Section 16(2)(c) After Shaurya Alloys: No Mechanical ITC Reversal for Supplier Default

Summary: The Punjab and Haryana High Court in Shaurya Alloys Pvt. Ltd. v. State of Punjab and Another upheld the validity of Section 16(2)(c) of the CGST Act and refused to read it down, but held that input tax credit cannot be mechanically reversed merely because the supplier later failed to deposit tax, filed a nil or short return, received an adverse alert, or had its registration cancelled retrospectively. The Court stressed that officers must investigate the supplier, invoices, tax periods, nature of default and recovery action before proceeding against the buyer; disclose the material relied upon; consider the buyer’s evidence under Section 155; avoid double recovery; and examine re-availment under Section 41(2) and Rule 37A. Where Section 74 or the fraud limb of Section 74A is invoked, the notice itself must contain facts connecting the buyer with fraud, wilful misstatement or suppression. The 424 writ petitions were remitted for fresh consideration rather than having the demands quashed, with protection against fresh coercive recovery pending reconsideration.

Section 16(2)(c) After Shaurya Alloys: What the Punjab and Haryana High Court Has Really Said

Why I sat down and read the whole judgment

Since yesterday one message has been travelling across every tax group on my phone. It says a Full Bench of the Punjab and Haryana High Court has held that a buyer’s input tax credit cannot be denied when his supplier does not pay the tax. The question that follows it is always the same. Is the buyer’s problem finally over?

I wish it were that simple. I went through the judgment itself, and what the Court has said is more careful than the forwards suggest. It is good news for the honest buyer. But it is not the news that is being circulated.

Let me put the correct facts first. The case is Shaurya Alloys Pvt. Ltd. v. State of Punjab and Another, CWP 34296 of 2024, decided on 1 October 2026 along with connected matters, 424 writ petitions in all. The Bench was a Division Bench of Chief Justice Ashwani Kumar Mishra and Justice Rohit Kapoor. It was not a Full Bench. The Court upheld Section 16(2)(c) of the CGST Act. It refused to read it down. It did not quash a single demand. And yet, officers who have been reversing credit with a two line order have been told in plain terms that they cannot go on like that.

What the buyers asked for

The question the Court put to itself was a fair one. A buyer has paid the tax to his supplier along with the price. He cannot see the supplier’s cash ledger. He cannot see whether the supplier’s own credit was good. Then what is he supposed to do to make sure that the tax reaches the Government?

The buyers said the law is asking for the impossible, and a law that asks for the impossible offends Articles 14, 19(1)(g), 21, 265 and 300A of the Constitution. If the Court was not inclined to strike the clause down, they asked that it be read down, so that only a buyer who dealt with a non existent supplier, or who was part of a fraud, should lose his credit.

Senior Advocate Sandeep Goyal gave an example which every trader will recognise. Take a chain that begins with a kabadiwala selling plastic scrap, passes through the plastic maker, the button maker, the shirt maker and the wholesaler, and ends with a retailer. If the man at the very top does not pay, or his registration is cancelled from a back date, the credit of every person below him falls like a row of parked cycles. The retailer at the end has all his papers and has never even heard the name of the defaulter. The buyers were careful to add that they hold no brief for bogus billing. Their complaint was only about genuine purchases.

The reply of the Department was short. Credit is a concession given by the statute, not a right one is born with. The Gujarat High Court has already upheld the clause in Maruti Enterprises v. Union of India, and the Supreme Court approved that view on 24 July 2026 in Bhandari Scrap Traders v. Union of India.

A system that stayed on paper

To my mind the most valuable part of the judgment is the history. The Court went back to the Act as it stood in July 2017 and reminded everyone how this clause was meant to work.

The supplier was to upload his sales in GSTR 1. The buyer was to confirm his purchases in GSTR 2. Both would then close the month in GSTR 3. Credit under the old Section 41 was only provisional. Under Section 42 the buyer’s claim was to be matched with the supplier’s valid return, and a return became valid only when the tax on it was paid in full. If there was a mismatch, both sides were to be told and given time to set it right. Only after that could anything be added to the buyer’s liability.

