Bona Fide Purchaser Not Liable for Supplier's default to deposit GST

The Hon’ble High Court of Tripura, in the landmark case of M/s. Sahil Enterprises Versus Union of India, through its Secretary, Government of India, Ministry of Finance, Department of Revenue, New Delhi., Commissioner, Central Goods & Services Tax, Tripura Assistant Commissioner, Tripura M/s. Sentu Dey, Represented by its Proprietor Sri Sentu Dey, Bairagi Bazar, Jumerdhepha - 2026 (1) TMI 385 - TRIPURA HIGH COURT, has delivered a pivotal judgment addressing the constitutional validity and interpretation of Section 16(2)(c) of the Central Goods and Services Tax (CGST) Act, 2017. The core issue before the court was whether a bona fide purchaser could be denied Input Tax Credit (ITC) for the failure of a supplier to deposit the tax collected with the Government. In a significant move to protect honest taxpayers, the court held that the provision must be 'read down' to apply only to collusive or fraudulent transactions, not to bona fide ones. Concluding that a purchaser who has duly paid the tax to a supplier cannot be penalized for the supplier's default, the court set aside the demand order against the petitioner and directed the authorities to allow the claimed ITC.

Facts of the Case:

• The petitioner, M/s. Sahil Enterprises, is a proprietary concern engaged in the trading of rubber products. The transactions in question occurred between July 2017 and January 2019.
• During this period, the petitioner purchased goods from its supplier, M/s Sentu Dey (Respondent no. 4), and paid a total of Rs. 1,11,60,830/- in Goods and Services Tax (GST) to the supplier.
• The supplier, M/s Sentu Dey, engaged in non-compliance. While it filed GSTR-01 returns reflecting the sales made to the petitioner, it subsequently filed 'Nil' GSTR-3B returns, thereby failing to deposit the tax it had collected from the petitioner with the Government.
• Consequently, the tax authorities took action against the petitioner. They denied the ITC claimed by the petitioner, blocked its Electronic Credit Ledger, issued a Demand-cum-Show Cause Notice under Section 73 of the CGST Act, and ultimately passed an order dated 17.05.2022 confirming the demand of Rs. 1,11,60,830/- along with interest and penalty.

Key Contentions:

The case presented a direct confrontation between the rights of a bona fide taxpayer and the statutory mandate of the tax law. This section distils the central arguments advanced by the petitioner, who sought relief from what it deemed an unjust penalty, and the revenue authorities, who defended the legislative provision as a necessary tool for tax compliance.

Petitioner's Contentions (M/S. Sahil Enterprises):

• Constitutional Challenge: Argued that Section 16(2)(c) of the CGST Act is arbitrary, unreasonable, and fundamentally violates the constitutional protections guaranteed under Articles 14 (Right to Equality), 19(1)(g) (Right to Practice any Profession), and 300-A (Right to Property).
• Impossible Burden: Asserted that the provision places an impossible burden on the purchaser. A buyer has no statutory mechanism to verify whether their supplier has filed the correct GSTR-3B returns and deposited the collected tax, making compliance with the condition practically impossible.
• Punishment for Another's Fault: Contended that denying ITC to a bona fide purchaser for the default of the selling dealer is unjust. It amounts to penalizing an honest taxpayer for a fault committed by another entity, over whom the taxpayer has no control.
• Double Taxation: Alleged that demanding the tax amount from the petitioner, after it had already been paid to the supplier, constitutes double taxation. This, they argued, is a violation of Article 265 of the Constitution, which mandates that no tax shall be levied or collected except by authority of law.

Respondents' Contentions (Union of India & CGST Department):

• Validity of Statute: Maintained that Section 16(2)(c) is constitutionally valid in all respects and does not infringe upon any fundamental rights.
• Legislative Freedom: Argued that the legislature possesses significant freedom and flexibility in enacting taxing statutes, and courts should exercise judicial restraint before interfering with such laws.
• Correctness of Order: Defended the demand order dated 17.05.2022, stating that it was legally sound and did not suffer from any defect, as it was passed in accordance with the existing statutory provisions.

