Denying Input Tax Credit to Bona Fide Recipients Where GST is Not Paid by the Supplier

[Shubham Sharma is a 2nd year BBA LLB (Hons.) law student at Chanakya National Law University]

A key distinction between GST and the pre-GST tax regime is that GST promises to eliminate the “cascading effect of taxes” or “tax on tax” that sellers often suffer from. Input tax credit (ITC) under GST is one such core concept that furthers this objective. ITC is the tax that a business pays on a purchase, and when it makes the sale, it can reduce its tax liability. ITC helps businesses reduce their tax liability on purchases by claiming credit to the extent of GST. ITC is the cornerstone of GST and can be claimed regardless of the location of the seller, making sales and purchases of products more accessible.

However, section 16 of the Central Goods and Services Tax Act, 2017 (“CGST Act”) lists certain requirements that have to be fulfilled by a business in order to claim ITC. One such condition provided in section 16(2)(c) of the CGST Act is that the tax charged in respect of the supply of goods must be actually paid to the government by the supplier. Thus, a claimant would be entitled to ITC only when, inter alia, the tax on supply has been paid to the government. Placing such a burden on the claimant is arbitrary and impractical as it is impossible for a claimant to determine whether or not the supplier has remitted the tax to the government. In case of default, the claimant will not only be denied ITC but also will face the additional burden of furnishing reverse ITC along with interest to the government. Such a provision clearly discriminates between bona fide claimants and fraudulent claimants of ITC.

The recent judgment of Madras High Court in Pinstar Automotive India Pvt. Ltd. v. Additional Commissioner (20 March 2023) is an example of the issue. The High Court ruled that the condition laid down in section 16(2)(c) of the CGST Act needs to be interpreted strictly and the mandate is upon the claimant to ensure compliance with the provision, failing which it would not be entitled to ITC. The author argues that the said ruling is problematic and incorrect as it denies the benefit of ITC to bona fide claimants. The author supports his argument by analyzing the said ruling in light of judicial pronouncements on the issue in the pre-GST regime as well GST regime.

Facts of the Case

In the present case, Pinstar Automotive India Pvt. Ltd (petitioner) was an assessee under the CGST Act and had received a pre-assessment notice from the respondent in regard to the issue relating to the invocation of section 16(2)(c). The petitioner stated that it had received certain supplies from three third parties – Techno Rubber Plastic and Co., Techno Rubber and Plastic, and Unique Autoplastics Private Limited and that it had paid the entirety of the amount including the tax to them. However, it was found that the suppliers had not filed GSTR 3B and no tax was remitted to the department, as a consequence of which the petitioner suffered a reversal of ITC. The petitioner argued that it was entitled to ITC as it had fulfilled all the conditions under the statute and had also adduced proof of the same. However, the stand of the petitioner was rejected unilaterally by the respondent who passed an order confirming the demand proposed in the pre-assessment notice. Aggrieved by this order, the petitioner moved the High Court seeking rectification of errors apparent on the face of the record under section 161 of the CGST Act.

Having heard both parties, the Court ruled that the requirements laid down in section 16 of the CGST Act to claim ITC need to be interpreted strictly to ensure that the interests of the revenue are not jeopardized. It observed (at para 9):“The provisions of the Central Goods and Services Tax Act, 2017 has, assimilating wisdom of experience from the erstwhile tax regimes, gone one step further to ensure that the interests of the revenue are protected by providing for a mandate that the tax liability is defrayed/met either at the hands of the supplier or the purchaser, the petitioner in this case.” Thus, the Court ruled that it was not the department’s fault that the suppliers in the present case failed to remit the tax to the department. Instead, the onus is on the supplier or purchaser to ensure compliance with section 16 without which they would not be entitled to ITC.

Analysis of the Issue

The heart of the controversy revolves around the interpretation of section 16(2)(c) of the CGST Act, which states that a recipient is eligible for ITC only if the tax levied on the supply of goods has been deposited with the government by the supplier. The bare provision of section 16(2)(c) of the CGST Act reads:

“Notwithstanding anything contained in this section, no registered person shall be entitled to the credit of any input tax in respect of any supply of goods or services or both to him unless, ––

subject to the provisions of section 41 or section 43A, the tax charged in respect of such supply has been actually paid to the Government, either in cash or through the utilization of input tax credit admissible in respect of the said supply;” [emphasis added]

The provision becomes troublesome if the words “has been actually paid to the Government” is interpreted to mean that it is the duty of the recipient to ensure that the tax paid by them on goods supplied by the supplier is actually transferred to the purse of the government by the supplier. This means that an additional burden will be placed on the claimant to cross-check whether the supplier has paid the tax to the government failing which, the claimant would not be entitled to ITC under the law. This risks the position of a bona fide purchaser who is precluded from claiming ITC even when the default occurs on the part of the supplier and not the claimant as is the case in the present matter. It is pertinent to note that this issue is not an alien one and was a highly debated issue even in the pre-GST regime. The jurisprudential position surrounding this issue can be understood from the following judicial decisions.

