'FAILS TO PAY' OR 'NON-PAYMENT' - REVISITING THE 180-DAYS GST-ITC REVERSAL MECHANISM

1. Brief Introduction

Section 16 of the Central Goods and Services Tax Act, 2017 ('CGST Act') grants entitlement to Input Tax Credit ('ITC'), which constitutes the backbone of the GST framework. GST was conceived as a seamless value-added tax system intended to eliminate cascading effects and ensure tax neutrality across the supply chain.

However, the second proviso to section 16(2) of the CGST Act introduces a significant restriction. It mandates the reversal of ITC, including interest, if the recipient fails to pay the value of the supply, along with tax, within 180 days of the invoice date.

The said proviso reads as,

'Provided further that where a recipient fails to pay to the supplier of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier, an amount equal to the input tax credit availed by the recipient shall be added to his output tax liability, along with interest thereon, in such manner as may be prescribed:'

In this regard, rule 37 has been prescribed, which requires that the registered person shall pay or reverse an amount equal to the ITC availed in respect of such supply, proportionate to the amount not paid to the supplier, along with interest payable thereon under section 50, while furnishing the return in Form GSTR-3B for the tax period immediately following the expiry of 180 days from the date of issue of the invoice. However, where the registered person subsequently makes payment of the amount towards the value of such supply along with the tax payable thereon to the supplier, he shall be entitled to re-avail the ITC already reversed.

Though ostensibly introduced as an anti-evasion measure, the provision raises substantial constitutional, commercial, and jurisprudential concerns, particularly when applied to genuine commercial transactions involving deferred payment arrangements.

This article critically examines the legal validity, scope, and implications of the 180-days condition and analyses whether the provision exceeds the legitimate boundaries of fiscal legislation.

Background:

Vide rule 4(7) of the CENVAT Credit Rules, 2004, a service recipient was required to reverse CENVAT credit in cases of non-payment of the value of input services within three months from the date of invoice. However, such credit could be reclaimed once payment to the service provider was eventually made.

To retain a similar provision under GST as an anti-evasion measure, the issue was discussed during the 5th GST Council Meeting held on 2-3 December 2016 (Para 3.viii of the Minutes) and the 6th GST Council Meeting held on 11 December 2016 (Para 11.xxi of the Minutes). After deliberations, the Council agreed to retain a similar provision in relation to services and also extend the scope in respect of goods, while extending the time limit for making payment from three months to six months from the date of issuance of the invoice.

2. Anti-Evasion Intent

The second proviso to section 16(2) of the CGST Act mandates that a registered recipient must reverse the ITC availed if payment towards the value of supply, along with tax, is not made to the supplier within 180 days from the date of invoice.

Historically, this provision appears to have been conceived primarily as an anti-evasion safeguard. As reflected from the legislative deliberations, the mechanism was intended to deter collusive 'paper transactions' and fraudulent passing of credit without any genuine underlying commercial activity or actual movement of funds.

However, while introducing this safeguard, the legislature appears to have overlooked the fact that 'paper transactions' can equally occur even where payments are routed through banking channels, and moreover, persons engaged in fraudulent transactions are unlikely to wait for 180 days for closure or settlement of such transactions.

Further, the law grants relaxation in respect of supplies on which tax is payable under the reverse charge mechanism ('RCM'). Retaining the same spirit, similar relaxation ought to have been extended to transactions involving import of goods, where IGST is discharged at the time of import in a manner substantially similar to RCM, as well as to cases where the supplier has admittedly deposited the GST with the Government, leaving no doubt regarding the genuineness of the transaction.

3. The Textual Shift: 'Fails to Pay' vs. 'Non-Payment'

A comparison with the pre-GST jurisprudence reveals a significant legislative shift. Under rule 4(7) of the CENVAT Credit Rules, 2004, the trigger was purely objective and binary, namely that the payment 'is not made within three months'. In contrast, the second proviso to section 16(2) of the CGST Act consciously employs the expression 'fails to pay', thereby introducing an element of default, omission, or neglect.

