Clipped from: https://taxguru.in/goods-and-service-tax/itc-denial-purchasers-due-suppliers-tax-default.html
Author’s Note
As we saw, most purchasers were penalised due to the supplier’s default. Sometimes suppliers forget to pay tax, and other times they become untraceable. But was this unconstitutional? Was it justified to punish an innocent purchaser? This case finally reached the High Court—let’s see what it said.
Introduction
Under the GST Act, a registered taxpayer who is the recipient of goods is liable to claim input tax credit on goods and services which he has received and paid tax on. This is subject to a condition stated in Section 16(2) of the Act.
The main condition is in Section 16(2)(c) of the Act, which states that ITC shall be available only if the tax charged in respect of such supply of goods and services has been actually paid to the Government by the supplier, either in the cash ledger or credit ledger by adjusting it with the available ITC, and it should be correctly reflected in the return filed for the relevant tax period.
Hence, prima facie, this section makes the buyer totally dependent on the supplier’s act of actually remitting the tax to the Government to take the benefit of ITC. This event is wholly beyond the control of the buyer.
While reading this provision during my CA preparations, I used to think that once the purchaser has received the goods or services, holds a valid tax invoice, and has paid the entire consideration including GST to the supplier, the statutory and contractual obligations of the buyer stand fully discharged.
Also, logically speaking, the subsequent payment of tax to the Government is a separate and independent obligation of the supplier. Then my question was: why is the buyer punished? In this case, the buyer has neither legal authority nor any practical mechanism of enforcement or verification by law.
Denial of ITC in such circumstances leads to arbitrary and disproportionate consequences, as the buyer is effectively penalised for the default of another person, despite the transaction being genuine and tax having already been borne economically by the buyer. This results in double taxation and defeats the core objective of GST as a value-added tax system intended to prevent cascading of taxes.
Hence, while the condition under Section 16(2)(c) may be constitutionally valid, its mechanical application against bona fide purchasers, in the absence of fraud, collusion, or non-genuine transactions, is legally unsustainable and has rightly been read down by courts to prevent injustice.
Facts of the High Court Case
M/s Sahil Enterprises, which was a trader of rubber products, had purchased some goods from a registered supplier between July 2017 and January 2019. For these purchases, the company paid GST of around Rs. 1 crore.
Although the supplier correctly reported outward supplies (sales) in its GSTR-1, it filed Nil GSTR-3B returns and did not deposit the collected GST with the Government.
Later, the department started an investigation by issuing a notice under Section 73 of the CGST Act for reversal of ITC, including interest and penalty. The department also blocked the petitioner’s electronic credit ledger and denied ITC on the ground that the tax had not been actually paid to the Government by the supplier under Section 16(2)(c). Aggrieved, Sahil Enterprises filed a writ petition challenging the denial and the constitutional validity and interpretation of Section 16(2)(c).
Legal Analysis of the High Court
First, the Tripura High Court held that Section 16(2)(c) is constitutionally valid and not violative of Articles 14 (equality), 19(1)(g) (trade and profession), 265 (taxation only by law), or 300-A (property rights) of the Constitution. Hence, as per the Court, this section is constitutionally valid.
However, the Court applied the doctrine of “reading down”, which is a recognised principle used to interpret a statutory provision in a manner that avoids disproportionate or unjust consequences.
By using this doctrine, the Court held that the legislative scheme is not able to differentiate between bona fide purchasers doing genuine transactions and those which are intentionally wrongful, i.e., non-genuine transactions where fraud or collusion exists. It is a fact that a purchasing dealer has no practical mechanism or control to ensure the supplier actually deposits the tax collected from it with the Government. In one of the articles, I have discussed the same regarding Suncraft Energy Pvt. Ltd. v. State of West Bengal.
Link for that article: https://taxguru.in/goods-and-service-tax/legal-deny-purchaser-gst-itc-due-to-non-compliance-supplier.html
Here also, I concluded that to impose such a burden on the buyer who has actually complied with all statutory requirements would be arbitrary and disproportionate, effectively resulting in double taxation on the buyer.