In a significant ruling in 2013, the Supreme Court in Commissioner of Central Excise, Jalandhar v. Kay Kay Industries, while allowing the recipient (respondent) to claim MODVAT credit even when the supplier had defaulted in his duty to pay tax received from the recipient on inputs to the department, held that “an assessee is not expected to verify with Department whether the supplier had paid duty on inputs or not supplied by Manufacturer-Supplier in order to avail deemed MODVAT credit.”  The Court further observed that where the assessee has followed the prescribed procedure, it would be unjustifiable and impractical to impose such a condition and would instead lead to transactions getting delayed. In the same year, the Delhi CESTAT in the case of CC & CCE v. Juhi Alloys Ltd  held: “A buyer can take steps that are in their control and he cannot be expected to verify the records of the supplier’s broker (i.e. dealer) to check whether, in fact, the supplier has paid duty on the goods supplied by him or not. Hence, as long as the bonafide nature of the consignee transaction is not doubted, credit should not be denied to the buyer.” A similar view was taken by the Jharkhand High Court in Commissioner of C. Ex., East Singhbhum v. Tata Motors Ltd., and by a Division Bench of Himachal Pradesh High Court in A.B. Tools Limited v. Commissioner of Central Excise.

Further, the ruling of Delhi High Court in Arise India Ltd. v. Commissioner of Tax is relevant to the discussion at hand. The issue involved in the case was a clause in the Delhi Value Added Tax Act (“DVAT Act”), section 9(2)(g), which is identical to section 16(2)(c) of the CGST Act. Section 9(2)(g) of the DVAT Act states:

 (2) No tax credit shall be allowed –

…

(g) to the dealers or class of dealers unless the tax paid by the purchasing dealer has actually been deposited by the selling dealer with the Government or has been lawfully adjusted against output tax liability and correctly reflected in the return filed for the respective tax period.”

The High Court, while striking down the above provision, observed that the DVAT Act does not create an intelligible distinction between bona fide purchasing dealers vis-à-vis fraudulent dealers which renders this provision invalid in terms of Article 14 of the Constitution. The Court was of view that such a provision casts an undue responsibility on the purchaser to verify whether the tax is paid by the seller to the government and also denies ITC to a purchaser even if the transaction is bona fide. Further, the Court said that in case the seller fails to deposit the tax, the authorities should move against the seller first and not the buyer for recovery of tax. This ruling was later upheld by the Supreme Court as well.

Coming to the new GST regime, one can observe a similar set of judicial decisions. For instance, the Madras High Court in M/s D.Y. Beathel Enterprises v. the State Tax Officer, the Court while allowing the recipient to claim ITC observed that strict action must be taken against a seller who due to omission on his part fails to remit the tax paid by the recipient. Similarly, in  Assistant Commissioner (CT), presently Thiruverkadu Assessment Circle, Kolathur, Chennai v. Infiniti Wholesale Ltd., the Madras High Court held that where the purchaser has proved that it has paid the due tax to the seller and furnishes the invoices for the same, it cannot be stopped from availing the ITC. The Court added that such a restriction on claiming ITC cannot be sustained and requires re-consideration.

Thus, from a plain reading of the above rulings of various High Courts in the pre-GST as well as GST regime, it can be inferred that the courts have ruled in favour of bona fide purchasers and allowed them to avail ITC even when their supplier had defaulted in remitting the tax to the kitty of the government. The courts took cognizance of the actions of authorities denying ITC to businesses where the seller has not deposited the tax and declared such conditions in the law as unfair, arbitrary, and inimical to business interests. The courts have clearly noted that it is impractical and unrealistic to expect the buyer of supplies to go and verify the supplier’s accounts or to inquire with the department whether the tax paid by them on the inputs has been collected or not.

On the issue of reversal of ITC and recovery of dues from buyers, it is useful to refer to the Press Release issued by the Central Board of GST Council dated 4 May 2018 which clearly stated that in case where the supplier defaults in payment of tax, there shall not be any automatic reversal of input tax credit to the buyer unless an exceptional case can be made out. Instead, the recovery shall be made from the supplier first. The Government’s intention behind ITC has further clarified in the 28th GST Council Meeting  where it recommended that recovery of unpaid tax be done from the defaulting supplier. Thus, in the present case, the petitioner was wrongfully denied ITC and instead charged with reversal of ITC and interest for no fault on its part.

Way Forward

It is ostensible that section 16(2)(c) of CGST Act 2017 in its present form is susceptible to an interpretation that imposes a duty on the recipient to crosscheck whether GST has been remitted by the supplier to the government for the invoice on which ITC has been collected from the recipient. However, under the current GST mechanism, it is an uphill task for businesses to determine whether or not the supplier has filed the tax to the government. This places businesses in a precarious situation where they are expected to determine whether the intentions of the suppliers are opportune or not. Adding to the woes of the businesses is the provision of reversal of ITC along with interest which clearly goes against the spirit of GST to facilitate ease of doing of businesses in the nation. Hence, it is imperative that the government seriously reconsider the above provisions and bring about a corresponding amendment in the GST law to eradicate the hardship faced by the recipients in claiming ITC. Further, there should be a mechanism set up to track payment by supplier against a particular invoice to avoid any undue hardships on recipients. Until then, it is expected that the judiciary take steps to ensure that ITC is not denied to bona fide purchasers.

– Shubham Sharma