Section 16(2)(c) After Shaurya Alloys: Shield Against Mechanical ITC Reversal

Summary: The Punjab and Haryana High Court’s decision in Shaurya Alloys Pvt. Ltd. v. State of Punjab and another provides an important safeguard to genuine purchasers facing reversal of input tax credit because of supplier-side defaults. While upholding the constitutional validity of section 16(2)(c) of the CGST Act, the High Court held that the provision cannot be applied mechanically or in isolation merely because the supplier failed to deposit tax, filed nil or short returns, became non-traceable or had its registration cancelled retrospectively. Supplier-side irregularities may justify investigation, but they do not by themselves establish that the recipient’s ITC is inadmissible. Authorities must independently examine the genuineness of the transaction, receipt and business use of goods or services, documentary evidence produced by the recipient, the precise nature of the supplier’s default, recovery action against the supplier and, where fraud is alleged, material establishing a nexus between the recipient and the wrongdoing. At the same time, the judgment does not create an unconditional right to ITC: the recipient continues to bear the burden of establishing eligibility under section 155. The practical protection therefore lies in maintaining a complete transaction trail consisting of invoices, transport and e-way bill records, inward and stock records, banking evidence and proof of consumption, business use or onward supply.

Introduction

The Punjab and Haryana High Court’s decision in Shaurya Alloys Pvt. Ltd. v. State of Punjab and another, CWP-34296-2024 and connected matters, pronounced on 1 October 2026, is an important ruling for every genuine purchaser facing reversal of input tax credit because the supplier did not pay GST, filed nil/short returns, became non-traceable, or had registration cancelled retrospectively. The judgment arose from a very large batch of 424 writ petitions, showing that the issue is not isolated but widespread across industries and States.

The Court did not strike down section 16(2)(c) of the CGST Act. It held the provision constitutionally valid. Therefore, the legal argument can no longer be framed simply as: “The buyer has paid GST to the supplier, so the buyer cannot be asked to reverse ITC in any case.”

That is not the law after this judgment.

The real strength of the decision lies elsewhere. The Court held that section 16(2)(c) cannot be used as a mechanical recovery tool against the purchaser merely because there is a supplier-side default. The Department must investigate the actual transaction, examine the recipient’s evidence, identify the nature of the supplier’s failure, consider action taken against the supplier, and establish a factual basis before fastening liability on the purchaser.

In practical terms, the judgment changes the debate from a narrow portal-based question— “Did the supplier deposit tax?”—to the real question— “Was the transaction genuine, were goods or services actually received, did the recipient act bona fide, and is there material connecting the recipient with the alleged fraud or tax loss?”

The statutory controversy

Section 16(1) of the CGST Act permits a registered person to take credit of input tax charged on supplies used or intended to be used in the course or furtherance of business, subject to prescribed conditions.

Section 16(2)(c) provides that no registered person shall be entitled to ITC unless:

the tax charged in respect of such supply has been actually paid to the Government, either in cash or through utilisation of input tax credit admissible in respect of the said supply.

The literal reading creates a serious commercial difficulty. A purchaser may:

buy goods from a GST-registered supplier;

receive a tax invoice;

receive and use the goods in business;

pay the supplier through banking channels, including the GST amount;

reflect the purchase in books and returns;

possess e-way bill, transport proof, stock register and payment trail;

yet later receive a notice because the supplier did not pay tax, did not file GSTR-3B, filed a nil return, vanished, or had registration cancelled retrospectively.

The purchaser does not have statutory power to inspect the supplier’s electronic cash ledger, electronic credit ledger, GSTR-3B, bank account, books, stock, or tax-payment position. Nor does the purchaser have coercive powers to recover tax from the supplier. The purchaser’s practical difficulty is genuine.

However, the Court held that this practical difficulty does not by itself invalidate section 16(2)(c). The provision remains part of the eligibility conditions for ITC. What the Court rejected was the Department’s practice of treating every supplier default as conclusive proof against the recipient.

What the Court actually decided

The core holding may be put simply:

Section 16(2)(c) is valid, but it cannot be applied in isolation or mechanically to reverse ITC from a purchaser merely because the supplier has failed to pay tax or the supplier’s registration has subsequently been cancelled.

The Court recognised that a cancellation of the supplier’s registration, including retrospective cancellation, a nil return, low tax payment, adverse intelligence input, departmental alert, or allegations against the supplier may give the Department a valid reason to investigate. But these facts are only the starting point of inquiry. They are not, by themselves, proof that the purchaser’s ITC is inadmissible.

