Since the advent of the Goods and Services Tax regime, a recurrent and deeply contested issue has been that of denial of Input Tax Credit to bona fide recipients in circumstances where the recipient has paid the full consideration, inclusive of tax to the supplier and has availed credit on the strength of valid tax invoices, yet the supplier, notwithstanding having collected the tax, has failed to remit the same to the exchequer or has neglected to disclose the corresponding outward supplies in the prescribed statutory returns. Despite the recipient’s scrupulous adherence to all statutory obligations within its dominion, tax authorities have increasingly sought to visit upon the recipient the consequences of the supplier’s default, thereby giving rise to serious questions concerning fairness, enforceability, and the limits of vicarious compliance under the GST framework.
In these disputes, bona fide purchasers of goods or genuine recipients of services increasingly find themselves ensnared in proceedings triggered not by any lapse on their part, but by the default of the suppliers. In numerous cases, suppliers, despite having collected tax from recipients, fail to remit the same to the government, often disappearing from the commercial landscape without filing returns or discharging their tax liability. This dereliction routinely results in the issuance of show cause notices and adverse adjudication orders against compliant recipients, compelling them to reverse legitimately availed input tax credit and, in many instances, to bear substantial interest and penalty burdens. The outcome is a deeply inequitable situation where innocent recipients are penalised for breaches entirely attributable suppliers, thereby eroding the foundational principles of neutrality and fairness that the GST regime purports to embody.
This issue, however, is not new. It reflects a structural problem that existed even under the earlier VAT regime. Under the Delhi Value Added Tax Act, 2004, Section 9(2)(g), which was inserted in 2009, provided that a purchasing dealer would not be entitled to input tax credit unless the selling dealer had actually deposited the tax with the Government or lawfully adjusted it and disclosed it correctly in its return. This provision effectively made the purchaser’s entitlement to credit dependent on the supplier’s compliance, regardless of whether the purchaser had acted in good faith or exercised due diligence. Importantly, it did not distinguish between honest transactions and cases involving fraud or collusion, thereby shifting the burden of supplier default entirely onto the recipient. This provision, in effect, can be said to be in pari-materia with Section 16(2)(c) of the CGST Act.
The constitutional validity of this provision was examined by the Delhi High Court in On Quest Merchandising India Pvt. Ltd. v. Government of NCT of Delhi (W.P.(C) 6093/2017), a judgment later affirmed by the Supreme Court in Commissioner of Trade & Taxes, Delhi v. Arise India Ltd. (SLP (C) No. 36750/2017). The High Court held that Section 9(2)(g) impermissibly transferred the consequences of the supplier’s failure, namely, non-payment or incorrect reporting of tax, onto the purchasing dealer. The Court observed that such an obligation was neither contemplated by the scheme nor capable of being fulfilled by the purchaser. Requiring a purchaser to ensure that the supplier had deposited tax was held to be legally impossible and constitutionally untenable. To save the provision from being struck down as violative of Article 14 of the Constitution, the Court read it down so that it would apply only in cases where the purchasing dealer had acted in collusion, connivance, or fraudulent concert with the defaulting supplier. Bona fide purchasers who held valid tax invoices, had made payments through banking channels, and had actually received the goods were thus protected from arbitrary denial of credit.
This reasoning has been consistently applied by Courts while deciding similar cases and provisions of law under the pre-GST indirect tax regime, including Central Excise and Service Tax. Under those laws, where tax had been collected but not paid to the Government, liability was fastened on the person who had collected the tax. Provisions such as Section 11D of the Central Excise Act, 1944 and Section 73A of the Finance Act, 1994 enabled the Department to recover such amounts directly from the defaulter, treating the collected tax as money held in trust for the Government. The purchaser or service recipient was never denied credit or saddled with tax liability merely because the supplier defaulted. This reflected the basic principle that once tax is collected, the responsibility to deposit it rests solely with the collector. The shift under GST, where this burden is effectively placed on the recipient, therefore marks a departure from settled and equitable principles.
Against this background, the input tax credit framework under Section 16 of the Central Goods and Services Tax Act, 2017, requires careful examination. Section 16(1) grants the substantive right to input tax credit, while Section 16(2) lays down the conditions for availing such credit. These include possession of a valid tax invoice [Section 16(2)(a)], receipt of goods or services [Section 16(2)(b)] and furnishing of the return under Section 39 [Section 16(2)(d)]. The most contentious condition, however, is contained in Section 16(2)(c), which requires that the tax charged on the supply must have actually been paid to the government.
Read literally, Section 16(2)(c) suffers from the same structural defect that existed under Section 9(2)(g) of the DVAT Act. It makes the recipient’s entitlement to credit dependent on the supplier’s tax payment—an event entirely outside the recipient’s control and visibility. The GST system’s digital design does not remedy this flaw. GSTR-2A is merely an auto-populated statement based on the supplier’s GSTR-1 and is neither a statutory return nor conclusive proof of tax payment. Yet, mismatches between GSTR-2A and GSTR-3B are routinely relied upon to deny credit, even though the law does not accord finality to such statements.
The disputes arising from GSTR-2A and GSTR-3B mismatches, therefore, closely resemble the situation addressed in On Quest Merchandising. In both regimes, the law as applied fails to distinguish between honest recipients and those involved in fraud. In both, recipients are expected to ensure compliance by another taxable person, an obligation that is legally impossible and in fact is a responsibility of the government, who possess sufficient information. Denial of credit in such circumstances disrupts the seamless flow of taxation and defeats the core design of the indirect tax system.
Importantly, the GST law itself provides sufficient mechanisms to deal with supplier default without penalising recipients. The registration system has been significantly strengthened through mandatory Aadhaar authentication under Section 25(6D) of the CGST Act, read with Rule 8 of the CGST Rules, 2017. Further, even where suppliers shut down or turn out to be fly-by-night operators, the Revenue is not without remedy. Section 79 of the CGST Act provides for recovery of tax dues from defaulting suppliers through coercive measures akin to recovery of arrears of land revenue. These include attachment and sale of property, recovery from debtors of the defaulting person, and other prescribed modes. The statute thus clearly recognises that the responsibility to pay tax rests with the supplier who collected it and equips the Department with adequate powers to recover such dues directly from the defaulter.
When Section 9(2)(g) of the DVAT Act is compared with Section 16(2)(c) of the CGST Act, their similarity is unmistakable. Both provisions link the recipient’s right to credit with the supplier’s compliance, create a form of indirect or vicarious liability, and risk arbitrary application if not read reasonably. The constitutional reasoning that led the Delhi High Court to read down Section 9(2)(g) in On Quest Merchandising, as affirmed by the Supreme Court in Arise India Ltd., therefore applies equally in the GST context.
It may thus be concluded that the principles laid down in On Quest Merchandising offer a strong judicial framework for interpreting Section 16(2)(c) of the CGST Act. While the legislature is entitled to regulate the availment of input tax credit and impose reasonable conditions, it cannot require compliance with obligations that are impossible to fulfil, nor can it penalise bona fide recipients for the default of suppliers. Enforcement measures must remain focused on those who are actually at fault and cannot, in the name of revenue protection, place compliant taxpayers on the same footing as the delinquent.
About the authors: Rishab J is an Associate Partner and Nitin Aditya K R is an Associate at Shivadass & Shivadass (Law Chambers).
Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.
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