Section 16(2)(c) and the Chain Supplier: The Limits of Bhandari Scrap Traders

Summary: The article examines the distinction between an immediate supplier’s failure to deposit GST and a default occurring further upstream in a supply chain. It analyses the Supreme Court’s 24 July 2026 order in Bhandari Scrap Traders, the Gujarat High Court’s judgment in Maruti Enterprise and the Tripura High Court’s ruling in Sahil Enterprises. The author argues that the words “such supply” in Section 16(2)(c) refer to the supply made to the claimant, rather than every preceding transaction. The discussion considers Section 41(2), Rule 37A, the burden under Section 155, the admissibility of credit utilised by the immediate supplier and the knowledge standard discussed by the Gujarat High Court. It identifies common defects in orders denying ITC solely on account of upstream defaults and sets out documentary evidence dealers should place on record. The article also notes the need to verify the current status of related proceedings and the applicable precedents before advancing the arguments in an appeal.

The fact pattern the Department keeps mislabelling

A dealer who has paid tax to its own supplier, and whose supplier has in turn paid that tax to the Government, does not lose input tax credit because some earlier dealer in the chain defaulted. That proposition follows from the words of Section 16(2)(c) of the Central Goods and Services Tax Act, 2017, and nothing in the recent Supreme Court order in Bhandari Scrap Traders holds otherwise.

The pattern recurs almost daily before the appellate authorities. A registered dealer buys goods from a registered supplier. It holds a tax invoice. The credit appears in its Form GSTR-2B without restriction or mismatch. The goods are received and used in business. The supplier files its Form GSTR-3B and discharges the tax on that outward supply. Months or years later the Department takes up a scrutiny, traces the supplier’s own purchases, finds a defaulter two or three steps above, and denies credit to the dealer at the end of the line.

The order of rejection then cites Bhandari Scrap Traders v. Union of India, as though the Supreme Court had settled the question. It had not. The Supreme Court decided a case about an immediate supplier who collected tax and kept it. It said nothing about a chain, and it did not authorise the Department to trace a default upwards and visit the consequence downwards.

This article sets out what the Supreme Court decided on 24 July 2026, what the Gujarat High Court decided before it, where the Tripura High Court stands, and precisely where the Department oversteps when it carries that authority into a chain supply case.

What the Supreme Court decided, and what it did not

The Supreme Court dismissed three special leave petitions and affirmed a judgment. It did not lay down a rule for chain supplies.

The order was passed on 24 July 2026 by a Bench of Hon’ble Mr. Justice Sanjay Kumar and Hon’ble Mr. Justice Sanjeev Sachdeva in SLP(C) No. 23931/2026, with SLP(C) No. 24088/2026 and SLP(C) No. 24103/2026. The petitions arose from the common judgment of the Gujarat High Court dated 1 May 2026 in R/Special Civil Application No. 18080 of 2023, Maruti Enterprise v. Union of India, and a batch of about fifty connected petitions.

The operative reasoning of the Supreme Court is contained in four short paragraphs. The Court held that the distinctions between the Delhi Value Added Tax Act, 2004, and the CGST Act, drawn by the Gujarat High Court from paragraph 42 onwards, and the scheme of availing credit set out in paragraph 56 of that judgment, demonstrate that no parity can be drawn between the two enactments. It noted the Gujarat court’s reliance on Section 41 and on Sections 73 and 74 of the CGST Act in the context of a purchasing dealer re-availing reversed credit once the supplier is made to discharge the liability. It then held that the High Court was justified in declining to declare Section 16(2)(c) unconstitutional or to read it down, expressed complete and respectful agreement, and dismissed the petitions.

Two features of that order deserve emphasis, because they are routinely overlooked in the orders of rejection.