These opposing arguments set the stage for the court to adjudicate on the fundamental questions of law at the heart of the dispute.

Issues Before the Court:

• Whether Section 16(2)(c) of the Central Goods and Services Tax Act, 2017, is unconstitutional for being violative of Articles 14, 19(1)(g), and 300-A of the Constitution of India?
• Whether the Input Tax Credit (ITC) can be denied to a bona fide purchasing dealer on account of the selling dealer's failure to deposit the tax collected with the Government?

Held by Court:

The Hon’ble High Court of Tripura in M/s. Sahil Enterprises Versus Union of India, through its Secretary, Government of India, Ministry of Finance, Department of Revenue, New Delhi., Commissioner, Central Goods & Services Tax, Tripura Assistant Commissioner, Tripura M/s. Sentu Dey, Represented by its Proprietor Sri Sentu Dey, Bairagi Bazar, Jumerdhepha - 2026 (1) TMI 385 - TRIPURA HIGH COURTheld as under:

• Observed that, Section 16(2)(c) places an onerous and impossible burden on a bona fide purchasing dealer. The court recognized that a purchaser has no control over the supplier and lacks any mechanism to verify if the tax paid has actually been deposited with the government.
• Noted that, the principle of 'reading down' a statutory provision is an accepted judicial method to save it from unconstitutionality. The court found it appropriate to apply this principle to distinguish between bona fide transactions and those that are not.
• Noted that, the issue is squarely covered by the Delhi High Court's landmark decision in On Quest Merchandising India Pvt. Ltd., which read down a pari materia provision in the Delhi VAT Act. This decision, the court highlighted, was implicitly approved by the Supreme Court when it dismissed the Special Leave Petition filed against it in Commissioner of Trade and Tax Delhi v. M/s Arise India Ltd.
• Observed that, while several other High Courts had upheld the constitutionality of Section 16(2)(c) without reading it down, those judgments failed to consider the practical impossibility faced by the purchaser. Furthermore, they did not notice the binding precedents set by the Delhi High Court and approved by the Supreme Court.
• Held that, while Section 16(2)(c) of the Act is not unconstitutional per se, it must be read down. The provision should not be interpreted to deny ITC to a purchaser in a bona fide transaction. Its application must be restricted to transactions that are collusive, fraudulent, or otherwise not bona fide.
• Held that, the department's invocation of Section 73 (for non-fraud cases) instead of Section 74 (for fraud, collusion, etc.) against the petitioner was significant. This confirmed that the department itself did not allege any collusion or fraudulent intent, thereby reinforcing the petitioner's status as a bona fide purchaser.
• Directed that, the impugned order dated 17.05.2022 passed by the respondent no. 3 is set aside.
• Directed that, the respondents must forthwith allow the petitioner to avail the ITC of Rs. 1,11,60,830/- that was previously denied.

This judgment provides a significant interpretive safeguard for taxpayers, ensuring that the burden of a supplier's default does not fall upon an honest purchaser.

Our Comments:

Analysis of Section 16(2)(c) of the CGST Act, 2017

Section 16(2)(c) of the CGST Act, 2017, establishes a critical condition for availing Input Tax Credit. It mandates that a registered person is entitled to ITC on a supply only if 'the tax charged in respect of such supply has been actually paid to the Government.' This provision effectively makes the buyer's right to ITC conditional on the supplier's compliance. By linking the recipient's credit to the supplier's action of depositing the tax, the section creates a significant risk for the buyer, who may have fulfilled all their obligations (i.e., paid the invoice amount, including tax) but still face ITC denial due to the supplier's default. The High Court rightly identified this as an 'onerous and impossible burden.'

Supportive Judgments and Pari Materia Provisions:

The Tripura High Court's decision is firmly rooted in a consistent line of judicial precedents that have dealt with similar statutory provisions under both VAT and GST laws. The court's reliance on this established jurisprudence strengthens its reasoning significantly.

