Introduction
One of the burning issues which is often litigated in the GST since its inception and implementation in the year 2017 is the reversal of Input Tax Credit by the recipient due to non-payment of output tax liability by the supplier.
As per Section 16(2)(c) of the CGST Act, one of the conditions to claim Input Tax Credit (ITC) is that the output tax collected by the supplier from the recipient of the supply in respect of the supply has been actually paid to the Government Exchequer, either
- In cash, or
- Through the utilisation of admissible ITC
However, several Show Cause Notices (SCNs) are being issued by the GST Department to the recipient of supply for the recovery of output tax liability in the form of reversal of Input Tax Credit (ITC) upon default in payment of such tax by the supplier to the government.
Grounds of Defense
Since this is a litigated issue, it becomes important to understand the grounds of defense that may be taken when replying to such SCNs. Such grounds are as follows:
(1) It may be noted that reliance may be placed on the judgment of the Hon'ble Madras High Court in the case of M/S. D.Y. BEATHEL ENTERPRISES VERSUS THE STATE TAX OFFICER (DATA CELL) , (INVESTIGATION WING) COMMERCIAL TAX BUILDINGS, TIRUNELVELI, (2021), where it was held that, "When it has come out that the seller has collected tax from the purchasing dealers, the omission on the part of the seller to remit the tax in question must have been viewed very seriously and strict action ought to have been initiated against him. In the case on hand, the respondent does not appear to have taken any recovery action against the seller / Charles and his wife Shanthi, on the present transactions. Thus, the impugned order suffers from certain fundamental flaws. It has to be quashed for more reasons than one.
a) Non-examination of Charles in the enquiry
b) Non-initiation of recovery action against Charles in the first place
Parallelly, the respondent will also initiate recovery action against Charles and his wife Shanthi."
The facts of the case are as such that the petitioners/assessee, being raw rubber sheets traders, had purchased goods from suppliers, namely, Charles and his wife Shanthi. A substantial portion of the sale consideration was only paid through banking channels and the payments made by the petitioners to the supplier included the GST component as well. Thereafter, relying on the GST returns filed by the suppliers, the assessee had availed ITC of the GST paid by them. Subsequently, on an inspection by the GST Department, it was discovered that the suppliers had defaulted in payment of output tax collected from the assessee. The Department without taking any action of recovery of tax from the defaulting suppliers, issued a SCN to the assessee and passed an order imposing the demand of entire output tax on the assessee. The said Court stated that the default in payment of output tax liability by the suppliers should not only have been viewed extremely seriously but also strict action of recovery proceedings should have been initiated against such suppliers.
In the above judgment it should be noted that the Hon'ble High Court has acknowledged the reliance by the assessee on the Press Release issued by the Central Board of GST council on 4.5.2018, wherein, it has been mentioned that there shall not be any automatic reversal of ITC from the buyer on non-payment of tax by the seller. In case of default in payment of tax by the seller, recovery shall be made from the seller. However, reversal of credit from buyer shall also be an option available with the revenue authorities to address exceptional situations like missing dealer, closure of business by the supplier or the supplier not having adequate assets etc.
In the above judgment it should be noted that the Hon'ble High Court has acknowledged the provisions of Section 16(2)(c) of CGST Act, 2017, which specifically states that one of the conditions of availment of ITC by the recipient is that the supplier has actually paid the tax collected to the government. However, given the facts of the present case, the said Court held that the Department could not demand GST from the recipient without first examining the supplier and initiating recovery action against the supplier for the amount of output tax liability defaulted since the order demanding entire tax liability from the buyer would be in contravention of the principle of natural justice.
(2) It may be noted that reliance may be placed on the judgment of the Hon'ble CHHATTISGARH High Court in the case of M/s. BHARAT ALUMINIUM COMPANY LIMITED VERSUS UNION OF INDIA AND OTHERS (2021), where it was held that, "the petitioner has come out with the purchases made, but it did not tally/match with 2A ITC shown by the seller meaning thereby the seller may not have filed return to remove the same. When the physical verification was offered to be made by petitioner it was not accepted. It is stated that for the recovery of like nature from the buyer, the action can only be available in the exceptional circumstances."
