Denying ITC as per Section 16(2)(c) of GST Act if Supplier fails to deposit Tax is Constitutional: Gujarat HC dismisses Maruti Enterprises’ petition [Read Order]

In a comprehensive judgment, the Division Bench of the Gujarat High Court dealt with a group of 42 writ petitions, led by Maruti Enterprises, challenging the vires of Section 16(2)(c) of the Central Goods and Services Tax (CGST) Act.

The Court held that the provision, which denies Input Tax Credit (ITC) if the supplier fails to deposit the tax, is neither arbitrary nor unconstitutional. It distinguished the GST regime from the earlier DVAT regime, emphasizing the destination-based nature of the tax and the existence of remedial mechanisms like Section 41(2) and Rule 37A.

The petitioners contended that denying ITC to bona fide purchasers solely because their supplier defaulted in depositing the tax was arbitrary, violative of Article 14, and imposed an "onerous burden" under the maxim Lex non cogit ad impossibilia.

The petitioners relied heavily on the Delhi High Court's decision in On Quest Merchandising India (P.) Ltd. vs. Government of NCT of Delhi, where a similar provision in the DVAT Act was read down. They argued that clauses (a), (aa), and (b) of Section 16(2) already established the genuineness of the transaction, and clause (c) unfairly penalized purchasers for a default entirely outside their control. They further argued that this resulted in double taxation and violated the right to trade under Article 19(1)(g).

The Revenue, represented by the Advocate General, countered that the GST scheme is fundamentally different from VAT. It was submitted that under the GST regime, tax is destination-based, and Section 53 mandates the transfer of ITC from the originating state to the destination state for inter-state supplies. If a supplier defaults but the recipient is allowed ITC based solely on invoices, the originating state would have to transfer funds it never actually received, causing massive revenue leakage.

The Coram of Justice A.S. Supehia and Justice Pranav Trivedi observed that the Delhi High Court's reasoning in On Quest Merchandising was based on the absence of provisions equivalent to Section 41(2) and Section 53 of the CGST Act in the DVAT law. The Court noted that the CGST Act includes specific safety nets: Section 41(2) mandates the reversal of credit if the supplier defaults, and Rule 37A provides for re-availment once the tax is paid, along with a grace period. Thus, the permanent deprivation of credit argued by the petitioners does not hold true.

The Court observed:

“Considering the aforesaid scenario, without Section 16(2)(c) where the inter-state supplier's supplier in the originating State defaults payment of tax (SGST+CGST collected) and the inter-state supplier is allowed to take credit based on their invoice, the originating State Government will have to transfer amounts it never received in the tax period in a financial year to the destination States, causing loss to the tune of several crores in each tax period. In my view, this renders the whole GST laws and schemes unworkable.”

Regarding the doctrine of "Reading Down", the Court, relying on Supreme Court precedents like Authorized Officer, CBI vs. Shanmugavelu, held that a statute cannot be read down simply because it is harsh. The doctrine is a judicial tool to salvage constitutionality.

The Court found that Section 16(2)(c) is clear, unambiguous, and necessary to maintain the fiscal balance of the destination-based GST system. The Court also rejected the contention that ITC is a vested right, reaffirming it is a statutory concession subject to strict conditions.

The Court concluded that while the provision might cause hardship to genuine purchasers, the remedy lies in strict enforcement of recovery against defaulting suppliers or legislative amendments to the scheme, not in reading down the statute.

Consequently, the writ petitions were dismissed on the point of law. However, the Court listed the matters for hearing on merits, leaving contentions and rights of parties open.

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