ITC Reversal Against Bona Fide Recipient Impermissible Without Prior Proceedings Against Defaulting Supplier

The Hon’ble Kerala High Court in the case of M/s. K.V. JOSHY AND C.K. PAUL Versus ASSISTANT COMMISSIONER, OFFICE OF THE ASSISTANT COMMISSIONER, CENTRAL TAX AND CENTRAL EXCISE, THRISSUR M/s. N.C. ASSOCIATES, M/s. SUNDHA MARKETING AND ASSISTANT COMMISSIONER, OFFICE OF THE PRINCIPAL COMMISSIONER, CENTRAL GST, MYSURU, KARNATAKA - 2025 (12) TMI 1438 - KERALA HIGH COURT held that Show Cause Notice issued under Section 73 seeking ITC reversal from bona fide recipient is quashed as no prior proceedings were initiated against suppliers despite statutory mandate under Section 42 of the CGST Act to first communicate discrepancies to both parties.

Facts:

M/s. K.V. Joshy & C.K. Paul ('the Petitioner'), a partnership firm, effected purchases from Respondents 2 & 3 covered by valid tax invoices with corresponding e-way bills during FY 2019-20, claimed ITC thereon after filing returns.

The Assistant Commissioner, Central Tax & Central Excise, Chalakudy ('the Respondent') issued SCN dated May 20, 2024 under Section 73 proposing disallowance and recovery of ITC plus penalty, alleging suppliers failed to upload outward supplies in GSTR-1 or remit tax.

The Petitioner contended possession of valid tax invoices, e-way bills, and payment proofs and argued that proceedings are impermissible without prior action against suppliers as mandated by Section 42 of the CGST Act. The Respondent contended that the Petitioner failed to ensure tax remittance by suppliers as per Section 16(2)(c) of the CGST Act despite prior notice.

Aggrieved by SCN the Petitioner filed WP(C) No.24617/2024 challenging Ext.P3 under Article 226Constitution of India.

Issue:

Whether SCN under Section 73 proposing ITC reversal against bona fide recipient is sustainable without prior proceedings against supplier for non-upload of outward supplies/non-remittance of tax?

Held:

The Hon’ble Kerala High Court in M/s. K.V. JOSHY AND C.K. PAUL Versus ASSISTANT COMMISSIONER, OFFICE OF THE ASSISTANT COMMISSIONER, CENTRAL TAX AND CENTRAL EXCISE, THRISSUR M/s. N.C. ASSOCIATES, M/s. SUNDHA MARKETING AND ASSISTANT COMMISSIONER, OFFICE OF THE PRINCIPAL COMMISSIONER, CENTRAL GST, MYSURU, KARNATAKA - 2025 (12) TMI 1438 - KERALA HIGH COURT held as under:

• Observed that, Section 16(2)(c) of the CGST Act conditions ITC eligibility on supplier's actual tax payment, but recovery procedure governed by Section 42 requires communication of discrepancy to both supplier and recipient.
• Held that, there is an obligation imposed upon the assessing authority, to issue a notice communicating the discrepancy, to both such persons, in case a short supply is found. Evidently, before issuing show cause notice, no such proceedings have been followed in this case.
• Held that, Section 42(5) adds discrepancy amount to recipient's output liability only if supplier fails to rectify after notice and the proceedings against recipient is premature without supplier notice.

Our Comments:

The judgment interprets Section 42CGST Act (before the amendment made on October 1, 2022) mandating sequential proceedings, i.e., discrepancy notice to supplier first, ITC reversal on recipient only post non-rectification. This decision aligns with the Calcutta HC in the case of Suncraft Energy Private Limited And Another Versus The Assistant Commissioner, State Tax, Ballygunge Charge And Others - 2023 (8) TMI 174 - CALCUTTA HIGH COURT as affirmed by the Supreme Court in SLP THE ASSISTANT COMMISSIONER OF STATE TAX, BALLYGUNJGE CHARGE & ORS.   Versus SUNCRAFT ENERGY PRIVATE LIMITED & ORS - 2023 (12) TMI 739 - SC Order, holding that no automatic ITC reversal for GSTR-2A/1A mismatch and that recovery should primarily be made from supplier absent collusion/exceptional cases such as missing dealer/business closure cases.