In the above judgement it should be noted that the Hon'ble High Court has acknowledged the reliance by the assessee on the Press Release issued by the Central Board of GST council on 4.5.2018 and on the judgment of the Hon'ble Madras High Court in the case of M/S. D.Y. BEATHEL ENTERPRISES VERSUS THE STATE TAX OFFICER (DATA CELL) and the assessee submitted that in case of default of payment of tax by the seller, the recovery shall be made from the seller and only in exceptional circumstances, it can be from the recipient, therefore, the Input Tax Credit which was claimed by the assesse cannot be denied for the reason that the seller has not uploaded their invoices on time.
(3) Reliance may be placed on the Press Release dated 4.05.2018 (Refer Page 1), wherein it was announced that – "No automatic reversal of credit: There shall not be any automatic reversal of input tax credit from buyer on non-payment of tax by the seller.
In case of default in payment of tax by the seller, recovery shall be made from the seller however reversal of credit from buyer shall also be an option available with the revenue authorities to address exceptional situations like missing dealer, closure of business by supplier or supplier not having adequate assets etc."
(4) Reliance may be placed on the minutes (refer page 20) of the 28th GST Council meeting dated 21.7.2018, wherein it was mentioned that "There would be no automatic reversal of input tax credit at the recipient's end where tax had not been paid by the supplier. Revenue administration shall first try to recover the tax from the seller and only in some exceptional circumstances like missing dealer, shell companies, closure of business by the supplier, input tax credit shall be recovered from
the recipient by following the due process of serving of notice and personal hearing."
(5) It may be noted that reliance may be placed on the judgment of the Hon'ble Delhi High Court in the case of ON QUEST MERCHANDISING INDIA PVT. LTD., SUVASINI CHARITABLE TRUST, ARISE INDIA LIMITED, VINAYAK TREXIM, K.R. ANAND, APARICI CERAMICA, ARUN JAIN (HUF) , DAMSON TECHNOLOGIES PVT. LTD., SOLVOCHEM, M/S. MEENU TRADING CO., & MAHAN POLYMERS VERSUS GOVERNMENT OF NCT OF DELHI & ORS. & COMMISSIONER OF TRADE & TAXES, DELHI AND ORS., (2017) where it was held that "the result of such reading down would be that the Department is precluded from invoking Section 9 (2) (g) of the DVAT to deny ITC to a purchasing dealer who has bona fide entered into a purchase transaction with a registered selling dealer who has issued a tax invoice reflecting the TIN number. In the event that the selling dealer has failed to deposit the tax collected by him from the purchasing dealer, the remedy for the Department would be to proceed against the defaulting selling dealer to recover such tax and not deny the purchasing dealer the ITC. Where, however, the Department is able to come across the material to show that the purchasing dealer and the selling dealer acted in collusion then the Department can proceed under Section 40A of the DVAT Act. Therefore, there was need to restrict the denial of ITC only to the selling dealers who had failed to deposit the tax collected by them and not punish bona fide purchasing dealers. The latter cannot be expected to do the impossible. If it seeks to visit disobedience with disproportionate consequences to a bona fide purchasing dealer, it will become vulnerable to invalidation on the touchstone of Article 14 of the Constitution."
The Hon'ble High Court of Delhi held that Section 9(2)(g) of The Delhi VAT Act is violative of Articles 14 and 19(1)(g) i.e. right to practice any profession, or to carry on any occupation, trade or business, of the Constitution of India, to the extent it disallows Input tax credit (ITC) of the recipient due to the default by the selling dealer in depositing tax to the Government. It was stated that since there were other statutory avenues available to the State to collect tax from the defaulting dealer, recovery of such tax liability by means of reversal of ITC of the innocent recipient should not be resorted to by the Tax Department. The Special Leave Petition (SLP) made to the Hon'ble Supreme Court by the Tax Department was not considered on merit and dismissed. However, several High Courts during the VAT-regime have ruled in favour of the assessee in similar situations and a plethora of similar court rulings are available to the aid of the assesse.
The above judgment by the Hon'ble Court has put forth few pertinent principles such as:
• Treatment of both the parties, the guilty purchaser and the innocent purchaser at par is a violation of Article 14 of the Constitution i.e. "Equality before law and the State shall not deny to any person equality before the law or the equal protection of the laws." Therefore, by treating unequals equally, the respective legislative provisions are violative of Article 14 of the Constitution.
• In this case, the purchaser has been asked to do something that is impossible, i.e to predict or anticipate that the selling dealer may or may not deposit the tax collected to the Government.
