GST Circular Trading - Penalty Cannot Be Capped at Rs. 10K but levied Equivalent to Full ITC Passed on

The Hon'ble Madras High Court in Tvl. SAM Enterprises & Ors. v. Commercial Tax Officer & Anr. [W.P. Nos. 2628 of 2026 and connected matters, dated February 18, 2026] dismissed the writ petitions filed by the assessee-entities engaged in alleged circular trading of medical equipment supplies, thereby upholding the penalty orders passed under Section 74 of the Central Goods and Services Tax Act, 2017 ( “the CGST Act” ). The Court held that the penalty under Section 122(1)(ii) and Section 122(1)(vii) of the CGST Act is mandatorily equivalent to the ineligible Input Tax Credit (ITC) availed or passed on — not capped at Rs. 10,000 — since the language of Section 122(1) of the CGST Act uses the expression "whichever is higher," leaving no discretion with the Assessing Officer to levy the lesser amount.

Facts:

Multiple entities — namely Tvl. SAM Enterprises, Tvl. New Life Healthcare Products, Tvl. Infix Global Healthcare LLP, Tvl. M.S. Global Health Care, Tvl. Sri Sana Enterprises, and Tvl. Q-Tech Surgical Products — all operating in the medical equipment supply business in Coimbatore, were subjected to assessment orders in Form GST DRC-07 under Section 74 of the respective GST Enactments for the tax periods spanning 2020-2021 to 2024-2025.

Revenue's investigation revealed that the circular trading turnover of these entities ranged from 96.6% to 100% of their total purchase and sales turnover — indicating that nearly all transactions were paper-based, without any actual movement of goods. The stated motive was not to transfer fake ITC downstream, but to artificially inflate business turnover in order to avail bank loans and project themselves as major players in the medical equipment sector.

By the impugned orders, penalties equivalent to the ineligible ITC availed were levied under Section 122(1)(vii) (taking/utilising ITC without actual receipt of goods) and Section 122(1)(ii) (issuing invoices without actual supply). The aggregate penalties under the two provisions totalled approximately Rs. 12.34 crores and Rs. 13.68 crores respectively across all matters.

The petitioners challenged these orders before the Madras High Court under Article 226 of the Constitution, seeking to quash the impugned DRC-07 orders by way of Writ of Certiorari.

Contentions of the Assessee: The petitioners contended that (i) the maximum penalty imposable under Section 122(1) is capped at Rs. 10,000, and any penalty beyond that is unjustified; (ii) relying on the doctrine of proportionality as laid down by the Supreme Court in Coimbatore District Central Cooperative Bank, Charanjit Lamba , and S.R. Tewari , punishment must be commensurate with the gravity of misconduct; and (iii) the motive was not to defraud the Government through fake ITC transfer but merely to enhance turnover for credit facilities.

Issues:

• Whether the penalty leviable under Section 122(1)(ii) and Section 122(1)(vii) of the CGST Act for wrongfully availed ITC through circular trading is mandatorily equivalent to the amount of ineligible ITC availed/passed on, or whether it can be capped at Rs. 10,000 at the discretion of the Assessing Officer?
• Whether the doctrine of proportionality applicable under labour law and service law jurisprudence — as expounded by the Supreme Court in Coimbatore District Central Cooperative Bank, Charanjit Lamba , and S.R. Tewari — can be invoked to interfere with and reduce the statutory penalty prescribed under Section 122(1) of the respective GST Enactments?

