Section 74 Cannot Turn Supplier Suspicion Into Purchaser Fraud

When Supplier Doubt Reached the Supreme Court

The Supreme Court's order in Additional Commissioner, Grade 2 & Anr. Versus M/s. Safecon Lifesciences Private Limited - 2026 (7) TMI 1276 - SC Order, may be short, but its practical significance is considerable. The Supreme Court dismissed the Department's Special Leave Petition against the Allahabad High Court judgment in M/s Safecon Lifescience Private Limited Versus Additional Commissioner Grade 2 And Another - 2025 (9) TMI 919 - ALLAHABAD HIGH COURT. The High Court quashed proceedings under Section 74 of the UPGST Act, 2017, in which ITC was denied to the purchasing dealer on the basis of doubts regarding the supplier.

The controversy is familiar in GST litigation. A purchasing dealer claims ITC on the basis of tax invoice, movement of goods, e-way bill, transport documents, banking-channel payment and GST portal reflection. Later, the Department raises suspicion about the supplier or about an earlier link in the supply chain. The question then arises whether the purchasing dealer's ITC can be denied, and more importantly, whether the Department can straightaway invoke Section 74 by alleging wrongful ITC without recording fraud, wilful misstatement or suppression of facts with intent to evade tax. Safecon answers this question in a disciplined manner. It does not say that fake ITC cases cannot be investigated. It says that serious proceedings under Section 74 require serious statutory ingredients.

The Purchase Was Documented, but the Supplier Was Suspected

Safecon Lifescience Private Limited was engaged in trading and manufacturing medicines/pharma products on a wholesale basis. It purchased medicines/pharma products from M/s Unimax Pharma Chem, Maharashtra. At the time of the transaction, the supplier was stated to be registered under GST and to hold a drug licence. The purchase was supported by a tax invoice dated 30.04.2021. The movement of goods was supported by an e-way bill and transport bilty. Payment was made through a banking channel. The assessee also relied on GST return records and portal reflection to show that the transaction had travelled through the ordinary GST reporting system.

The Department, however, initiated proceedings under Section 74. The basis was information received from the office of the Principal Chief Commissioner, Central Intelligence Unit, Central Excise and Central Tax, Vadodara Zone. According to the Department, the supplier was connected with doubtful transactions and had shown purchases from firms whose registrations had been cancelled. On this footing, the Department alleged that the assessee had wrongly availed ITC.

The High Court noticed an important feature. The assessee had produced primary documents relating to its own transaction. The Department did not bring cogent material to rebut the assessee's documents. Instead, the orders proceeded substantially on information received from another departmental wing. This is where the case moved from a simple ITC dispute to a deeper question of statutory discipline.

Section 16 Gives Credit, but Conditions Must Be Tested Fairly

Section 16 of the CGST/UPGST law is the starting point for ITC entitlement. It permits a registered person to take credit of input tax charged on supplies used or intended to be used in the course or furtherance of business, subject to statutory conditions. Section 16(2) sets out key conditions. The recipient must possess a tax invoice or other prescribed document. The recipient must have received the goods or services. The tax charged in respect of the supply must have been actually paid to the Government, either in cash or through utilisation of ITC. The recipient must also furnish the return under Section 39.

In many ITC disputes, the Department relies on Section 16(2)(c), which refers to the actual payment of tax to the Government. That provision is important, but it cannot be applied mechanically. The recipient may be expected to prove the genuineness of its purchase, receipt of goods, tax invoice, movement and payment. However, where the recipient produces such primary evidence and the transaction is reflected on the portal, the Department must examine the matter carefully before denying credit. Suspicion about the supplier is relevant for inquiry, but it cannot automatically become a finding against the purchaser.

The High Court's approach is therefore practical. It does not dilute Section 16. It recognises that ITC is conditional. At the same time, it insists that denial of ITC must be based on proper material. If the purchasing dealer has shown actual movement of goods, banking-channel payment and GST return trail, the Department must do more than refer to a third-party suspicion. It must examine whether the purchaser itself was involved in fraud, had knowledge of the irregularity, or failed to satisfy the statutory conditions.