• ITC cannot be denied to the recipient in the absence of any material evidence in the hands of the Department of collusion between the supplier and the recipient to defraud the Department.
Therefore, penalizing the recipient for the fault of a third party, i.e. the defaulting supplier, even in the absence of any collusion between the two is unjust and where the purchaser is bonafide and there is absence of mala fide intention, connivance or wrongful association of the purchaser with the supplier, the reversal cannot be sought from purchaser.
• So long as the purchasing dealer, at the time of entering into the transaction with the selling dealer, has taken all the necessary steps to verify that the selling dealer has a valid registration and a tax invoice has been issued in accordance with the law, he cannot be reasonably expected to keep a track of whether the selling dealer has indeed deposited the tax so collected or whether he has lawfully adjusted such tax against eligible and available ITC.
(6) Reliance may be placed on Doctrine of impossibility and the applicability of legal maxim of Lex non Cogit Ad impossibilia, which mentions that law cannot compel a man to do anything vain or impossible or to do something which he cannot possibly perform, since the recipient cannot be expected to keep a track of whether the selling dealer has indeed deposited the tax so collected and therefore, the benefit of ITC ought not be denied to the recipient taxpayer on account of default of the supplier, over whom such recipient taxpayer does not exercise any control. Reliance may be placed on the judgment of the Hon'ble Bombay High Court in the case of "INDIAN SEAMLESS STEEL AND ALLOYS LTD. VERSUS UNION OF INDIA, wherein it was held that "it is also a well settled principle of law that the law does not compel a man to do that which he cannot possibly do and the said principle is well expressed in legal maxim "lex non cogit ad impossibilia" which is squarely attracted to the facts and circumstances of the present case."
(7) The condition to claim Input Tax Credit as provided in Section 16(2)(c) of CGST Act, 2017 was legislated with the underlying objective that the ITC of the recipient shall be intrinsically linked to the discharge of tax by the supplier through the earlier envisaged return filing system of GSTR-1, GSTR-2 and GSTR-3, however the same was not made functional. However, due to the suspension of GSTR-2 and GSTR-3 and the introduction of GSTR-3B, the recipients have no full-proof mechanism to confirm whether their suppliers are discharging the correct output tax liability. Therefore, the conundrum still stands as to how a recipient of supply may ensure that the supplier has actually paid the output tax liability collected from him that corresponds to the Input Tax Credit claimable by such recipient since no such purchase invoice-level matching and acceptance was made available or functional.
It may be argued that the GST portal is being continuously upgraded and enabling functionalities have been made available that enable the recipient of supply to know the return filing status of GSTR-3B of the supplier through their GSTR-2A/2B, nevertheless it is still not full-proof evidence of whether the supplier has indeed paid GST on the supplies in question. The expectation that the recipient ought to monitor the actual payment of GST collected by each of their vendors is not only onerous but also impractical and impossible.
It is to be noted that since GSTR-2A was introduced sometime in the year 2019, for the period before its introduction there was no tool, report or functionality made available by the GST Department to the recipient taxpayers to know at all whether the supplier has actually deposited the GST collected from him. Furthermore, for the period after the introduction of GSTR-2A, even using the functionalities made available such as that of mentioning supplier's GSTR-3B filing status in the recipient's GSTR-2A/2B and making available other GST reports, ascertaining by the recipient whether tax collected by supplier in respect of the impugned transaction has been actually paid is not conclusive.
The ITC reversal mechanism, as laid down in section 41 read with Rules, is kept in abeyance. The facility to furnish GSTR - 2 and GSTR - 3 Forms is also not available. Accordingly, there is no system-based matching of the ITC being carried out presently. Therefore, the recipient of the supply has no means to ensure that the tax actually levied in respect of supplier has in reality been paid to the Government and the practical application of such erstwhile provisions of Section 41, 42, 43 and 43A cannot be sought without the supportive administrative mechanism or functionalities available on the GST Portal.
