Raj Jaggi
Prior Scrutiny Depends on the Source of the Information
Section 61 of the CGST Act, 2017 provides a mechanism for scrutiny of returns. If a discrepancy is noticed, the Proper Officer may seek an explanation from the registered person before taking further action. The key question is whether this scrutiny procedure under Section 61 read with Rule 99 must always be followed before proceedings under Section 74A can be initiated.
The Allahabad High Court, Lucknow Bench, examined this issue in M/s Neelkanth Entrepreneurs Private Limited v. State of U.P. & Another, 2026-VIL-1036-ALH, decided on 09.09.2026. The judgment also considered whether the SCN contained sufficient allegations to invoke Section 74A(5)(ii) and whether the High Court should interfere with the notice at the initial stage.
The Court drew an important distinction based on the source of the information. Where proceedings arise from independent information or verification, Section 61 scrutiny need not necessarily precede Section 74a. However, where the Department relies solely on discrepancies found in the returns and has no independent material, Section 61 read with Rule 99 may serve as an important procedural safeguard. Thus, Section 61 is not a mandatory gateway in every case; its relevance depends on how and from where the alleged discrepancy has emerged.
Independent Verification Led to Section 74A Proceedings
The petitioner, a registered company engaged in works-contract services, had sub-contracted portions of its infrastructure work to eighteen registered sub-contractors during FY 2025-26. According to the petitioner, the transactions were genuine and supported by work orders, tax invoices, measurement sheets, completion records, banking documents and GST records.
The Department, however, alleged that the eighteen sub-contractors were bogus and non-existent and that ITC had been wrongfully availed on fictitious transactions. On this basis, the Deputy Commissioner, State Tax, Lucknow issued an SCN dated 09.07.2026 under Section 74A(1) proposing tax, interest and penalty.
Instead of filing a reply to the SCN, the petitioner approached the High Court. It principally contended that the Department could not directly invoke Section 74A without first following Section 61 read with Rule 99, and that the SCN did not contain the necessary ingredients for invoking Section 74A(5)(ii). The controversy therefore centred on whether independent verification could justify direct proceedings under Section 74A without prior scrutiny of returns.
Section 61 Is Not the Only Route to Section 74A
Section 61 provides a mechanism for scrutinising returns. It enables the Proper Officer to identify discrepancies and seek an explanation from the registered person. This is essentially a verification process and, by itself, does not determine tax liability.
Section 74A operates differently. Proceedings may be initiated where it appears to the Proper Officer that tax has not been paid or has been short-paid, tax has been erroneously refunded, or ITC has been wrongly availed or utilised. The information leading to such proceedings may come not only from scrutiny under Section 61 but also from audit, inspection, search, independent verification, or other relevant sources.
Therefore, Section 61 cannot be treated as a compulsory first step in every case. The expression “where it appears to the proper officer” in Section 74A is broad enough to cover information obtained independently of return scrutiny. Where such independent material exists, proceedings under Section 74A may be initiated without first invoking Section 61.
Rule 99 Becomes Mandatory When Section 61 Scrutiny Has Actually Been Invoked
The ruling should not be read as holding that Section 61 and Rule 99 are merely optional provisions that the Department can disregard at will. The Court drew a more careful distinction.
Rule 99 of the CGST Rules, 2017 prescribes the procedure for scrutiny of returns under Section 61. Its mandatory requirements therefore apply only when scrutiny under Section 61 has actually been initiated. In such a situation, the Department cannot commence the scrutiny process and thereafter disregard the statutory procedure governing that very process.
The petitioner relied upon Qualicum Solutions Pvt. Ltd. v. Chief Commissioner of CT & GST, 2024-VIL-1614-ORI; Amex Services v. Deputy Commissioner, Sales Tax, 2024-VIL-593-CAL; Goverdhandham Estate Pvt. Ltd. v. State of Rajasthan, 2024-VIL-1448-RAJ; Pepsico India Holdings Pvt. Ltd. v. Union of India, 2025-VIL-1006-GAU; and Ramhari & Brothers v. Joint Commissioner (State Tax), Bharatpur, 2026-VIL-738-RAJ. The petitioner argued that where the alleged discrepancy arose from returns and GST portal data, an opportunity to explain it through the scrutiny mechanism should precede Section 74A proceedings.