First, the Court was dealing with the constitutional vires of Section 16(2)(c). The Gujarat High Court had expressly clarified, in paragraph 5 of its judgment, that it had not examined the merits of individual matters and that its judgment was confined to the examination of vires. Paragraph 90 of that judgment directed the Registry to list the writ petitions to be decided on merits, and left the rest of the contentions and the rights of the parties open. A judgment confined to vires, affirmed in an order confined to vires, cannot be the authority for a finding of fact in an individual dealer’s assessment.

Second, the factual substratum was a direct transaction. The challenge throughout proceeded, in the words of paragraph 4 of the Gujarat judgment, on a sole aspect, namely the default of the supplier in depositing the tax collected. The supplier in question was the dealer’s own supplier. No petitioner before the Gujarat High Court, and no petitioner before the Supreme Court, was a dealer whose own supplier had paid and whose grievance was an upstream default. That question was simply not before either Court.

The Gujarat reasoning, read whole and not in extract

The Gujarat High Court upheld Section 16(2)(c) because it read the provision together with Section 41(2), Section 53 and Section 155 of the CGST Act and Rule 37A of the Central Goods and Services Tax Rules, 2017. The Department relies on the conclusion and ignores the reasoning that produced it.

The judgment was delivered by Hon’ble Mr. Justice A.S. Supehia and Hon’ble Mr. Justice Pranav Trivedi and is marked Approved for Reporting. Its central propositions are these.

The credit is a statutory concession and not a vested right, available on the conditions the statute prescribes, and clauses (a) to (d) of Section 16(2) are to be read conjointly and not independently (paragraphs 63, 73 and 80).

Section 41(2) requires a recipient to reverse credit where the supplier has not paid, and the proviso permits the recipient to re-avail that credit once the supplier pays. Rule 37A sets out the operational procedure, allowing the recipient to retain the credit until 30 September of the following financial year and to reverse it by 30 November, with interest running only beyond that date (paragraphs 58, 62, 74 and 75).

Section 53 and the destination based character of the levy were decisive. The Court held that if credit were allowed in the originating State on an invoice alone, that State would have to transfer to the destination State an amount it never received (paragraphs 59 to 61, following the Kerala High Court in M. Trade Links).

Section 155 places the burden of proving eligibility on the person claiming credit, and the Court noted that neither the Delhi High Court nor the Tripura High Court had examined the effect of that provision (paragraphs 69 and 70).

Three further passages matter a great deal for the chain cases, and they are examined later in this article. Paragraph 76 holds that the maxim lex non cogit ad impossibilia is not attracted, because a purchaser can protect itself by an indemnity clause in its agreement with the supplier. Paragraph 87 adopts the balanced approach of the European Court of Justice in Axel Kittel. Paragraph 88 records that the Government must undertake a comprehensive re-evaluation and build a real time tracking mechanism to insulate bona fide recipients.

Read whole, the judgment is not an instrument for denying credit to a compliant dealer. It is a judgment that upholds a provision on the express footing that the statute contains a mechanism of reversal and re-availment, that the Department can and must recover from the defaulter, and that credit is to be denied only where the recipient knew or ought to have known of the evasion.

Tripura’s contrary view, and why it is not dead

The Tripura High Court read Section 16(2)(c) down to protect a bona fide purchaser, and the Supreme Court’s order in Bhandari Scrap Traders did not set that judgment aside.

In M/s Sahil Enterprises v. Union of India, WP(C) No. 688 of 2022, decided on 6 January 2026, a Bench of Hon’ble the Chief Justice Mr. M.S. Ramachandra Rao and Hon’ble Mr. Justice S. Datta Purkayastha held that there is no mechanism with the recipient to verify whether the supplier has discharged its liability, a fact the respondents did not dispute (paragraph 16); that the purchasing dealer cannot be asked to do the impossible (paragraph 20); and that the provision places an onerous burden on a bona fide purchasing dealer (paragraph 22). The Court declined to strike the provision down. It held instead, at paragraph 57, that Section 16(2)(c) is not violative of Articles 14, 19(1)(g), 265 or 300A, but ought not to be interpreted to deny credit to a purchaser in a bona fide transaction, and should be applied only where the transaction is found to be not bona fide, collusive or fraudulent.