Section 74 Demands More Than a Wrong Credit Allegation

The most important part of the judgment concerns Section 74. Section 74 applies where tax has not been paid, has been short-paid, has been erroneously refunded, or where ITC has been wrongly availed or utilised by reason of fraud, wilful misstatement or suppression of facts to evade tax. The words 'by reason of' are important. Wrong availment of ITC alone is not enough for Section 74. The wrong availment must be connected with fraud, wilful misstatement or suppression of facts with intent to evade tax.

This distinction is crucial. GST law contains different provisions for different kinds of defaults. Not every tax dispute is fraud. Not every incorrect claim is suppression. Not every ITC mismatch is wilful misstatement. Section 74 is a serious provision because it carries extended limitation and higher consequences. Therefore, it cannot be used as a routine route merely because the Department disagrees with the taxpayer's claim.

The High Court found that the authorities had not recorded any finding that Safecon had committed fraud, made a wilful misstatement or suppressed facts with intent to evade tax. The orders were founded on suspicion regarding the supplier and information received from another wing. That was not enough. The absence of the statutory ingredients of Section 74 made the proceedings unsustainable.

Instruction No.05/2023-GST Reinforces the Same Discipline

The assessee relied upon Instruction No. 05/2023-GST dated 13.12.2023. This Instruction is important because it clarifies the Department's understanding of Section 74. It states that Section 74(1) can be invoked only in cases where there is fraud, wilful misstatement or suppression of facts to evade tax on the part of the taxpayer. It further clarifies that Section 74(1 cannot be invoked merely on account of non-payment of GST without specific material evidence of fraud, wilful misstatement or suppression of facts to evade tax. Such evidence should also be made part of the show cause notice.

This Instruction is practically significant for both sides. For officers, it provides a clear framework before invoking Section 74. The file must show why the case is not merely an ordinary tax dispute. The show cause notice must disclose the material supporting fraud, wilful misstatement or suppression. For taxpayers, it provides a strong ground to question mechanical Section 74 notices where serious words are used without supporting facts.

In Safecon, the High Court found that the requirements reflected in this Instruction were not satisfied. No proper finding of fraud, wilful misstatement or suppression had been recorded against the assessee. Therefore, the invocation of Section 74 could not be sustained.

Continental Foundation Keeps the Mens Rea Principle Alive

The High Court also relied on the Supreme Court's decision in M/s Continental Foundation Joint Venture Sholding, Nathpa HP Versus Commissioner of Central Excise, Chandigarh-I - 2007 (8) TMI 11 - Supreme Court. Although that judgment arose under the Central Excise law, the underlying principle remains highly relevant because Section 11A of the Central Excise Act used language similar in substance to the extended-period provisions now found in GST.

In Continental Foundation, the Supreme Court explained that suppression involves deliberate intent. A mere omission to give correct information is not suppression unless it is deliberate and intended to prevent payment of duty. An incorrect statement cannot automatically be equated with wilful misstatement. The word 'wilful' matters because it imports knowledge and intention. Similarly, suppression must mean failure to disclose full information with intent to evade payment.

This principle is central to tax litigation. Revenue authorities may find errors, omissions or incorrect claims. But when they invoke provisions meant for fraud or suppression, they must prove the higher threshold. The law does not permit every mistake to be painted as evasion. Safecon applies this settled principle in the GST context. Unless the Department can show deliberate conduct by the taxpayer, Section 74 cannot be invoked merely by using serious words.

Departmental Intelligence Must Be Verified, Not Copied

Another important aspect of the High Court's reasoning concerns departmental information. The proceedings against Safecon were based on information from the Central Intelligence Unit. Such information may be useful. It may warrant scrutiny. It may alert the jurisdictional officer to possible fraud in the supply chain. But information is not proof in itself. Before using it against a taxpayer, the authority must verify it and link it to the taxpayer's conduct.

The High Court observed that information from another departmental wing must be verified before being used against a registered dealer. This is a valuable principle in modern GST administration. The GST system generates large volumes of data. Intelligence inputs flow between central and state authorities. Risk parameters may flag suspicious suppliers. But a purchasing dealer cannot be condemned merely because information exists against another person. The officer must assess whether the information actually affects the transaction under consideration.

The problem is more serious when the material relied upon is not supplied to the taxpayer. If adverse material is used, the taxpayer must know it and be given an opportunity to respond. Natural justice requires that the taxpayer not be asked to meet an invisible case. Safecon reinforces this basic principle. Information may trigger proceedings, but verified and disclosed material must support the final action.