Further, it also draws an analogy from the Supreme Court decision in The Commissioner Trade And Tax Delhi Versus M/s. Shanti Kiran India (P) Ltd. - 2025 (10) TMI 607 - SC Order, which upheld the Delhi High Court's ruling in On Quest Merchandising India Pvt. Ltd., Suvasini Charitable Trust, Arise India Limited, Vinayak Trexim, K.R. Anand, Aparici Ceramica, Arun Jain (HUF), Damson Technologies Pvt. Ltd., Solvochem, M/s. Meenu Trading Co., & Mahan Polymers Versus Government of NCT of Delhi & Ors. & Commissioner of Trade & Taxes, Delhi And Ors. - 2017 (10) TMI 1020 - DELHI HIGH COURT. The Delhi High Court had interpreted the Section 9(2)(g) under Delhi VAT Act to exclude bona fide purchasers from denial of ITC when valid tax invoices were issued by registered selling dealers and there was no mismatch in returns.

Although Notification No. 56/2023-Central Tax extends limitation for issuing final orders under Section 73, the court made it clear that the statutory requirement of following Section 42 procedure cannot be circumvented.

Relevant Provisions:

Section 42 of the CGST Act as stood prior to 01.10.2022

“Section 42. Matching, reversal and reclaim of input tax credit.

(1) The details of every inward supply furnished by a registered person (hereafter in this section referred to as the 'recipient') for a tax period shall, in such manner and within such time as may be prescribed, be matched

(a) with the corresponding details of outward supply furnished by the corresponding registered person (hereafter in this section referred to as the - 'supplier') in his valid return for the same tax period or any preceding tax period;

(b) with the integrated goods and services tax paid under Section 3 of the Customs Tariff Act, 1975 in respect of goods imported by him; and

(c) for duplication of claims of input tax credit.

(2) The claim of input tax credit in respect of invoices or debit notes relating to inward supply that match with the details of corresponding outward supply or with the integrated goods and services tax paid under Section 3 of the Customs Tariff Act, 1975 (51 of 1975) in respect of goods imported by him shall be finally accepted and such acceptance shall be communicated, in such manner as may be prescribed, to the recipient.

(3) Where the input tax credit claimed by a recipient in respect of an inward supply is in excess of the tax declared by the supplier for the same supply or the outward supply is not declared by the supplier in his valid returns, the discrepancy shall be communicated to both such persons in such manner as may be prescribed.

(4) The duplication of claims of input tax credit shall be communicated to the recipient in such manner as may be prescribed.

(5) The amount in respect of which any discrepancy is communicated under sub-section (3) and which is not rectified by the supplier in his valid return for the month in which discrepancy is communicated shall be added to the output tax liability of the recipient, in such manner as may be prescribed, in his return for the month succeeding the month in which the discrepancy is communicated.

(6) The amount claimed as input tax credit that is found to be in excess on account of duplication of claims shall be added to the output tax liability of the recipient in his return for the month in which the duplication is communicated. (7) The recipient shall be eligible to reduce, from his output tax liability, the amount added under sub-section (5), if the supplier declares the details of the invoice or debit note in his valid return within the time specified in sub-section (9) of Section 39.

(8) A recipient in whose output tax liability any amount has been added under sub-section (5) or sub-section (6), shall be liable to pay interest at the rate specified under sub-section (1) of Section 50 on the amount so added from the date of availing of credit till the corresponding additions are made under the said sub-sections.

(9) Where any reduction in output tax liability is accepted under sub-section (7), the interest paid under sub-section (8) shall be refunded to the recipient by crediting the amount in the corresponding head of his electronic cash ledger in such manner as may be prescribed: Provided that the amount of interest to be credited in any case shall not exceed the amount of interest paid by the supplier.

(10) The amount reduced from the output tax liability in contravention of the provisions of sub-section (7) shall be added to the output tax liability of the recipient in his return for the month in which such contravention takes place and such recipient shall be liable to pay interest on the amount so added at the rate specified in sub section (3) of Section 50.”

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