This distinction is crucial:

Circumstance noticed by Department	Legal consequence after Shaurya Alloys
Supplier registration cancelled	Basis for inquiry; not automatic basis for ITC denial
Cancellation made retrospective	Department must examine why, from which date, and whether it affects the particular buyer’s transaction
Supplier did not file GSTR-3B	Relevant fact; not conclusive against recipient
Supplier paid nil or insufficient tax	Requires investigation into default and recovery; does not automatically prove recipient’s ineligibility
Supplier declared bogus/fake	Department must still examine recipient’s purchase and recipient’s alleged nexus with fraud
Intelligence or DGGI alert	May trigger verification; cannot substitute evidence in adjudication
Invoice appearing in GSTR-2B	Helpful evidence, but not by itself conclusive proof of physical receipt
Invoice not appearing in GSTR-2B	May require explanation under applicable law; it does not prove non-receipt of goods by itself

The judgment therefore protects a genuine buyer from arbitrary ITC reversal, but it does not protect an accommodation-entry beneficiary, a collusive buyer, or a purchaser unable to establish the actual receipt and business use of goods or services.

Why the ruling matters

For several years, departmental proceedings in supplier-default cases have frequently followed a predictable pattern:

The Department finds that the supplier did not pay tax, did not file GSTR-3B, was non-existent at the declared premises, or had registration cancelled.

A notice is issued to the recipient alleging that ITC is inadmissible under section 16(2)(c).

The notice asks the recipient to reverse ITC with interest and penalty.

The recipient produces invoice, bank payment, e-way bill and stock records.

The authority nevertheless confirms demand by saying that supplier tax payment is a statutory condition.

The High Court has now made it clear that such an approach is not enough. The adjudicating authority cannot merely repeat the words of section 16(2)(c). It must decide the purchaser’s case on facts and evidence.

The judgment is especially relevant in the following situations:

The supplier was registered on the date of supply but registration was cancelled later.

Registration was cancelled retrospectively, sometimes from the date of grant of registration.

The supplier uploaded GSTR-1 but did not file GSTR-3B.

The purchase reflects in GSTR-2A or GSTR-2B, but the supplier defaulted in payment.

The recipient made payment through bank and has a complete transaction trail.

E-way bill and transport documents establish physical movement of goods.

The recipient has inward register, stock register, production record or onward-sale evidence.

The Department relies only on a supplier alert, investigation report or third-party statement.

The Department alleges fraud without showing how the purchaser participated in it.

The Court’s framework for officers

The High Court’s contribution is not merely a broad statement of fairness. It laid down a working framework for officers dealing with ITC reversal cases. The underlying message is that adjudication must be evidence-based, transaction-specific and procedurally fair.

1. Supplier default is not the end of inquiry

If a supplier has not deposited tax, the Department must not stop at that fact. It must determine:

Which invoices are involved;

Which tax period is involved;

What precisely is the supplier’s default;

Whether tax was not paid at all, paid partly, paid under a wrong head, or paid later;

Whether the supplier’s default is established from reliable records;

What recovery action has been initiated against the supplier;

Whether the tax has already been recovered from the supplier.

This is important because a demand against the recipient cannot become a substitute for a proper supplier-side investigation and recovery exercise.

2. Retrospective cancellation is not conclusive

A retrospective cancellation order may appear serious, but it does not erase the purchaser’s evidence or automatically make every past supply fictitious.

The proper officer must examine:

The cancellation order and the reasons recorded therein;

The effective date of cancellation;

Whether the order was passed after notice and opportunity to the supplier;

Whether cancellation was based on non-filing of returns, non-functioning of premises, fraud, or another ground;

Whether the cancellation itself has been appealed, restored or stayed;

Whether the relevant supply occurred during a period when the supplier was operational and shown as active on the GST portal;

Whether the cancellation order contains any finding concerning the specific invoice or transaction of the recipient.

A later cancellation of registration does not automatically establish that goods were never supplied on an earlier date.

3. The recipient’s evidence must be examined

The purchaser has a burden under section 155 to prove eligibility for ITC. That burden is real. But it can be discharged through credible documentary and commercial evidence.

An authority must not reject evidence through stock phrases such as “documents are self-serving” or “supplier is non-existent.” The authority must deal with each category of proof and explain why it is accepted or rejected.