(8) It may be noted that reliance may be placed on the judgment of the Hon'ble Punjab and Haryana High Court in the case of Gheru Lal Bal Chand Vs. The state of Haryana, (2011), wherein it was held that "Denial of Input credit on the ground that dealers from whom materials have been purchased failed to deposit full tax in the State treasury - Held that:- Once the law defines the registered dealer and tax-paid goods, the assessee, i.e., purchasing dealer, produced the bill issued by the registered dealer then his burden is discharged and he cannot be held responsible or he cannot be forced to go around from pillar to post to collect the material in order to get the rebate. To conclude, no liability can be fastened on the purchasing registered dealer on account of non-payment of tax by the selling registered unless it is fraudulent, or collusion or connivance with the registered selling dealer or its predecessors with the purchasing registered dealer is established."
Therefore, as per the said judgment, the necessity of the differentiation between honest and dishonest taxpayers has to be acknowledged by the law. In the aforesaid case, it was held that the Law cannot anticipate a possibility of a virtually impossible eventuality and it clearly puts forward the principle that the liability can be fastened to a person who either acts fraudulently or has been a party in collusion with the offender. Law ought not put an onerous responsibility on the innocent taxpayer otherwise, law may not pass the test of validity considering the touchstone of Articles 14 and 19 of the Constitution of India.
(9) It may be noted that reliance may be placed on the judgment of the Hon'ble High Court of Delhi in the case of Bharti Telemedia Ltd. Vs. Union Of India & Ors. (Delhi High Court) W.P.(C) no 6293/2019 and on the judgment of Hon'ble Calcutta High Court in the case of M/S. LGW INDUSTRIES LTD & ORS., RAJ METAL INDUSTRIES & ANR., VICTORIA GLOBAL & ANR., SURYA ALLOY INDUSTRIES LTD. & ANR., M/S. TASHI AIR PRIVATE LTD. & ANR. VERSUS UNION OF INDIA & ORS. (2021), wherein writ petition was filed challenging the constitutional validity and vires of section 16(2)(c) of the CGST Act, 2017 and the petitioner/assesse challenged on the ground that section 16(2)(c) of the CGST Act, 2017 is ultra-virus and violative to Article 14 of the Constitution of India. It was held that the Department has been vested with all the powers to recover any revenue lost owing to non-payment of taxes by defaulting suppliers, therefore, the ITC cannot be denied to the recipient for the default on the part of supplier.
(10) It is to be noted that reliance may be placed on the judgment of the Hon'ble The Madras High Court in the case of M/s. Shri Ranganathar Valves Private Limited v. Assistant Commissioner (CT), (FAC), Velandipalayam Assessment Circle, Coimbatore, wherein it was held that "This issue has been dealt with in the case of ASSISTANT COMMISSIONER (CT) , PRESENTLY THIRUVERKADU ASSESSMENT CIRCLE, KOLATHUR, CHENNAI VERSUS INFINITI WHOLESALE LTD. [2016 (9) TMI 1431 - MADRAS HIGH COURT] wherein it has held that Input Tax Credit cannot be disallowed on the ground that the seller has not paid tax to the Government, when the purchaser is able to prove that the seller has collected tax and issued invoices to the purchaser. As such, restriction of the amount of Input Tax Credit on this ground, cannot be sustained and requires re-consideration."
Therefore, as per the aforesaid judgment, it was held that Input Tax Credit restriction in the hands of buyer, on the ground of tax collected but remaining unpaid to the Government by the seller "cannot be sustained" and "requires re-consideration" while disposing the writ in respect of restriction of the amount of ITC claimed.
(11) It is to be noted that reliance may be placed on the judgment of the Hon'ble Supreme Court in the case of COMMISSIONER OF CENTRAL EXCISE, JALANDHAR VERSUS M/S. KAY KAY INDUSTRIES, (2013), wherein it was held that "When all the conditions precedent had been satisfied, to require the assessee to find out from the departmental authorities about the payment of excise duty on the inputs used in the final product which have been made allowable by the notification would be travelling beyond the notification, and in a way, transgressing the same - This would be practically impossible and would lead to transactions getting delayed."
(12) The Finance Act, 2022 has newly substituted Section 41(2) of CGST Act, 2017, that is yet to be notified in the Official Gazette and such an amendment shall come into effect prospectively from the date of notification. As per the aforesaid Section, is provided that:
"The credit of input tax availed by a registered person under sub-section (1) in respect of such supplies of goods or services or both, the tax payable whereon has not been paid by the supplier, shall be reversed along with applicable interest, by the said person in such manner as may be prescribed:
Provided that where the said supplier makes payment of the tax payable in respect of the aforesaid supplies, the said registered person may re-avail the amount of credit reversed by him in such manner as may be prescribed."
