ITC Denial for Supplier Default Not Unconstitutional: Gujarat HC upholds S.16(2)(c) CGST, Creates Contrary Judicial Opinion [Read Order]

The Gujarat High Court declared the constitutionality of Section 16(2)(c) of the Central Goods and Services TaxAct, 2017 (CGST Act) in a historic ruling. The Court ruled that it is not unconstitutional to deny a buyer an Input Tax Credit (ITC) based only on the supplier's failure to deposit the tax with the government.

The Division Bench comprising Justice A.S. Supehia and Justice Pranav Trivedi delivered a common judgment on a batch of over 50 petitions, including the lead matter Maruti Enterprise vs. Union of India. The verdict specifically addresses the "contradictory view" adopted by other High Courts, creating a clear judicial divergence on the interpretation of the GST regime.

Contradictory Judicial Views

The ruling recognises a strong disagreement among judges about how to interpret the requirements for obtaining ITC.

• Delhi, Tripura, and Telangana High Courts' "Pro-Taxpayer" Viewpoint: The Delhi High Court's reasoning in the matter of On Quest Merchandising India (P.) Ltd. vs. Government of NCT of Delhi was a major source of support for the petitioners. In that instance, the Court looked at the Delhi VAT Act and decided that it is not reasonable to expect a buyer to do the impossible that is, to keep track of whether a supplier has deposited tax. The Delhi High Court "read down" the clause, ruling that legitimate buyers with legitimate invoices could not be punished for their suppliers' wrongdoing.

The Tripura High Court adopted this position in Sahil Enterprises. The Telangana High Court, in other cases, effectively ruled that penalizing a legitimate buyer for a supplier's default violates both the principle of Lex non cogit ad impossibilia (the law does not compel the impossible) and Article 14 (equality).

• Gujarat, Kerala, and Patna High Courts' "Pro-Revenue" Perspective: In contrast, the Gujarat High Court declined to apply the On Quest reasoning to the CGST Act. The Kerala High Court (M. Trade Links) and Patna High Court rulings, which supported the stringent interpretation of ITC regulations, were acknowledged by the Bench. The Gujarat High Court concurred with these courts, stressing that the GST's fiscal structure differs significantly from the previous VAT system.

Why Gujarat High Court Disagreed with the "Reading Down" Approach?

The Court provided three primary reasons to distinguish and disagree with the contradictory views of the Delhi and Tripura High Courts:

1. The Destination-Based Tax Character of GST: The judgment highlighted a critical structural difference between the DVAT Act (pre-GST) and the CGST Act. Under the old VAT laws, tax credit did not cross state lines. However, GST is a destination-based tax. The Court observed that if a supplier in State A collects tax but fails to deposit it, and the purchaser in State B is allowed to keep the ITC, the "Originating State" (State A) would be forced to transfer tax funds to the "Destination State" (State B) that it never actually received.

The Court relied on the lucid explanation of the Kerala High Court in M. Trade Links vs. Union of India, which stated that allowing credit without tax payment would render the "whole GST laws and schemes unworkable" and cause huge revenue loss to originating states.

2. Remedial Mechanisms (Section 41 & Rule 37A): The Gujarat Bench pointed out that the Delhi High Court's ruling was rendered without reference to the CGST Rules' Section 41(2) and Rule 37A.According to Section 41(2), the recipient shall reverse the ITC if a supplier does not pay tax. Proviso to Section 41(2) & Rule 37A: However, these rules permit the buyer to re-avail the credit immediately in the next month once the supplier pays the tax, in contrast to the severe outcome that the petitioners expected.

The Court held that since the credit is not permanently lost but only suspended until payment, the provision is not arbitrary or overly harsh.

3. ITC is a Concession, Not a Vested Right: The Supreme Court reaffirmed that ITC is a statutory "concession" or "entitlement," not a fundamental or vested right, based on its rulings in Commissioner of Sales Tax, UP vs. Modi Sugar Mills (1961) and, more recently, ALD Automotive Pvt. Ltd. vs. Commercial Tax Officer (2019). Modi Sugar Mills: "In interpreting a taxing statute, equitable considerations are entirely out of place... The Court must look squarely at the words of the statute." The Bench decided that strict adherence to the requirements outlined in Section 16(2) is required in order to get this concession.

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]

Observations on "Double Taxation"

A major argument by the petitioners was that denying ITC effectively results in "double taxation" once when the supplier collects it (and keeps it), and again when the purchaser pays it on their output supply.

The Court rejected this argument, stating: "The contention regarding double taxation is misconceived... Where the statute provides for reversal and re-availment of credit, the same cannot be characterized as double taxation."

The Court clarified that the tax is legally levied only on the "supply." The purchaser's liability to pay tax on their output is independent of their ability to claim credit for their inputs.

Final Observations of the Court

While upholding the vires of the provision, the Gujarat High Court acknowledged the genuine hardship faced by honest purchasers. In a significant observation, the Court urged the Government to address the "conundrum" faced by purchasers.

The court observed that "It is high time that... the Government undertakes a comprehensive re-evaluation of the dicey situation which purchasers are facing... The Government should implement a robust, technology-driven tracking mechanism enabling verification of payments made by suppliers against specific invoices in real time, thereby insulating bona fide recipients from the defaults of their vendors."

The Court clarified that while it cannot "read down" the statute or declare it ultra vires, it expects the Legislature to amend the framework to protect genuine dealers from unscrupulous suppliers.

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