Section 16(2)(c) of GST Act 2017: Constitutional Validity Statutory Evolution & ITC denial Limits

Summary: The constitutional validity of Section 16(2)(c) of the CGST Act, 2017 stands substantially settled following the Supreme Court’s decision in Bhandari Scrap Traders v. Union of India, which declined to declare the provision unconstitutional or read it down. However, the supplied material emphasises that this does not permit automatic or mechanical denial of Input Tax Credit merely because the supplier failed to remit tax to the Government. The applicable statutory framework, relevant tax period, genuineness of the transaction, recipient’s conduct and nature of the supplier’s default remain material. Particular importance is attached to the statutory change from 1 October 2022, when substituted Section 41(2) introduced an express reversal and subsequent re-availment mechanism, followed by Rule 37A dealing with specified supplier defaults. The material therefore distinguishes the pre-1 October 2022 regime from the subsequent framework and states that later machinery cannot automatically be applied retrospectively. It further distinguishes Rule 37, concerning the recipient’s failure to pay the supplier, from Rule 37A, concerning supplier non-payment of tax. Decisions including Suncraft Energy, Shree Karni Electrovision, Sumetco Alloys, Neelkanth Entrepreneurs and Shaurya Alloys are discussed in this evolving context. The material particularly relies upon Shaurya Alloys for the proposition that constitutional validity and administrative application are separate questions. Where Section 74 is invoked, supplier default alone cannot automatically establish fraud, wilful misstatement or suppression by the recipient.

Constitutional Validity of Section 16(2)(c)

Section 16(2)(c) of the CGST Act, 2017 makes payment of the tax charged on a supply to the Government a condition for availment of Input Tax Credit. The provision has generated considerable litigation where the transaction is genuine, the supplier is registered, the recipient has paid the supplier the consideration including GST and the goods or services have been received, but the supplier has failed to remit the tax to the Government.

The constitutional controversy surrounding Section 16(2)(c) has now been substantially settled by the Supreme Court in ^[1] Bhandari Scrap Traders v. Union of India, decided on 24 July 2026, but the Union has filed SLP in ^[2] Union of India Vs. Sahil Enterprises and ^[3] Union of India Vs. Malaya Rub Tech Industries both are from Tripura High Court. However the Hon’ble Supreme Court upheld the validity of the provision and declined to read it down.

• The important question now is not whether Section 16(2)(c) is constitutionally valid, but how it is to be applied in a particular case, having regard to the statutory framework, the relevant period, the conduct of the recipient and the nature of the supplier’s default.

Bhandari Scrap Traders and Maruti Enterprise

In ^[4] Maruti Enterprise v. Union of India, the Gujarat High Court upheld Section 16(2)(c), taking into account the wider GST framework, particularly Section 41 and the mechanism of reversal and subsequent re-availment of ITC.

The Supreme Court in Bhandari Scrap Traders affirmed that approach and held that there were no grounds to declare Section 16(2)(c) unconstitutional or to read it down. The consequence is clear.

A challenge based merely on the proposition that a bona fide recipient cannot control the supplier’s tax compliance can no longer sustain a constitutional challenge to Section 16(2)(c) as it is no more res-integra.

Section 41(2) and the Change from 1 October 2022

Bhandari, however, does not mean that every reversal of ITC on account of supplier default is automatically valid. The Finance Act, 2022 substituted Section 41 with effect from 1 October 2022. The substituted Section 41(2) introduced an express mechanism for reversal of ITC where the supplier has not paid the tax and subsequent re-availment when the supplier makes payment.

The statutory scheme therefore became one of availment, supplier default, reversal, subsequent payment and re-availment. This is a significant change from the original Section 41 applicable during the initial years of GST. Accordingly, the statutory regime applicable to ITC availed before 1 October 2022 cannot automatically be equated with the regime introduced thereafter.

Rule 37 and Rule 37A

Rule 37 and Rule 37A deal with different defaults. Rule 37 concerns failure of the recipient to pay the supplier the value of the supply together with tax within the prescribed period. Rule 37A concerns the consequences arising from non-payment of tax by the supplier in the circumstances prescribed by the Rule.

The distinction is therefore fundamental. Rule 37 deals with the recipient’s default towards the supplier, whereas Rule 37A deals with the supplier’s default towards the Government. Rule 37A was inserted by Notification No. 26/2022-Central Tax dated 26 December 2022 and provides the mechanism for reversal and subsequent re-availment in the circumstances contemplated by the Rule. Consequently, an order founded upon supplier non-payment must identify and apply the correct statutory provision and cannot mechanically invoke Rule 37.

