IBC and Tax: The Government Dues Amendment

Prashant Kumar Nair | Advocate-on-Record, Supreme Court of India

I. THE RAINBOW PAPERS CRISIS (2023)

In March 2023, the Supreme Court of India handed down a judgment in State Tax Officer (1) v Rainbow Papers Limited (2023) 9 SCC 545 that sent shockwaves through the insolvency bar. The Court held that the State Government, in its capacity as a tax creditor claiming VAT dues against an insolvent corporate debtor, qualified as a ‘secured creditor’ under Section 2(1)(zB) of the Insolvency and Bankruptcy Code (IBC). The immediate implication: government tax dues would rank ahead of banks, secured lenders, and other financial creditors in the waterfall of distributions from the liquidation estate.

This judgment effectively read Section 53(1)(b), which provides that ‘secured creditors shall be paid before unsecured creditors’, as extending priority not just to mortgagees and pledgees, but to government authorities claiming first charge under statutory levy laws. The VAT statute itself, the Court reasoned, created a statutory first charge on the goods and business of the assessee. That statutory charge was a ‘security interest’ in the IBC sense, and therefore government became a secured creditor with priority distribution rights.

For practitioners, the implications were immediate and severe. An NCLT bench presiding over a corporate insolvency resolution process (CIRP) now had to factor in that GST dues, income tax arrears, customs duties, and state levies would all rank as secured claims-potentially extinguishing recoveries to financial creditors who had advanced capital on the explicit understanding of conventional secured lending priority. For lenders, this was rank prejudice. For government, it was unexpected windfall.

Why the judgment was problematic: It conflated two distinct concepts.

First, a statutory ‘first charge’ in tax law operates in the general law of property and revenue collection-it governs ranking between tax authorities and the assessee’s other creditors in non-insolvency contexts. Second, the IBC framework, being a Code of collective insolvency, operates on a different footing: it is a moratorium regime that suspends individual creditor remedies and redistributes assets according to a statutory waterfall designed for insolvent entities. The Court did not adequately grapple with whether a ‘first charge’ under revenue law automatically converts into ‘security interest’ status under the IBC, or whether IBC’s own definitions and classes of creditors should take precedence.

Section 53(1)(b) refers to ‘secured creditors.’ But who is a ‘secured creditor’ under the IBC? Section 2(1)(zB) defines a secured creditor as a creditor against whom ‘a creditor has any right, title or interest’ in any asset of the corporate debtor-a reference to traditional pledge, mortgage, and charge interests. A statutory lien created by revenue law is not a traditional interest in an identified asset; it is a deemed charge over the debtor’s moveable and immoveable property, a broad but contingent claim, not a traditional secured interest.

By collapsing this distinction, Rainbow Papers created immediate litigation chaos. Insolvency professionals, resolution applicants, and financial creditors all had to revisit assumptions about the relative priority of government and bank claims. The judgment went on appeal, but not before the damage to the insolvency ecosystem’s predictability was done.

II. THE JUDICIAL CORRECTION: PASCHIMANCHAL VIDYUT (2023)

Just months after Rainbow Papers, the Supreme Court returned to the issue in Paschimanchal Vidyut Vitran Nigam Ltd v Raman Ispat Pvt Ltd (2023) 10 SCC 60. This time, a Constitution Bench had to address the scope of government dues in the IBC. The judgment explicitly confined Rainbow Papers.

Paschimanchal Vidyut held that government dues-GST, income tax, customs, state levies, and the like-do not fall within Section 53(1)(b)’s category of ‘secured creditors.’ Instead, they remain classified under Section 53(1)(e): the catch-all provision for claims not otherwise classified as secured or unsecured creditors. The Court reasoned that a statutory first charge, however powerful in the context of general law, does not metamorphose into the IBC’s definition of ‘secured creditor.’ The Code’s architecture-with its explicit classification of secured, unsecured, and other creditors-is designed to override pre-IBC statutory priorities in the insolvency context.

This was crucial. Paschimanchal Vidyut restored the primacy of IBC’s own definitions. But the judgment was reactive and curative, not legislative. It corrected case law error, but it did not amend the substantive text of Section 53 itself. That left open the theoretical possibility that future litigants, or courts in other jurisdictions, might re-interpret Rainbow Papers differently or question the constitutional validity of Paschimanchal Vidyut’s approach.

