There are multiple options available to the tax authorities to recover the income tax dues of any person who has evaded payment of income tax. One of the widely used provision to recover income tax dues is section 226 (3) of the Income Tax Act, 1961. Although this provision gives wide powers to the Income Tax authorities to recover dues from the third parties under the conditions mentioned in the said provision, however, there is widespread misapplication of the same which has resulted in undue loss to the assessee (who is the borrower) as well as the third party i.e. the Bank/Financial Institution. We will try to understand how this provision is being misapplied and how it is resulting into the loss for the Bank as well as the assessee.
Firstly, let us go through what section 226(3) of the Income Tax Act, 1961 lays down.It states that:
“The Income-tax Officer may, at any time or from time to time, by notice in writing require any person from whom money is due or may become due to the assessee or any person who holds or may subsequently hold money for or on account of the assessee, to pay to the Income-tax Officer either forthwith upon the money becoming due or being held or at or within the time specified in the notice (not being before the money becomes due or is held) so much of the money as is sufficient to pay the amount due by the assessee in respect of arrears or the whole of the money when it is equal to or less than that amount.”
In order to understand any provision, it is relevant to appreciate the legislative intent which led to framing of such provision. In the instant case, the power has been vested with the income tax authorities to recover any amount to the extent of default of Income Tax Dues from the third party essentially under two conditions. Firstly, when the third party to whom the notice under section 226(3) is issued has borrowed some money from the assessee and hasn’t paid that money back. Secondly, when such third party is holding any money on account of the assessee. To enlarge the ambit of application of the aforesaid provision, the words ‘may become due’ and ‘may subsequently hold money’ have been included. However, the most important aspect which manifests the legislative intent of the drafters of this law is evident by the very fact that the third parties under the aforesaid provision are those persons who either ‘owe’ any money to the assesee or ‘hold’ any money for the assessee.
Therefore, in such cases where assessee has taken a loan from the Bank/Financial Institution (Cash Credit, Term loan, etc.) then neither the Bank ‘owes’ any money to the assessee nor the money which is lent by the Bank is ‘held’ by the bank for the assessee. On the contrary, the assessee owes the loan amount to the Bank. But the same cannot be said for the deposit accounts (Saving Bank A/c, Fixed Deposits, etc) where the Bank is ‘holding’ that amount for the assessee i.e. where credit balance is available.
The aforesaid inference is the settled principle of law which has been time and again reaffirmed by the judgments of various Hon’ble High Courts across the Country. Hon’ble High Court of Madras in K M Adam Vs. ITO  33 ITR 26, has held thatthe loan fund cannot be said to be a debt to a bank to the customer nor could it be said to be money on account of the customer, and hence it cannot be attached. Further, the Hon’ble High Court of Calcutta in P C Chandra & Sons Vs. Dy Commissioner of Income Tax,  373 ITR 223, cited the aforesaid case law and held that the Cash Credit Account cannot be attached by the Income Tax authorities. Moreover, the Hon’ble Gujrat High Court in Kaneria Granito Ltd Vs. Assistant Commissioner of Income Tax, MANU/GJ/2079/2016, while deciding upon the validity of putting a hold on cash credit and term loan account of the petitioner by the Income Tax authorities has held that the accounts were opened to enable the assessee to borrow the money from the bank for the purpose of its business and therefore, would necessarily be in the nature of a loan or a cash credit facility, in either case, would be in the nature of borrowing by the assessee from the bank. Thus, the bank and the assessee, therefore, do not have the debtor-creditor relationship. Accordingly, the Hon’ble Gujrat High Court has set aside the order of attachment under section 226(3) of the Income Tax Act, 1961.
Despite of the above judgements, notices issues under section 226(3) of the Income Tax Act, 1961 are erroneously treated as attachment orders for even loan accounts. This creates some practical issues both for the Bank/Financial institution as well as the assessee who is the borrower. For example, when loan account which has been erroneously attached pursuant to the notice under section 226(3) of the Income Tax Act, 1961 and subsequently, it has been classified as Non performing asset and the Bank has entered into a scheme of settlement with the borrower as per the RBI guidelines, then such account cannot be closed since it is freezed. Hence, the Bank/Financial institution is prevented from recovering its dues from the borrower pursuant to such erroneous freezing of account. Apprehension of coercive action in case of removal of such hold without obtaining permission of the concerned income tax authority leads to non removal of hold and the procedure for obtaining such permission is often tedious and time consuming which ultimately leads to litigation.
Therefore, power given to the income tax authorities under section 226(3) of the Income Tax Act, 1961 should be exercised wisely so as to avoid any undue hardships to third parties which is also in furtherance of the legislative mandate of the aforesaid provision i.e. non-encroachment upon the right of recovery of the Bank/financial institution and thereby balancing the rights of both the entities
Views expressed here are personal only.
Author-Raghav kumar Singh, Law Officer, SBI.