ITC Needs More Than an Invoice: Tax Must Reach the Government

The Credit Chain Now Has a Clear Supreme Court Signal

The Supreme Court order in Bhandari Scrap Traders Versus Union of India & Ors. - 2026 (7) TMI 1839 - SC Order, has brought much-needed clarity to one of the most debated conditions for availing input tax credit under GST. The issue was whether Section 16(2)(c) of the CGST Act, 2017 is unconstitutional or should be read down to protect a bona fide purchasing dealer when the supplier fails to deposit the tax collected from him.

The Supreme Court has affirmed the Gujarat High Court judgment in Maruti Enterprise Through Its Authorized Partner, Jigneshbhai Bharatbhai Tarpara, Bhandari Scrap Traders Through Its Prop. Gopalbhai Champaklal Sharma Versus Union Of India & Ors. - 2026 (5) TMI 127 - GUJARAT HIGH COURT. The Gujarat High Court had upheld the validity of Section 16(2)(c) and refused to read it down. The Supreme Court agreed with the Gujarat view and dismissed the Special Leave Petitions. In doing so, it also noted the contrary approach of the Tripura High Court 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 COURT, where Section 16(2)(c) had been read down to protect bona fide purchasers.

The central message is clear. A purchasing dealer cannot claim ITC merely because he possesses an invoice, has received goods, has paid the supplier, and the transaction appears in GSTR-2A or GSTR-2B. Under Section 16(2)(c), the tax charged in respect of the supply must actually be paid to the Government. Bona fide conduct may explain hardship, but it does not override the statutory condition.

The Real Contest Was Between Fairness and Statutory Design

The grievance of purchasing dealers was not imaginary. A genuine buyer may receive goods, pay the invoice value along with GST, and avail credit based on documents generated through the GST system. Later, if the supplier fails to file GSTR-3B or pay the tax to the Government, the buyer may face reversal of ITC. From the buyer's perspective, this appears harsh because the buyer has already paid tax to the supplier and may have no practical control over the supplier's subsequent conduct.

This fairness argument persuaded the Tripura High Court 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 COURT. The Tripura High Court held that Section 16(2)(c) should be read down so that ITC is denied only where the transaction is not bona fide, or is collusive or fraudulent. It relied upon the Delhi VAT line of cases, particularly 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, which was followed in Commissioner of Trade And Taxes Delhi Versus Arise India Limited, On Quest Merchandising India Pvt. Ltd. - 2018 (1) TMI 555 - SC Order, and later referred to in The Commissioner Trade And Tax Delhi Versus M/s. Shanti Kiran India (P) Ltd. - 2025 (10) TMI 607 - SC Order.

However, the Gujarat High Court took a different view. It accepted the hardship but held that GST has a different statutory design from the Delhi VAT regime. The Gujarat High Court examined Sections 16, 41, 49, 53, 73, 74 and 155 of the CGST Act, along with Rules 36, 37A, 59, 60 and 86 of the CGST Rules. On that basis, it held that Section 16(2)(c) is not arbitrary, unconstitutional or liable to be read down.

The Supreme Court preferred the Gujarat approach. It specifically noted that the detailed exercise undertaken by the Gujarat High Court had not been undertaken by the Tripura High Court. That observation is important. It means that the issue is not to be decided only by asking whether the purchaser is bona fide. It must be decided by reading the entire GST credit architecture.

ITC Is Conditional, Not Automatic

Section 16 is the gateway provision for input tax credit. Section 16(1) entitles 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. However, this entitlement is expressly subject to conditions and restrictions.

Section 16(2) begins with a non-obstante expression. It provides that no registered person shall be entitled to credit unless the conditions mentioned in clauses (a) to (d) are satisfied. These conditions include possession of a tax invoice or debit note, receipt of goods or services, actual payment of tax to the Government, and filing of a return under Section 39. Later amendments also introduced supplier reporting and communication-based conditions through clauses such as Section 16(2)(aa) and related provisions.

Clause (c) is at the centre of the present controversy. It provides that, subject to Section 41, the tax charged in respect of the supply must have been actually paid to the Government, either in cash or through utilisation of admissible ITC. The phrase 'actually paid to the Government' is decisive. It shows that ITC is not based solely on the buyer's private payment to the supplier. It depends upon the tax reaching the Government treasury.