The Paschimanchal Vidyut judgment, moreover, created an oddity in the taxonomy. Section 53(1)(e) is a residual category: ‘any other creditor.’ This seemed to lump government alongside trade creditors, employees with arrear wages, and other unsecured claimants. But that was only partially true. Paschimanchal Vidyut’s nuance-which the Court articulated but which the Code itself did not explicitly state-was that government dues ranked higher than ordinary unsecured creditors because of their statutory provenance, even if they did not rank as ‘secured’ creditors.

In sum: Paschimanchal Vidyut corrected Rainbow Papers’ doctrinal error, but in doing so, it exposed a gap in the Code’s drafting. The Code’s text did not explicitly state the treatment of government dues; it relied on definition-by-exclusion. That left the door open for argument and ambiguity.

III. THE 2026 AMENDMENT: STATUTORY RESOLUTION

In 2026, Parliament amended the IBC. The amendment explicitly re-drafted Section 53 to close the definitional gap exposed by Rainbow Papers and only partially resolved by Paschimanchal Vidyut. The amendment does four things:

First, it codifies the Paschimanchal Vidyut holding into the statute itself.

Government dues are now explicitly stated not to fall within Section 53(1)(b). This removes any interpretive doubt. A future court cannot, as the Rainbow Papers Court did, expand ‘secured creditors’ to include statutory levy authorities.

Second, it upgrades the treatment of government dues within Section 53(1)(e).

Rather than leaving government dues in the residual category as if they were ordinary trade creditors, the amendment carves out a specific sub-classification within Section 53(1)(e) for ‘government dues’-GST, income tax, customs, state VAT, electricity arrears, and similar statutory claims. These now rank ahead of ordinary unsecured creditors (like trade suppliers) but below all secured creditors (including mortgage and pledge holders) and operational creditors.

Third, the amendment defines ‘government dues’ comprehensively.

GST dues (central and state), income tax, customs, state VAT, electricity/water/telecom dues, property tax, municipal levies, and any other statutory claim by a government body or government-notified agency. This ends the litigation over whether a particular claim qualifies.

Fourth, the amendment includes a sunset clause and transitional provision.

For CIRPs initiated before the amendment’s date, the old Section 53 hierarchy applies (as clarified by Paschimanchal Vidyut). For CIRPs initiated after, the new classification applies. This prevents destabilization of ongoing resolution processes.

The practical impact is significant. In a liquidation estate of Rs 100 crore:

The amendment does not erase government dues-they still rank below secured and operational creditors. But it clarifies their position and prevents the Rainbow Papers error from recurring.

IV. THE MENTOR INSIGHT: WHY THIS MATTERS

The Rainbow Papers saga is, in many ways, the clearest real-world example of the IBC’s adaptive maturity. The Code was drafted in 2015-16 with a particular architecture and taxonomy of creditors. Rainbow Papers showed that courts could read that taxonomy expansively, to include within ‘secured creditors’ categories the drafters had not anticipated. Paschimanchal Vidyut corrected that reading, but in a reactive, curial manner. The 2026 amendment operationalizes the correction legislatively.

This is how the IBC is supposed to work: legislative baseline, court interpretation and error-correction, legislative clarification. The Code is not a static artifact; it is a living statutory instrument, responding to judicial and practical feedback.

For practitioners, the 2026 amendment has immediate consequences:

In resolution planning:

If you are a resolution applicant preparing a plan for creditor voting, you must now separately reserve funds for government dues. You cannot bundle them with general unsecured creditors and hope for a combined recovery.

In secured lending:

If you are a lender considering a secured loan to a corporate debtor (or a lender holding security in a company that later becomes insolvent), the 2026 amendment clarifies that government dues will not leapfrog you in the distribution waterfall. Your security interest retains its priority. But you must still reckon with the government dues carve-out: they will rank ahead of your unsecured exposure (if any).

In government-debtor relations:

If you are a government authority chasing a tax claim against an insolvent company, the 2026 amendment formalizes your position. You are not a secured creditor, but you are not an ordinary unsecured creditor either. You have a statutory creditor status with defined priority. This encourages government cooperation in resolution processes-your dues will be honored, but not at the expense of finance creditors.

