2025 (12) TMI 1438 - HC - GST

Input tax credit mismatch and recovery from recipient without supplier discrepancy notice u/s42-show cause notice quashed

Disallowance of ITC against the recipient without initiating statutory discrepancy proceedings against the suppliers was examined under ss. 42 and 73 of ... Disallowance of ITCproceedings have been initiated against the petitioner without initiating any other proceedings against the suppliers - adherence of limitation contemplated under Section 73 of the Act, in initiating the proceedings, which is within three years from the due date for furnishing of annual tax return for the financial year or not - HELD THAT:- When coming to Sub Section (3) of Section 42, it can be seen that, there is an obligation imposed upon the assessing authority, to issue a notice communicating the discrepancy, to both such persons, in case a short supply is found. Evidently, before issuing Ext.P3 show cause notice, no such proceedings have been followed. Sub Section (5) of Section 42 is also relevant in this regard, which would indicate that, the amount in respect of which any discrepancy is communicated under sub-section (3) and which is not rectified by the supplier in his valid return for the month in which discrepancy is communicated, shall be added to the output tax liability of the recipient, in such manner as may be prescribed, in his return for the month succeeding the month in which the discrepancy is communicated. Thus, consequence of issuance of notice to both parties, particularly in respect of the supplier thereof, is specifically contemplated in Sub Section 5 and only in the absence of the supplier failing to rectify the discrepancy, the output tax liability can be imposed upon the recipients. Therefore, going by the scheme contemplated under Section 42, as it stood at the relevant time, no proceedings should have been initiated against the petitioner in the nature of Ext.P3, without issuing a notice to the supplier. The petitioner is entitled to succeed. This is particularly because, as rightly pointed by the learned counsel for the petitioner, it is an admitted position that, no proceedings have been initiated against the suppliers, who are 2nd and 3rd respondents herein, before the issuance of Ext.P3 notice under Section 73. This amounts to the failure on the part of the official respondents in following the statutory stipulations contained in Section 42. Apart from the above, said proceedings is not at all justifiable, in the light of the principles laid down in Suncraft Energy Pvt. Ltd. [2023 (8) TMI 174 - CALCUTTA HIGH COURT], to which it is fully agreed upon. As observed above, in the said decision, it was held that the recovery proceedings can be initiated against the supplier, only if the proceedings initiated against the purchaser did not materialize. This writ petition is disposed of quashing Ext.P3, holding that, as there are no proceedings so far initiated against the 2nd and 3rd respondents, the notice in nature of Ext.P3 could not have been issued to the petitioner. However, it is clarified that, any observation made by this Court will not preclude the authority concerned from initiating proceedings against the 2nd and 3rd respondents. 1. ISSUES PRESENTED AND CONSIDERED 1) Whether a show cause notice proposing disallowance and recovery of input tax credit from a recipient can be sustained when the tax authority has not first followed the statutory mechanism requiring communication of discrepancy to both recipient and supplier and the consequential steps contemplated for supplier default, as per Section 42 (as it stood at the relevant time). 2) Whether, on the admitted facts, the initiation of proceedings only against the recipient (without any proceedings against the suppliers) is legally unsustainable, in light of the Court's acceptance of the principle that recovery should ordinarily be pursued against the supplier first, and resort against the purchaser is justified only in limited situations such as collusion or other exceptional contingencies. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Sustainability of recipient-focused proceedings without following the Section 42 mechanism (as it stood at the relevant time) Legal framework (as discussed by the Court): The Court considered Section 16(2)(c) (condition that input tax credit is claimable only if tax charged has been actually paid to Government) together with the procedure contemplated under Section 42 governing 'matching, reversal and reclaim of input tax credit'. The Court specifically examined Section 42(3) (obligation to communicate discrepancy to both recipient and supplier) and Section 42(5) (addition to recipient's output tax liability only where discrepancy communicated under Section 42(3) is not rectified by the supplier in the relevant period). Interpretation and reasoning: The Court held that, although Section 16(2)(c) imposed a condition linked to actual payment of tax, the statutory scheme for addressing mismatch/non-payment at the relevant time required the assessing authority to first issue a discrepancy communication to both the recipient and the supplier under Section 42(3). The Court treated this as a mandatory step. It further reasoned that Section 42(5) indicates that the recipient's liability consequences are designed to arise only after the supplier is given the opportunity to rectify the discrepancy, and only upon the supplier's failure to do so. Since no Section 42(3) discrepancy communication was issued to the supplier before the impugned notice, the Court found that the statutory process was not followed. Conclusions: Proceedings seeking to disallow and recover input tax credit from the recipient, without first issuing notice/communication to the supplier as contemplated under Section 42 and without adhering to the sequencing embedded in Section 42(3) and 42(5), were held to be not legally sustainable. The impugned show cause notice was quashed on this ground. Issue 2: Whether proceedings against the purchaser alone were unjustified absent supplier proceedings and absent exceptional factors Legal framework (as applied by the Court): The Court applied the principle (as accepted in its reasoning) that where the purchaser possesses proper tax invoices and claims input tax credit, denial/reversal and recovery from the purchaser without action against the selling dealer is unjustified unless circumstances warranting such an approach exist. The Court expressly agreed with and applied the reasoning it extracted and relied upon from the Suncraft Energy line of decisions, to the effect that action should first be directed against the supplier, and purchaser-focused recovery is permissible only in exceptional situations such as collusion, missing dealer, closure of business, lack of adequate assets, or similar contingencies. Interpretation and reasoning: The Court treated it as an admitted position that no proceedings had been initiated against the suppliers before issuance of the impugned notice under Section 73. It further recorded that none of the exceptional situations (including collusion) justifying immediate action against the purchaser were shown to exist in the case. On these facts, the Court held that initiating recovery proceedings against the recipient straightaway was not justifiable and could not be sustained. Conclusions: The Court concluded that the impugned notice was legally unsustainable because the authority proceeded against the recipient without first proceeding against the suppliers and without establishing any exceptional basis (such as collusion) for bypassing supplier-first recovery. The Court clarified that its observations would not preclude initiation of proceedings against the suppliers. Note on limitation: The Court expressly declined to decide the limitation contention, holding it unnecessary after concluding that the notice was unsustainable on the above grounds.