The Gujarat High Court held, and the Supreme Court accepted, that the conditions in Section 16(2) must be read together. A buyer cannot stop at the invoice, receipt of goods, and reflection in GSTR-2B. Eligibility must satisfy all statutory conditions, including actual payment of tax. This is a strict reading, but it is now the controlling reading after the Supreme Court's order.

The Credit Claimant Must Prove Eligibility

Section 155 of the CGST Act provides that where any person claims eligibility for input tax credit, the burden of proving the claim lies on that person. This provision played an important role in the Gujarat High Court's reasoning.

The purchasing dealers argued that they could not verify whether the supplier had actually paid tax. The Gujarat High Court accepted that there may be practical difficulties but held that the statutory burden cannot be ignored. The expression 'eligible' in Section 155 is linked to the statutory conditions for ITC. If actual payment of tax is one of those conditions, the person claiming credit must establish eligibility in accordance with the Act.

This does not mean that every purchaser must physically monitor the supplier's bank account or tax ledger. It means that ITC is a statutory claim and must be subject to statutory conditions. The system may provide data through GSTR-2A and GSTR-2B, but those statements are not a final constitutional guarantee of credit where the tax has not actually been paid.

For professionals, this changes the conversation about compliance. ITC due diligence can no longer be limited to invoice possession and goods receipt. Vendor compliance, return-filing discipline, tax-payment risk, indemnity clauses, contract safeguards, and periodic vendor reconciliation now form part of ITC risk management.

The GST Scheme Is Not the Delhi VAT Scheme

A major reason for the Supreme Court's approval of the Gujarat view is the difference between the GST and Delhi VAT frameworks. The Delhi High Court considered Section 9(2)(g) of the Delhi VAT Act 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,. That provision was read down to protect bona fide purchasing dealers because the Court found that purchasers could not be asked to do the impossible and that the Department could proceed against defaulting sellers.

The Gujarat High Court held that those VAT principles could not be mechanically transplanted into GST. Under VAT, credit generally operated within the State. Under GST, particularly in inter-State transactions, credit flows through the IGST mechanism and affects revenue settlement between the Centre, the originating State and the destination State. This makes the GST credit chain wider and more fiscally interconnected.

Section 53 of the CGST Act was important in this discussion. It deals with the transfer of input tax credit. If credit is allowed even when tax has not actually been received, the Government may be required to transfer or settle amounts that were never collected. That is why the Gujarat High Court said that reading down Section 16(2)(c) could have cascading fiscal consequences.

The Supreme Court accepted this distinction. It stated that no parity could be drawn between the Delhi VAT Act and the CGST Act so as to treat a purchasing dealer under GST in the same manner as a bona fide purchasing dealer under Delhi VAT when the supplier fails to pay tax.

Reversal Need Not Be the End of Credit

A crucial part of the Gujarat reasoning was Section 41 of the CGST Act. After substitution by the Finance Act, 2022 with effect from 01.10.20222, Section 41 provides for the availment of ITC and its reversal where the supplier fails to pay tax. Section 41(2) requires reversal of ITC, along with applicable interest, where the supplier has not paid the tax. However, its proviso allows the recipient to re-avail the credit once the supplier pays the tax.

Rule 37A of the CGST Rules gives operational shape to this idea. Broadly, where a recipient has availed ITC in respect of an invoice appearing in GSTR-2B but the supplier has not furnished the corresponding GSTR-3B and paid the tax within the stipulated timeline, the recipient must reverse the credit within the prescribed time. Once the supplier later pays the tax, the recipient can re-avail the credit.

This mechanism was treated as a statutory balance. The buyer may face temporary reversal, but the law does not permanently destroy credit if the supplier later discharges the tax. This was one reason the Gujarat High Court rejected the argument of double taxation. According to the Court, the statute creates a reversal-and-re-availment mechanism; therefore, hardship or delay cannot be equated with unconstitutional double taxation.

From a business standpoint, this remains difficult. Reversal affects working capital. Interest may arise in specified situations. The buyer may have to chase the supplier. But as a matter of constitutional law, the Supreme Court has accepted that the statutory structure is valid.

Reading Down Cannot Rewrite a Clear Fiscal Condition

Courts use the doctrine of reading down to save a statutory provision from unconstitutionality by giving it a narrower meaning. However, reading down is not a tool for rewriting a clear fiscal condition merely because its operation causes hardship.