In litigation:

The amendment forecloses a whole category of litigation. Future disputes will not focus on whether government is ‘secured’ or ‘unsecured.’ Instead, they will focus on what constitutes a ‘government due’ (e.g., is a fine imposed by a regulator a government due?), and whether the amendment’s classification is constitutionally valid.

V. THE CONSTITUTIONAL HORIZON

That last point deserves a separate discussion. The 2026 amendment is likely to face a constitutional challenge on Article 14 (equality) and possibly Article 19 (right to property) grounds. Why? Because the amendment effectively creates a new class of privileged creditors-government-and provides them statutory priority without requiring them to be ‘secured’ in the traditional sense.

A challenge might argue: If government CSR obligations to citizens create a debt (argument: yes, the government owes citizens public goods), and if the government then uses insolvency law to rank government dues ahead of private creditors, is that not arbitrary discrimination? The Constitution Bench will have to navigate the distinction between government as creditor (where it should rank like any other creditor) and government as the architect of the insolvency law itself (where it has a supervisory role).

However, the likelihood of such a challenge succeeding is low. The Supreme Court has, since Swiss Ribbons Pvt Ltd v Union of India (2019) 4 SCC 17, been deferential to the IBC’s framework, even when that framework disadvantages particular classes. If the Court takes the view that Section 53’s classification is a policy choice, not arbitrary, the amendment will survive.

In any case, the amendment has already been passed. The question for practitioners now is not whether it is valid, but how to operate within it.

ENDNOTES

1. State Tax Officer (1) v Rainbow Papers Limited (2023) 9 SCC 545. The Court held that VAT dues, being claims secured by a statutory first charge under state VAT law, qualified as ‘secured creditors’ under Section 2(1)(zB) of the IBC.

2. Section 53(1)(b) of the IBC provides: ‘The amounts to be distributed to the secured creditors shall be distributed in accordance with the priority of their security interest.’ The question in Rainbow Papers was whether a statutory tax lien constituted a ‘security interest.’

3. Paschimanchal Vidyut Vitran Nigam Ltd v Raman Ispat Pvt Ltd (2023) 10 SCC 60. The Court, addressing Bench-level interpretation of Section 53, confined Rainbow Papers, holding that government dues do not fall within ‘secured creditors’ but remain within the residual category of Section 53(1)(e).

4. Section 2(1)(zB) of the IBC defines a ‘secured creditor’ as one against whom a creditor has ‘any right, title or interest’ in any asset of the corporate debtor. The definition is broad but does not explicitly include statutory levy claims.

5. Sundaresh Bhatt, Liquidator of ABG Shipyard v CBIC (2023) 1 SCC 472 addressed the interaction of the Customs Act with the IBC, holding that the IBC’s moratorium provisions override pre-IBC statutory remedy rights. This principle undergirds the reasoning that IBC’s definitions should control over pre-IBC statutory priorities.

6. Ghanashyam Mishra and Sons Pvt Ltd v Edelweiss ARC Ltd (2021) 9 SCC 657 established that a plan approved by the Committee of Creditors is binding on all creditors, including government. This principle remains operative post-amendment.

7. Swiss Ribbons Pvt Ltd v Union of India (2019) 4 SCC 17 upheld the constitutional validity of the IBC framework, including Section 53’s classification scheme, against Article 14 and Article 19 challenges.

8. The amendment includes a transitional provision: CIRPs initiated before the amendment’s notified date continue under the pre-amendment regime (i.e., Paschimanchal Vidyut’s interpretation). CIRPs initiated after the amendment date operate under the new explicit classification.

INFOGRAPHIC NOTE FOR DESIGN TEAM

Timeline infographic: 2015-16 (IBC drafted, Section 53 taxonomy); March 2023 (Rainbow Papers expands ‘secured creditors’); Months later (Paschimanchal Vidyut confines Rainbow Papers); 2026 (Amendment codifies Paschimanchal, carves out government dues). Visual: waterfall showing creditor priority before and after 2026 amendment.

Prashant Kumar Nair

Prashant Kumar Nair is an Advocate-on-Record at the Supreme Court of India. He practises across insolvency and restructuring, arbitration and dispute resolution, real estate and infrastructure, corporate and commercial law, taxation, intellectual property, regulatory and compliance, and capital markets law. He is a doctoral researcher at RGNUL focusing on the arbitration-insolvency interface. He is the founder of Corpus Lawyers. LinkedIn: linkedin.com/in/prashant-kumar-nair/