• 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: This case is the cornerstone of the court's rationale. Dealing with a nearly identical provision under the Delhi VAT Act, the Delhi High Court established the principle of reading down the law to protect bona fide purchasers from the defaults of their suppliers. It held that the provision could not be used to penalize honest buyers and that the department's remedy was to proceed against the defaulting seller.
• Commissioner of Trade And Taxes Delhi Versus Arise India Limited, On Quest Merchandising India Pvt. Ltd. - 2018 (1) TMI 555 - SC Order: The Supreme Court's dismissal of the Special Leave Petition (SLP) filed against the Quest Merchandising judgment gave the High Court's reasoning significant precedential value. The Tripura High Court correctly interpreted this dismissal as an implicit approval of the principles laid down by the Delhi High Court.
• SHANTI KIRAN INDIA PVT LTD Versus COMMISSIONER TRADE & TAX DEPTT. - 2013 (2) TMI 80 - DELHI HIGH COURT: This case, which also dealt with the denial of ITC under the DVAT regime, followed the Quest Merchandising ruling. Its subsequent affirmation by the Supreme Court further solidified the legal position that ITC cannot be denied where the bona fides of the transaction are not in doubt, reinforcing the precedent set in Arise India.
• National Plasto Moulding, M/s. Society Soap Works And Anr, Jugal Kishore Daga, Abhay Associates And Anr, Madhu Jain, Mahabir Prasad Mahendra Kumar, Dipankar Banik, Vijay Trading Co., Tolaram Surendar Kumar Kundalia And Anr, Surender Kumar Kundalia, Gunchand Dalchand, Hemkaran Stores, M/s. Rathi Traders And Anr, . Versus The State of Assam, The Commissioner of State Taxes (Earlier Known As The Commissioner of Taxes) Guwahati, The Superintendent of Taxes, Nishant Sales Corporation, The Union of India, The Commissioner Central Goods And Service Tax Guwahati, The Assistant Commissioner Central Goods Ana Service Tax Tezpur, Jvl Agro Industries Ltd. - 2024 (8) TMI 836 - GAUHATI HIGH COURT: This judgment is particularly relevant as it directly applied the rationale from Quest Merchandising to Section 16(2)(c) of the CGST Act itself. The Gauhati High Court also read down the provision to protect bona fide transactions, providing a direct precedent under the same statute.

Contrary Judgments and the Court's Rationale for Departure:

The court acknowledged a divergent view taken by several other High Courts—including those of Kerala, Patna, Madhya Pradesh, Madras, and Andhra Pradesh—which had upheld the validity of Section 16(2)(c) without reading it down. However, the Tripura High Court provided a compelling and multi-faceted critique for its departure from this contrary line of reasoning, identifying three fundamental flaws in the opposing judgments.

• Overlooking Practical Impossibility: The other High Courts failed to adequately consider the practical impossibility for a purchasing dealer to ensure or even verify that the selling dealer has deposited the tax with the government, as no statutory tool is available for this purpose.
• Ignoring Binding Precedents: Crucially, the contrary judgments did not notice or consider the compelling line of reasoning from the Delhi High Court in Quest Merchandising, which was affirmed not once, but twice, by the Supreme Court in Arise India and Shanti Kiran. This omission significantly weakened the persuasive value of their conclusions.
• Disregarding the Principle Against Double Taxation: The Tripura High Court highlighted that the very purpose of ITC is to avoid the cascading effect of taxes. It reasoned that forcing a bona fide purchaser, who has already paid the tax to the supplier, to pay it again to the exchequer amounts to double taxation. The court noted that the other High Courts had overlooked this fundamental principle underlying the entire ITC mechanism.

The Final conclusion, the judgment of the Hon’ble Tripura High Court stands as a crucial bulwark for genuine taxpayers. By meticulously reading down Section 16(2)(c), the court has powerfully reinforced the judicial principles of fairness, reasonableness, and the prevention of impossible compliance burdens. This ruling provides much-needed relief and clarity, affirming that the objective of a tax system is to collect revenue from the correct party, not to unjustly penalize honest businesses for the fraudulent actions of others in the supply chain, and to uphold the legislative intent of ITC to prevent double taxation.

 (Author can be reached at [email protected])