Khurja Scrap Trading Shows the Emerging Allahabad Line

The High Court also referred to M/s Khurja Scrap Trading Company Versus Additional Commissioner Grade-2 (Appeal) & Another - 2025 (9) TMI 53 - ALLAHABAD HIGH COURT. That case dealt with the invocation of Section 74 and the requirement of fraud, wilful misstatement or suppression. The Court in that case referred to Instruction No. 05/2023-GST dated 13.12.2023 and held that strict compliance was required.

The relevance of Khurja Scrap lies in the evolving judicial approach of the Allahabad High Court. Where the selling dealer was registered at the time of the transaction and the purchasing dealer produced primary documents, an adverse inference against the purchasing dealer cannot be drawn mechanically. If Section 74 is invoked, the Department must show that the case goes beyond ordinary wrong availment and amounts to fraud or suppression.

This line of reasoning is important because it protects bona fide purchasing dealers without weakening genuine anti-evasion action. If the purchaser is part of a fraudulent chain, Section 74 can be invoked. If the purchaser has colluded, suppressed facts or knowingly participated in fake transactions, the Department can act. But if the purchaser has documents, movement, payment and portal trail, the Department must establish more than suspicion.

The Supreme Court's Dismissal Strengthens the Practical Value

The Supreme Court's order in Additional Commissioner, Grade 2 & Anr. Versus M/s. Safecon Lifesciences Private Limited - 2026 (7) TMI 1276 - SC Orderis brief. It condoned the delay and dismissed the Special Leave Petition, observing that there was no good ground to entertain it. Strictly speaking, dismissal of an SLP by a short order does not always amount to a detailed declaration of law on every aspect of the High Court judgment. However, in practice, the High Court judgment continues to stand, and the Department's challenge has failed.

This makes the ruling important for officers and professionals dealing with Section 74 notices in ITC cases. The Allahabad High Court's reasoning remains undisturbed. The core principles therefore carry stronger persuasive value. Section 74 must not be used casually. Doubts about suppliers must be examined. Purchaser documents must be considered. Departmental information must be verified. Adverse material must be supplied. Fraud, wilful misstatement and suppression must be specifically supported.

For taxpayers, the Supreme Court's dismissal gives additional confidence to rely on Safecon where facts are similar. For officers, it is a reminder that Section 74 notices must be carefully framed and factually supported from the beginning. A weak Section 74 foundation may not survive judicial scrutiny.

The Practical Message for ITC Disputes

Safecon does not provide blanket protection for every ITC claim. It does not say that a purchasing dealer can ignore Section 16 conditions. It does not say that the Department cannot investigate fake suppliers. It does not say that cancellation of supplier registration is irrelevant in every case. The judgment is narrower and stronger. It says that where the purchasing dealer has produced credible documents showing an actual transaction and movement of goods, ITC cannot be denied under Section 74 merely on suspicion unless the statutory ingredients are established.

The practical lesson for taxpayers is to preserve the transaction trail. Tax invoice, e-way bill, transport bilty, proof of receipt, banking-channel payment, GSTR reflection, correspondence, and due diligence records may become decisive. In an ITC dispute, the taxpayer must be able to show that the transaction was real and that it acted bona fide.

The practical lesson for the Department is equally clear. If the case is truly one of fraud, the notice must say so with facts. If wilful misstatement or suppression is alleged, the notice must disclose the material basis. If information is received from another wing, it must be verified and linked to the taxpayer. A Section 74 notice should not be drafted as a stronger version of a Section 73 notice. The legal threshold is different, and the record must show that difference.

Suspicion May Start Inquiry, but It Cannot Sustain Section 74

The combined effect of the Allahabad High Court judgment and the Supreme Court's dismissal of the Department's SLP is clear. Suspicion may justify inquiry, verification, and calling for documents, but it cannot sustain Section 74 proceedings where the purchasing dealer has produced primary evidence of a genuine purchase, movement of goods, and payment through a banking channel.

Section 74 must remain confined to cases supported by material showing fraud, wilful misstatement or suppression of facts with intent to evade tax. Safecon therefore reminds officers and professionals that GST enforcement must be evidence-based. Departmental intelligence may trigger action, but it must be verified; serious allegations may be made, but they must be supported.

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