TaxTMI 
TaxTMI 
Supplier Default and the Buyer's ITC - Liability Must Be Established, Not Assumed
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....upplier Default and the Buyer's ITC - Liability Must Be Established, Not Assumed<br>By: - Raj Jaggi<br>Goods and Services Tax - GST<br>Dated:- 5-10-2026<br><br>A Valid Provision Still Requires Lawful Application A purchasing dealer may receive goods or services or both, hold a proper tax invoice and pay the entire invoice value, including GST, through banking channels. Yet, years later, the Department may seek reversal of input tax credit because the supplier failed to deposit the tax or its registration was retrospectively cancelled. The resulting dispute raises two separate questions: whether actual payment of tax to the Government can be prescribed as a condition for ITC, and whether every supplier default automatically justifies recovery from the purchaser. The Punjab and Haryana High Court has examined this distinction in Shaurya Alloys Private Limited v. State of Punjab and Another, 2026-VIL-1131-P&H, decided on 01.10.2026, in CWP No. 34296 of 2024 and 423 connected writ petitions. The Division Bench comprising Chief Justice Ashwani Kumar Mishra and Justice Rohit Kapoor upheld Section 16(2)(c), read with Section 155, while prescribing detailed guidelines against its mec....
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....hanical application. The judgment neither grants unconditional ITC to every purchaser claiming good faith nor permits supplier default to replace inquiry and adjudication. The Purchaser's Difficulty and the Department's Concern The petitions concerned proceedings arising from alleged non-payment of tax by suppliers, nil or short declaration of output-tax liability, cancellation of registration and supplier-related alerts or investigation material. The purchasers maintained that they had received the supplies, paid the tax component and preserved the commercial records. Their central grievance was that they could neither compel the supplier to deposit tax nor independently verify the actual payment of tax against each invoice. They challenged the constitutional validity of the provision and alternatively sought to restrict its operation to fraud, collusion and fictitious transactions. The Department relied upon the express conditions governing ITC and the claimant's burden of proof under Section 155. It also asserted that several transactions were not genuine and that invoices, banking entries or e-way bills could form part of an arrangement involving accommodat....
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....ion invoices or circular trading. The Court therefore refrained from deciding the factual entitlement of each petitioner. Its task was to explain the statutory framework and prescribe the inquiry necessary to distinguish a genuine transaction affected by supplier default from an independently inadmissible ITC claim. Payment to the Supplier and Payment to the Government Section 16(1) permits a registered person to take credit of input tax on supplies used or intended to be used in the course or furtherance of business, subject to the statutory conditions. Section 16(2) makes that entitlement conditional. These conditions include possession of the prescribed document, receipt of goods or services, furnishing of the relevant return and compliance with the additional requirements applicable to the tax period. Under clause (c), subject to Section 41, the tax charged on the supply must actually have been paid to the Government, either in cash or through utilisation of admissible ITC. The purchaser's payment to the supplier and the supplier's payment to the Government are two separate acts. When the purchaser pays the full invoice amount, including GST, it settles the amo....
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....unt payable to the supplier. However, this payment does not, by itself, establish that the supplier has deposited the corresponding tax with the Government. Section 16(2)(c) requires actual payment of that tax to the Government, and the judgment has upheld this statutory condition. At the same time, the supplier's failure to deposit tax cannot, by itself, justify automatic reversal of the purchaser's ITC. The proper officer must examine the purchaser's invoices, payment records and evidence of actual receipt of goods or services. The officer must also consider the circumstances of the supplier's default, the action taken to recover tax from the supplier and the provisions governing reversal and subsequent re-availment of credit, as applicable to the relevant tax period. The judgment therefore requires a balanced examination. Payment of GST to the supplier does not establish an unconditional right to ITC, but supplier default does not permit the Department to ignore a genuine transaction and the purchaser's supporting evidence. The decision on ITC must follow a proper inquiry and a reasoned application of the relevant statutory provisions. Constitutional....
