhra Pradesh High Court & Punjab HC

Does that mean that if you buy a property knowingly very well that department had not cleared the seller of liability of demand? The fact is that the decision of the Supreme Court that the department should file a civil suit for getting a transfer declared null and void will not help the case of a petitioner if it is proven that transfer was with motive to defraud revenue or deliberately done despite getting a notice from the department .

Apex Court judgment in Ranade Case may not be applicable in all cases

The case before Punjab & Haryana High Court in Karnail Singh v. Union of India was a case where an order attaching the property and the order declaring a sale to be void in terms of Section 281 was under challenge. Reliance was placed upon the decision of the Supreme Court in The Tax Recovery Officer II v. Gangadhar Vishwanath Ranade. But after pointing out that the language of Section 281 underwent a change under Taxation Laws (Amendment) Act, 1975 and that Gangadhar Vishwanath Ranade arose under the unamended provision, the Division Bench of Punjab & Haryana High Court held that it is no more necessary to drive the revenue to file a civil suit.

Andhra Pradesh High Court favoured the Revenue in a writ in Shriya Bhupal v. ACIT (2018) 95 taxmann.com 230 (AP). The court held that the petitioner can still demand that the Revenue should file a civil suit to determine if the conditions given in proviso to section 281(1) apply to his/her/its case.

The fact was that the petitioner had purchased an immovable property from a party despite knowing well that there was an order by the AO declaring the sale of the said property by the assessee to the petitioner to be void in terms of section 281, since the said sale was below market price and there was outstanding demand of tax arrears payable by the assessee.

Relevant portion of the High Court Order is given below :

46. At the time when the Supreme Court considered the import of Section 281, the provision contained the words with the intention to defraud the revenue. But by the amendment introduced in 1975, these words deleted. Therefore, irrespective of whether the transfer was with a view to defraud the revenue or not, the transfer is declared void by the statute itself. Hence, the question of the Revenue going to the Court to establish that the transfer was with intent to defraud the revenue does not arise.

However, the High Court also recognized that the proviso to sub-section (1) of Section 281 that provides that the transfer shall not be void if it is made (1) for adequate consideration and without notice of the pendency of the proceeding or without notice of such tax or another sum payable by the assessee, or (2) with the previous permission of the Assessing Officer.

Therefore, it is possible for the petitioner to contend that the questions of fact that would make a case fall within the proviso to sub-section (1) of Section 281 may have to be adjudicated only by a Civil Court and not by the Tax Recovery Officer and that therefore, the ratio in Gangadhar Vishwanath Ranade would still be applicable.

Hon’ble High Court dismissed the petition when it found that the petitioner was already knowing that the AO had rejected the tax clearance petition u/s 230 (law at that time) . It was held that clause (i) of section 281(1) which inter alia provides that the transfer shall not be void if it is made without notice of any tax or another sum payable by the assessee under the Act was not applicable since, in the instant case, on account of the refusal of the Assessing Officer, to issue a certificate under section 230A, petitioner became aware of arrears of tax and other sums payable by the assessee.

The Court also rejected the petitioner’s plea that if the Department found that a property of the assessee had been transferred with the intention to defraud the revenue, it would have to file a suit under rule 11(6), to have the transfer declared void under section 281, holding that if a transfer had been made by a defaulter in contravention of rule 11(6), it was automatically void. 

Another case is of Madras High Court in Champa Devi v. Tax Recovery Officer (2018) 257 Taxman 296: 170 DTR 36 (Mad.) in which the facts were that the petitioner purchased a property. Later the TRO declared the transfer of property to her as void, as it was already attached by the department.

The petitioner filed a writ stating that she was a bona fide purchaser of said property for adequate consideration and as on the date of purchase, there were no encumbrances/charges on the property. Further, there were no-income-tax dues payable by the petitioner’s vendor and to that effect, a certificate was issued by Assistant Commissioner. It was also submitted that Tax Recovery Officer attached the petitioner’s property for arrears of the vendor long after the petitioner had purchased the property and therefore, a notice of attachment would not bind the petitioner.

Dismissing the petition the Court held that; if petitioner’s claim was that property was not liable for such attachment, then she had to make a claim before Tax Recovery Officer and for such reason, petitioner could not have approached writ court invoking jurisdiction under Article 226 of Constitution of India.

Can transfer of asset be denied for a subsequent demand on seller ?

In the case before Madras High Court in J. Manoharakumari v. TRO, [2021] 127 taxmann.com 337 (Madras HC), the facts were that the seller and buyers were fighting a civil suit over the transfer of property for which there were a valid sales agreement. The buyer got the decree in his favour but the TRO served an attached notice on the Registrar stating that there were demands pending against the transferor.

The buyer filed a writ which allowed by the Madras high court holding that “The fruits of the decree in a contested suit could not be denied merely because the seller or one of the persons had incurred subsequent tax liability. The fruits of decree dated back to the date of the suit.

Since there was no demand when the right to purchase was vested in the buyer on account of valid sales agreement , department can not invoke section 281 for any subsequent demand on the legal heir of the property at the subsequent date of transfer.

What if I convert asset from investment to stock-in-trade ?

Now this idea of conversion may arise because section 281 provides that the provision is inapplicable on assets which are stock-in-trade. This is clear from Explanation attached to section 281 which is as under:

Explanation.—In this section, “assets” means 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.

However, it does not mean that just to hoodwink the department you will resort to scheme of conversion of investment to stock-in-trade and then transfer the case. The Courts have caught such cleverness of Assessee and gave judgment in favour of revenue

In Twinstar Holdings Ltd. v. Anand Kedia, DCIT (2003) 260 ITR 6 (Bom.) the court held that clause (i) of the proviso to section 281(1) refers to a bona fide transfer for value, without notice of the pendency of proceedings.It was also held that the assessee had transferred the shares under a sham dissolution as an asset. Under the block assessment orders, the shares were treated as stock-in-trade and therefore, the Assessing Officer had treated the difference between the market value of the shares as on 31.3.1999 and the book value as undisclosed business income.

Under that order, the shares had to be valued at market value and not at cost. In the circumstances, it was not open to the petitioner to contend that the transfer was for adequate consideration. Therefore, clause (i) of the proviso had no application.