Punjab & Haryana High Court Lays Down Guidelines For ITC Reversal Where Supplier Fails To Deposit GST

The Punjab and Haryana High Court has upheld the constitutional validity of Section 16(2)(c) of the Central Goods and Services Tax (CGST) Act but held that the provision cannot be used mechanically to make a purchasing dealer reverse input tax credit (ITC) merely because the selling dealer failed to deposit tax with the government.

A Division Bench comprising Chief Justice Ashwani Kumar Mishra and Justice Rohit Kapoor held that Section 16(2)(c), read with Section 155, cannot be treated as a standalone provision to automatically shift the seller's tax default to the buyer.

“Section 16(2)(c) read with Section 155 of the Act of 2017 cannot be construed as a standalone provision, so as to mechanically saddle liability on the purchasing dealer to reverse ITC on the failure of the selling dealer to deposit tax with the Government, without the proper officer first examining, after affording due opportunity of hearing to the purchasing dealer, the circumstances in which the selling dealer has failed to deposit the tax, the genuineness of the transaction, and the statutory mechanism available for recovery of such tax in the relevant period” the court held.

The court was dealing with a batch of petitions challenging ITC denial or reversal where selling dealers had failed to discharge their tax liability. In several cases, the department had also relied on cancellation of suppliers' GST registrations, including retrospective cancellation.

While upholding the provision, the court said the proper officer must examine the circumstances in which the seller failed to pay tax, the genuineness of the transaction and the statutory mechanisms available to recover the tax from the seller.

“The existence of the remedy against the selling dealer, including under Section 76 of the Act of 2017, is a relevant part of the statutory scheme which cannot be rendered toothless,” the court observed.

However, the court clarified that Section 16(2)(c) consequences can follow where the transaction involves fraud or collusion, there is no actual receipt of goods or services, or the purchasing dealer otherwise fails to establish its entitlement to ITC.

The court then laid down the following 14 guidelines for proper officers of the Central government, Punjab, Haryana and Chandigarh:

• No mechanical ITC reversal: Section 16(2)(c) cannot be invoked routinely; supplier registration cancellation, nil/short tax liability or alerts may trigger inquiry but cannot alone justify ITC denial or reversal.
• Officer must apply mind: Before issuing a notice, the officer must examine the supplier, invoices, tax periods, ITC involved, nature of the tax default and recovery proceedings against the seller.
• Direct link with buyer: Investigation leading to the notice must establish a direct link between the purchasing dealer and suppliers to establish violation of Section 16(2).
• Details and material in SCN: The notice must disclose the relevant particulars, material relied upon, supplier details and alleged wrongful ITC, with relied-upon documents supplied to the noticee.
• Fraud must be linked to buyer: Where Section 74 or applicable Section 74A is invoked, the notice must contain the foundational facts for fraud, wilful misstatement or suppression; the seller's fraud cannot automatically be attributed to the buyer.
• Buyer's evidentiary burden: The purchasing dealer must establish ITC eligibility under Section 155 through material such as invoices, proof of receipt, e-way bills, transport records, weighbridge slips and stock or consumption records.
• Retrospective cancellation: Where ITC denial is based on retrospective cancellation of the seller's registration, the officer must examine the cancellation grounds, effective date, and their bearing on the genuineness of the particular supply.
• Seller-side recovery must be considered: The officer must ascertain recovery proceedings against the seller, avoid double recovery and allow the buyer to avail or re-avail credit to the extent permitted under Section 41(2) and Rule 37A, subject to Section 17(5)(i).
• Law applicable to relevant period: Officers must apply the statutory framework in force during the relevant tax period and cannot retrospectively impose later amendments or re-availment mechanisms.
• Buyer's registration: A purchasing dealer's registration cannot be cancelled, including retrospectively, merely because ITC was availed from a supplier whose registration was subsequently cancelled.
• Personal hearing and cross-examination: The buyer must receive a personal hearing, and a request to cross-examine third parties whose statements are relied upon must be considered through a reasoned order.
• Reasoned final order: The final order must deal with the buyer's reply and documents and record specific findings on each disputed Section 16(2) condition and, where applicable, fraud or suppression attributable to the noticee.
• DRC-03 payment not enough: A deposit made during investigation, including through DRC-03, does not dispense with the requirement of a show-cause notice setting out the foundational facts.
• Applies to pending and future cases: The guidelines will govern proceedings already pending before proper officers as well as proceedings initiated thereafter.

The court also considered suggestions aimed at protecting genuine purchasers, including alerts when supplier cancellation proceedings begin and technology-based verification of tax payment against specific invoices. It left these policy measures to the government and GST Council.

On the individual petitions, the court said it had not examined the facts of each case. Many notices and orders appeared to have been based only on the seller's default or retrospective cancellation of registration, while the revenue had alleged that some transactions were not genuine. The court left those factual questions to the proper officers.

For cases still at the show-cause notice stage, the petitioners can file replies or supplementary replies with supporting material within eight weeks. The proper officer must then pass a reasoned order after hearing them and applying the guidelines.

Where orders have already been passed, the matters must be revisited after a personal hearing and fresh reasoned orders. Amounts already deposited or recovered, including through ITC reversal, will abide by the fresh decision and be adjusted or refunded with admissible interest wherever warranted.

The court also directed that no fresh coercive recovery be undertaken pursuant to the impugned notices or orders until the proper officer takes a fresh decision. The department, however, remains free to proceed against defaulting selling dealers in accordance with law.

For Petitioner: Senior Advocate Sandeep Goyal appeared and advanced submissions

For Revenue: Advocate Puneet Agrawal and Advocate Urvashi Dhugga also advanced submissions for the petitioners. Senior Standing Counsel Sourabh Goel advanced submissions for the Revenue