In general civil jurisprudence, a party cannot be said to have 'failed' to discharge an obligation unless such obligation has actually matured. If a valid contract provides that payment shall become due on Day 300, there can be neither a legal debt nor a default on Day 181. By mechanically applying a 180-days countdown irrespective of contractual terms, the revenue authorities effectively convert an unexpired contractual credit period into an artificial statutory breach.

The word 'fails', as defined in Black's Law Dictionary, when used as a verb, means 'to be deficient or unsuccessful'. The expression 'failure of consideration' has been explained therein as:

'A seriously deficient contractual performance that causes a contract's basis or inducement to cease to exist or to become worthless. Scholars disapprove of this term as misleading, since failure of performance is more accurate. Unlike consideration, the phrase failure of consideration relates not to the formation of a contract but to its performance'

Thus, in legal terminology, 'failure' ordinarily connotes a default, breach, or neglect of an existing obligation. It does not encompass a structured and mutually agreed-upon future payment arrangement.

In Badri Prasad vs. District Judge, Gonda, it was observed that a party can be said to have 'failed to pay' only when it neglects to perform something which it was contractually or legally required to do. Similarly, in Dhan Singh Ramkrishna Chaudhri vs. Laxminarayan Ramkishan & Anr, the Hon'ble Supreme Court observed:

'Failure and Default are two synonymous terms. Failure means a falling short, and default means omission of that which a man ought to do. .'

Further, a critical flaw in the administrative enforcement of the proviso lies in the manner in which the statutory trigger is interpreted. The department routinely equates the phrase 'fails to pay' with mere 'non-payment'. In effect, the authorities interpret the provision as though it stated: 'where payment is not made within 180 days.'

By doing so, the authorities effectively add words to the statute which Parliament deliberately chose not to employ. Such interpretation disregards settled contractual principles and rewrites private commercial arrangements by creating a statutory default even where no contractual default exists.

It is for this reason that the provision, in its present mechanical application, is facing serious constitutional and legal challenges before various High Courts. Taxpayers are increasingly contending that the rule disrupts legitimate commercial credit cycles, particularly where the underlying supply is genuine and the tax has already been deposited with the exchequer.

4. Disruption of Genuine Commercial Business Models

By ignoring the distinction between structural credit terms and actual default, the application of the proviso leads to serious anomalies across several legitimate business models:

• Supplies Made in Lots: In large manufacturing or infrastructure arrangements, a single umbrella invoice may be raised on Day One, whereas the actual delivery of goods takes place in phases over six to nine months. Commercially, a purchaser cannot reasonably be expected to make payment for goods that have not yet been received. Nevertheless, the 180-days period begins from the date of the invoice, thereby compelling premature reversal of ITC.

More importantly, the first proviso to section 16(2) provides that where goods covered under a single invoice are received in lots or instalments, ITC can be availed only upon receipt of the last lot or instalment. Consequently, in several cases, the purchaser may not even have availed the ITC due to the operation of the first proviso, yet the trigger for reversal under the second proviso may already commence from the invoice date itself. This creates an inherent statutory inconsistency.

• Hire Purchase and Deferred Payment Arrangements: Asset-backed financing structures and hire purchase transactions are fundamentally designed around deferred payment schedules extending over several months or years. Requiring the recipient to discharge the entire invoice value along with tax within 180 days defeats the very commercial purpose and economic utility of such arrangements.

• Retention Money in Works Contracts: In infrastructure and construction contracts, a specified portion of the contract value, generally ranging from 5% to 10%, is contractually retained until completion of the defect liability period or satisfactory performance certification. Since such an amount is not yet contractually due, there is no 'failure' to make payment. Nevertheless, the proviso mechanically mandates proportionate reversal of ITC even in the absence of any contractual default.

• Payment delays are frequentlysequential rather than deliberate. In infrastructure and public works projects awarded by the Government or Highway Authorities, contracts are routinely sub-contracted under 'pay-when-paid' or 'pay-when-approved' commercial dynamics. When the public authority delays clearing the main contractor's bills, that cash-flow crunch automatically cascades down to the sub-contractors. Because this delay is a direct, sequential consequence of the Government's own funding timeline, treating it as a culpable 'failure to pay' under GST law introduces severe commercial absurdity and structural injustice into genuine business transactions.

