A purchaser may hold a valid tax invoice, receive the goods or services, pay the full invoice amount through banking channels and correctly disclose the transaction in GST returns. Yet the purchaser can still face reversal of Input Tax Credit (ITC) if the supplier fails to remit the tax collected to the government.
This situation arises from Section 16(2)(c) of the Central Goods and Services Tax Act, 2017, which links a recipient’s eligibility for ITC to the supplier’s payment of tax. The provision has become a major source of disputes because it potentially exposes an honest recipient to a financial consequence caused entirely by another taxpayer’s default.
The controversy becomes sharper because the CGST Act separately authorises the department to recover tax directly from a person who collected it but failed to deposit it. Taxpayers and professionals have therefore questioned why recovery action frequently begins with the buyer instead of the defaulting supplier.
Section 16(2)(c) Links ITC to Supplier’s Tax Payment
Section 16 prescribes the conditions that a registered person must satisfy to claim ITC. These include possession of a valid tax invoice, receipt of the goods or services and filing of the prescribed return.
Section 16(2)(c) adds another condition: the tax charged on the relevant supply must have actually been paid to the government, either in cash or through the utilisation of admissible ITC.
Unlike most eligibility conditions, compliance with this requirement is not entirely within the purchaser’s control. Once the buyer pays the invoice value—including GST—to the supplier, the buyer has no direct statutory mechanism to compel or independently confirm the supplier’s ultimate payment of that particular tax amount to the government.
Consequently, a recipient who has complied with every obligation falling within its control may still be called upon to reverse the credit, pay interest and, depending on the allegations, contest penalty proceedings.
In economic terms, the buyer may effectively bear the GST burden twice: first by paying it to the supplier and again through reversal or recovery of the credit.
Section 76 Provides a Direct Remedy Against the Seller
Section 76 of the CGST Act addresses cases in which a person collects an amount representing tax but fails to pay it to the government.
The provision empowers the authorities to demand the amount from the person who collected it. Interest and penal consequences may also follow in accordance with law. Significantly, this recovery mechanism operates independently of whether the underlying supply was taxable.
Section 76, therefore, appears to provide the department with a direct route against a supplier who has received GST from a customer but retained the money instead of depositing it with the exchequer.
This creates a difficult question of enforcement policy: if the law specifically permits recovery from the person who collected and withheld the tax, should ITC reversal against the recipient be the first course of action?
The legislation does not expressly prescribe a mandatory sequence requiring the department to exhaust proceedings against the supplier before invoking Section 16(2)(c) against the recipient. The absence of such sequencing has contributed substantially to buyer-side disputes.
Why Proceedings Frequently Begin With the Buyer
One practical reason is that a compliant purchaser is generally easier to identify and pursue.
A buyer claiming ITC will ordinarily have an active GST registration, regularly filed returns, identifiable bank accounts and assets against which recovery proceedings can be initiated. The recipient’s ITC details are also readily available in the GST system.
A defaulting supplier, by comparison, may have discontinued business, cancelled its registration, shifted premises or become untraceable. In suspected fake-invoice arrangements, the supplier may have been a shell entity established principally to issue invoices and pass on credit.
Proceedings against such suppliers can require extensive investigation, including tracing the entity and its controllers, examining bank accounts, issuing summons and identifying attachable assets. Even after the liability is established, actual recovery may prove difficult.
The buyer, therefore, can become the more convenient recovery target despite not being the person who retained the tax.
Administrative convenience, however, does not resolve the underlying fairness concern. Taxpayers argue that the department should not transfer the consequences of ineffective recovery from a defaulting supplier to an otherwise genuine purchaser.
Automated Mismatch Detection Makes Buyer-Side Action Easier
Technology-driven GST compliance has also changed the manner in which ITC disputes arise.
Differences between ITC claimed in GSTR-3B and the credit reflected in GSTR-2B can be identified electronically. Notices based on return data or reconciliation discrepancies can consequently be issued without the extensive field investigation ordinarily required to establish that a supplier collected tax but deliberately failed to deposit it.
Such mismatches may arise for several reasons, including:
- the supplier’s failure to furnish invoice details;
- delayed reporting or amendment of invoices;
- incorrect GSTIN or invoice particulars;
- cancellation of the supplier’s registration;
- failure to file the relevant return;
- non-payment of the supplier’s output-tax liability; or
- suspected circular trading and fake invoicing.
A mismatch is an important compliance indicator, but it does not by itself conclusively establish that the underlying transaction was fictitious. There may be cases in which goods were actually transported, payments were made through banking channels and the buyer had no connection with the supplier’s subsequent default.
Authorities must therefore distinguish between a documentary or reporting lapse and a transaction involving collusion or fraud.
Buyer Expected to Prove the Transaction’s Genuineness
The recipient claiming ITC ordinarily bears the responsibility of establishing eligibility for the credit. A tax invoice and proof of payment may not always be treated as sufficient, particularly where the supplier is found to be non-existent or the movement of goods is disputed.
