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Issues: (i) Whether Section 16(2)(c), read with Section 155, of the Central Goods and Services Tax Act, 2017 is unconstitutional or must be read down to confine ITC reversal to fraudulent, collusive, or non-genuine transactions; (ii) Whether and subject to what safeguards a purchaser's ITC may be denied or reversed when the supplier defaults in depositing tax or its registration is subsequently cancelled.
Issue (i): Whether Section 16(2)(c), read with Section 155, of the Central Goods and Services Tax Act, 2017 is unconstitutional or must be read down to confine ITC reversal to fraudulent, collusive, or non-genuine transactions.
Analysis: Input tax credit is a statutory concession, and actual payment of tax to the Government is integral to the credit mechanism. Section 16(2)(c) operates subject to Section 41 and forms part of an integrated statutory framework governing eligibility, reversal, recovery from the supplier, and subsequent re-availment. The earlier matching and reconciliation framework under Sections 42 and 43 was not operationalised, but the resulting difficulty concerns the manner of enforcement rather than the constitutional validity of the condition itself.
Analysis: The possibility of arbitrary or mechanical action in individual cases does not invalidate Section 16(2)(c). The condition cannot be restricted only to fraud, collusion, or fictitious transactions by reading down its text; instead, it must be applied harmoniously with the statutory safeguards and recovery mechanisms available against the defaulting supplier.
Conclusion: Section 16(2)(c), read with Section 155, is constitutionally valid and is not read down to limit its operation exclusively to fraudulent, collusive, or non-genuine transactions.
Issue (ii): Whether and subject to what safeguards a purchaser's ITC may be denied or reversed when the supplier defaults in depositing tax or its registration is subsequently cancelled.
Analysis: The non-operationalisation of the original matching mechanism, the phased substitution of Section 41, and the subsequent introduction of Rule 37A require the statutory regime applicable to the relevant tax period to be applied. For periods before Rule 37A, the absence of a re-availment mechanism is material. The statutory power to recover tax collected but not deposited by the supplier, including under Section 76, remains a relevant part of the scheme and cannot be rendered ineffective.
Analysis: Subsequent or retrospective cancellation of the supplier's registration, a nil or short tax declaration, or an alert concerning the supplier may justify an inquiry but cannot alone justify denial or reversal of ITC. The notice must disclose the relevant supplier, invoices, tax periods, nature of the default, material relied upon, and the status of recovery proceedings against the supplier. The purchaser may discharge the burden of proof through invoices and evidence of actual receipt and movement of goods or services. A notice invoking fraud, wilful misstatement, or suppression must itself state the foundational facts connecting the purchaser to such conduct. Personal hearing, reasoned consideration of the purchaser's material, and examination of the grounds for retrospective cancellation are required.
Conclusion: ITC cannot be denied or reversed mechanically merely because the supplier defaulted or its registration was subsequently cancelled. Reversal may follow where the purchaser fails to establish eligibility or where fraud, collusion, non-receipt of goods or services, or other grounds rendering the credit inadmissible are established in accordance with law.
Final Conclusion: Pending notices and completed adjudications must be dealt with afresh in conformity with the prescribed safeguards, after adequate opportunity to furnish material and be heard. Amounts already reversed, deposited, or recovered shall be adjusted or refunded as warranted by the fresh determination, and no fresh coercive recovery may be undertaken until that determination.
Ratio Decidendi: Actual payment of tax is a valid statutory condition for input tax credit, but Section 16(2)(c) must be enforced as part of the integrated GST scheme and cannot be used to impose mechanical reversal upon a bona fide purchaser without a fact-based inquiry, procedural fairness, and consideration of recovery from the defaulting supplier.
Input tax credit reversal requires supplier-default inquiry, purchaser evidence, and procedural safeguards before recovery action.
Actual payment of tax remains a statutory condition for input tax credit under the integrated GST framework; that condition is not confined to fraudulent, collusive, or non-genuine transactions. However, supplier default, retrospective registration cancellation, short tax declaration, or alerts cannot by themselves trigger mechanical denial or reversal. Authorities must apply the regime governing the relevant period, pursue available recovery against the supplier, issue a detailed notice, allow evidence of receipt and movement of supplies, provide a hearing, and give reasoned findings. Fraud-based action requires facts linking the purchaser to the alleged conduct. Pending and completed matters require fresh determination with consequential adjustment or refund where warranted, without fresh coercive recovery beforehand.
Input tax credit - supplier's default in payment of tax - Harmonious construction of Section 16(2)(c) of the CGST Act - Show cause notice under Section 74 - foundational facts of fraud Input tax credit - supplier's default in payment of tax - Harmonious construction of Section 16(2)(c) of the CGST Act - Validity and manner of invoking the condition for input tax credit that the tax charged on the supply must have been actually paid to the Government, where the supplier defaults - HELD THAT: - The requirement of actual payment of tax is foundational to input tax credit, which is a statutory concession, and Section 16(2)(c) is constitutionally valid. However, the provision cannot be treated as a standalone condition or invoked mechanically merely because the supplier's registration was subsequently cancelled, or its return reflected nil or short tax liability. The proper officer must consider the genuineness of the supply, the recipient's supporting material, the nature and circumstances of the supplier's default, the recovery proceedings available against the supplier, and the statutory framework applicable during the relevant period. Fraud, collusion, non-receipt of goods or services, or failure of the recipient to establish eligibility remain grounds for denial of credit in accordance with law. Gujarat High Court in Maruti Enterprises [2026 (5) TMI 127 - GUJARAT HIGH COURT] has upheld the constitutional validity of Section 16(2)(c) of the Act of 2017, and the Special Leave Petition against the said judgment has been dismissed by the Supreme Court in Bhandari Scrap Traders [2026 (7) TMI 1839 - SC ORDER] with the observation that no parity can be drawn between the provisions of the Delhi Value Added Tax Act, 2004 and the Act of 2017 so as to treat a purchasing dealer under the latter on par with a bona fide purchasing dealer under the former. Judicial discipline, therefore, also counsels us against reading down the provision on the lines of Gheru L[Paras 98, 99, 103, 105] The constitutional challenge was rejected. Pending notices and concluded adjudications were directed to be dealt with afresh or revisited, as applicable, in accordance with the prescribed safeguards, after opportunity of hearing. Show cause notice under Section 74 - foundational facts of fraud - Fraud of supplier - attribution to purchasing dealer - Invocation of proceedings under Section 74 for reversal of input tax credit on allegations of fraud, wilful misstatement or suppression by the purchasing dealer - HELD THAT: - A notice invoking the extended period must itself disclose the foundational facts supporting the inference of fraud, wilful misstatement or suppression by the noticee; a bare recital of those expressions is insufficient and cannot be supplemented through a subsequent affidavit or explanation. The supplier's fraud cannot, without facts establishing a direct link with the purchasing dealer, be attributed to the purchaser. The notice must disclose the material relied upon and the adjudicating authority must consider the recipient's evidence and record findings on the disputed conditions for credit. [Paras 102, 103] Proceedings founded on Section 74 must conform to these requirements, and the requisite factual foundation must be stated in the notice itself. Final Conclusion: The challenge to Section 16(2)(c) was rejected, but its mechanical invocation against purchasing dealers was disapproved. The writ petitions were disposed of with directions for adjudication or reconsideration under the prescribed safeguards, without coercive recovery until fresh determination.