Therefore, the newly substituted Section 41(2) read with Section 16(2)(c) of CGST Act, 2017 is applicable prospectively, where it is stated to reverse such Input Tax Credit (ITC) along with payment of applicable interest in respect of which the output tax liability has not been paid by the supplier. Since, the applicability of such a section is prospective in nature, the Department cannot invoke such a section to demand reversal of ITC from the recipient of supply in the event of non- payment of output tax liability by the supplier for the period before its applicability. It is to be noted that such reversed Input Tax Credit can be re-availed once the supplier discharges the output tax liability. CBIC shall provide rules, mechanism and framework for the reversal of such ITC by the recipient in case the supplier has not discharged the taxes.
(13) The GST Department has been issuing Show Cause Notices (SCNs) to the recipient of a supply even in a case where the supplier's supplier has defaulted in discharging the tax collected from his recipient of supply (i.e. the immediate supplier of the concerned recipient), and that the immediate supplier avails such corresponding disputed Input Tax Credit (i.e against which the output tax liability has not been discharged by his supplier), to discharge his output tax liability collected from the concerned recipient. Therefore, in the case of the concerned recipient of supply, the Input Tax Credit becomes disputed and claiming the same may be objectionable even though he cannot exercise any control over the actions of his immediate supplier or his supplier' supplier in discharging their output tax liability. Also, since there is no window or facility available in the hands of the recipient
to ascertain whether his supplier's supplier has discharged his output tax liability, the requirement of burden of proof as provided u/s 155 of CGST Act, to ascertain the fulfilment of the condition to claim ITC as laid out u/s 16(2)(c) by such an innocent recipient is onerous, unjust and practically impossible. Therefore, the subsequent denial of ITC to such a recipient on the actions or inactions of such preceding chain of suppliers is violative of principle of natural justice and such an innocent recipient may invoke the legal maxim Lex non Cogit Ad impossibilia in the defense to reply to such SCNs.
(14) The recipient may invoke the defense of violation of his constitutional right by virtue of Article 300A of the Constitution of India i.e. No person shall be deprived of his property save by the authority of law. The article protects an individual from interference by the State and dispossess a person of the property unless it is in accordance with the procedure established by law. Several High Courts have acknowledged the petitioner's submission of a ground of defense stating violation of
the recipient's constitutional right to Article 300A in regard to department's action of forceful recovery of tax by means of reversal of ITC from the recipients in case of non-payment of taxes by the supplier.
Conclusion
(1) Considering the above, it is more important than ever for the recipient of supply to undertake and ensure a thorough background check of the supplier and that a robust system is in place of Know-your-supplier (KYS) before entering into any purchase transactions. To safeguard the interest of the recipient, he would be well advised to look into the possibility of acquiring an undertaking/indemnity from high-risk vendors (i.e., vendors filing GST returns irregularly) to ensure their interests are protected in case of any future demand from the GST authorities.
(2) Another pertinent question is raised which requires in-depth consideration by the CBIC and GST Council is enumerated hereafter. The proviso to newly substituted Section 41(2) of CGST Act, 2017, which is yet to be notified, and is applicable prospectively states that the recipient of the supply may re-avail the ITC earlier reversed on the subsequent payment of the output tax liability by the supplier. However, since its applicability is prospective in nature, for the period prior to the applicability of the aforesaid section, there is a requirement to plug the loophole in GST legislation to allow the recipient of supply the benefit to reclaim such ITC reversed in case the Government is able to recover the tax amount from the defaulting seller by initiating recovery proceedings as provided u/s 79 of CGST Act, 2017.
(3) In recent times, the tax authorities have resorted to an alternate action plan of blocking the input credit as per the Rule 86A of CGST Rules, 2017, thereby restricting the buyer to avail the input credit if there is mismatch in credit details on account of default or error made by the supplier. Furthermore, several affected buyers have reached the Courts and have received favourable judgments. Hence, it is important that the said issue is taken up by the GST Council for a detailed deliberation and a proper resolution is provided to the industry.
(4) Therefore, it may be concluded that the department should not demand any kind of tax liability from the recipient of supply for the fault of the supplier unless proper investigation and recovery proceedings are initiated against the defaulting supplier.
DISCLAIMER: The contents of this article are solely for informational purpose and for the reader's personal non- commercial use. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.
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