Rule 86A of the CGST Rules – Ripe for Constitutional Challenge

[Aaryana Anand is a 4th year BSc. LL.B (Hons.) student at Gujarat National Law University, Gandhinagar]

Rule 86A (‘rule 86A’) was inserted in theCGST Rules, 2017 (‘Rules’), with effect from 26 December 2019. The said provision provides wide powers to the Commissioner or an officer authorized by him, not below the rank of an Additional Commissioner, to impose restrictions on Input Tax Credit (‘ITC’) in a case where he has reason to believe that the ITC has been fraudulently availed or is ineligible. Such officer can unblock the same if conditions for disallowance no longer exist or if one year has lapsed from the date of imposition of such restriction. 

In Kalpsutra Gujarat v. Union of India (2020) 120 taxmann.com 101 (Gujarat), the applicant, which is a partnership firm, through one of its partners, had asked the High Court to issue a writ of mandamus or any other appropriate writ, direction or order, striking down rule 86A in so far as it gives power to block ITC through no fault of the registered bona fide recipient, as ultra vires of section 16 of the CGST Act. The applicant further also asked for a direction allowing it to utilize the ITC till the time it is proved that the supplier did not honor his tax liability. The question that the Court put before the respondents in this case, is whether omission on part of the supplier will be sufficient to block the ITC of the applicant. The Court noted the possible misuse of the Rule by the revenue authorities to harass the taxpayer and directed proper guidelines to be issued prescribing the procedure to be followed in order to invoke the said rule 86A. However, no such guidelines have been issued to date. This article analyses a number of constitutional challenges to rule 86A that remain unexplored, in the following sections. 

Rule 86A is Ultra Vires the CGST Act

The CGST Rules draw from powers conferred by the CGST Act, 2017. Conditions under section 16 of the Act restrict the availment of credit, and warrant reversal in cases where credit has been wrongly availed. The right to avail and utilize ITC for discharging tax liability is a legal right arising from the statute, and it is trite in law that this right can be curtailed only with the specific power of the law and not otherwise (Eicher Motors Ltd. v. Union of India (1999) 106 ELT 3 (SC)).  None of the provisions contained in section 16 or any of the other sections under the Act empower the government to block ITC under any circumstances. The Act provides for the provisional taking of credit on a self-assessment basis, and the blocking of credit goes against the scheme of the Act. 

Further, a condition present in rule 86A for restriction, namely, that a registered supplier who has been found to be non-existent or not to be conducting business from his place of registration, is not present in section 16 of the Act. Thus, the powers prescribed vide rule 86A does not flow from the Act, and can be challenged on the ground that it is ultra vires of the Act.

Issuance of a Show Cause Notice

It is established law that if any penal action is taken against an assessee, irrespective of whether there is a provision under the Act or not, the minimum requirement is that the principles of natural justice must be followed. These minimum requirements include a show cause notice and an opportunity to be heard. Under the GST regime, the same is ensured under section 73 of the Act, which provides a mechanism to allow for the Revenue to provide a notice and opportunity of hearing to an assessee.

In ICICI Bank Limited v. Union of India , the Bombay High Court held that if it is the view of the Revenue that the petitioners liable to pay service tax are evading its payment, the former can take recourse to section 73 of the Act and determine the amount of service tax payable by latter. However, a demand or recovery notice without adjudication is illegal and unlawful.

However, in cases pertaining to rule 86A, department is not issuing a show cause notice to the assessee under section 73 of the Act. Thus, rule 86A appears to bypass the provisions of section 73, which mandates a notice and an opportunity of hearing. Therefore, an action of blocking credit ledger is violative of principles of natural justice. 

Recipient Should Not Suffer on Account of a Supplier’s Default 

Rule 86A subjects a bona fide assessee to undue hardship by the blockage their credit ledger, where credit was rightfully claimed, due to the default of their supplier. This is tantamount to equating the default of the recipient with that of the supplier. Section 43A was inserted into the Act vide the CGST (Amendment) Act, 2018. Section 43A(6) provides that the supplier and the recipient of a supply shall be jointly and severally liable to pay tax, or to pay the input tax credit availed, as the case may be, in relation to outward supplies. 

However, section 43A has not been notified yet. Therefore, the same does not apply. In the absence of section 43A being notified, this power has not been contemplated by the Act. Further, the notification of rule 86A prior to section 43A is indicative of the fact that the rule did not intend to draw validity from section 43A. Thus, the blocking of a recipient’s credit ledger on the account of default of a supplier, vide rule 86A, is wanting of statutory authority at present.

On the perusal of the aforesaid provisions, it can be said that there is a specific mechanism for reversing the credit in the case of a discrepancy in the ITC availed by the recipient, against the output liability of the supplier. However, the ITC reversal mechanism, as laid down in section 41 read with Rules, is kept in abeyance. The facility to furnish GSTR – 2 and GSTR – 3 Forms is also not available. Accordingly, there is no system-based matching of ITC being carried out presently, and till the time such provisions are given effect, the recipients shall be eligible to claim ITC provisionally on the basis of the invoice issued by customer.

It has been held in a catena of judgments that a bona fide recipient cannot be made to suffer on account of a supplier’s default. In Quest Merchandising India Pvt. Ltd. v. Govt. of NCT of Delhi, the assessee had duly paid the tax to the supplier, but the supplier did not deposit the tax to the Government. The assessee argued that the purchasing dealer can check on the web portal of the department if the selling dealer is a fictitious person or a person whose registration stands cancelled. The Court held that the purchasing dealer was being asked to do the impossible, i.e. to anticipate the selling dealer who will not deposit the tax collected by him from such purchasing dealers to the Government, and therefore avoid transacting with such selling dealers. The Delhi High Court read down the concerned provision to not include a buyer who has bona fide entered into purchase transactions with validly registered dealers who have issued tax invoices against the transaction. The Court explained that such provision, if not read down, is violative of Article 14 of the Constitution for being inherently arbitrary. The only case when such provision applies is if the tax authorities comes across some material to show that the purchasing dealer and the selling dealer, acted in collusion in detriment to the exchequer. However, in the event that the selling dealer has failed to deposit the tax collected, the remedy for the authorities is to proceed against the defaulting selling dealer to recover such tax and not to deny the purchasing dealer his input. The Supreme Court affirmed the said case and dismissed the Revenue’s petition seeking special leave to appeal against this decision.

In Sri Vinayaga Agencies v. Assistant Commissioner, Madras High Court held that law could not empower tax authorities to reverse the ITC availed, on a plea that the selling dealer has not deposited the tax. It can revoke input credit only if it relates to the incorrect, incomplete or improper claim of such credit. A similar view has been taken by various other high courts throughout India. 

Conclusion

An analysis of rule 86A of the CGST Rules reveals that the same subjects a bona fide assessee to undue hardship by the blocking their credit ledger, where credit was rightfully claimed, due to the default of their supplier. Further, section 16 provides no procedure to be followed in such cases of disallowance of credit. In light of the trite constitutional issues discussed above, sufficient grounds exist for a challenge against an order passed under rule 86A in a jurisdictional high court. 

– Aaryana Anand

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