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Can Purchasing Dealers Be Forced to Reverse ITC? Says No
The has delivered a significant ruling that offers clarity and relief to genuine purchasing dealers under the Goods and Services Tax (GST) regime. While upholding the constitutional validity of , a Division Bench comprising Chief Justice Ashwani Kumar Mishra and Justice Rohit Kapoor firmly held that this provision cannot be invoked mechanically to reverse merely because the supplier failed to deposit tax or had its registration cancelled.
The court, in a batch of 424 writ petitions led by , laid down 14 detailed guidelines for proper officers of the Centre, Punjab, Haryana and the Union Territory of Chandigarh. These guidelines aim to ensure that Section 16(2)(c) is applied as part of the integrated statutory scheme, not as a standalone weapon to shift the seller's tax default onto the buyer.
The Core Legal Question
The central issue before the court was what obligation Section 16(2)(c) places on a purchasing dealer who has already paid the tax amount to the supplier, but has no means to verify whether that supplier actually deposited the tax with the government. The provision states that ITC shall be available only if
"the tax charged in respect of such supply has been actually paid to the Government, either in cash or through utilisation of input tax credit admissible in respect of the said supply."
Petitioners argued that this condition, when read with
(placing the
on the person claiming ITC), compelled them to perform an impossible act—especially given that the matching and reconciliation mechanism originally built into the law was never implemented.
, appearing for the petitioners, illustrated the problem through a supply chain running from a kabadiwala (scrap dealer) to a retail customer. He showed how a single default or several links up the chain could deny ITC to a genuine purchaser holding all requisite documents. He argued that the provision, in practice, violated , and invoked the maxim (the law does not compel the impossible).
Court's Observations on the Statutory Scheme
The Bench noted that the original scheme under Sections 37 to 42 of the CGST Act provided for matching of returns, communication of discrepancies to both parties, and reclaim of credit once the supplier rectified the default. It was this mechanism that enabled the purchasing dealer to know of a supplier's default in a time-bound manner, and it was in that context that placed the on the person claiming ITC.
However, it was undisputed that this was never implemented due to technical glitches. Section 42 was eventually omitted and Section 41 substituted with effect from , while (providing for reversal and of ITC where the supplier fails to file returns) was inserted only from . Before , there was no mechanism for a purchaser to re-avail reversed credit even if the supplier later paid the tax.
The court observed:
"The vice complained of, namely, that the purchasing dealer is called upon to perform an impossible act, does not inhere in the text of Section 16(2)(c). It arises when the provision is torn out of the statutory scheme of which it is an integral part and is applied in a routine and mechanical manner."
It further held that
, which specifically deals with tax collected but not paid,
"cannot be rendered otiose in the GST scheme on account of indiscriminate invocation of Section 16(2)(c)."
The court stressed that buyers cannot be held endlessly liable to trace out the whereabouts of suppliers from whom purchases were made years ago.
Validity Upheld, Declined
Despite these strong observations, the Bench held that Section 16(2)(c) does not suffer from any constitutional infirmity. It noted that actual payment of tax "constitutes its very foundation" of ITC, and that the vires challenge was "at best, feeble." The real grievance, the court said, was against the manner of invocation, not the provision itself.
The court declined to read down the provision to apply only in cases of fraud or collusion, as the petitioners had alternatively sought. Citing the 's ruling in
—which was affirmed by the in
—the court held that
counselled against such a reading. However, it clarified that upholding validity
"does not conclude the matter,"
because
Maruti Enterprises
itself sustained the provision on the premise that the purchaser is not left remediless. That premise holds only if Section 16(2)(c) is invoked with due regard to the remedies against the defaulting supplier.
The 14 Guidelines: A New Framework for ITC Adjudication
The court laid down 14 guidelines to govern all pending and future proceedings. Key among them are:
- No mechanical reversal : Cancellation of the supplier's registration (including ), a nil or short return by the supplier, or an alert from another source may be a legitimate starting point for inquiry, but cannot by themselves justify denial or reversal of ITC.
- Officer must apply mind : Before issuing a , the proper officer must record satisfaction on the particulars of the supplier and invoices, the precise nature of the default, the circumstances of the supplier's failure to pay, and the status of any recovery proceedings against the supplier under .
- Direct link with buyer : The investigation must establish some direct link between the purchasing dealer and the supplier. Fraud by the supplier cannot be automatically attributed to the buyer unless the notice discloses facts connecting the two.
- Disclosure of material : The notice must disclose the material relied upon, and documents such as alert notices, inspection reports, statements and e-way bill, toll and banking data must be supplied to the noticee.
- : The purchasing dealer may discharge its burden under through tax invoices, e-way bills, transport receipts, weighbridge slips and stock records. The officer must consider and deal with these in the order.
- : Where ITC denial rests on , the officer must examine the grounds and effective date of cancellation and their bearing on the particular supply.
- Seller-side recovery : The officer must ascertain the status of proceedings against the supplier, coordinate with the jurisdictional authority where the supplier falls elsewhere, and ensure the same tax is not realized twice. must be allowed to the extent permissible under the .
- No automatic cancellation of buyer's registration : A purchasing dealer's registration cannot be cancelled merely because its supplier's registration was cancelled, without independent satisfaction under .
- Personal hearing and cross-examination : Personal hearing must be granted under , and requests to cross-examine third parties whose statements are relied upon must be decided by reasoned order.
- Reasoned final order : The final order must record specific findings on each disputed condition of Section 16(2). A deposit made during investigation, including through , will not dispense with the requirement of disclosing foundational facts.
Policy Suggestions and Directions
The court also commended several suggestions for consideration by the Government and the , including portal alerts when supplier cancellation proceedings begin, real-time invoice-wise verification of supplier tax payment, and biometric and PAN/Aadhaar authentication at registration. It declined, however, to issue any on these policy matters.
On the individual petitions, the court noted that many impugned notices and orders appeared founded solely on the supplier's default or . It directed that petitioners at the stage may file replies within eight weeks, to be decided by reasoned orders applying the guidelines. Where orders had already been passed, the proper officer must revisit them and pass fresh orders after hearing. Amounts deposited or recovered will abide by the fresh decision and be adjusted or refunded with admissible interest where warranted. No fresh will be taken until then, and the Department remains free to proceed against defaulting suppliers.
Impact on Legal Practice
This ruling is a landmark for GST practitioners and corporate taxpayers alike. It curbs the tendency of tax authorities to mechanically deny ITC based on supplier defaults, especially where the supplier's registration is cancelled retrospectively. The guidelines create a robust framework of procedural safeguards that align with principles of and the lex non cogit maxim. For legal professionals, the judgment provides a ready checklist for challenging ITC reversals and for drafting show cause notices that withstand judicial scrutiny. It also underscores the importance of the integrated statutory scheme and the need for authorities to exhaust remedies against the defaulting supplier before targeting the genuine buyer. The 's consideration of policy suggestions may further reduce litigation in the long run.
Conclusion
The has struck a careful balance—upholding the constitutional validity of Section 16(2)(c) while ensuring it is not used as a blunt instrument against honest taxpayers. By mandating a holistic, evidence-based approach, the court has reinforced the foundational principle that the law does not compel the impossible. This judgment will likely serve as a persuasive precedent for other High Courts and the in similar disputes, shaping the future of ITC adjudication in India.
