Facts of the Case

A search and seizure operation under Section 132 of the Income-tax Act, 1961 was conducted on 18.01.2011 at the premises of Respondent Nos. 3 to 6 and their firm M/s Stockguru India, during which cash amounting to ₹34.69 crores and various bank accounts were seized and later converted into fixed deposit receipts pursuant to orders of the criminal court.

Subsequently, FIRs were registered alleging cheating, criminal breach of trust and operation of a money circulation scheme. Parallel proceedings under the Prevention of Money Laundering Act, 2002 were initiated, alleging that the seized funds constituted proceeds of crime obtained through fraudulent investment schemes.

After completion of block assessments, the Income Tax Department raised substantial tax demands for Assessment Years 2010–11 and 2011–12 and filed an application under Section 226(4) of the Income-tax Act seeking release of the FDRs for recovery of tax dues. The Special Judge rejected the application by order dated 05.02.2018, leading to the present petition under Section 482 CrPC by the Assistant Commissioner of Income Tax.

Issues Involved

Whether the Income Tax Department is entitled to appropriate seized funds towards tax recovery under Section 226(4) of the Income-tax Act when such funds are alleged to be proceeds of crime and are subject to proceedings under the Prevention of Money Laundering Act, and which statute would prevail in case of conflict between the Income-tax Act and PMLA.

Petitioner’s Arguments

The Income Tax Department contended that the seized money was taken into custody during a lawful search under Section 132 and that subsequent assessment resulted in legally recoverable tax demands. It was argued that Section 132B and Section 226(4) empower the Department to appropriate seized assets towards outstanding tax liabilities.

Reliance was placed on decisions holding the Income Tax Department to be a secured creditor and asserting that criminal courts cannot impede tax recovery proceedings under a special fiscal statute. It was further contended that PMLA proceedings were initiated much later and could not override the earlier seizure and tax recovery rights.

Respondents’ Arguments

The Directorate of Enforcement and the State opposed the petition, contending that the seized funds were prima facie proceeds of crime obtained through fraudulent Ponzi schemes and could not be treated as income of the accused. It was argued that PMLA, being a later special statute with an overriding clause under Section 71, would prevail over the Income-tax Act.

It was further submitted that until the conclusion of PMLA proceedings and determination of whether the funds constituted proceeds of crime, the Income Tax Department could not appropriate the amounts, as such premature release would prejudice criminal proceedings and the rights of defrauded investors.

Court Order / Findings

The Delhi High Court examined the object and scheme of both statutes and held that while the Income-tax Act seeks to levy and collect tax on lawful income, PMLA is aimed at forfeiture of proceeds of crime and restoration of such property to legitimate claimants.

The Court held that money obtained through fraud and deception cannot, at the threshold, be treated as income of the accused. Until the conclusion of the criminal trial and adjudication under PMLA, the seized funds could not be appropriated towards tax liability.

Applying the “dominant purpose” test and relying on precedents including Solidaire India Ltd. and Bank of India vs. Ketan Parekh, the Court held that PMLA, being a subsequent special enactment with an overriding clause, would prevail over the Income-tax Act in the present circumstances.

Important Clarification

The Court clarified that the Income Tax Department’s right to recover tax arises only in respect of lawful income of an assessee. Where funds are prima facie proceeds of crime and are subject to adjudication under PMLA, tax recovery must await the outcome of criminal proceedings, and fiscal statutes cannot override confiscatory provisions of PMLA.

Final Outcome

The petition filed by the Assistant Commissioner of Income Tax was dismissed. The Delhi High Court upheld the order dated 05.02.2018 rejecting the application under Section 226(4) of the Income-tax Act and held that the seized funds could not be released or appropriated towards tax recovery until conclusion of proceedings under the Prevention of Money Laundering Act.

Link to download order- https://www.mytaxexpert.co.in/uploads/1769682444_ASST.COMMISSIONEROFINCOMETAXVsSTATEORS.pdf

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