Held:

The Hon'ble Madras High Court in W.P. Nos. 2628 of 2026 and connected matters held as under:

• Observed that , the impugned orders clearly established that the petitioner entities were engaged in circular trading with 1% or less genuine transactions, and the circular trading turnover constituted between 96.6% to 100% of their total turnover — conclusively demonstrating a systematic scheme to inflate turnover for banking purposes, without any real movement of goods.
• Noted that , the language in Section 122(1) of the respective GST Enactments uses the expression "whichever is higher," which affords no discretion to the Assessing Officer to levy the lesser amount of Rs. 10,000. The impugned orders recorded adequate reasons showing proper application of mind, and therefore could not be found fault with on the ground of procedural irregularity.
• Noted further that , Section 11-AC of the Central Excise Act, 1944 — on which the Supreme Court's ratio in Dharamendra Textile Processors and Rajasthan Spinning and Weaving Mills was based — is structurally different from Section 122 of the CGST Act, 2017; and that the Supreme Court itself had confined the said ratio to Section 11-AC alone. Therefore, the proportionality decisions from labour/service law jurisprudence cited by the petitioners cannot be transposed to the GST penalty framework.
• Held that , even if Section 122(1A) of the respective GST Enactments is applied, prima facie the assessee is liable to a penalty equivalent to the evaded or ineligible ITC availed or passed on. The petitioners, having wrongly availed ITC and passed on the credit to inflate turnovers to take undue advantage of the banking system, are prima facie liable to penalty under Section 122(1).
• Directed that , since the requirement of pre-deposit of 10% of the penalty under Section 107 of the respective GST Enactments would cause undue hardship and render the appellate remedy illusory given the magnitude of the penalties, the pre-deposit condition is dispensed with. The petitioners are granted liberty to file appeals before the Appellate Authority within thirty (30) days of receipt of this order, and the Appellate Authority is directed to dispose of the same preferably within ninety (90) days.

Our Comments:

• Relevant Provisions:Section 122(1) of the CGST Act , prescribes penalty for specific offences. Clause (ii) covers issuance of invoices without actual supply of goods or services, and Clause (vii) covers taking or utilising ITC without actual receipt of goods or services. For both clauses, the penalty is "ten thousand rupees or an amount equivalent to the tax evaded or the ITC availed/passed on, whichever is higher." The use of the phrase "whichever is higher" is pivotal — it mandates that where the ITC wrongly availed is more than Rs. 10,000 (which will almost always be the case in substantial transactions), the penalty must equal the ITC amount, with no room for discretion.
• Section 74 of the CGST Act , governs determination of tax not paid or erroneously refunded or ITC wrongly availed or utilised by reason of fraud, wilful misstatement, or suppression of facts. Proceedings under this section carry a higher penalty exposure compared to Section 73, reflecting the gravity of fraudulent conduct.
• Section 122(1A) of the CGST Act, (inserted by the Finance Act, 2020) w.e.f 01-01-2021 further provides that any person who retains the benefit of circular trading or at whose instance such transactions are conducted shall also be liable to penalty equivalent to the amount of tax evaded or ITC availed.

Brief of Pari Materia / Contrary Judgments: The Supreme Court in Union of India v. Dharamendra Textile Processors, [(2008) 13 SCC 369] , construed Section 11-AC of the Central Excise Act, 1944, as a mandatory penalty provision leaving no discretion once conditions of fraud/suppression are established. The Court in Union of India v. Rajasthan Spinning and Weaving Mills, [(2009) 13 SCC 448] clarified that the ratio in Dharamendra Textile is confined to Section 11-AC alone and cannot be extended to other statutory provisions. The Madras HC in the present case drew a clear distinction between Section 11-AC (which provides for penalty equal to duty determined) and Section 122(1) (which uses "whichever is higher" between Rs. 10,000 and ITC availed/passed on), and confirmed the mandatory, non-discretionary character of the GST penalty provision.

Significance: This decision is a significant precedent for the GST administration in cases of circular trading. It firmly closes the door on assessee seeking to invoke proportionality principles borrowed from labour or service jurisprudence to dilute statutory GST penalties. The Court's practical relief — dispensing with the pre-deposit requirement for filing the Section 107 appeal — ensures that the appellate remedy remains accessible even where the penalty quantum is large, balancing fiscal discipline with procedural fairness.

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