GST Rule 86B Before 1 October 2022: Validity of 1% Cash Payment Requirement & Recovery

Summary: The validity and enforceability of Rule 86B of the CGST Rules, 2017, particularly before 1 October 2022, raise important questions about delegated legislative powers and the recovery of GST already discharged through the electronic credit ledger. Advocate Ravindra Kumar Rastogi examines show cause notices issued under Section 73 for FY 2022-23 demanding one per cent of output tax in cash despite taxpayers having fully discharged their tax liabilities using otherwise eligible input tax credit. Rule 86B, introduced through Notification No. 94/2020-Central Tax with effect from 1 January 2021, restricts utilisation of the electronic credit ledger where monthly taxable supplies exceed ₹50 lakh, subject to specified exceptions. The author argues that, before 1 October 2022, Section 49(4) authorised conditions governing credit utilisation but did not expressly authorise restrictions, while Section 49(12), specifically empowering the Government to prescribe a maximum proportion of tax payable through credit, became operative only from that date. The analysis examines Sections 148 and 164, principles restricting delegated legislation, and judicial decisions including Kunj Behari Lal Butail, Nazir Ahmad and State of U.P. v. Singhara Singh. Particular attention is given to the Himachal Pradesh High Court’s decision in A.M. Enterprises, which questioned Rule 86B’s statutory backing without declaring it invalid. Independently, the article contends that breach of a payment-mode restriction does not automatically establish unpaid tax or wrongly utilised credit recoverable under Section 73 when the underlying liability has already been fully discharged. The possible consequences for interest, penalties, GST registration and departmental adjudication are examined alongside the Revenue’s competing interpretation.

Rule 86B and Section 73: Can GST Already Paid Through ITC Be Demanded Again?

Show cause notices under Section 73 of the CGST Act, 2017 are now being issued for FY 2022-23 on a ground that has nothing to do with turnover or with the eligibility of credit. The dealer has declared every supply, has paid the whole of his output tax, and holds credit that nobody disputes. The only complaint is that in a month in which his taxable supply crossed fifty lakh rupees he paid the tax entirely out of the electronic credit ledger and did not pay one per cent of it in cash, as Rule 86B of the CGST Rules, 2017 requires. On that footing one per cent of the output tax of those months is demanded over again as tax, with interest under Section 50 and penalty under Section 73(9).

Such a notice raises two questions, and they are separate. The first is whether, for the months before 1 October 2022, there was any provision in the Act which allowed the Government to cap the use of the credit ledger at all. The second is whether, even if the rule is taken to be valid, a breach of it can be turned into a demand of tax under Section 73. This article takes them in that order.

Rule 86B of CGST Rules: Scope, 99% ITC Restriction and Exceptions

Rule 86B was inserted by Notification No. 94/2020 Central Tax dated 22.12.2020 with effect from 01.01.2021. It opens with the words “Notwithstanding anything contained in these rules” and provides that a registered person shall not use the amount available in the electronic credit ledger to discharge output tax in excess of ninety nine per cent of such liability, where the value of taxable supply, other than exempt and zero rated supply, exceeds fifty lakh rupees in a month. The heading of the rule is “Restrictions on use of amount available in electronic credit ledger”.

The first proviso lifts the restriction in several cases. Two of them matter in almost every notice. Clause (a) applies where the proprietor, karta, managing director or any two partners or whole time directors have paid income tax of more than one lakh rupees in each of the last two financial years. Clause (d) applies where the registered person has paid, through the electronic cash ledger, more than one per cent of the total output tax liability, applied cumulatively, up to that month in the current financial year. A notice which does not show that these clauses were examined has not even established that the rule applied.

Statutory Authority for Introducing Rule 86B Under Section 164

The preamble of Notification No. 94/2020 recites only one source of power: Section 164 of the Act. It does not refer to Section 49(4). It does not refer to Section 148. This matters, because Section 164 is a general power. Sub-section (1) allows rules “for carrying out the provisions of this Act”, and sub-section (2) allows rules on matters which the Act requires or permits to be prescribed. Both presuppose that something in the Act itself calls for the rule. The inquiry therefore shifts to the Act as it stood on the relevant dates.

Section 49(4) Before 1 October 2022: Conditions Versus Restrictions on ITC

Section 49(4), in its original form, read:

“The amount available in the electronic credit ledger may be used for making any payment towards output tax under this Act or under the Integrated Goods and Services Tax Act in such manner and subject to such conditions and within such time as may be prescribed.”

