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 bona fide purchaser when the supplier defaults. The HC held that the provision, if applied to penalize a purchaser who has paid tax to the supplier and complied with statutory precautions, would impose disproportionate and impossible burdens, engaging Art. 14 concerns; however, it upheld the provision's validity by reading it down to operate only where the underlying transaction is non-bona fide, collusive, or fraudulent to defraud revenue. Consequently, denial of ITC to the bona fide purchaser was held impermissible and the impugned order was set aside; the petition was allowed in part.

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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.

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