The Karnataka High Court has set aside a GST adjudication order demanding ₹36.22 lakh from a scrap trader, holding that proceedings under Section 74 cannot rest on allegations against the supplier without foundational facts indicating fraud or misstatement by the purchaser itself.
A Division Bench of Justice M. Nagaprasanna and Justice Hema Kulkarni also found that the authorities had repeatedly proceeded on the premise that the taxpayer had not replied, despite replies and supporting documents being on record.
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The Court overturned the Single Judge’s order relegating the trader to a statutory appeal and directed refund of the deposit made pursuant to the High Court’s orders. However, it permitted the department to resume proceedings from the stage of considering the taxpayer’s reply to the first notice, only if such action remained permissible in law.
The appellant, Kunal Traders, is a Belagavi-based proprietorship engaged in supplying cast iron scrap and cast iron borings. The dispute concerned input tax credit claimed for financial year 2019–20 on purchases from M/s Laxmi Enterprises.
The department alleged that the supplier was involved in bill trading or circular trading. It questioned ITC of ₹11,76,252 on purchases having a taxable value of ₹65,34,732. The disputed credit comprised CGST and SGST of ₹5,88,126 each.
Following scrutiny of returns, the department issued an initial communication dated April 17, 2023, seeking an explanation or payment of the disputed amount along with interest and penalty.
The trader submitted a reply on May 4, 2023, maintaining that the credit complied with Section 16 and was supported by valid tax invoices. It also stated that no transactions had been undertaken with the supplier after financial year 2019–20.
The proceedings subsequently included a DRC-01A intimation dated September 24, 2025, and a show-cause notice dated September 29, 2025, invoking Section 74.
The taxpayer pointed out that it had already replied to the intimation through the GST portal on September 27, 2025. Its subsequent response referred to that reply and the portal acknowledgement, and offered bank statements, weighment slips, purchase invoices and sales invoices issued to Ashok Iron Works for verification.
The trader maintained that the purchases were genuine, the transactions were recorded in its books, payments were made through banking channels and the purchases were reflected in returns.
It argued that proceedings under Section 74 could not be initiated merely on the basis of findings concerning the supplier without establishing fraud or collusion on the purchaser’s part.
The adjudicating authority considered the documents insufficient to establish actual receipt of goods. It referred to the absence of supplier-issued weighment slips, lorry receipts and details of payments to lorry owners.
Relying also on enforcement findings concerning the supplier, the authority concluded that receipt of goods had not been established and denied credit under Section 16(2)(b).
The trader challenged the adjudication order before the High Court. On July 23, 2026, the Single Judge declined interference because an appellate remedy was available under Section 107 of the GST Act.
In the writ appeal, the taxpayer argued that its replies had repeatedly been ignored and that the notice lacked the foundational facts necessary to invoke Section 74.
The State defended the Single Judge’s decision, submitting that the trader could place its documents and objections before the appellate authority.
The Division Bench nevertheless examined the legality of initiating proceedings under Section 74 and the authorities’ treatment of the taxpayer’s responses.
The Bench observed that the allegations concerned the supplier’s involvement in fraudulent transactions. The notice did not directly disclose facts against the appellant establishing the fraud or misstatement necessary for invoking Section 74.
The Court emphasised that merely using expressions such as fraud, wilful misstatement or suppression does not supply the factual foundation required for proceedings under that provision.
It relied on the Supreme Court’s decisions in GR Infra Projects Limited v. State of Madhya Pradesh, cited in the judgment as 2026 SCC OnLine SC 2084, and Tata Steel Limited v. Union of India, cited as 2026 SCC OnLine SC 1702.
As discussed in the High Court’s judgment, these decisions require the show-cause notice itself to disclose the facts from which fraud, wilful misstatement or suppression is inferred. The statutory expressions cannot be mechanically recited to invoke the extended limitation period.
Applying those principles, the Division Bench held that the initiation of proceedings and the resulting adjudication order were contrary to law.
The Court also examined the department’s repeated assertions that the taxpayer had not furnished an explanation.
It noted that the reply dated May 4, 2023, was already on record when the subsequent communication stated that no explanation or documents had been submitted. A similar approach followed the reply filed on September 27, 2025.
The Bench further noted that the personal hearing endorsement indicated production of documents with the reply. Although the adjudication order mentioned personal hearings, what had occurred during those hearings was neither clearly indicated nor appropriately considered.
The defects therefore concerned both the legal basis for invoking Section 74 and the consideration of the taxpayer’s defence.
Allowing the appeal, the Division Bench set aside the Single Judge’s order dated July 23, 2026, and the adjudication order dated March 27, 2026.
The Court also directed refund of the deposit made with the department pursuant to its orders.
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