2026 (1) TMI 385 - HC - GST

Input tax credit denial when supplier defaults on tax payment: s.16(2)(c) read down; bona fide buyers protected.

The dominant issue was whether s.16(2)(c) CGST Act, 2017 (ITC contingent on supplier's tax payment) is unconstitutional and whether ITC can be denied to a ... Constitutional validity of Section 16(2)(c) of the Central Goods and Services Tax Act, 2017 - availment of input tax credit on the supplier having actually paid the tax to the Government - HELD THAT:- There is a failure by the Parliament, while enacting Section 16 (2)(c) of the Act, to make a distinction between purchasing dealers who have bona fide transacted with the selling dealer by taking all precautions as required by the Act and those that have not. Therefore, there is need to restrict the denial of ITC only to the selling dealers who had failed to deposit the tax collected by them and not punish bona fide purchasing dealers - The purchasing dealer cannot be asked to do the impossible, i.e., to identify a selling dealer who will not deposit with the Government, the tax collected by him from purchasing dealers, and avoid transacting with such selling dealers. What section 16(2)(c) of the Act requires the purchasing dealer to do is that after transacting with the selling dealer, somehow ensure that the selling dealer does in fact deposit the tax collected from the purchasing dealer; and if the selling dealer fails to do so, undergo the risk of being denied the ITC. It would be extremely difficult for a purchasing dealer to ensure that the selling dealer deposits the GST collected from him with the Government - if the law seeks to visit disproportionate consequences to a bona fide purchasing dealer, it will become vulnerable to invalidation on the touchstone of Article 14 of the Constitution. In CST v. Radhakrishan [1978 (10) TMI 38 - SUPREME COURT] sanction for prosecution of a dealer under the M.P. General Sales tax Act was given by the Commissioner of Taxes under section 46 (1) (c) of the said Act, though there was a procedure for recovery of tax by imposing penalty under section 22(4-A) of the said Act. The validity of the sanction was questioned on the ground that under the Sales Tax Act, the Commissioner is entitled to pursue two different procedures for enforcing and realizing the assessment made, but as there is no guidance as to the circumstances in which he should resort to either of the two procedures, the provision regarding grant of sanction is invalid. The same issue arose in the Delhi High Court in M/s Shanti Kiran India (P) Ltd v. The Commissioner Trade and Tax, Delhi [2013 (2) TMI 80 - DELHI HIGH COURT] i.e whether the benefit of ITC is available to the registered purchaser dealers who paid taxes to the registered seller dealer(s) in terms of invoice(s) raised by them even though those seller dealers did not deposit the collected tax with the Government. The Delhi High Court held in favour of the purchaser dealers and against State. The fact that Section 74 of the Act which lays down the procedure for determination of tax not paid or short paid or erroneously refunded or input tax credit wrongly availed or utilised by reason of fraud or any wilful misstatement or suppression of facts, is not invoked by respondent No. 3 is very significant - the respondents are not disputing that the petitioner did pay the GST of Rs. 1,11,60,830/- to respondent no. 4, the supplier, though they contend that the latter has not passed over the same to the Government. There is no allegation by the respondents that petitioner had failed to discharge its liability towards tax on the purchases made by it. It is their case that the respondent no. 4 has fraudulently retained the GST paid by petitioner to it - the transaction between the petitioner and the respondent no. 4 is a bona fide transaction and not a collusive transaction tainted by fraud etc., and that the conduct of respondent no. 4 is blameworthy. Petitioner therefore cannot be penalised by invoking Section 16(2) (c) of the Act and denied the ITC. Section 16(2) (c) of the Act is held not violative of Art. 14, 19(1) (g) or 265 or 300-A of the Constitution of India - Section 16(2) (c) of the Act ought not to be interpreted to deny ITC to purchasers in a bona fide transaction like the petitioner and it should be read down and applied only where the transaction is found to be not bona fide or is a collusive transaction or fraudulent transaction to defraud the revenue - the order is set aside. Petition allowed in part. 1. ISSUES PRESENTED AND CONSIDERED (i) Whether Section 16(2)(c) of the CGST Act, 2017 is unconstitutional as violating Articles 14, 19(1)(g), 265 and 300-A of the Constitution, when it conditions ITC on the supplier's actual payment of tax to the Government. (ii) Whether Section 16(2)(c) should be read down so that ITC is not denied to a bona fide purchasing dealer who has paid GST to the supplier and whose transaction is not collusive/fraudulent. (iii) Whether the demand order reversing ITC, issued under Section 73 (i.e., not involving fraud/wilful misstatement/suppression), could be sustained against a purchaser where the supplier defaulted in remitting collected GST. 2. ISSUE-WISE DETAILED ANALYSIS Issue (i) - Constitutionality of Section 16(2)(c) Legal framework: The Court examined Section 16(2)(c), which conditions entitlement to ITC on the tax charged on the supply having been 'actually paid to the Government', and noted the statutory scheme of ITC as avoiding double taxation, while treating ITC as available subject to eligibility conditions under Section 16. Interpretation and reasoning: The Court accepted that the statutory condition linking ITC to actual payment to Government is part of the legislative design, and applied the presumption of constitutionality. It held that the provision can be sustained if interpreted in a constitutionally compliant manner, because the vice identified was not the mere existence of the condition, but its blanket application even to bona fide purchasing dealers who cannot practically verify the supplier's remittance. Conclusion: Section 16(2)(c) was held not violative of Articles 14, 19(1)(g), 265 or 300-A. Issue (ii) - Reading down Section 16(2)(c) to protect bona fide purchasers Legal framework: The Court applied the principle of reading down to preserve constitutionality where a provision, if applied literally in all cases, produces arbitrary/disproportionate results. The Court treated the practical impossibility for a purchaser to ensure the supplier's tax remittance as central to Article 14 scrutiny. Interpretation and reasoning: The Court found (and noted the respondents did not dispute) that there is no mechanism enabling the recipient to verify whether the supplier has filed the relevant return and actually paid tax to the Government, making compliance with a literal reading effectively impossible for an honest purchaser. It held that placing the risk of the supplier's default on a bona fide purchaser imposes an 'onerous burden' and leads to disproportionate consequences, making the blanket denial of ITC vulnerable under Article 14. The Court further reasoned that denying ITC to a purchaser who already paid GST to the supplier would, in effect, compel a second payment without an express legislative mandate for double taxation in such circumstances, undermining the purpose of ITC as avoidance of double tax burden. Conclusion: Section 16(2)(c) was read down and held inapplicable to deny ITC where the purchase transaction is bona fide. It is to be applied to deny ITC only where the transaction is not bona fide or is collusive/fraudulent to defraud revenue. Issue (iii) - Validity of the ITC reversal/demand order against the purchaser under Section 73 Legal framework: The Court treated invocation of Section 73 (cases not involving fraud/wilful misstatement/suppression) as significant for characterising the purchaser's conduct and the nature of the transaction. Interpretation and reasoning: The Court held that the department did not allege that the purchaser failed to pay GST to the supplier or that the transaction was collusive or fraudulent; rather, the case proceeded on the basis that the supplier retained the tax and failed to remit it. Since the proceeding was under Section 73 and not under the fraud-related provision, and since the purchaser's payment of GST to the supplier was not disputed, the Court concluded the transaction was bona fide and the supplier's conduct was blameworthy. On the Court's reading down of Section 16(2)(c), the purchaser could not be denied ITC merely because the supplier failed to deposit the tax. Conclusion: The impugned demand order reversing ITC was set aside, and the authorities were directed to allow ITC to the purchaser to the extent denied.