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.... Validity Does Not Authorise Automatic Reversal The Court held that actual payment of tax to the Government is a basic condition for claiming ITC, and Parliament has the power to prescribe that condition. A purchaser's difficulty in verifying the supplier's payment does not, by itself, make Section 16(2)(c) unconstitutional. Similarly, if an officer applies the provision mechanically or unfairly in a particular case, that action may be challenged, but it does not make the provision itself invalid. The Court therefore rejected the constitutional challenge to Section 16(2)(c), read with Section 155. The Court also refused to restrict the provision to cases involving fraud, collusion or fictitious transactions. Such a restriction would mean that the condition of actual payment of tax could be enforced only in those cases. The Court did not accept this interpretation: the statutory condition remains applicable even where fraud or collusion is not established. However, whether ITC should be reversed in a particular case must be decided after examining the relevant facts, evidence and statutory safeguards. In reaching this conclusion, the Court considered Maruti Enterpri....
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....ses v. Union of India, 2026 SCC OnLine Guj 4013; 2026-VIL-432-GUJ, in which the Gujarat High Court upheld the provision while considering the remedies for recovery from the defaulting supplier and subsequent re-availment of credit. It also considered Bhandari Scrap Traders v. Union of India, 2026 SCC OnLine SC 1570; 2026-VIL-69-SC, decided on 24.07.2026, in which the Supreme Court dismissed the special leave petitions through a reasoned order affirming that view. Following this judicial position, the Punjab and Haryana High Court upheld the provision but required officers to apply it through proper inquiry, consideration of the purchaser's evidence and reasoned adjudication. The Statutory History Changes the Legal Inquiry The original GST framework contemplated provisional credit and matching of inward and outward supply details through Sections 41, 42 and 43. The matching machinery was intended to communicate discrepancies and permit verification and correction. However, the envisaged system was not fully operationalised. The purchaser consequently lacked the invoice-wise means contemplated by that architecture to ascertain whether the supplier had actually discharged th....
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....e corresponding tax liability. This practical difficulty informed the Court's insistence that Section 16(2)(c) could not be treated as an isolated provision. Paragraph 103(ix) requires officers to distinguish the framework before 01.10.2022, the changes effective from 01.10.2022 and the introduction of Rule 37A from 26.12.2022. From 01.10.2022, Section 41 was substituted, Sections 42 and 43 were omitted and Section 16(2) (ba) became operative. Section 16(2) (aa), effective from 01.01.2022, must likewise not be applied to an earlier period. The Court specifically required consideration of the absence, before 26.12.2022, of the later specific re-availment mechanism for credit reversed because of supplier default. The relevant tax period must therefore be identified before selecting the applicable conditions and consequences. Rule 37A Must Be Applied Within Its Own Scope Rule 37A was inserted by Notification No. 26/2022-Central Tax dated 26.12.2022. It addresses the specified situation where the supplier has furnished the invoice or debit-note details in its outward-supply statement but has not furnished the corresponding return in Form GSTR-3B within the prescribed perio....
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....d. The Rule provides for reversal and subsequent re-availment when the corresponding return is furnished. Its operation depends upon its own conditions and timelines; it cannot be used as a general explanation for every supplier-related discrepancy. The Court therefore rejected reliance on Rule 37A as a blanket justification for retrospective denial merely because the supplier's registration was subsequently cancelled. The substituted Section 41 and its proviso, together with the applicable rules, must be considered where tax is subsequently paid. Importantly, the judgment does not authorise officers to impose a later condition on an earlier tax period. Nor does it automatically exempt all earlier transactions from Section 16(2)(c). It requires a period-specific examination of the framework and of the consequences of supplier default. Supplier Alerts Begin Inquiry but Do Not Complete It Paragraph 103(i) of the judgment provides that subsequent or retrospective cancellation of the supplier's registration, nil or short tax liability in its return, or an alert, intimation or complaint may justify inquiry. These circumstances cannot, by themselves, constitute the basis....