Those decisions were distinguished because scrutiny under Section 61 had already been undertaken in the cases concerned, and the prescribed statutory procedure had thereafter not been followed. The present case stood on a materially different footing: the petitioner's returns had admittedly never been selected for scrutiny, and the Show Cause Notice arose from independent verification concerning the eighteen sub-contractors allegedly found to be bogus and non-existent.
The reasoning was consistent with Nagarjuna Agro Chemicals (P) Ltd. v. State of U.P., reported in 2023 SCC OnLine All 5339 (decided on 15.05.2023) - 2023-VIL-1170-ALH,andDevi Traders Vs State of Andhra Pradesh, 2023 SCC Online AP 1886 - 2023-VIL-396-AP . Reference was also made to Mandarina Apartment Owners Welfare Association v. Commercial Tax Officer,2024 SCC Online Mad 3501-2024-VIL-721-MAD. These authorities support the proposition that Section 61 scrutiny is not an indispensable condition precedent to initiating demand proceedings in every case.
Return-Based Discrepancy and Independent Information Must Not Be Treated Alike
Perhaps the most significant aspect of the ruling is the qualification attached to the Court's conclusion. The Court did not lay down an absolute rule that Section 61 can always be bypassed. It expressly recognised that where the Proper Officer possesses only return-based discrepancy material and there is no independent source of information, Section 61 and Rule 99 may operate as a mandatory procedural safeguard.
This qualification gives the judgment its proper balance. Suppose the Department merely compares GSTR-3B with another return or statement and notices a difference. If nothing beyond that electronic discrepancy is available, the statutory scrutiny mechanism assumes considerable importance because it gives the taxpayer an opportunity to explain reconciliation differences, timing issues, amendments or other matters before formal adjudication begins.
The position is different where an investigation or independent verification allegedly reveals that suppliers do not exist, invoices are fictitious or the underlying transactions themselves are fabricated. In such a case, the Department is not merely asking the taxpayer to reconcile two electronic figures. It is alleging an independent factual basis for wrongful ITC. Requiring Section 61 scrutiny as an inflexible preliminary step in such circumstances would import into Section 74A a condition that the statutory scheme does not prescribe.
The practical test emerging from the judgment is therefore the source and character of the information forming the basis of the Show Cause Notice. The mere fact that GST returns or portal data may also form part of the evidentiary material does not necessarily convert an independently generated investigation into a Section 61 scrutiny proceeding.
Fraud Cannot Be Invoked Merely by Using Statutory Expressions - But the SCN Need Only Disclose the Foundational Case
The second major issue concerned Section 74A(5)(ii). The petitioner argued that the Show Cause Notice lacked sufficient material to establish fraud, wilful misstatement or suppression with intent to evade tax. According to the petitioner, the transactions were genuine, the subcontractors were registered and operational, payments were made through banking channels, and the works were actually executed.
A key legal distinction exists between the absence of jurisdictional allegations and a dispute about the truth of those allegations. If a notice merely reproduces expressions such as “fraud”, “wilful misstatement” or “suppression” without disclosing any factual basis connecting the taxpayer with the alleged conduct, a jurisdictional objection may arise. Statutory labels cannot substitute for foundational facts.
But that was not how the impugned notice was viewed in the present case. The notice specifically alleged that the works purportedly subcontracted to eighteen firms were bogus, that the entities themselves were non-existent, and that substantial ITC had been availed on fictitious invoices. An allegation that an entire chain of subcontracting and invoices was structured around fictitious entities was, at the Show Cause Notice stage, capable of supplying the factual foundation for invocation of Section 74A(5)(ii).
Reference was made to Tvl. K. Ezhil Arasan, Contractor v. Joint Commissioner (ST) Intelligence, Salem, 2026:MHC:2274 - 2026-VIL-630-MAD; (decided on 08.06.2026) . At the initiation stage, the statutory requirement is satisfied where the notice expressly alleges fraud, wilful misstatement, or suppression, and those allegations are traceable to the material forming the basis of the proceeding.
This does not mean that the allegations stand proved merely because they appear in the notice. It means only that the jurisdiction to initiate proceedings and the ultimate proof of the allegations are different questions.
A Jurisdictional Defect Is Different from a Disputed Factual Defence
The Court's distinction is particularly useful for GST litigation. If the Show Cause Notice contains no foundational ingredients for invoking the relevant statutory provision, the defect may go to jurisdiction and can justify interference at the notice stage.