We all know what happened. GSTR 2 and GSTR 3 never saw the light of day. The due dates were extended, extended again, and finally shelved. The Department did not deny this before the Court. For years the whole country ran on GSTR 3B, and a buyer taking credit had nothing to go by except his own purchase register.

From 1 October 2022 the matching provisions, Sections 42 and 43, were removed and Section 41 was rewritten. Credit is now taken on self assessment and has to be reversed with interest if the supplier has not paid. Rule 37A followed on 26 December 2022. Under it the buyer reverses credit if the supplier has not filed GSTR 3B by 30 September after the year ends, and takes it back when the supplier files.

The Court made two observations here which are worth noting down. Even today a buyer can only find out whether the supplier has filed his return. Whether that return is correct, he has no means to check. And for the years before Rule 37A, the law had no door at all through which a buyer could get his credit back after the supplier paid. Most of the 424 cases belong to those years.

Is the clause valid? Yes

On this the Court did not hesitate. Section 16(2)(c), read with Section 155, is valid. Actual payment of tax to the Government is the very basis of the concession. If the tax has not come in, there is nothing to give credit of.

The request to read down the clause was also turned away. The old VAT decisions which we have all cited for years, Gheru Lal Bal Chand of this very High Court and On Quest Merchandising of the Delhi High Court, were given under different laws. The Supreme Court has said in Bhandari Scrap Traders that the Delhi VAT position cannot be borrowed for GST, and has agreed with the Gujarat High Court that the clause needs neither striking down nor reading down. With that order in the field, the High Court declined to limit the clause to cases of fraud and collusion.

This must be understood clearly. After this judgment nobody can argue that an honest purchase, by itself, closes the matter. But the Court did not stop there. It said that upholding the clause does not conclude the issue. How the clause is used is a separate question, and that is where the buyer gets his relief.

Valid, but not to be used blindly

Now comes the real ratio. The Court held that Section 16(2)(c) cannot be pulled out of the Act and applied on its own. It lives along with Section 41, Sections 73 and 74, Section 75(12), Section 76, Section 79, Section 155 and Rules 37A and 88C, and with the law as it stood in the period under dispute.

The thinking behind this is plain common sense. Who comes to know first when a supplier does not pay? The Department. The moment the tax declared in GSTR 1 is more than the tax paid in GSTR 3B, the system shows it. Section 75(12) allows that difference to be recovered from the supplier straightaway, with no assessment. Rule 88C allows an intimation to him to pay or explain. The buyer, sitting in his shop, knows nothing of all this. The Court accepted that a buyer cannot be made liable without end to trace out suppliers from whom he bought goods years ago.

So the Court held that a later failure of the seller to deposit tax cannot, on that fact alone and without looking into the circumstances, result in mechanical reversal of the buyer’s credit. It also recorded that officers had been invoking the clause as a matter of routine, very often for no better reason than that the supplier’s registration was found cancelled.

Three reasons that are not enough

Anyone who has replied to these notices knows the three stock reasons. The Court took them up one by one. Each can be a reason to inquire. None of them, standing alone, is a reason to deny or reverse credit.

• The supplier’s registration was cancelled after the sale, even if it was cancelled from a back date.
• The supplier filed a nil return or paid less tax than he should have.
• An alert or a complaint was received by the Department.

On back dated cancellation the Court wants the officer to ask three things. Why was the registration cancelled? From which date? And does it have anything to do with the invoice in question? If the supplier was registered on the day of supply, a cancellation order passed long afterwards cannot by itself decide the matter.

There is one more protection which many will welcome. The buyer’s own registration cannot be cancelled, and certainly not from a back date, only because he took credit from a supplier who was later cancelled. For that the officer needs an independent ground under Section 29(2).

First go after the man who collected the tax

Section 76 is a provision we rarely see being used. It says that a person who has collected tax and not paid it over must pay it forthwith, with interest and penalty. The Court said this section cannot be reduced to a dead letter by using Section 16(2)(c) against buyers without discrimination.

What follows is a duty on the officer before he issues notice to the buyer. He has to identify the suppliers, the invoices, the tax periods and the amount. He has to find out what exactly the default is and how it came about. And he has to place on record what has been done to recover the tax from the supplier under Sections 73, 74, 75(12), 76 and 79.