The provision spoke of manner, conditions and time. It did not speak of restrictions. The words “and restrictions” were added after “subject to such conditions” by Section 110(b) of the Finance Act, 2022, and that clause was brought into force on 01.10.2022 by Notification No. 18/2022 Central Tax dated 28.09.2022. A rule which describes itself in its own heading as a rule of “Restrictions” could not, for April to September 2022, draw support from a provision which at that time permitted only conditions.

There is a point of substance here and not only of words. A condition regulates how a right is exercised. A cap of ninety nine per cent takes away a part of the right itself, since it forbids the use of admitted credit for one per cent of the liability and compels cash in its place. Parliament evidently saw the difference, which is why it added the second word.

Section 49(12): Prospective Power to Restrict ITC Utilisation From 1 October 2022

The same Section 110 of the Finance Act, 2022 inserted sub-section (12) in Section 49. It provides that, notwithstanding anything contained in the Act, the Government may, on the recommendations of the Council, subject to such conditions and restrictions, specify the maximum proportion of output tax liability which may be discharged through the electronic credit ledger by a registered person or a class of registered persons. This too came into force only on 01.10.2022.

Three features of this insertion deserve notice.

(a) It is not retrospective. The Finance Act, 2022 contains no deeming clause for Section 49(12) and no clause validating anything done under Rule 86B before 01.10.2022.

(b) The contrast lies in the very next section. Section 111 of the same Finance Act substituted Section 50(3) and declared that it shall be deemed to have been substituted with effect from 1 July 2017. In adjoining sections of one enactment Parliament gave retrospective operation to one amendment and withheld it from the other. That choice has to be respected.

(c) It cannot be passed off as clarificatory. It opens with a non obstante clause, confers a power to be exercised on the recommendation of the Council, and takes effect from a date appointed by notification. If Section 49(4) already carried the power to fix a maximum proportion, sub-section (12) was unnecessary, and the legislature is not presumed to enact what is unnecessary.

The conclusion for April to September 2022 is plain. During those months the Act contained neither the word “restrictions” in Section 49(4) nor the power in Section 49(12). A notice for FY 2022-23 which cites Section 49(12) for April, May or June 2022 relies on a provision that was not on the statute book in those months.

Limits of Delegated Legislation Under Section 164 of CGST Act

It is settled that a rule must conform to the parent Act and cannot travel beyond it. In Kunj Behari Lal Butail v. State of H.P., (2000) 3 SCC 40, the Supreme Court held that a general power to make rules for carrying out the purposes of an Act cannot be used to bring into existence substantive rights or obligations which the Act does not contemplate. An obligation to pay tax in cash while admitted credit lies unused in the ledger is a substantive obligation. Before 01.10.2022 the Act did not contemplate it.

Section 164(4) points the same way. It tells us how far a rule may go upon its own breach: the rules may provide that a contravention shall be liable to a penalty not exceeding ten thousand rupees. A rule cannot provide that its breach creates a liability to tax, and Rule 86B does not even attempt to say so.

Section 148: Special Procedures for Payment of GST and Statutory Safeguards

There was one provision in the Act, from the beginning, which dealt with a special procedure for payment of tax by a class of registered persons. Section 148 permits the Government, on the recommendations of the Council and subject to such conditions and safeguards as may be prescribed, to notify certain classes of registered persons and the special procedures to be followed by them, including those with regard to payment of tax. Rule 86B does precisely this. It picks out a class, namely persons whose taxable supply in a month exceeds fifty lakh rupees, and lays down for that class a different mode of payment.

Yet no notification under Section 148 was issued, no class was notified, and no safeguards were prescribed. The general power in Section 164 was used instead. The answer to this is as old as Nazir Ahmad v. King Emperor, AIR 1936 PC 253: where a power is given to do a certain thing in a certain way, the thing must be done in that way or not at all. The Supreme Court adopted the rule in State of U.P. v. Singhara Singh, AIR 1964 SC 358, observing that if it were otherwise the statutory provision might as well not have been enacted. If a cap on credit could be introduced under Section 164 without any of the safeguards of Section 148, those safeguards would mean nothing.

A.M. Enterprises Vs State of Himachal Pradesh (Himachal Pradesh High Court)

The validity of Rule 86B came up before a Division Bench of the Himachal Pradesh High Court in M/s A.M. Enterprises v. State of Himachal Pradesh, CWP No. 1517 of 2024, decided on 20.09.2024. The registration of the dealer had been cancelled for violation of the rule over periods which included April 2022 to March 2023. The Court noticed that the State had given no answer to the plea that the rule had no backing in the Act, observed that rules framed under Section 164 must have backing in the main body of the statute, and then said in paragraph 25:

“We do find force in the petitioner’s contention that Rule 86B of the Act has no statutory backing and appears to be ultra vires the provisions of the HPGST Act, 2017.”