The Tripura Court attached weight to a matter of pleading that arises in very many of these cases. At paragraphs 53 and 54 it observed that the Assistant Commissioner had invoked only Section 73, which deals with cases other than fraud or wilful misstatement, and that the failure to invoke Section 74 was very significant. On that footing it held, at paragraph 56, that the transaction was bona fide and the dealer could not be penalised.

The status of that judgment is the point most often misstated in the orders of rejection. The Supreme Court’s order records that it was informed that a special leave petition has been entertained in relation to the Tripura decision. It then distinguished that decision on the ground that the Tripura High Court had not undertaken the exercise the Gujarat High Court performed. The Supreme Court did not dismiss the petition against Sahil Enterprises, and it did not declare that judgment to be bad law. Its present status should be verified from the record before the point is argued either way.

The position, therefore, is that two High Courts have taken divergent views, that the Supreme Court has affirmed one of them in an order confined to vires, and that the question of a chain supply was before neither.

“Such supply” does not travel up the chain

The statutory condition is tied to one identified supply, the supply made to the claimant, and the Department has no textual warrant to read it as a condition about every supply that preceded it.

Section 16(2) opens with the words “no registered person shall be entitled to the credit of any input tax in respect of any supply of goods or services or both to him unless”. The words “to him” fix the transaction. Clause (c) then requires that “the tax charged in respect of such supply has been actually paid to the Government”. The expression “such supply” carries back to the supply to him, and to no other.

Every other clause of the sub-section is anchored to the same transaction and confirms the reading. Clause (a) speaks of a tax invoice issued by a supplier, meaning his supplier. Clause (aa) speaks of the details of that invoice furnished by the supplier and communicated to the recipient. Clause (b) speaks of the recipient having received the goods. Clause (ba) speaks of the credit in respect of the said supply not having been restricted under Section 38. The Gujarat High Court itself held, at paragraph 80, that the clauses are to be read conjointly. Read conjointly, they describe a single supply between two identified persons.

What the Department does in a chain case is to detach clause (c) from that anchor and treat it as a condition about the integrity of the whole chain. That is an addition to the statute. The Gujarat High Court, in the very judgment on which the Department relies, recorded at paragraph 86(b) and (d) the settled propositions that a taxing statute is to be interpreted literally, that the Court must interpret it in the light of what is clearly expressed, that it cannot imply anything which is not expressed, and that it cannot import provisions so as to supply an assumed deficiency. Those propositions were quoted from the Constitution Bench in Commissioner of Sales Tax v. Modi Sugar Mills Ltd., AIR 1961 SC 1047. A Department that invokes the Gujarat judgment cannot disown the canon of construction the judgment adopted.

The legislative scheme points the same way. Where Parliament wished to make a recipient answerable for a supplier’s default, it said so expressly in Section 41(2), and it confined the obligation to the recipient of that supply. Where it wished to place a burden of proof, it said so in Section 155, and it confined the burden to the person claiming the credit. Neither provision speaks of the supplier’s supplier.

It may be added that the Department’s own remedy lies elsewhere. Sections 73 and 74 empower it to proceed against the defaulter. The Gujarat High Court recorded at paragraph 87 that it is not the case of the Department that it is destitute or vulnerable to the inaction of a seller who has not paid, and at paragraph 88 that the Government must take prompt and immediate steps for recovery from the erring suppliers instead of compelling purchasers to pursue cumbersome alternate remedies.

The admissible credit argument, which must be met and not evaded

The one textual foothold the Department has in a chain case lies in the closing words of clause (c), and it is a narrow one that the Department almost never establishes on the record.

Clause (c) permits the tax on the supply to be paid “either in cash or through utilisation of input tax credit admissible in respect of the said supply”. The argument runs thus. The immediate supplier discharged its output tax not in cash but by utilising credit. That credit came from its own purchase. Its own supplier defaulted. Therefore the credit utilised was not admissible, the payment was not a good payment, and the condition in clause (c) remains unsatisfied in the hands of the dealer at the end of the line.

