Kerala HC: Revenue Cannot Deny ITC to Buyers Without First Pursuing Defaulting Suppliers

The High Court of Kerala has delivered a significant ruling concerning the operational dynamics of the Input Tax Credit (ITC) mechanism under the Central Goods and Services Tax (CGST) Act. In the matter of M/S. K.V. Joshy & C.K. Paul vs. The Assistant Commissioner , the court clarified that tax authorities cannot summarily deny ITC to a purchasing dealer simply because the selling dealer failed to discharge their tax liability.

The Backdrop of the Dispute

The petitioner, a registered assessee under the CGST Act , claimed input tax credit for purchases made during the 2019-2020 financial year. Despite possessing valid tax invoices and e-way bills verifying the transportation of goods, the petitioner found their ITC claim under fire. The Assistant Commissioner issued a Show Cause Notice (SCN) under Section 73 of the Act, proposing the disallowance of the claimed credit and the imposition of a penalty.

The core of the dispute arose because the petitioner's suppliers failed to furnish details of the supplies or remit the corresponding tax to the government. Consequently, the Revenue sought to shift the burden of this non-payment onto the buyer.

Arguments from the Trench

Counsel for the petitioner argued that the Revenue failed to adhere to the statutory scheme of Section 42 of the CGST Act , which mandates a specific procedure for matching and reversing tax credits. The petitioner maintained that they had acted in good faith, possessed valid documents, and had paid the tax to the supplier. Relying on the landmark Suncraft Energy ruling, they contended that the department must first proceed against the supplier before targeting the buyer.

Conversely, the Revenue argued that the petitioner failed to satisfy the condition under Section 16(2)(c) of the CGST Act , which makes ITC eligibility contingent upon the actual payment of tax to the government. They further justified the show cause notice by noting that the time limit for issuing final orders had been extended by the Central Board of Indirect Taxes and Customs, rendering their action legally timely.

A Legal Rebuff to Arbitrary Recovery

Justice Ziyad Rahman A.A.th analyzed the statutory framework and noted that the law does not permit the department to bypass the supplier in favor of an easier recovery target. By looking at the legislative intent and judicial precedents—specifically the Calcutta High Court’s ruling in Suncraft Energy and the Supreme Court’s stance in Shanti Kiran India (P) Ltd —the Court emphasized that the Revenue’s approach was procedurally flawed.

The Court held that the "reading down" of similar provisions in other regional tax laws (as seen in the Delhi VAT Act cases) reinforces the principle that a bona fide purchasing dealer should not be punished for the defaults of a supplier, unless a clear nexus of collusion is established.

Key Observations

The judgment offers several pivotal insights into the obligations of the Revenue:

• On Arbitrariness: "The first respondent without resorting to any action against the fourth respondent... has ignored the tax invoices produced by the appellant... the action of the first respondent has to be branded as arbitrarily."
• On Procedural Failure: "It is an admitted position that, no proceedings have been initiated against the suppliers... This amounts to the failure on the part of the official respondents in following the statutory stipulations..."
• On Collusion: "In the event that the selling dealer has failed to deposit the tax collected... the remedy for the Department would be to proceed against the defaulting selling dealer to recover such tax and not deny the purchasing dealer the ITC."

Final Verdict: Implications for Future Assessments

The Kerala High Court ultimately quashed the show cause notice issued to the petitioner. Crucially, the Court clarified that this judgment serves as a protection for compliant taxpayers; however, it does not provide an escape for defaulting suppliers. The authorities remain fully empowered—and are arguably obligated—to pursue the suppliers directly to recover the unpaid dues.

This decision serves as a stern reminder to tax authorities that the mechanisms of the GSTR platform are for "taxpayer facilitation" and should not be weaponized to automatically reverse a buyer's legitimate credit without exhausting due process against the non-compliant seller.