Rule 86A blocking of input tax credit quashed for lack of written reasons and procedural fairness

The Gujarat HC quashed the blocking of input tax credit (ITC) under Rule 86A of CGST Rules. The court held that Rule 86A confers drastic powers requiring strict compliance with procedural safeguards. The authority must have objective material to form "reason to believe" that credit was fraudulently utilized and must record reasons in writing before blocking ITC. Since no reasons were conveyed to the taxpayer and the power affects civil consequences, principles of natural justice must be followed. The blocking order was set aside as the authority failed to satisfy mandatory requirements of reasonableness and procedural fairness.

---

---

Issues Involved:
1. Blocking of Input Tax Credit (ITC) under Rule 86A of the Central Goods and Services Tax (CGST) Rules, 2017.
2. Compliance with principles of natural justice.
3. Validity and application of Rule 86A in the absence of Section 43A of the CGST Act, 2017.
4. Bona fide recipient's liability for the supplier's default.

Detailed Analysis:

1. Blocking of Input Tax Credit (ITC) under Rule 86A of the CGST Rules, 2017:
The petitioner, a proprietary concern engaged in trading M.S. Scrap, challenged the blocking of ITC amounting to Rs. 97,17,290 by the respondent under Rule 86A. The petitioner claimed to have received the necessary tax invoices, weighment slips, and e-way bills for the purchases made from M/s. Anmol Enterprise, which were duly reflected in the relevant GST forms (GSTR-3B, GSTR-2A, and GSTR-2B). The blocking of ITC was reportedly done without assigning any reasons, leading to the present writ application.

2. Compliance with principles of natural justice:
The court emphasized that Rule 86A, which allows blocking of ITC, requires the authority to have "reasons to believe" that the credit has been fraudulently availed or is ineligible. This belief must be based on objective material and recorded in writing. The court noted that the impugned order lacked any reasons and failed to meet the requirements of Rule 86A, thus constituting an arbitrary exercise of power. The court also highlighted the necessity of providing post-decisional hearing to the affected party within a reasonable period, typically not beyond two weeks from the date of blocking the ECL.

3. Validity and application of Rule 86A in the absence of Section 43A of the CGST Act, 2017:
The court observed that Rule 86A, which allows blocking of ITC, was notified before Section 43A of the CGST Act, 2017, which provides for joint and several liability of the supplier and recipient, was brought into force. Since Section 43A has not been notified, the court opined that Rule 86A lacks statutory authority to block a recipient’s credit ledger due to the supplier’s default. The court noted that the absence of a system-based matching of ITC further complicates the issue, as the recipients are currently eligible to claim ITC provisionally based on the invoice issued by the supplier.

4. Bona fide recipient's liability for the supplier's default:
The court referred to several precedents, including the Delhi High Court's decision in Quest Merchandising India Pvt. Ltd. and the Madras High Court's decision in Sri Vinayaga Agencies, which held that a bona fide recipient should not be penalized for the supplier's failure to deposit tax. The court reiterated that the authorities should proceed against the defaulting supplier rather than denying the recipient their legitimate ITC. The court emphasized that any action against the recipient must be based on evidence of collusion or fraud involving the recipient and the supplier.

Conclusion:
The court allowed the writ application in part, quashing the impugned order blocking the ECL of the petitioner. The respondents were granted the liberty to pass a fresh order under Rule 86A in compliance with the principles of natural justice and the observations made by the court. The court underscored the need for objective material and recorded reasons to justify the blocking of ITC, ensuring that bona fide recipients are not unduly penalized for the supplier's defaults.

---