5. The Core Conflict: Central Fiscal Law vs. Contractual Autonomy

A fundamental legal tension exists between the second proviso to section 16(2) of the CGST Act and the principles embodied in the Indian Contract Act, 1872. While the Contract Act recognizes complete autonomy of contracting parties to mutually agree upon extended credit periods and deferred payment structures, the GST framework effectively imposes a rigid 180-days limitation for retention of ITC.

From the perspective of statutory interpretation, the CGST Act may operate as a lex specialis governing fiscal conditions for availment of ITC, whereas the Contract Act functions as the lex generalis governing contractual relationships. However, although the GST provision does not invalidate the underlying commercial contract, it substantially penalizes legitimate commercial arrangements by treating standard credit structures as statutory defaults.

Further, section 63 of the Indian Contract Act embodies the 'doctrine of waiver' and permits a promise to:

• • dispense with performance,
  • extend the time for performance,
  • or accept any satisfaction deemed fit.

Thus, where a supplier agrees to an extended payment timeline, whether under the original contract or through a subsequent modification, the supplier lawfully exercises the statutory right available under section 63 to extend the time for performance.

Once the supplier himself waives or extends the timeline for receiving payment, compelling the recipient to make payment within 180 days of the invoice date effectively requires the recipient to perform an obligation which, under the governing contract, is not yet due. It is a settled principle of law that a statutory condition compelling performance of an impossibility either cannot be enforced or must be read down to the extent necessary to make compliance reasonably possible.

Though the CGST Act does not expressly mandate payment within 180 days, denial of ITC and levy of interest indirectly compel such payment by imposing severe fiscal consequences. This strikes at the very foundation of GST as a seamless credit-based tax system.

The Contradiction

The GST department's interpretation gives rise to a striking legal paradox:

• • Under Civil Law (Contract Act): An extension of time granted under section 63 is perfectly lawful. The original due date stands substituted by a fresh legally enforceable due date. Until such an extended period expires, the supplier cannot legally treat the purchaser as a defaulter.
  • Under Tax Law (CGST Proviso): The department disregards the contractual extension and treats the recipient as having 'failed to pay' immediately upon expiry of 180 days from the invoice date, even though no legally enforceable debt may yet be due under civil law.

Thus, by disregarding section 63 of the Contract Act, the GST framework effectively penalizes the exercise of a statutory contractual right recognized under another Central enactment. The provision thereby creates a legal fiction whereby a person is deemed to have 'failed to pay' a sum which, in law, may not yet have become payable.

6. Can it be argued that the timeline of 180 Days should commence from the 'Agreed Date of Payment'?

Yes. From the standpoint of harmonious construction and avoidance of statutory absurdity, a strong argument exists that the 180-days period should commence from the contractually agreed date of payment and not mechanically from the date of invoice.

Two important legal principles support such an interpretation:

(i) Harmonious Construction of 'Fails to Pay' with section 63

If Parliament consciously used the expression 'fails to pay', and not the phrase 'payment is not made', the word 'fails' must be interpreted in its legal and contractual context.

A person can be said to have 'failed' to make payment only when a legally enforceable obligation to pay has matured and remains unperformed. Where the supplier, in exercise of rights recognized under section 63 of the Indian Contract Act, 1872, extends the time for payment to Day 300, the liability to pay itself matures only on Day 300. Consequently, any 'failure', if at all, can arise only thereafter.

Viewed in this manner, the 180-days period contemplated under the second proviso to section 16(2) should logically commence only after the expiry of the contractually agreed payment period. Any contrary interpretation would disregard the contractual extension lawfully recognized under section 63 and artificially create a statutory default before the debt itself becomes due.

(ii) The Mischief Rule (Anti-Evasion Limitation)

Under the Mischief Rule of Interpretation, a statutory provision must be construed in a manner that suppresses the specific mischief sought to be remedied without adversely affecting genuine transactions.

