The Punjab and Haryana High Court has held that input tax credit (ITC) cannot be denied or reversed mechanically merely because a supplier has failed to deposit tax or its GST registration has subsequently been cancelled, including retrospectively.
The bench of Chief Justice Ashwani Kumar Mishra and Justice Rohit Kapoor directed GST authorities to examine the underlying transactions, the circumstances of the supplier’s default and the statutory recovery mechanism before proceeding against purchasing dealers.
At the same time, the Court upheld the constitutional validity of Section 16(2)(c), read with Section 155. It rejected the plea to restrict the provision’s operation only to cases involving fraud, collusion or fictitious transactions.
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Background: Buyers Challenged Liability For Suppliers’ Failure To Deposit GST
The petitions raised a common question: what obligation does a purchasing dealer, who has already paid GST to its supplier, bear to ensure that the supplier deposits that tax with the Government, particularly when the purchaser has no means of verifying the deposit?
The taxpayers challenged Section 16(2)(c), which makes actual payment of the tax charged on a supply to the Government a condition for claiming ITC. They argued that requiring purchasers to ensure compliance by suppliers amounted to demanding an impossible act.
They relied on the legal principle that the law cannot compel a person to perform an impossibility and alleged violations of constitutional protections. Alternatively, they sought an interpretation under which responsibility for a supplier’s default could be imposed on the purchaser only in exceptional circumstances, such as fraud, collusion or transactions involving non-existent suppliers.
The Court examined the common legal issues without determining the individual facts of every petition.
Section 16(2)(c) Upheld, But Mechanical Enforcement Rejected
The bench held that the requirement of actual payment of tax to the Government forms part of the foundation of ITC. Since ITC is a statutory concession, the legislature can prescribe conditions governing its availability.
The Court explained that the possibility of arbitrary or improper application in individual cases does not make the provision itself unconstitutional. The remedy lies in ensuring that officials exercise their powers within the statutory framework and observe the safeguards it provides.
However, Section 16(2)(c), read with Section 155, cannot be treated as an isolated provision to automatically impose ITC reversal on a purchasing dealer whenever the supplier defaults.
Before taking such action, the proper officer must examine the circumstances of non-payment, the genuineness of the transaction and the recovery mechanisms available under the law applicable to the relevant tax period. The purchaser must also receive an opportunity of hearing.
Supplier’s Cancellation Or ‘Nil’ Return Is Only A Starting Point For Inquiry
The Court found that Section 16(2)(c) had been invoked routinely in numerous cases merely because the selling dealer’s registration had been cancelled, without examining the reasons for cancellation.
It held that subsequent cancellation of a supplier’s registration, a return showing nil or short tax liability, or an alert or complaint may justify initiating an inquiry. These circumstances cannot, by themselves, constitute the basis for denying or reversing the purchaser’s ITC.
Where retrospective cancellation is relied upon, the officer must examine the grounds and effective date of cancellation, and whether those grounds affect the genuineness of the particular supply made to the purchaser.
The bench also clarified that Rule 37A cannot serve as a general justification for retrospectively denying ITC whenever a supplier’s registration is subsequently cancelled. The rule must operate within its prescribed circumstances and applicable period.
Officers Must Identify The Default And Disclose Supporting Material
Before issuing a show cause notice based on Section 16(2)(c), the proper officer must apply their mind to the available material and record satisfaction regarding the supplier, invoices, tax periods and amount of disputed ITC.
The officer must identify the precise default: whether the supplier failed to pay tax entirely, paid less than the amount due, or discharged liability using inadmissible ITC. The circumstances of the default and the status of recovery proceedings against the supplier must also be examined.
The Court further directed that the investigation preceding a notice should establish a direct link between the purchaser and the suppliers relevant to the alleged violation of Section 16(2).
The notice must disclose the particulars and material supporting the proposed denial or reversal. Relied-upon documents—including alert notices, inspection reports, panchnamas, statements and relevant transport or banking records—must be supplied to the taxpayer, subject to any lawfully claimed privilege.
Supplier’s Fraud Cannot Automatically Be Attributed To The Buyer
The Court laid particular emphasis on proceedings invoking fraud, wilful misstatement or suppression of facts.
Where Section 74, or Section 74A for the period to which it applies, is invoked on these grounds, the notice must contain the foundational facts supporting the allegation against the purchasing dealer. Merely repeating the statutory expressions is insufficient.
A deficient notice cannot be justified later through a counter-affidavit or subsequent explanation.
The bench held that a supplier’s fraud does not automatically become the purchaser’s fraud. The notice must disclose facts connecting the purchaser with the alleged misconduct. The final order must also record a specific finding on fraud, wilful misstatement or suppression attributable to the taxpayer concerned.