4. Fraud cannot be borrowed from the supplier

If the Department proposes demand under section 74 or section 74A, as applicable to the relevant period, the show-cause notice must contain foundational facts indicating fraud, wilful misstatement or suppression attributable to the notice.

It is not sufficient to allege:

The supplier was found to be bogus; therefore, the recipient has availed fraudulent ITC.

The missing link is material showing that the recipient knew of, participated in, facilitated, or was connected with the alleged supplier fraud. In other words, supplier-side fraud cannot be mechanically transferred to the recipient.

5. No double recovery

If the tax in respect of the disputed invoices has already been paid by or recovered from the supplier, the Department must account for that fact. The same tax liability cannot effectively be collected twice—once from the supplier and again through ITC reversal from the recipient—without proper adjustment and legal basis.

6. Natural justice is substantive, not cosmetic

A taxpayer is entitled to a meaningful opportunity to answer the allegations. This includes:

Complete disclosure of relied-upon documents and material, subject to lawful privilege;

Opportunity to file supporting records;

Personal hearing under section 75(4), where adverse decision is contemplated;

A reasoned order addressing the taxpayer’s evidence;

Consideration of cross-examination requests where the case is based on third-party statements.

A notice based on undisclosed investigation material or an order that ignores detailed evidence cannot be defended merely by citing section 16(2)(c).

The evidence a genuine buyer should preserve

The judgment is a relief, but only for taxpayers who can prove their case. The practical lesson is clear: documentation must tell one complete commercial story.

An invoice and bank payment alone may not always be enough. A strong ITC defence is built through a connected chain of evidence showing purchase, movement, receipt, accounting, consumption or resale, and payment.

Transaction-wise document checklist

Stage	Documents to maintain
Vendor selection	GST registration verification, PAN, address proof, business profile, bank verification, past dealings, vendor declaration
Commercial order	Purchase order, rate confirmation, quotation, contract, email or WhatsApp correspondence
Supply invoice	Original tax invoice, invoice serial continuity, HSN/SAC, quantity, taxable value, tax breakup
Goods movement	E-way bill, transporter LR/GR, vehicle number, freight bill, toll evidence where available, delivery challan
Receipt of goods	Gate entry, inward register, goods receipt note, unloading proof, weighbridge slip, quality report
Accounting	Purchase ledger, creditor ledger, stock register, inventory reconciliation, journal entries
Payment	Bank statement, payment advice, UTR details, cheque details, supplier ledger confirmation
Business use	Production register, consumption record, job-work record, BOM, outward supply linkage, sales invoice
GST compliance	GSTR-2A/2B download, GSTR-3B workings, ITC register, reconciliation statement
Defence preparation	Supplier registration status on transaction date, cancellation order, correspondence with supplier, affidavit if relevant

Not every business will have every document. For example, a service recipient may not have e-way bills or weighbridge slips. But the taxpayer should produce evidence appropriate to the nature of supply.

Illustrative example

Assume a manufacturer purchased 100 MT of MS scrap from Supplier A in July 2023. Supplier A was active on the GST portal when the invoice was issued. The purchaser paid the invoice, including GST, through RTGS. The goods moved under e-way bill and LR, entered the factory gate, were weighed, recorded in raw-material stock, consumed in manufacturing, and linked to finished goods sold with GST payment.

In 2025, Supplier A’s registration is retrospectively cancelled from April 2023 because it did not file returns.

After Shaurya Alloys, the cancellation does not by itself permit reversal of the purchaser’s ITC. The Department must examine whether this particular purchase was genuine, consider the buyer’s documents, investigate the supplier’s default, and show material—if it alleges fraud—connecting the purchaser with the alleged fraudulent arrangement.

On the other hand, if the purchaser has only an invoice and a payment entry but no transport proof, no inward entry, no stock correlation, no consumption record and no explanation for unusual trade terms, the Department may have a much stronger basis to question the genuineness of the transaction.

How to answer a show-cause notice

A reply to an ITC reversal notice should not be limited to the statement that “payment was made through banking channel” or “the supplier was registered on the date of invoice.” It should be structured around the statutory conditions and the High Court’s framework.

Suggested structure

1. Preliminary objection to mechanical invocation

State that the notice proceeds only on supplier-side allegations—such as retrospective cancellation, nil GSTR-3B, non-payment of tax, supplier non-traceability or intelligence report—without any independent finding on the recipient’s transaction.