Section 76 and Supplier Liability

Section 76 specifically deals with tax collected but not paid to the Government. It therefore imposes an independent liability upon the person who collected the tax. Section 76 does not override Section 16(2)(c). Both provisions operate within the statutory scheme. Section 76 addresses the supplier’s liability, while Section 16(2)(c), read with Section 41(2) and Rule 37A, governs the recipient’s ITC.

The existence of a statutory remedy against the supplier nevertheless remains relevant when examining whether the Department has properly proceeded against the person responsible for the tax default.

Pre-2022 and Post-2022 Statutory Regimes

The distinction between the pre-2022 and post-2022 regimes is now particularly important. Section 16(2)(c) existed from 1 July 2017. However, the present Section 41(2) reversal and re-availment mechanism came into force only from 1 October 2022, and Rule 37A was introduced subsequently. Therefore, in a case relating to an earlier period, the Department must establish the precise statutory authority for applying the subsequent machinery to that period.

This is not an attempt to reopen the constitutional validity of Section 16(2)(c). The constitutional issue stands concluded by Bhandari. The question is one of statutory applicability and retrospectivity.

Shanti Kiran India and Earlier Jurisprudence

In ^[5] Commissioner, Trade & Tax, Delhi v. M/s Shanti Kiran India (P) Ltd., decided on 9 October 2025, the Supreme Court declined to interfere with the judgment protecting the bona fide purchasing dealer under the Delhi VAT Act. The decision is relevant for the broader principle that the liability of a purchasing dealer must be determined with reference to the statutory scheme applicable to the transaction. However, it cannot be directly transplanted into the GST regime because the Supreme Court in Bhandari distinguished the VAT framework from the CGST framework.

Similarly, ^[6] D.Y. Beathel Enterprises Vs. State Tax Officer, decided by the Madras High Court, remains relevant to the principle that the Department should identify and proceed against the defaulting supplier. However, being a pre-amendment decision, it cannot now be relied upon to challenge the constitutional validity of Section 16(2)(c). The purchaser-protective approaches adopted in Sahil Enterprises and Instakart must likewise be read subject to the subsequent Supreme Court decision in Bhandari.

Suncraft Energy and Supplier Examination

In ^[7] Suncraft Energy Private Limited and Ors. Vs. The Assistant Commissioner, State Tax, Ballygunge Charge and Ors. (02.08.2023 – CALHC), the Hon’ble High Court of Kolkata has said that the Seller has to be examined from all aspects as the purchaser is giving all the details and this position was before 01.10.2022 and the Union of India has carried the matter to the Hon’ble Supreme Court, and the Hon’ble Supreme Court has dismissed the S.L.P filed by ^[8] The Assistant Commissioner of State Tax, Ballygunjge Charge and Ors vs Suncraft Energy Private Limited and Ors. observing that the dispute is a minute one.

Several High Courts have pronounced the judgements on these guidelines.

Subsequent High Court Decisions

The subsequent decisions of the High Courts demonstrate that the constitutional issue and the adjudicatory issue must be kept separate. In ^[9] Shree Karni Electrovision vs. Union of India, the Rajasthan High Court recognised the mandatory nature of Section 16(2)(c) while also considering the reversal and re-availment mechanism under Section 41(2) and Rule 37A. ^[10] In Sumetco Alloys Pvt. Ltd. v. Union of India, the Rajasthan High Court recognized the effect of Bhandari and declined to reopen the constitutional challenge.

In ^[11] Neelkanth Entrepreneurs Pvt. Ltd. v. State of U.P., the Allahabad High Court likewise treated the constitutional issue as settled. Most importantly, in ^[12] Shaurya Alloys Pvt. Ltd. v. State of Punjab, decided on 1 October 2026, the Punjab and Haryana High Court, while accepting the constitutional validity of Section 16(2)(c), emphasised that the provision cannot be applied mechanically or in isolation. The Department must examine the statutory framework, the nature of the supplier’s default, the genuineness of the transaction and, where Section 74 is invoked, the foundational facts establishing fraud, wilful misstatement or suppression.

Burden of Proof Under Section 155

Section 155 places the burden of proving eligibility for ITC upon the claimant. The recipient must therefore be able to establish the genuineness of the transaction through invoices, payment records, proof of receipt of goods or services and other contemporaneous evidence. However, this does not mean that the recipient must produce records exclusively within the supplier’s control, such as the supplier’s internal tax-payment records. The Department must establish the factual foundation for the allegation of supplier default.