Purchasers Must Still Establish Their Eligibility For ITC
The judgment retained the purchasing dealer’s burden under Section 155 to establish entitlement to credit.
The Court stated that purchasers may discharge this burden through tax invoices and evidence of actual receipt of goods or services. Relevant material may include e-way bills, transport receipts, weighbridge slips, stock records and consumption records.
The proper officer must consider this evidence and address it in the adjudication order.
Where transactions involve fraud or collusion, goods or services were not actually received, or the purchaser otherwise fails to establish eligibility, the statutory consequences can follow in accordance with law.
Recovery Against Suppliers Must Be Examined; Same Tax Cannot Be Realised Twice
The bench held that the statutory remedy against a defaulting supplier is a relevant consideration that cannot be rendered ineffective.
Officers must ascertain and record the status of proceedings against the selling dealer. Where the supplier falls under another Central or State authority’s jurisdiction, the officer must communicate with the jurisdictional authority concerned.
If the supplier has deposited the tax, or the Department has recovered it in respect of the same supply, that fact must be taken into account to prevent the same tax from being realised twice.
The purchaser may avail or re-avail credit to the extent permitted under the proviso to Section 41(2) and Rule 37A, subject to examination of Section 17(5)(i) on the facts of the case.
Later ITC Conditions Cannot Be Applied To Earlier Tax Periods
The Court directed authorities to apply the statutory framework that existed during the disputed tax period.
It distinguished the period before October 1, 2022, when the original Section 41 operated and the matching provisions in Sections 42 and 43 had not been operationalised, from the subsequent framework introduced through amendments and Rule 37A.
Conditions or mechanisms introduced later cannot be applied to periods before they came into force. This includes Section 16(2)(aa), which became effective on January 1, 2022.
For periods before the introduction of Rule 37A on December 26, 2022, officers must bear in mind the absence of the later statutory mechanism for re-availing credit reversed because of supplier default.
Buyers’ Registrations Cannot Be Cancelled Solely Because Suppliers’ Registrations Were Cancelled
The Court also addressed cancellation of purchasing dealers’ registrations.
It held that a purchaser’s registration cannot be cancelled, particularly retrospectively, merely because credit was claimed on purchases from a supplier whose registration was subsequently cancelled.
Such action requires independent satisfaction that a ground under Section 29(2) exists and compliance with the prescribed procedure.
Personal Hearing And Reasoned Orders Required
The guidelines require a personal hearing under Section 75(4). Where third-party statements are relied upon and the taxpayer requests cross-examination, the officer must consider and decide the request through a reasoned order, taking account of whether those statements form the basis of the proposed action.
The adjudication order must explain the relevant facts and the basis of the decision, address the taxpayer’s reply and documents, and record specific findings on each disputed condition under Section 16(2).
A payment made during investigation through Form GST DRC-03 or otherwise does not, by itself, remove the requirement for a notice containing the foundational facts. The nature and effect of such a deposit must be determined on the facts of the case.
The Court directed that its guidelines govern both pending proceedings and proceedings initiated thereafter.
Fresh Examination Ordered; Recovery Protection Granted
For cases pending at the show cause notice stage, the petitioners were permitted to file replies or supplementary replies with supporting material within eight weeks. Officers must thereafter pass reasoned orders after granting a hearing and applying the guidelines.
Where notices lack the required particulars or supporting material, the authorities must supply them. Any objections to supplementary notices or corrigenda introducing new grounds or provisions must be decided in the fresh order.
Where adjudication orders have already been passed, the proper officer must revisit the matter, provide a personal hearing and pass a fresh reasoned order. Supplementary notices or corrigenda may be issued with the necessary particulars and a proper opportunity to reply.
The Court expressly clarified that the impugned orders were not being interfered with, but would abide by the fresh orders passed following reconsideration.
Amounts already deposited or recovered, including through ITC reversal or ledger debits, will also remain subject to the fresh decision. Adjustment or refund, together with admissible interest, must follow wherever warranted under the law.
The Court prohibited fresh coercive recovery action against the petitioners under the challenged notices or orders until the proper officer takes a fresh decision. All factual and legal pleas were left open, and the Department remains free to proceed against defaulting suppliers.
Portal Alerts And Verification Tools Recommended
The bench also recommended policy consideration of immediate portal alerts when supplier-registration cancellation proceedings begin, technology enabling invoice-specific verification of tax payment, and stronger registration checks.
These suggestions were left to the Government and the GST Council. The Court issued no mandatory directions requiring their implementation.
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