2. Separate each disputed invoice

Prepare an invoice-wise chart containing:

Supplier GSTIN;

Invoice number and date;

Taxable value and GST;

E-way bill number;

LR/GR number;

Vehicle number;

Date of receipt;

Gate entry/GRN number;

Stock/production reference;

Bank payment UTR;

GSTR-2A/2B reflection;

ITC claimed period.

3. Establish actual receipt

Attach and explain the documents proving physical receipt and business use of goods or receipt of services.

4. Establish bona fides

Demonstrate that the supplier was shown as registered at the relevant time, that reasonable vendor verification was performed, that payment was made through normal banking channels, and that the transaction was commercially genuine.

5. Demand disclosure of adverse material

Seek copies of the cancellation order, supplier investigation report, statements, inspection report, GST return analysis, e-way bill analysis, alleged fake-invoice list, and all other material relied upon.

6. Challenge the fraud allegation

Where section 74/74A is invoked, specifically plead that the notice does not set out any foundational facts showing fraud, wilful misstatement or suppression by the recipient.

7. Raise the double-recovery point

Ask the Department to disclose whether tax has been recovered or is recoverable from the supplier and whether any amount has already been deposited by the supplier against the disputed invoices.

8. Request hearing and cross-examination

Ask for a personal hearing. If reliance is placed on statements of supplier, transporter, broker, employee or third party, request cross-examination and insist on a speaking order if such request is rejected.

Model paragraph for a reply

The following paragraph can be adapted for a show-cause notice reply:

The proposed reversal rests solely upon alleged default, non-filing of returns and/or subsequent cancellation of registration of the supplier. Such circumstances may justify verification, but cannot constitute conclusive proof against the noticee. The notice does not dispute the receipt of goods by the noticee through any independent evidence; it does not deal with the e-way bills, transport records, gate-entry documents, goods receipt notes, stock records, payment through banking channels and utilisation of inputs in the course of business furnished by the noticee.

In Shaurya Alloys Pvt. Ltd. v. State of Punjab and another, CWP-34296-2024 and connected matters, decided on 01.10.2026, the Punjab and Haryana High Court upheld the validity of section 16(2)(c), but held that it cannot be invoked mechanically or in isolation merely because a supplier has defaulted in payment of tax or its registration has been subsequently cancelled. The authority is required to independently examine the genuineness of the recipient’s transaction, evidence of receipt of goods or services, the nature of supplier default, action taken for recovery from the supplier, and any material establishing nexus of the recipient with the alleged fraud.

In the present case, there is no material even remotely suggesting that the noticee was party to any fraud, collusion, accommodation-entry arrangement or wrongful availment of credit. A subsequent or retrospective cancellation of the supplier’s registration cannot retrospectively nullify a genuine transaction supported by contemporaneous documentary and commercial evidence. The proposed demand is therefore liable to be dropped.

A note of caution

This ruling should not be cited as though it creates an absolute rule that ITC can never be reversed from a purchaser after supplier default. It does not.

The High Court has preserved the legal force of section 16(2)(c) and the burden of proving ITC eligibility under section 155. The judgment gives protection against arbitrary and mechanical adjudication; it does not excuse a recipient from proving the supply, receipt, business use and bona fides of the claim.

Therefore, the correct legal position is:

A genuine purchaser is not automatically liable merely because the supplier defaulted.

A supplier’s retrospective cancellation is not conclusive proof against the buyer.

The Department must investigate and adjudicate the purchaser’s case independently.

The purchaser must produce credible evidence of a real transaction.

In fraud cases, the Department must establish a factual nexus between buyer and supplier-side wrongdoing.

Recovery cannot be pursued mechanically or result in double collection of the same tax.

Conclusion

Shaurya Alloys is a significant correction to the practice of treating the purchaser as the easiest target whenever a supplier defaults. It restores the central importance of evidence, transaction reality, recovery from the actual defaulter, and procedural fairness.

For a bona fide taxpayer, the decision provides a powerful ground to resist ITC reversal where the Department relies only on the supplier’s cancellation, default, non-filing, adverse alert or alleged non-existence. The defence, however, must be built on records—not only on legal submissions.

The most useful working principle from the judgment is this:

A supplier-side irregularity may start an investigation; it cannot, without an independent examination of the recipient’s transaction and evidence, end the recipient’s ITC claim.