Supplier Default Alone Cannot Trigger ITC Reversal: Punjab & Haryana HC Clarifies Scope of Section 16(2)(c)

Executive Summary

• The Punjab and Haryana High Court upheld the constitutional validity of Section 16(2)(c) of the CGST/PGST Act, 2017.
• However, the Court prohibited the Revenue from mechanically reversing input tax credit (ITC) from bona fide purchasers upon supplier default.
• Selling-dealer non-payment, nil GSTR-3B filings, or retrospective registration cancellations are triggers for inquiry, not conclusive proof of recipient fraud.
• The Court formulated 14 binding procedural guidelines, mandating prior recovery efforts against defaulting suppliers.

1. The Issue

Over 400 registered purchasing dealers challenged demand notices and assessment orders passed under Sections 73 and 74 of the CGST/PGST Act, 2017. The Revenue had disallowed and recovered their input tax credit solely because their respective selling dealers had defaulted in depositing the collected tax, uploaded nil returns in Form GSTR-3B, vanished post-transaction, or suffered retrospective cancellation of their GST registrations.

The assessees demonstrated that they possessed valid tax invoices, had moved goods under genuine e-way bills accompanied by weighment and toll slips, and had discharged the full consideration along with the tax component through formal banking channels. The core legal questions were twofold: whether Section 16(2)(c)—which conditions ITC on actual payment of tax to the government exchequer—is constitutionally valid; and whether the Revenue can demand summary reversal of credit from a bona fide recipient without first initiating recovery against the delinquent selling dealer.

2. Department's Arguments

The Revenue contended that Section 16(2) begins with an explicit non-obstante clause that overrides the general entitlement under Section 16(1). Relying on the doctrine that tax credit is a statutory concession rather than an inherent or vested constitutional right (Union of India v. VKC Footsteps India Pvt. Ltd.; Jayam & Company v. Assistant Commissioner), the Revenue argued that Parliament possesses plenary competence to attach conditions to that concession.

The Revenue submitted that Section 16(2)(c) creates an absolute statutory condition precedent: until the tax charged on the supply actually reaches the exchequer, the recipient possesses no legal right to retain the credit. Under Section 155 of the CGST Act, the burden of proving that credit has been validly availed rests squarely on the assessee. The Revenue maintained that the recipient must bear the risk of its chosen counterparty's non-compliance, and the exchequer cannot suffer revenue loss merely because the purchasing dealer acted in good faith.

3. Assessee's Arguments

The assessees argued that conditioning credit on the independent actions of a third-party seller imposes an impossible condition (lex non cogit ad impossibilia), infringing Article 14 and Article 19(1)(g) of the Constitution. A purchasing dealer has no statutory authority or administrative machinery to verify whether a registered supplier has deposited the tax collected into the treasury.

The assessees submitted that the selling dealer acts as an authorized collection agent of the State. Once the buyer pays the tax on invoice, the debt becomes a sovereign debt recoverable from the seller under Section 79. Relying on pre-GST jurisprudence (Commissioner of Trade & Taxes v. Arise India Ltd.; On Quest Merchandising India Pvt. Ltd. v. Government of NCT of Delhi) and GST rulings (Suncraft Energy Pvt. Ltd. v. Assistant Commissioner of State Tax), the assessees argued that the Revenue cannot proceed against a bona fide purchaser without first exhausting recovery measures against the defaulting supplier.

4. Holding and Reasoning

The Division Bench delivered a balanced ruling, preserving the statutory provision while disciplining its administrative application:

• Constitutional Validity Upheld: The Court repelled the constitutional challenge to Section 16(2)(c), holding that tax credit is a concession governed by legislative policy. The requirement that tax must reach the exchequer before credit is granted is neither arbitrary nor unconstitutional (Paragraph 98).
• Prohibition of Mechanical Reversal: The Court held that despite the validity of Section 16(2)(c), the Revenue cannot invoke it in a routine, mechanical manner against purchasing dealers. A discrepancy between GSTR-2A/2B and GSTR-3B, a seller's nil return, or the subsequent retrospective cancellation of a seller's registration merely constitutes grounds to initiate an inquiry, not conclusive evidence of fraud against the buyer (Paragraph 99).
• Discharge of Statutory Onus: Under Section 155, when a purchasing dealer places on record valid tax invoices, proof of physical delivery (transport receipts, e-way bills, weighment records), and bank statements establishing payment of invoice price plus tax, the initial burden of proving bona fides is discharged. The burden then shifts to the Revenue to establish complicity, circular trading, or collusion (Paragraph 103).
• Fourteen Binding Guidelines: The Court laid down 14 comprehensive guidelines governing Section 16(2)(c) proceedings. Most notably: (i) the primary obligation to pay tax lies upon the supplier; (ii) the proper officer must first exhaust coercive recovery measures against the defaulting supplier under Sections 73, 74, and 79, unless the supplier is proven to be non-existent, untraceable, or insolvent; (iii) retrospective cancellation cannot invalidate transactions that occurred when registration was active; and (iv) where fraud under Section 74 is alleged, specific material demonstrating collusion must be disclosed in the show cause notice, accompanied by full disclosure of adverse intelligence reports and an opportunity for cross-examination (Paragraph 103).
• Remittal: The Court quashed the impugned orders and remitted all 424 petitions back to the adjudicating authorities for fresh evaluation strictly in terms of the 14 guidelines (Paragraph 104).