Authorities may examine whether the recipient can establish:
- the identity and GST registration of the supplier;
- the tax invoice and purchase order;
- actual receipt of goods or services;
- movement of goods through e-way bills and transport documents;
- entries in stock and inventory records;
- payment of consideration through verifiable banking channels;
- use or subsequent supply of the purchased goods;
- correspondence and commercial negotiations with the supplier; and
- reconciliation of the transaction with statutory returns.
For service transactions, recipients may also need contracts, work reports, emails, deliverables and other material showing that the services were genuinely rendered.
These requirements are intended to prevent fraudulent ITC claims. The difficulty arises when a genuine buyer is asked to prove not merely the commercial transaction but also the supplier’s subsequent discharge of tax—an act over which the buyer has no direct control.
ITC Is a Statutory Benefit Subject to Conditions
The legal position commonly advanced by the revenue is that ITC is created by statute and may be claimed only after satisfying every condition imposed by the legislation. A purchaser cannot demand credit solely on grounds of equity if a statutory requirement remains unfulfilled.
The supplied material refers to the decision in Bhandari Scrap Traders as supporting the validity of Section 16(2)(c) and the proposition that ITC is a statutory benefit rather than an unconditional right.
Under this approach, the fact that the recipient acted honestly may not, by itself, override the express requirement that the supplier must have paid the tax to the government.
Nevertheless, the validity of the condition and the fairness of the department’s enforcement method are separate questions. Even if Section 16(2)(c) is legally enforceable, it may still be argued that authorities should first take meaningful action against the supplier who collected and retained the tax.
Revenue Protection Versus Taxpayer Fairness
The government has a legitimate interest in preventing fraudulent credit claims. If recipients were permitted to retain ITC merely by producing invoices and payment records, dishonest businesses could potentially structure transactions through non-compliant or fictitious suppliers and shift the loss to the revenue.
At the same time, requiring every buyer to guarantee a supplier’s tax compliance creates significant commercial uncertainty. Supplier status and return details available on the GST portal may assist due diligence, but they cannot give the purchaser complete control over the supplier’s future conduct.
A business may verify that a supplier is registered and compliant on the transaction date, only to discover later that the supplier failed to file a return, did not discharge its liability or had its registration cancelled retrospectively.
Treating every such recipient as being at fault could undermine the GST system’s objective of allowing seamless credit across the supply chain.
Recovery Against Defaulting Supplier Should Receive Priority
A more balanced enforcement model would require the authorities to first identify the nature of the supplier’s default and take effective recovery action against the person who collected the tax.
ITC denial against the recipient could then be reserved principally for cases involving:
- fictitious or non-existent supplies;
- collusion between the buyer and supplier;
- circular trading;
- fake invoices;
- absence of proof that goods or services were received;
- payments returned in cash or through accommodation entries; or
- failure by the recipient to undertake reasonable supplier verification.
Where the transaction is genuine and the buyer has paid the entire consideration through legitimate channels, the department should record why recovery from the supplier is impossible or ineffective before shifting the burden to the purchaser.
Such an approach would continue to protect revenue while distinguishing fraudulent claims from cases involving an innocent recipient.
Businesses Must Strengthen Supplier Due Diligence
Until the law or binding judicial precedent conclusively settles the relationship and enforcement sequence between Sections 16(2)(c) and 76, businesses should maintain extensive transaction-level documentation.
Taxpayers should periodically verify suppliers’ GST registration status, monitor whether invoices appear in GSTR-2B, reconcile purchase registers with portal-generated statements and promptly follow up on missing or incorrect invoices.
Contracts may also contain clauses requiring suppliers to file accurate returns, deposit tax within the prescribed period and compensate the buyer for any ITC loss caused by non-compliance. For commercially significant transactions, businesses may consider retaining part of the payment until the relevant invoice is properly reflected in the GST system, subject to contractual and statutory requirements.
However, contractual safeguards only provide a private remedy against the supplier. They do not necessarily prevent the GST department from initiating proceedings against the recipient.
Need for Clear Legislative or Judicial Guidance
The continuing conflict between Section 16(2)(c) and the recovery mechanism under Section 76 requires clearer guidance.
A statutory framework prescribing the order of recovery, the level of due diligence expected from purchasers and protection for demonstrably bona fide recipients could reduce litigation. It would also help ensure that enforcement is directed primarily against the person responsible for collecting and withholding government revenue.
Until that clarity emerges, genuine buyers remain vulnerable to ITC reversal when suppliers default. Their strongest protection lies in comprehensive documentation proving the transaction, receipt of supplies, banking payment and reasonable supplier verification.
The central issue is ultimately one of proportionality: revenue must be protected from fraudulent credit claims, but an honest purchaser should not automatically become the preferred recovery target merely because the actual defaulter is harder to pursue.
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