Court affirms that purchasing dealers cannot be mechanically penalized for sellers' tax defaults; mandates thorough inquiry before denying Input Tax Credit, balancing government revenue protection with bona fide taxpayer rights.
In a landmark judgment delivered on October 1, 2026, the Punjab and Haryana High Court (Division Bench comprising Chief Justice Ashwani Kumar Mishra and Justice Rohit Kapoor) addressed a crucial issue concerning the Goods and Services Tax (GST) regime-specifically, the interpretation and application of Section 16(2)(c) of the Central Goods and Services Tax Act, 2017 (CGST Act). The case, involving a batch of 424 writ petitions including Shaurya Alloys Pvt Ltd versus State of Punjab and others, centered on whether a purchasing dealer can be held liable to reverse Input Tax Credit (ITC) merely because the selling dealer failed to deposit the collected tax with the government.
Section 16(2)(c) mandates that no registered person shall be entitled to claim ITC unless the tax charged on the supply has been actually paid to the government, either in cash or through admissible ITC. Petitioners challenged the constitutional validity of this provision, arguing it imposed an impossible obligation on bona fide purchasing dealers who lack means to verify the seller's tax compliance, thus violating Articles 14, 19(1)(g), 21, 265, and 300A of the Constitution.
The Court meticulously analyzed the statutory scheme of the CGST Act, including related provisions such as Sections 41, 42, 73, 74, 75, 76, 155, and the CGST Rules, particularly Rule 37A introduced in December 2022 to provide mechanisms for reversal and re-availment of ITC. It was observed that the original GST framework envisaged a robust automated system for matching and reconciliation of returns between suppliers and recipients, enabling purchasers to verify whether sellers had deposited the tax. However, due to technical and administrative challenges, this mechanism was never fully operationalized, creating practical difficulties for purchasers in complying with Section 16(2)(c).
The Court held that Section 16(2)(c) is constitutionally valid and forms an integral part of the GST scheme, with the condition of actual tax payment being foundational, not extraneous, to the concept of ITC. However, the Court emphasized that the provision cannot be enforced in isolation or mechanically against purchasing dealers who have acted in good faith with proper documentation. The mere failure of a selling dealer to deposit tax or retrospective cancellation of the seller's registration does not automatically render the purchaser's ITC inadmissible.
Drawing upon prior judgments including the Gujarat High Court's ruling in Maruti Enterprises (affirmed by the Supreme Court in Bhandari Scrap Traders), and other High Court decisions from Delhi, Gauhati, Tripura, and Karnataka, the Court underscored the necessity of a balanced approach. It recognized that while ITC is a statutory concession subject to conditions, the purchaser cannot be expected to act as a guarantor for the supplier's tax compliance, especially when the statutory machinery to verify such compliance was not in place for significant periods.
Significantly, the Court issued detailed guidelines to be followed by tax authorities before invoking Section 16(2)(c) against purchasers:
- Section 16(2)(c) should not be invoked routinely or mechanically merely based on seller's registration cancellation or default.
- The proper officer must conduct a detailed inquiry, record satisfaction on particulars of default, nature of tax non-payment, proceedings against the supplier, and the genuineness of the transaction.
- Show cause notices must specify foundational facts, disclose material relied upon, and supply documents such as invoices, e-way bills, transport, banking, and investigation records to the purchaser.
- Where fraud or willful misstatement is alleged (invoking Section 74), the notice must contain specific facts linking the purchaser to such misconduct, not mere bald allegations.
- The purchaser bears the burden under Section 155 to prove eligibility for ITC and may rely on tax invoices, proof of receipt of goods/services, and other relevant evidence.
- Retrospective cancellation of seller's registration alone cannot invalidate purchaser's ITC without due examination of grounds and adherence to procedural safeguards.
- Orders denying ITC must be reasoned, addressing all disputed conditions, and afford opportunity of personal hearing including requests for cross-examination.
- Purchasers who have deposited amounts during proceedings retain the right to have such deposits considered appropriately.
- All pending and future proceedings must comply with these guidelines. No fresh coercive action shall be taken until fresh decisions are made under this framework.
The Court further recognized the government's obligation to pursue recovery from defaulting suppliers under Section 76 and related provisions, ensuring that liability is not unfairly shifted to purchasers. It commended suggestions for technological and procedural reforms to improve real-time verification and alert mechanisms on the GST portal to protect genuine taxpayers.
In conclusion, the Punjab and Haryana High Court harmonized the statutory provisions with principles of fairness and reasonableness, ensuring that bona fide purchasers are shielded from arbitrary denial of ITC while preserving the government's right to recover unpaid taxes from defaulting suppliers. The judgment is poised to provide clarity and guidance for GST officials and taxpayers alike, strengthening the integrity and efficacy of the GST input tax credit mechanism.
Bottom Line:
Goods and Services Tax, Section 16(2)(c) of CGST/SGST Act, 2017 upheld as constitutionally valid - However, provision cannot be invoked mechanically against purchasing dealer merely because selling dealer failed to deposit tax or its registration was later cancelled - Proper officer must examine genuineness of transaction, material against purchaser, proceedings against supplier, and statutory scheme applicable to relevant period - Detailed guidelines issued for invocation of Section 16(2)(c).
Statutory provision(s): Central Goods and Services Tax Act, 2017 Sections 16(2)(c), 41, 42, 43, 74, 75(12), 76, 79, 155; Central Goods and Services Tax Rules, 2017 Rule 37A, Rule 36, Rule 88C
Shaurya Alloys Pvt Ltd v. State of Punjab, (Punjab And Haryana)(DB) : Law Finder Doc Id # 2990603