5. Then and Now: The Pre-GST Lineage

The judgment continues the lineage of value-added tax jurisprudence concerning the bona fide purchaser. Under Section 9(2)(g) of the Delhi Value Added Tax Act, 2004, the Delhi High Court in On Quest Merchandising India Pvt. Ltd. (2017) read down a similar restriction, holding that treating bona fide buyers on par with fraudulent dealers creates an impermissible class, a view affirmed by the Supreme Court in Arise India Ltd. (2018). Similarly, in State of Maharashtra v. Suresh Trading Company (1998), the Supreme Court ruled that a purchasing dealer cannot be penalized by retrospective cancellation of its seller's registration.

In Central Excise, the Allahabad High Court held in CCE v. Juhi Alloys Ltd. (2014) that a buyer who has verified a supplier's registration and paid through banking channels cannot be expected to trace the treasury deposits of upstream inputs. In the GST regime, Shaurya Alloys aligns Section 16(2)(c) with these constitutional guardrails, ensuring that a statutory concession does not become an instrument of arbitrary recovery.

6. Allied Law Lens

The Court invoked the maxim lex non cogit ad impossibilia (the law does not compel the impossible) alongside the Indian Evidence Act, 1872 / Bharatiya Sakshya Adhiniyam, 2023. While Section 155 of the CGST Act places the burden of proof regarding ITC eligibility on the taxpayer, this burden must be read in harmony with Section 106 of the Evidence Act. A taxpayer can only prove facts within its own knowledge—namely, receipt of goods, possession of tax documents, and payment through banking channels. Whether the supplier deposited the proceeds into the treasury is a matter within the exclusive knowledge of the supplier and the tax administration.

7. Analysis and Conclusion

Shaurya Alloys establishes an equitable middle ground. By upholding Section 16(2)(c) while circumscribing its enforcement with 14 mandatory guidelines, the High Court has dismantled the automated, portal-driven reversal practice adopted by field formations.

The requirement that the Revenue must first attempt recovery against the defaulting seller before pursuing the buyer incorporates the ratio of the Calcutta High Court's ruling in Suncraft Energy into a structured evidentiary test. Unless the Revenue establishes active collusion or fictitious billing, bona fide commercial purchasers can no longer be subjected to summary demands. While the Revenue may challenge these restrictions in the Supreme Court, the decision provides immediate, binding relief across Punjab, Haryana, and Chandigarh, and carries persuasive authority across the country.

8. Practice Tips

1. Compile a Complete Inward Evidentiary Dossier: For any high-value input dispute, assemble a multi-tiered defense file containing the purchase order, tax invoice, e-way bill with vehicle verification, weighment slips, toll plaza logs, and bank debit advice reflecting payment of the gross amount.
2. Challenge Premature Recipient Action: In show cause notice replies, explicitly plead Guideline 2 of Shaurya Alloys and Suncraft Energy, calling upon the adjudicating authority to disclose the recovery steps taken against the supplier.
3. Rebut Retrospective Cancellations: Where the selling dealer's GSTIN was cancelled retrospectively, submit a screenshot of the GST portal verifying that the registration was "Active" on the exact invoice date, invoking Suresh Trading Company.
4. Demand Disclosure and Cross-Examination: If the SCN alleges a fake invoice ring under Section 74, demand complete copies of any inspection reports, third-party statements, or investigation reports relied upon, and formally seek cross-examination before the adjudicating authority.

References

Judgments:

• Shaurya Alloys Pvt. Ltd. v. State of Punjab and Another, CWP No. 34296 of 2024 (O&M), decided on 01 October 2026; [2026] LiveLaw (P&H) 582.
• Commissioner of Trade & Taxes v. Arise India Ltd., (2018) SCC OnLine SC 3859; (2024) 129 GSTR 542 (SC).
• On Quest Merchandising India Pvt. Ltd. v. Government of NCT of Delhi, (2017) 105 VST 240 (Del).
• Suncraft Energy Pvt. Ltd. v. Assistant Commissioner of State Tax, (2023) 153 taxmann. com 482 (Cal); SLP dismissed in Diary No. 41548/2023.
• State of Maharashtra v. Suresh Trading Company, (1998) 109 STC 439 (SC); (1997) 11 SCC 378.
• Union of India v. VKC Footsteps India Pvt. Ltd., (2022) 2 SCC 603.
• Jayam & Company v. Assistant Commissioner, (2016) 15 SCC 125.
• CCE v. Juhi Alloys Ltd., 2014 (302) ELT 487 (All).

Statutory Provisions:

• Sections 16(1), 16(2)(c), 73, 74, 75, 79, and 155, Central Goods and Services Tax Act, 2017.
• Section 9(2)(g), Delhi Value Added Tax Act, 2004.
• Articles 14, 19(1)(g), and 300A, Constitution of India.

Case Snapshot

• Case Name: Shaurya Alloys Pvt. Ltd. v. State of Punjab 
• Court and Bench: High Court of Punjab and Haryana at Chandigarh; Ashwani Kumar Mishra, C.J. and Rohit Kapoor, J. (Opinion authored by Ashwani Kumar Mishra, C.J.)
• Case Type and Number: CWP No. 34296 of 2024 (O&M) with CWP No. 25765 of 2026 and connected batch
• Date of Judgment: 01 October 2026
• Neutral / Reporter Citation: CWP No. 34296 of 2024; [2026] LiveLaw (P&H) 582; 2026 TAXSCAN (HC) 894
• Provisions Involved: Sections 16(1), 16(2)(c), 73, 74, 75, 79, and 155 of the Central Goods and Services Tax Act, 2017 / Punjab Goods and Services Tax Act, 20