Tax Recovery Officer Can't Void Third-Party Mortgages: Madras High Court In Sree Gokulam Chit's Case

The Madras High Court has recently set aside an income tax recovery order that had declared a mortgage created in favour of Sree Gokulam Chit and Finance, a chit fund part of the Gokulam Group, as void from the outset.

Justice Senthilkumar Ramamoorthy held that the Income Tax Department can recover its dues by selling an attached property, but the Tax Recovery Officer cannot decide the validity of a transfer in favour of a third party. The court said the recovery framework does not permit such an adjudication.

“The Second Schedule is intended to enable the TRO to recover arrears from a defaulting assessee or his representatives in interest, but not to enable the adjudication of the validity of a transfer in favour of a third party,” the court said

The case relates to a residential property in Korattur, Chennai. The owner had been facing income tax proceedings for several years. His return for the 2011–12 assessment year was taken up for scrutiny. A tax demand of over Rs 3.21 crore followed, including interest and penalty. A recovery certificate was issued in February 2016, and a statutory notice calling upon him to clear the arrears was served soon after.

On the day the notice was received, the individual taxpayer completed the purchase of the Korattur property. Several months later, he deposited the title deeds of the same property with Sree Gokulam Chit and Finance as security.

A memorandum recording the deposit of title deeds was executed in November 2016. The security was intended to cover present and future liabilities.

The financial relationship later expanded. In 2018, the taxpayer and his wife stood as sureties for a chit transaction involving a partnership firm. Defaults followed. Arbitration proceedings were initiated by the chit fund. An ex parte award was later passed in its favour, and attachment orders were obtained in execution.

In parallel, the tax department proceeded with recovery. The property was attached in September 2019. An auction was proposed in 2022. When the chit fund objected on the strength of its mortgage, the Tax Recovery Officer rejected the objection and declared the mortgage void ab initio. That declaration was challenged before the High Court.

The court held that the mortgage could not prevail over the department's tax recovery. At the same time, it clarified that the law does not treat such transfers as void altogether.

“Rule 16(2) of the Second Schedule indicate clearly that transfers are not either void ab initio or even liable to be declared void,” the court said.

“ Instead, under Section 281(1), such transfer is void as against any claim in respect of any tax or any other sum payable by the assessee; and under Rule 16(2), it is void against claims enforceable under the attachment.In neither case, the statute provides that such transfer would be completely unenforceable”, it added.

The court set aside only the declaration that the mortgage was void from inception. It allowed the tax authorities to proceed with the sale of the property and adjust their dues from the sale proceeds.

Any surplus, if available, must be retained and paid out later depending on the final outcome of proceedings between the chit fund and the borrower.

For Petitioner: A.S. Sriraman and S. Sridhar

For Respondent: Senior Standing Counsel, B. Ramanakumar, Junior Standing Counsel Avinash Krishnan Ravi