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.... for denying or reversing the purchaser's ITC. An alert identifies a possible problem; it does not establish the nature of the particular supply, the purchaser's conduct or the precise statutory condition that has failed. For retrospective cancellation, paragraph 103(vii) of the judgment requires examination of both the grounds and the effective date of cancellation, and whether those grounds affect the genuineness of the particular supply. A later compliance default and evidence that the supplier never existed may have different implications. The officer must explain how the cancellation material bears upon the transaction under examination. The effective date alone cannot replace that reasoning. Satisfaction Must Precede the Show Cause Notice Before issuing a notice founded upon Section 16(2)(c), the proper officer must apply his mind and record satisfaction concerning the supplier, disputed invoices, relevant periods, amount of ITC and precise default. Paragraph 103(ii) of the judgment distinguishes complete non-payment, short payment and discharge through ITC that is itself inadmissible. The circumstances of the supplier's failure and the status of recovery....
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.... proceedings against it must also be examined. Paragraph 103(iii) further requires investigation to establish a direct link between the purchaser and the suppliers relevant to the alleged violation of Section 16(2). The notice must disclose the particulars and material supporting the proposed denial, identify the suppliers and explain how the credit was allegedly wrongly availed. Under paragraph 103(iv) of the judgment, relied-upon documents must be supplied, subject to any lawfully claimed privilege. These may include alerts, inspection reports, panchnamas, statements and e-way bill, vehicle, toll or banking data. A purchaser cannot meaningfully answer an allegation resting on undisclosed supplier-related material. Disclosure is therefore an essential part of the opportunity to defend the claim. The Supplier's Fraud Does Not Automatically Become the Purchaser's Fraud The Court applied M/s G.R. Infra Projects Limited Ratlam Versus The State of Madhya Pradesh & Ors. - 2026 (8) TMI 1497 - SC Order, and M/s. Tata Steel Limited Versus Union of India through the Secretary Ministry of Finance and Ors. - 2026 (8) TMI 1587 - Supreme Court. These decisions require....
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.... the foundational facts supporting fraud, wilful misstatement or suppression to emerge from the notice itself. Repeating statutory expressions does not establish the officer's satisfaction, and a counter-affidavit before the Court cannot supply the missing foundation. Paragraph 103(v) of the judgment accordingly requires facts connecting the purchaser with the alleged fraud. A supplier's non-payment, false return or fraudulent conduct cannot simply be attributed to every customer. The same requirement applies, for the period governed by Section 74A, where the Department relies upon fraud, wilful misstatement or suppression. This does not make fraud a universal prerequisite for denial of ITC under Section 16(2)(c); it identifies the additional factual foundation required when proceedings or consequences are invoked on the basis of culpable conduct. Section 155 Requires Evidence of the Commercial Transaction The judgment expressly preserves the purchaser's burden under Section 155. A tax invoice or assertion of good faith is insufficient by itself to establish every disputed condition. Paragraph 103(vi) of the judgment identifies evidence such as invoices, proof ....
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....of receipt, e-way bills, transport receipts, weighbridge slips and stock and consumption records. Banking records and other contemporaneous documents can support that evidence. The records must collectively establish the commercial reality of the supply and answer the specific objections raised. For example, if Harpreet Ltd. purchases raw material from Aayra Ltd., its defence should connect the invoice with transportation, inward receipt, stock entry, payment and subsequent consumption or sale. If the Department disputes vehicle movement, merely producing an invoice will not resolve that objection. Conversely, reliable records establishing actual receipt and use cannot be discarded solely because the supplier subsequently defaults. The officer must evaluate the evidence and explain the findings. On the contrary, proven collusion, absence of receipt or failure to establish entitlement may still justify denial in accordance with law. Recovery from the Supplier Must Remain a Real Remedy Section 76 specifically addresses amounts collected as tax but not paid to the Government. The Court held that this remedy cannot be rendered ineffective by routine recourse against purchasers....