Two more points are tied to this. Tax on one supply cannot be collected twice, once from the supplier and again from the buyer, so the officer must check what has already come in. And where the supplier pays up later, the buyer’s claim to take the credit, or to take it back, under Section 41(2) and Rule 37A has to be considered, subject to Section 17(5)(i). A condition brought into the law later cannot be applied to an earlier period.

His fraud is not my fraud

Most of these demands come under Section 74, for the obvious reason that it gives a longer time limit and a heavier penalty. On this the Court has spoken clearly. The fraud of the seller does not, on that fact alone, become the fraud of the buyer. If the Department wants to invoke Section 74, the notice itself must state the facts which connect the buyer with fraud, wilful misstatement or suppression. Copying the words of the section into the notice will not do. The same holds good for the fraud limb of Section 74A in the later years.

The Court drew support from two Supreme Court decisions of recent weeks, G.R. Infra Projects Limited and Tata Steel Limited v. Union of India dated 25 August 2026. Both say that the basic facts for the extended period must be found in the show cause notice and must show that the officer applied his own mind.

In day to day practice I think this will be the most useful part. We regularly see Section 74 notices which say only that the supplier was found non existent on inspection, or that he did not pay tax. Not one word on what the buyer did wrong. Such a notice can now be questioned on that ground alone.

The buyer still has to prove his purchase

Let nobody think the buyer has been let off. Section 155 puts the burden of proving a credit claim on the person who makes it, and the Court has left that burden exactly where it was.

What the Court has explained is how the burden is met. Tax invoices, e way bills, lorry receipts, weighbridge slips, stock and consumption records, proof that the goods or services were received, and payment through the bank. When these are filed, the officer has to look at them and say what he makes of them. He cannot write that the documents were perused and then confirm the demand because the supplier defaulted.

There is an old piece of advice in our profession, and this judgment proves it once more. The case is won or lost on the day of purchase, by the papers kept that day, and not on the day the notice comes.

What officers must now do

The Court has laid down guidelines for all pending and future proceedings before the proper officers of the Centre, Punjab, Haryana and Chandigarh. I give them below in my own words and in my own order, not as numbered in the judgment.

1. Section 16(2)(c) is not to be invoked against a buyer in a routine or mechanical way.

2. A cancelled supplier, a nil or short return, or an alert can start an inquiry. It cannot finish one.

3. Before notice, the officer must look into the suppliers, the invoices, the periods, the amount, the exact default and the recovery action against the supplier, and record his satisfaction.

4. The notice must tell the buyer the grounds and the material relied on. That material must be given to him, except what is lawfully privileged.

5. If Section 74, or the fraud limb of Section 74A, is invoked, the facts tying the buyer to fraud, wilful misstatement or suppression must be in the notice itself.

6. The evidence filed by the buyer under Section 155 must be considered. So must the question whether a back dated cancellation has any bearing on the transaction.

7. The officer must find out what has been recovered from the supplier, avoid double recovery, and consider the buyer’s claim to credit under Section 41(2) and Rule 37A.

8. Conditions introduced later are not to be applied to earlier periods.

9. The buyer’s registration is not to be cancelled merely because his supplier’s registration was cancelled afterwards.

10. Personal hearing is a must. A request for cross examination has to be decided with reasons. The final order must give a finding on each condition of Section 16(2) that is in dispute.

What happens to the 424 cases

The Court did not examine the facts of each petition. All of them go back to the officers.

If the case is still at the notice stage, the taxpayer gets eight weeks to file a reply, or an additional reply, with his documents. Whatever particulars and material were not given to him earlier have to be given now. After hearing him the officer will pass a reasoned order.

If an order has already been passed, the officer has to take up the matter again, hear the taxpayer in person and pass a fresh reasoned order. He may issue a supplementary notice or a corrigendum where needed and allow a reply to it. The Court took care to say that it is not interfering with the orders under challenge. They will stand or fall with the fresh decision.

Till then, no fresh coercive recovery can be made under those notices and orders. If money has already been paid or recovered, or credit already reversed in the ledger, it will be adjusted or refunded with admissible interest, depending on how the fresh decision goes.

Every plea of fact and law remains open to the buyers. The Department is free to continue against the defaulting suppliers. Counsel