Government Dues under IBC: Rainbow Papers and After

When the Code was enacted, one of its deliberate choices was to lower the priority of government dues, which had ranked high under the Companies Act. Tax authorities have since contested that choice in many forms: by continuing recovery, by refusing to accept extinguishment of dues, and by claiming to be secured creditors on the strength of statutory charges. This note explains the position of government dues at each stage of insolvency, the conflicting Supreme Court decisions in Rainbow Papers and Paschimanchal Vidyut, and the 2026 amendments that resolved the conflict.

1. Government as Operational Creditor

• Section 5(21). A debt in respect of the payment of dues arising under any law and payable to the Central Government, a State Government or a local authority is an operational debt, so tax and similar authorities are operational creditors (Topic 9)
• Long title. The Code's long title refers to balancing the interests of all stakeholders including alteration in the order of priority of payment of government dues, signalling a deliberate policy of placing such dues below financial creditors (Topic 1)

Figure 1: Government dues at each stage

2. Moratorium, Claims and Extinguishment

• Moratorium. During the moratorium, tax authorities cannot recover dues by attachment or sale of the debtor's assets; in Sundaresh Bhatt v CBIC (2022), the Supreme Court held that customs authorities could only file a claim and could not sell the debtor's goods (Topic 22)
• Claims. Authorities must file claims with the resolution professional like other creditors (Topic 33)
• 2019 amendment. Section 31(1) was amended to make an approved plan expressly binding on the Central Government, State Governments and local authorities to whom statutory dues are owed.
• Ghanashyam Mishra and Sons v Edelweiss ARC, 2021. Statutory dues not included in an approved plan are extinguished, and no proceedings can be taken for them for the period before approval (Topic 42)

3. Priority in Liquidation

• Section 53(1)(e). Amounts due to the Central and State Governments, including amounts to be received in the Consolidated Funds, for the whole or any part of the period of two years before the liquidation commencement date, rank equally with debts owed to secured creditors for any amount unpaid after enforcement of their security.
• Rank. This places government dues below process costs, workmen and secured creditors who relinquish security, employees and unsecured financial creditors; dues for earlier periods fall among the remaining debts under section 53(1)(f) (Topic 57)
• Contrast. Under the Companies Act, government revenues had been among the preferential payments in winding up; section 327(7) now disapplies those provisions in liquidation under the Code (Topic 34)

4. State Tax Officer v Rainbow Papers, 2022

• Facts. The Gujarat sales tax department claimed VAT dues from Rainbow Papers in its CIRP; the approved plan provided little for them, and the department argued that section 48 of the Gujarat VAT Act created a first charge on the dealer's property in its favour.
• Holding. Decided on 6 September 2022 by a bench of two judges, the Supreme Court held that the statutory charge was a security interest within section 3(31), so the State was a secured creditor.
• Consequence. A resolution plan that ignores the statutory dues of the State as a secured creditor is not in accordance with law, and the committee and the NCLT must consider them; the approval of the plan was set aside.
• Impact. The decision unsettled many plans and encouraged authorities, including land development authorities claiming lease premium, to assert secured status in insolvency proceedings.

5. Paschimanchal Vidyut and the Review

Figure 2: Two views of statutory charges

• Paschimanchal Vidyut Vitran Nigam v Raman Ispat, July 2023. In a liquidation, the Supreme Court held that the order of priority in section 53, read with the overriding effect of section 238, governs; dues claimed under other statutes cannot obtain a higher priority, and it observed that Rainbow Papers had not considered section 53.
• Review dismissed. Later in 2023, in Sanjay Kumar Agarwal v State Tax Officer, a bench of two judges dismissed petitions seeking review of Rainbow Papers, so both lines of authority stood, Rainbow Papers in the context of resolution plans and Paschimanchal in liquidation.
• Uncertainty. Resolution applicants and creditors faced uncertainty about whether statutory charges would have to be treated as secured claims, affecting the value of bids.

Figure 3: How the law on government dues developed

6. The 2026 Amendments

• Explanation to section 3(31). Clarifies that a security interest arises only from an agreement or arrangement between parties, and not merely by operation of law, so a statutory charge does not by itself make the government a secured creditor.
• Explanation to section 53(1)(e)(i). Provides that government dues for the two years before liquidation rank under section 53(1)(e)(i) whether or not they are secured, and whether any security arises by agreement or by operation of law, with the balance under section 53(1)(f)
• Effect on land authorities. Claims of land authorities for lease premium and similar dues now rank under clauses (e) and (f), unless the authority holds a security interest created by agreement; as lessors, they retain practical influence over plans that use their land (Topic 36)
• Result. The amendments legislatively displace the reasoning of Rainbow Papers and restore the policy of the Code that government dues rank below financial creditors; the published summaries describe the change as clarificatory, which may affect pending matters.

7. Frequently Asked Questions

Is a tax department a secured creditor because its statute creates a first charge?

After the 2026 Amendment, no. The Explanation to section 3(31) provides that a security interest must arise from an agreement or arrangement, not merely by operation of law. Before that, Rainbow Papers (2022) had held that such a charge made the State a secured creditor.

Can a tax authority recover old dues from the company after a resolution plan is approved?

No, if the dues are not provided for in the plan. Ghanashyam Mishra (2021) held that they are extinguished, since the plan binds the government under section 31(1).

Where do government dues rank in liquidation?

Dues for the two years before the liquidation commencement date rank under section 53(1)(e), equally with the unpaid balance of secured creditors who enforced their security, below unsecured financial creditors. Older dues fall under section 53(1)(f).

8. Related Topics

• Topic 42: Section 31. Approval and the clean slate.
• Topic 57: Section 53. The waterfall mechanism.
• Topic 80: IBC, Income Tax and GST. Tax issues in insolvency.