Where those ingredients are specifically pleaded, however, and the taxpayer says they are factually incorrect, the dispute ordinarily moves into adjudication. The Court cannot, without examining the complete evidentiary record, determine in writ proceedings whether eighteen sub-contractors genuinely executed the works, whether measurement sheets establish actual performance, whether banking transactions correspond to genuine supplies, or whether invoices represented real transactions.
The petitioner possessed work orders, tax invoices, measurement sheets, completion records, bank statements, GSTR-2A/B2B particulars, and other documents, which, according to it, established the genuineness of the transactions. Those documents may ultimately prove important. But their evidentiary effect has to be tested against the Department's material alleging that the sub-contractors were fictitious. That exercise belongs primarily to adjudication.
Accordingly, the ruling maintains an important distinction: a Show Cause Notice must disclose the factual foundation necessary for invoking the statutory provision, but the High Court need not decide at the notice stage whether that factual foundation will ultimately be proved.
Supplier Default and Fictitious Supplier Are Legally Different Situations
The petitioner also relied on Suncraft Energy Pvt. Ltd. v. Assistant Commissioner, State Tax, (2023) 117 GSTR 78 - 2023-VIL-487-CAL; affirmed by the Supreme Court in SLP(C) no. 027827/2023 - 2023-VIL-99-SC, to contend that ITC should not be automatically denied to a bona fide purchaser merely because of a default attributable to the supplier.
The distinction in the present case is important. Suncraft Energy concerned a genuine supplier who had collected tax but allegedly failed to deposit it. The present Show Cause Notice questioned something more fundamental—the very existence and genuineness of the supplying entities and the underlying transactions.
These two situations should not be conflated. In a supplier-default case, the recipient may contend that it purchased genuine goods or services, possessed valid invoices, made payment, and had no control over the supplier's subsequent failure to discharge tax. However, where the Department alleges that the supplier itself is fictitious and no genuine supply occurred, the first question is whether the underlying transaction ever existed.
This does not mean that the Department's allegation of a fictitious supplier is conclusive. The taxpayer remains entitled to establish the genuineness of the transaction through contractual documents, evidence of actual execution, movement or receipt of supplies, banking records, and other relevant material. The judgment merely recognises that Suncraft Energy cannot automatically determine such a factual controversy at the Show Cause Notice stage.
A Show Cause Notice Is Ordinarily the Beginning of Adjudication, Not Its Conclusion
The third issue concerned the High Court's jurisdiction under Article 226. Judicial review against a mere Show Cause Notice is ordinarily exercised sparingly. The underlying reason is straightforward: a notice ordinarily makes allegations and calls for an explanation; it does not finally determine liability.
The Court referred to Union of India v. Kunisetty Satyanarayana, (2006) 12 SCC 28; State of U.P. v. Brahm Datt Sharma, (1987) 2 SCC 179; and Special Director v. Mohd. Ghulam Ghouse, (2004) 3 SCC 440. The recognised exceptions to the alternative-remedy principle, including those explained in Whirlpool Corporation v. Registrar of Trade Marks, (1998) 8 SCC 1 — 1998-VIL-09-SC, were also considered.
The petitioner had not even filed its reply to the Show Cause Notice before approaching the High Court. Its principal defences—the genuineness of the sub-contractors, actual execution of works, payment through banking channels, reflection of transactions in GSTR-2A, and supporting documentary evidence—required examination by the Adjudicating Authority.
The writ petition was therefore dismissed. Importantly, dismissal did not amount to confirmation of the allegations in the Show Cause Notice. The petitioner was permitted to file a detailed reply within four weeks, raising all factual and legal contentions. The Adjudicating Authority was required to consider the reply independently, provide an adequate opportunity of hearing, and permit relevant documents to be placed on record. All rights and contentions on the merits of the Show Cause Notice were expressly kept open.
Independent Information Permits Direct Action, but Liability Requires Adjudication
The ruling in Neelkanth Entrepreneurs draws a clear distinction between initiating proceedings and determining liability. Where the Department possesses independent information indicating wrongful availment of ITC or other tax irregularities, it may directly invoke Section 74A without first undertaking scrutiny under Section 61. However, where the case arises solely from discrepancies noticed in the returns, Section 61 read with Rule 99 may serve as an important procedural safeguard.
Direct initiation of proceedings, however, does not establish the taxpayer’s liability. The allegations in the SCN must still be tested through proper adjudication, after considering the taxpayer’s reply, supporting documents and other evidence on record. Thus, independent information may dispense with prior return scrutiny, but it cannot dispense with a fair and reasoned adjudication.
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