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..... Paragraphs 103(ii) and 103(viii) of the judgment require ascertainment and recording of supplier-side proceedings, including proceedings under Sections 73, 74, 75(12) read with Section 79, or Section 76. Where the supplier falls under another Central or State authority, the proper officer must communicate with the jurisdictional officer concerned. The Court has not laid down an absolute rule that the Department must first exhaust every recovery measure against the supplier before proceeding against the purchaser. However, the officer cannot ignore the supplier who collected the tax but failed to deposit it. The officer must ascertain whether recovery proceedings have been initiated against that supplier, examine their progress and record the relevant position while deciding the purchaser's ITC claim. If the supplier has subsequently deposited the tax, or the Department has recovered it from the supplier, that fact must be taken into account. The same tax relating to the same supply should not be recovered twice. The officer must accordingly examine whether the purchaser can avail or re-avail the credit under the proviso to Section 41(2) and Rule 37A, having regard to th....
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....e conditions and statutory framework applicable to the relevant period. Restoration of credit is nevertheless not automatic in every case. The officer must also examine whether any statutory restriction applies, including Section 17(5)(i), which concerns tax paid under the demand provisions specified in that clause. Its applicability must be determined under the law governing the particular case. Thus, subsequent payment or recovery from the supplier is a material fact, but the purchaser's entitlement to restored credit must still be decided under the applicable provisions. Hearing and Reasoned Findings Are Essential Safeguards Paragraph 103(xi) of the judgment requires a personal hearing in terms of Section 75(4). Where third-party statements are relied upon and cross-examination is sought, the request must be considered and decided through a reasoned order, having regard to whether those statements form the basis of the proposed action. The direction requires a meaningful decision on the request; it does not declare that cross-examination must invariably be granted in every proceeding. Under paragraph 103(xii) of the judgement, the order must state the relevant fa....
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....cts and basis of the decision as required by Section 75(6), address the reply and documents and record findings on each disputed condition of Section 16(2). Where Section 74 is invoked, a specific finding concerning fraud, wilful misstatement or suppression attributable to the purchaser is additionally required. The judgment also prohibits cancellation of the purchaser's registration merely because its supplier's registration was cancelled: an independent ground under Section 29(2) and compliance with the prescribed procedure are necessary. Similarly, Paragraph 103(xiii) provides that an investigation-stage deposit through DRC-03 does not, by itself, dispense with the notice's required factual foundation; its character and effect must be examined. Fresh Decisions Were Directed without Quashing Existing Orders The precise relief in paragraph 105 deserves attention. For matters at the notice stage, the petitioners were permitted to submit replies or supplementary replies with supporting material within eight weeks. Missing particulars and material had to be supplied. Where adjudication orders already existed, the proper officer was directed to revisit the matter, gr....
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....ant a personal hearing and pass a fresh reasoned order. Supplementary notices or corrigenda could be issued in the terms specified by the Court, and objections to any new ground or provision were left open for determination. The Court clarified that the existing orders were not set aside, but their effect would depend on the fresh orders passed after reconsideration. Any amount already deposited or recovered, including through reversal of ITC or debit to the electronic ledger, would also be dealt with according to the fresh decision. Where legally due, such amounts would be adjusted or refunded with admissible interest. Until the fresh decision, no fresh coercive recovery action could be taken against the petitioners under the disputed notices or orders. All factual and legal arguments remained open, and the Department could continue proceedings against defaulting suppliers. The Court therefore directed a fresh examination of each case; it did not automatically allow ITC or order an immediate refund. The Practical Value Lies in Evidence and Proper Adjudication Paragraph 103(xiv) of the judgement makes the guidelines applicable to pending and future proceedings before pr....
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....oper officers. They help taxpayers question deficient notices, obtain relied-upon documents and establish genuine supplies. The judgment binds within its applicable jurisdiction; elsewhere, its reasoning may be relied upon subject to governing precedent. Replies must still address the disputed invoices, relevant law and supporting evidence. The Court suggested invoice-wise verification and timely supplier alerts for consideration by the Government and GST Council, but did not direct their implementation. The central principle in Shaurya Alloys Private Limited v. State of Punjab and Another, 2026-VIL-1131-P&H, is that ITC conditions must be enforced through proper inquiry, disclosure of material and reasoned findings. Supplier default alone cannot replace examination of the purchaser's entitlement under the applicable law. *** =============<br> Scholarly articles for knowledge sharing by authors, experts, professionals ....