Candour requires the next sentence to be stated as well. The Court went on to say that it need not rest its decision on that issue, and it granted relief on the ground that cancellation of registration was disproportionate. The rule was therefore not struck down, and reports which say that it was are inaccurate. What the judgment offers is the considered view of a Division Bench on the very provisions involved. It is persuasive, not conclusive, and it should be cited for what it is.

The judgment is useful on a second point which is often missed. The Court recorded that the credit in the ledger was the dealer’s own money, that it had been used to discharge his tax liability, that there was no default in discharge of tax as such, and that no prejudice had been caused to the department. That finding goes directly to the second question.

Section 73: Whether Violation of Rule 86B Creates Recoverable GST Liability

Section 73(1) can be invoked where tax has not been paid or has been short paid or erroneously refunded, or where input tax credit has been wrongly availed or utilised. In a Rule 86B case the first three do not arise. The output tax charged by Section 9 of the CGST Act and Section 5 of the IGST Act has been paid in full, and paid on time. The complaint is about the mode of payment and not about the amount.

The department is then left with the words “wrongly utilised”. That reading also fails, for the following reasons.

• The credit was validly availed under Section 16 and was used to pay the dealer’s own output tax, which is the very purpose for which Section 49(4) allows it to be used.
• Neither the Act nor the Rules contain a deeming provision by which use of eligible credit beyond ninety nine per cent is to be treated as tax not paid.
• Where the Rules intended a consequence for breach of Rule 86B they provided it in terms, as in Rule 21(g), which makes such a breach a ground for cancellation of registration. Nothing converts the breach into a demand of tax.
• A demand under Section 73 does not correct the mode of payment. It collects one per cent a second time, while the credit already debited for that one per cent is not restored. The Government then holds more than the tax charged by Section 9. Article 265 forbids collection of tax without authority of law, and that authority must be found in a charging provision: Mathuram Agrawal v. State of M.P., (1999) 8 SCC 667.

Interest and penalty fall with the demand. Interest under Section 50(1) is for failure to pay tax within the prescribed period, and there was none. Section 50(3) is for credit wrongly availed and utilised, which is not the allegation. Penalty under Section 73(9) is consequential on tax determined as payable. At the highest, the breach of a rule attracts the general penalty that Section 164(4) and Section 125 contemplate, and nothing more.

Applicability and Enforceability of Rule 86B From 1 October 2022

For months after 01.10.2022 the argument is narrower but it does not disappear. Section 49(12) is an enabling provision. It does nothing until the Government, on the recommendation of the Council, specifies a maximum proportion. Rule 86B was made on 22.12.2020 under Section 164, nearly two years before that power existed, and it has not been reissued or notified afresh under Section 49(12). Whether a rule made before a power came into being can be treated as an exercise of that power is an open question, and a fair one to raise. In these months the dealer should in any case press clause (d) of the proviso, because cash paid from April onwards is counted cumulatively and often exceeds one per cent by the later part of the year.

Revenue’s Counterarguments on Validity and Enforcement of Rule 86B

The department is not without an answer, and a reply which ignores it will not survive an appeal. It will be said that the word “conditions” in the unamended Section 49(4) was wide enough to cover a ceiling of ninety nine per cent, that the insertion of “and restrictions” and of Section 49(12) was made by way of abundant caution, and that Section 164(2) reaches every matter which may be prescribed. It will also be said that A.M. Enterprises is obiter on vires, and that no High Court has yet declared the rule invalid. An adjudicating officer cannot in any event declare a rule ultra vires; he is bound by it.

For that reason the vires point must be raised in the reply so that it is on record, but the reply should stand equally on the grounds an officer can accept: that the provisos were not examined, that Section 49(12) is cited for months when it did not exist, and that no tax remains unpaid for Section 73 to operate upon. The question of validity will finally be settled only in writ jurisdiction.

Conclusion: Validity of Rule 86B and Recovery of 1% Cash Payment

For April to September 2022 the demand of one per cent in cash rests on a rule which, on the text of the Act as it then stood, had nothing to stand on. Parliament supplied the power only from 01.10.2022 and chose not to look back. For the later months the rule may have a parent, but the parent has not yet spoken through a notification of its own. And for the whole period one simple fact remains: the tax was paid. A rule about how tax is to be paid cannot be made the means of collecting it twice.