The mischief targeted by the 180-days condition is clearly the practice of fake invoicing, accommodation entries, and fraudulent availment of ITC where no real payment is intended to take place.

• In a fake transaction, there is no genuine contract and no real intention to pay.
• In legitimate commercial transactions protected under section 63 of the Contract Act, such as retention money clauses, deferred payment structures, and hire purchase arrangements, the intention to make payment is genuine, though contractually deferred.

Therefore, if the 180-days period is reckoned from the agreed due date of payment rather than the invoice date, the provision would continue to effectively curb fake invoicing while simultaneously protecting bona fide commercial credit arrangements. Such an interpretation would preserve the anti-evasion purpose of the legislation without disrupting legitimate business practices.

7. Levy of interest - A disguised penalty?

The levy of interest under rule 37 read with section 50 of the CGST Act raises serious jurisprudential and constitutional concerns, particularly where the supplier has already deposited the output tax with the Government.

The Hon'ble Supreme Court has consistently held in several landmark decisions, including Pratibha Processors vs. Union of India and Mahindra & Mahindra Ltd. vs. Union of India, that interest is compensatory in nature. Interest is levied to compensate the revenue for the loss occasioned by the delayed payment of tax or the delayed availability of Government funds.

The most vulnerable aspect of the present provision arises where the supplier has already discharged the output tax liability by filing Form GSTR-3B and depositing the tax into the Government exchequer. In such circumstances, the State has suffered no revenue loss whatsoever. Cases involving non-payment of tax by the supplier stand on a different footing and are outside the scope of the present discussion.

Once the tax has already been deposited with the Government, compelling the recipient to pay interest creates an artificial and inequitable recovery mechanism. In substance, the revenue suffers no deprivation of funds during the intervening period. Consequently, the levy of interest loses its compensatory character and assumes the nature of a punitive exaction.

The principle that interest cannot be levied where the Government already possesses the tax amount has also received judicial recognition in other GST contexts. In Refex Industries Ltd. vs. Assistant Commissioner of CGST & Central Excise and Mahadeo Construction Co. vs. Union of India, the Hon'ble High Courts held that interest cannot be demanded on the delayed filing of returns where sufficient funds were already available in the electronic cash ledger. The same principle applies with equal force in the present context.

Where the Government has already received the tax from the supplier, there is no delay in realization of revenue and, consequently, no loss to the exchequer. In the absence of any compensable injury, the demand for 'interest' effectively operates as a penalty disguised in the form of interest.

Such a demand may also raise issues relating to unjust enrichment and potentially offend Article 265 of the Constitution, which mandates that no tax shall be levied or collected except by authority of law. Further, the provision may amount to an arbitrary and disproportionate restriction upon legitimate trade and commerce under Article 19(1)(g) of the Constitution.

8. To sum up

Although the 180-days payment condition under section 16(2) of the CGST Act may be justified as an anti-evasion measure intended to curb fake invoicing and non-genuine credit transactions, its indiscriminate application to bona fide commercial arrangements raises serious constitutional and jurisprudential concerns.

The provision fails to distinguish between cases of actual default and transactions involving legally recognized deferred payment structures, such as retention money, hire purchase arrangements, milestone-based contracts, and continuous supplies. Significantly, the statute merely uses the expression 'has not been paid' and does not employ terms such as 'fails to pay' or 'defaults in payment'. Therefore, a contractual deferment of payment cannot automatically be equated with wrongful non-payment or breach of obligation.

The levy of interest under rule 37 further compounds the anomaly, since the supplier has already discharged the output tax liability and the Government has already received the tax. In the absence of any loss to the revenue, the compensatory basis of interest itself becomes questionable.

To that extent, the provision arguably travels beyond a legitimate fiscal measure and enters the field of regulating commercial payment terms governed by the Indian Contract Act, 1872. A constitutionally harmonious interpretation would therefore require the provision to be confined to sham or abusive transactions involving actual default, rather than genuine commercial arrangements entered into in the ordinary course of business.

[The views expressed in this article are the personal opinions of the author, based on his professional experience, and have been prepared for academic use only.]