The Gujarat High Court relied on the Supreme Court's discussion in THE AUTHORISED OFFICER, CENTRAL BANK OF INDIA Versus SHANMUGAVELU - 2024 (2) TMI 291 - Supreme Court (LB), where it was explained that reading down is used to preserve legislation where a literal interpretation would create constitutional difficulty. It is not to be used when the provision is clear, valid and consistent with the legislative scheme.

The Gujarat High Court found Section 16(2)(c) clear and unambiguous. It held that the provision secures Government revenue and checks fraudulent or defaulting conduct in the credit chain. When Section 16(2)(c) is read with Sections 41, 53 and 155 and Rule 37A, it does not create a constitutional infirmity requiring reading down.

The Supreme Court accepted this reasoning. Therefore, after Bhandari Scrap Traders, the argument that Section 16(2)(c) should be read down to protect every bona fide purchaser has become very difficult to sustain.

Tripura Gave Relief to Bona Fide Purchasers, but Its Force Is Now Limited

The Tripura High Court took a taxpayer-friendly view 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 COURT. It held that Section 16(2)(c) should not be interpreted to deny ITC to purchasers in bona fide transactions. It read down the provision so that it would apply only where the transaction is not bona fide, or is collusive or fraudulent. On the facts, it noted that the Department had proceeded under Section 73 and not Section 74, indicating the absence of fraud or wilful misstatement against the petitioner. It therefore directed that ITC be granted to the purchaser.

That judgment was grounded in the principle that law should not compel the impossible. A purchaser cannot control the supplier's tax payment. A genuine buyer should not be punished for the supplier's default. The moral force of that argument remains strong. Many professionals and businesses will continue to feel that the burden on genuine buyers is commercially harsh.

However, after the Supreme Court's order in Bhandari Scrap Traders, the Tripura approach cannot be treated as the safer legal position. The Supreme Court noticed Sahil Enterprises and still affirmed the Gujarat High Court judgment. It specifically said that the detailed analysis undertaken by Gujarat had not been undertaken by Tripura. Therefore, while Sahil Enterprises remains important as a statement of taxpayer hardship, its precedential value on reading down Section 16(2)(c) stands substantially weakened.

The Supplier Must Be Chased, but the Purchaser Must Also Protect Himself

One practical outcome of the judgment is that purchasing dealers must strengthen vendor controls. The Gujarat High Court acknowledged the genuine hardship faced by bona fide purchasers and urged the Government to undertake a comprehensive re-evaluation and implement a robust, technology-driven tracking mechanism. The Court expected prompt recovery action against erring suppliers and appropriate legislative or administrative solutions for genuine purchasers.

Until such reform arrives, businesses must protect themselves contractually and operationally. Purchase agreements should include supplier indemnity clauses for non-payment of GST. Payment terms may be structured to retain a portion until return compliance is confirmed. Vendor master checks, periodic GSTR-2B reconciliation, supplier compliance scoring, and follow-up on non-filers will become more important.

This is not an ideal commercial burden, but it is now part of GST risk management. ITC is valuable, and the Supreme Court has confirmed that its availability depends on statutory conditions. Businesses must therefore treat supplier compliance as part of procurement discipline.

Supplier Recovery Must Not Become an Empty Promise

The judgment also carries an important message for the Department. If tax has been collected by the supplier but not paid to the Government, the defaulting supplier remains the real wrongdoer. For the period governed by the present statutory framework, recovery or determination of such liability would have to be examined under Section 74A of the CGST Act, 2017, subject to the facts and applicable limitation.

The Gujarat High Court expected prompt recovery action against erring suppliers, instead of leaving bona fide purchasers to pursue difficult private remedies. Thus, while Section 16(2)(c) has been upheld, its fair working depends upon two things moving together: purchaser due diligence and effective departmental recovery from defaulting suppliers.

ITC Follows Tax Actually Paid

The Supreme Court has affirmed that Section 16(2)(c) is neither unconstitutional nor liable to be read down merely to protect bona fide purchasers. The Gujarat High Court's detailed reasoning now holds the field, while the Tripura reading-down approach stands substantially weakened.

The ruling recognises the hardship of genuine buyers, but treats ITC as a statutory entitlement subject to statutory conditions. Invoice, goods receipt and GSTR-2B reflection are important, but not always sufficient. Until tax reaches the Government, Section 16(2)(c) remains a hard statutory checkpoint, though re-availment may be possible when the supplier later pays.

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