Supplier Default and Section 74 Fraud Allegations

A supplier’s failure to pay tax cannot, by itself, establish fraud by the recipient. This distinction becomes critical where Section 74 is invoked. The Department must establish the recipient’s own fraud, wilful misstatement or suppression in accordance with the statutory requirements. The Supreme Court’s recent decision in ^[13] M/s Tata Steel Ltd. v. Union of India, decided on 25 August 2026, reinforces the importance of satisfying the statutory requirements for invoking Sections 73 and 74 and establishing the necessary foundation for a Section 74 proceeding. Thus, a supplier’s tax default and the recipient’s alleged fraud are distinct factual questions.

Present Legal Position

The law relating to Section 16(2)(c) has now moved from a constitutional controversy to a question of statutory application.

Bhandari Scrap Traders has settled the constitutional validity of Section 16(2)(c). The provision cannot ordinarily be challenged merely because the recipient cannot control the supplier’s tax compliance. At the same time, Bhandari does not authorise mechanical reversal of ITC. Section 16(2)(c) must operate within the statutory framework of Sections 41, 73, 74, 76 and 155 and Rules 37 and 37A.

For pre-1 October 2022 periods, the applicability of the subsequent Section 41(2) and Rule 37A machinery requires separate examination. The Department must establish the statutory authority for applying the relevant mechanism to the period in question. The latest judgment in Shaurya Alloys reinforces the distinction between constitutional validity and administrative application.

A genuine transaction cannot automatically be treated as fraudulent merely because the supplier failed to remit tax. The Department must establish the supplier’s default, apply the correct statutory provision, consider the applicable reversal and re-availment mechanism and, where fraud is alleged, establish the recipient’s own involvement.

The present legal position may therefore be succinctly stated: Bhandari Scrap Traders closes the constitutional challenge to Section 16(2)(c); it does not authorise mechanical reversal of ITC, retrospective application of subsequent statutory machinery, invocation of an incorrect rule or an automatic inference of fraud from the supplier’s default. But we have to examine what the Hon’ble Supreme Court would do as it has stayed coercive action in ^[14] Sumetco Alloys Private Limited Vs. Union of India & Ors in SLP 33701/2026 dated 30.09.2026, as the Hon’ble Rajasthan High Court by following M/s. Bhandari Scrap has dismissed the writ petitions against which the Petitioner has approached the Hon’ble Apex Court and has ordered notice in Sahil Enterprises and Malaya Rubber Industries.

I request the eminent readers to go through the article and give your suggestions if any.

Reference

[1] Bhandari Scrap Traders v. Union of India, reported in [2026] 188 taxmann.com 986 (SC) [24-07-2026] ↩

[2] Sahil Enterprises Vs Union of India; Union of India Vs. Sahil Enterprises in SLP (C) No. 31573/2026 ↩

[3] Malaya Rub-Tech Industries Vs Union of India; Union of India Vs. Malaya Rub Tech Industries in SLP (C) No. 31578/2026 ↩

[4] Maruti Enterprise v. Union of India, reported in [2026] 115 GST 695 (Gujarat) ↩

[5] Commissioner, Trade & Tax, Delhi v. M/s Shanti Kiran India (P) Ltd., Civil Appeal No(s). 2042-2047/2015 ↩

[6] D.Y. Beathel Enterprises Vs. State Tax Officer – [2021] 91 GSTR 300 (Mad) ↩

[7] Suncraft Energy Private Limited and Ors. vs. The Assistant Commissioner, State Tax, Ballygunge Charge and Ors. – [2023] 117 GSTR 78 (Cal) ↩

[8] The Assistant Commissioner of State Tax, Ballygunjge Charge and Ors. vs. Suncraft Energy Private Limited and Ors. – [2024] 121 GSTR 290 (SC) ↩

[9] Shree Karni Electrovision vs. Union of India – [2026] 189 taxmann.com 840 (Rajasthan) [17-08-2026] ↩

[10] Sumetco Alloys Pvt. Ltd. v. Union of India, DBCWP No. 9323/2026 dated 13-08-2026 ↩

[11] Neelkanth Entrepreneurs Private Limited Vs State of U.P., Writ Tax No. 1024/2026 ↩

[12] Shaurya Alloys Pvt. Ltd. v. State of Punjab, CWP No. 34296 of 2024 (O&M) and connected matters, decided 01.10.2026 ↩

[13] M/s Tata Steel Ltd. v. Union of India, 2026 INSC 920; [2026] 189 taxmann.com 520 (SC) [25-08-2026] ↩

[14] Sumetco Alloys Private Limited Vs. Union of India & Ors. in SLP 33701/2026 dated 30.09.2026 ↩

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