In light of this, Section 16(2)(c) cannot be interpreted to deny ITC to a bona fide purchaser solely because the supplier failed to remit the tax, in the absence of fraud, collusion, or non-genuine transactions.
Outcome by the Court
Applying these principles, the Court set aside the departmental order denying ITC and demanding reversal, and directed the revenue to restore the blocked ITC of approx. Rs. 1 crore to the petitioner. In doing so, it reinforced that denial of ITC in genuine cases of supplier non-compliance unjustifiably punishes an otherwise compliant taxpayer.
Judicial Trends on Section 16(2)(c)
Including the case discussed in the article for which I had shared the link, the constitutional validity of Section 16(2)(c) has been upheld by multiple High Courts. The interpretation of its applicability has evolved. In earlier jurisprudence under VAT laws (like in the case of On Quest Merchandising India Pvt. Ltd.), it was held that denial of credit to bona fide buyers was impermissible absent collusion or fraud. This was implicitly affirmed by the Supreme Court in Arise India Ltd. and subsequent cases.
In GST, several High Courts (Kerala, Patna, Andhra Pradesh, Madras, Gauhati, etc.) have taken varying stances—from mechanical application to requiring opportunities for buyers to prove genuineness—indicating judicial discomfort with mechanical denial of ITC where the buyer acted in good faith. Currently, I am not aware of any Supreme Court ruling on the above matter till date, but let’s see what happens next.
But while researching this, I saw that under the pre-GST i.e., VAT laws, the Supreme Court in Arise India Ltd. related matters (affirming the above High Court’s view) effectively upheld the principle that input tax credit cannot be denied to a purchasing dealer where transactions are genuine and there is no allegation of fraud or collusion, merely because the selling dealer failed to deposit tax with the Government.
The Tripura High Court’s judgment aligns with this developing jurisprudence protecting bona fide purchasers.
Practical Problems Faced by My Clients Due to Section 16(2)(c)
A few of my clients who are genuine taxpayers faced significant practical difficulties under the literal application of Section 16(2)(c), like double taxation and cash flow burden, where a buyer who fully paid GST to a supplier and complied with all statutory conditions sometimes had credit denied when the supplier defaulted in depositing that tax. Due to this section, buyers are forced to reverse ITC and pay output tax again with interest without any relief, resulting in double taxation and adverse impact on working capital.
Also, as we discussed, there is a lack of control over supplier compliance. That means there is no statutory or technological mechanism where buyers can verify real-time tax remittances by suppliers. Hence, a genuine buyer cannot practically ensure that a supplier’s GSTR-3B returns reflect actual tax payment, yet denial of credit was based on the supplier’s default. This is an element wholly out of the buyer’s control, which the Court also agreed with.
Litigation and Issues
We know that litigation is a very costly affair. The tax offices routinely issued show cause notices to buyers under Section 16(2)(c), forcing taxpayers into prolonged litigation to justify their honesty. Buyers were often required to produce extensive documentary proofs like invoices, payment evidence, and transport documents that are beyond the statutory obligations, incurring compliance costs and delays.
Also, in some instances, like the case discussed above, the buyer’s electronic credit ledger is blocked by the department, which disrupts regular business operations and forces taxpayers into interim tax payments. This also affects the going concern of the business, or may have a cascading impact on liquidity, tax planning, and supply chains. Buyers are not only denied ITC but also face heavy interest and penalties on the amount of denied credit, even when there was no evidence of fraud or collusion by them.
The Tripura HC judgment directly addresses these concerns by ensuring that bona fide compliance by the purchaser is not penalised due to another’s malfeasance.
Conclusion
The Tripura High Court’s ruling in M/s Sahil Enterprises v. Union of India provides important relief and clarity in GST litigation. It protects bona fide purchasers from being penalised for supplier defaults. It aligns the law with commercial realities where a buyer cannot reasonably ensure another party’s tax compliance, and it underscores the principle that ITC, though a statutory benefit, is meant to prevent cascading taxation and not punish compliant taxpayers.
This judgment will significantly benefit taxpayers, especially MSMEs and supply chain participants, and should lead to reduced litigation on this issue if consistently followed in adjudication and appellate forums.
Author can be contacted at aman.rajput@mail.ca.in
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