Section 278B of the Income Tax Act

Source:  Delhi High Court 

Why in News? 

Recently, Justice Ravinder Dudeja ruled that a director cannot be personally prosecuted for a company’s actions unless the company itself is made an accused. It held that failure to implead the company is a fatal defect, emphasizing that under Section 278B of the Income Tax Act, both the company and its officers must be jointly arraigned for liability. 

• The Delhi High Court held this in the matter of Rakesh Agarwal v. ITO  (2025). 

What was the Background of Rakesh Agarwal v. ITO (2025) Case ? 

• M/s SNR Buildwell Pvt. Ltd., a private company, failed to discharge its tax liabilities for the Assessment Years 2014-15, 2015-16, and 2016-17. This non-payment resulted in the Income Tax Department raising a demand for tax dues amounting to Rs. 4,44,82,912/-. During the pendency of recovery proceedings initiated by the Department, it came to light that Rakesh Agarwal, who was a Director of the company, had transferred an Audi Car bearing Registration Number UK 07 BE 2759 to his daughter-in-law without providing adequate consideration in return. 
• The Income Tax Department treated this transfer as void under Section 281 of the Income Tax Act, 1961, on the grounds that it was undertaken to frustrate the recovery proceedings. Consequently, the Department initiated criminal prosecution against both Nilesh Agarwal and Rakesh Agarwal, the Directors of the company, under Section 276 of the Income Tax Act, 1961, which pertains to the offence of removal, concealment, transfer, or delivery of property to thwart tax recovery. 
• The Principal Commissioner of Income Tax accorded sanction for prosecution of the petitioner-Directors under Section 276 of the Income Tax Act. The Income Tax Office thereafter filed complaints against the Directors before the trial court. However, notably, the company itself, M/s SNR Buildwell Pvt. Ltd., was not arrayed as an accused in the complaints. The petitioner-Directors objected to the maintainability of the prosecution on this ground, contending that in the absence of the company being made a party to the proceedings, prosecution against them as Directors alone is not permissible under law. 
• The trial court, by orders dated 06.06.2024, rejected the objections raised by the petitioner-Directors and held that the complaints were maintainable. The trial court proceeded to list the matter for framing of charges. Aggrieved by these orders, the petitioner Directors approached the High Court of Delhi. 

What were the Court’s Observations? 

• The High Court observed that Section 278B of the Income Tax Act, 1961, creates a statutory deeming fiction wherein both the company and every person in charge of and responsible for the conduct of its business are deemed to be guilty of an offence committed by the company. The legislative intent embedded in this provision is unambiguous: the company, being the principal offender, must first be arraigned as an accused in the proceedings. Only thereafter can vicarious liability be fastened upon its officers and Directors. 
• The Court noted that the jurisprudence developed under Section 141 of the Negotiable Instruments Act, which contains a similar vicarious liability provision, is directly applicable to Section 278B of the Income Tax Act.  
• The Supreme Court in Aneeta Hada v. Godfather Travels & Tours had laid down the binding principle that for maintaining prosecution against Directors under a vicarious liability provision, the arraignment of the company is imperative. The company, being a juristic person, must be impleaded as an accused, and without its impleadment, the Directors cannot be prosecuted. The foundation of such prosecution lies in the commission of the offence by the company itself, and liability can extend to its Directors only thereafter. 
• The Court observed that the complaints in the present case were entirely premised on the company's liability arising from its outstanding tax dues and the alleged transfer of company assets. No independent allegation was made against the petitioner-Directors in their personal capacity.  
• The Show Cause notice dated 31.10.2019 was addressed only to the company and explicitly stated that the prosecution of the petitioners was being undertaken "in the capacity of Director of the company," thereby making it abundantly clear that the petitioners were being prosecuted solely on the basis of vicarious liability. 
• The Court held that the omission to implead the company is therefore not a mere technical or procedural irregularity that could be cured through subsequent amendment of the complaints. Rather, this omission goes to the root of jurisdiction and renders the entire prosecution legally unsustainable.  
• The continuation of proceedings against the petitioner-Directors as Directors alone, without impleading the company as an accused, would be contrary to Section 278B of the Income Tax Act and the law declared in Aneeta Hada, thereby constituting an abuse of the process of law. 

What is Section 278B of the Income Tax Act, 1961 ? 

• Overview and Purpose: 
  • Section 278B of the Income Tax Act, 1961, establishes a framework of vicarious liability that extends criminal responsibility from corporate entities to individuals overseeing their operations.  
  • This provision ensures that individuals cannot evade accountability by sheltering behind the corporate structure.  
  • It applies to companies, firms, and any association of persons, whether incorporated or not, creating a comprehensive mechanism to hold decision-makers personally responsible for tax violations. 
• Primary Liability Framework: 
  • Section 278B(1) provides that where an offence under the Income Tax Act has been committed by a company, every person in charge of and responsible for the conduct of its business, as well as the company itself, shall be deemed guilty of the offence.  
  • Such individuals are liable to be proceeded against and punished accordingly. This provision creates a deeming fiction extending liability from the corporate entity to responsible individuals. 
  • The section incorporates a crucial safeguard. Individuals shall not face punishment if they prove that the offence was committed without their knowledge or that they exercised all due diligence to prevent its commission.  
  • This defence mechanism allows responsible individuals to escape liability by demonstrating either their lack of awareness or their proactive efforts to prevent violations. 
• Enhanced Liability for Active Involvement: 
  • Section 278B(2) imposes heightened liability on specific corporate officers. Where an offence is proved to have been committed with the consent or connivance of, or is attributable to any neglect on the part of, any director, manager, secretary, or other officer, such officer shall be deemed guilty.  
  • This provision targets individuals whose actions, omissions, or authorisation directly facilitated the offence. Such officers face liability without the benefit of the "due diligence" defence available under Section 278B(1). 
• Concurrent Punishment Mechanism: 
  • Section 278B(3) ensures that both the company and responsible individuals can be punished simultaneously.  
  • Where an offence carries imprisonment and fine as punishment, the company faces fine while individuals may face both imprisonment and fine. This prevents situations where only the corporate entity is punished while individuals escape consequences. 
• Scope and Definition: 
  • The Explanation to Section 278B broadly defines "company" to include any body corporate, firm, and association of persons or body of individuals, whether incorporated or not. 
  •  The term "director" is contextualised to mean a partner in firms and any member controlling the affairs of associations.  
  • This expansive definition ensures the provision applies to various business organisations. 
• Defences and Significance: 
  • An individual can defend against prosecution by proving either absence of knowledge regarding the offence or exercise of due diligence in prevention. Due diligence encompasses implementing internal compliance mechanisms, monitoring systems, and taking corrective action upon discovery of irregularities. 
  • Section 278B serves critical objectives by preventing misuse of corporate structures to evade individual accountability, encouraging compliance through personal responsibility, and promoting transparency in tax practices. By deeming individuals guilty of company offences, the provision creates a deterrent effect and ensures that senior management cannot hide behind corporate veils to escape consequences for tax violations. Companies must therefore prioritise compliance and implement robust internal controls to mitigate prosecution risks under this section.