The argument deserves a serious answer rather than indignation, and there are four.

First, the qualifying words attach to the said supply, which is again the supply to the claimant. On the natural reading, what must be admissible is the credit utilised in respect of that supply, not the entire credit history of the supplier. The Department’s reading requires the same expansion of “said supply” that the previous section of this article has shown to be unwarranted.

Second, admissibility is a legal status, not an assumption. Credit standing in a supplier’s electronic credit ledger is admissible until it is held otherwise by an order. If the Department says the credit utilised was inadmissible, it must identify the credit, identify the proceeding in which it was held inadmissible, and show the reversal. An assertion that someone upstream defaulted is not a finding that a particular credit was inadmissible on the date it was utilised.

Third, Section 41(2) and Rule 37A supply the lawful route and the Department must show it has been followed. The scheme is that the recipient of the defaulted supply reverses the credit with interest and re-avails it when the supplier pays. That recipient is the immediate supplier in a chain case, not the dealer two steps below. The Gujarat High Court upheld the provision precisely because this mechanism exists. A Department that bypasses the mechanism and jumps to the far end of the chain is not applying the judgment it cites.

Fourth, the enquiry is fact specific and must be conducted. Whether the immediate supplier paid in cash or by credit is visible in its Form GSTR-3B. Whether any credit it used has been reversed is a matter of record. An order that denies credit without these findings is an order without reasons on the only question that could support it.

The practical consequence is that the dealer should obtain and place on record the immediate supplier’s Form GSTR-3B for the relevant tax period, and should frame its ground so that the burden of establishing inadmissibility, having been asserted by the Department, is seen to rest where the assertion was made.

Paragraph 87: the standard the Gujarat Court itself adopted

The most useful passage for a dealer in a chain case is in the judgment the Department relies upon. At paragraph 87 the Gujarat High Court adopted the test that credit may be denied only where the recipient knew or ought to have known of the fraudulent evasion.

The passage reads that the Act provides the authorities with enough power to proceed against the selling dealer for recovery, that Sections 73 and 74 empower the Department to proceed against defaulting parties, and that a balanced approach is needed, which finds place in the decision of the European Court of Justice in Axel Kittel v. Belgian State (C-439/04) and Belgian State v. Recolta Recycling SPRL (C-440/04). The Court then stated the principle in terms: under this principle, the availment of input tax credit can be denied only if it is shown that the recipient knew or ought to have known that their purchase was connected with a fraudulent evasion of tax.

That sentence should be read with care in a chain case, because it does three things at once.

It places the onus of demonstration on the Department. The words are “only if it is shown”. Section 155 puts on the dealer the burden of proving eligibility, which it discharges by producing the invoice, the Form GSTR-2B entry, proof of receipt of goods, proof of payment and the supplier’s Form GSTR-3B. The further allegation that the purchase was connected with a fraudulent evasion is an allegation by the Department, and the Court required it to be shown.

It fixes the subject of the knowledge as the recipient’s own purchase. The question is whether this dealer knew or ought to have known that its purchase was connected with an evasion. A default three steps above, of which the dealer had no notice and no means of notice, does not answer that question.

It imports a standard of fraudulent evasion, not of mere non payment. A supplier who files returns and later fails to pay is in default. That is not, without more, a fraudulent evasion with which the dealer’s purchase was connected.

It must be stated fairly that paragraph 87 sits alongside paragraphs 71 and 72, which the Department invariably cites. Paragraph 71 observes that non deposit has a cascading effect on a purchaser who becomes a subsequent supplier. Paragraph 72 observes that a bona fide purchaser must exercise due diligence and, upon becoming aware of non compliance by the supplier, refrain from further transactions that would perpetuate the credit chain. Those observations are not a licence to deny credit for an upstream default. Paragraph 72 is expressly conditioned on the purchaser becoming aware, which is the same knowledge standard that paragraph 87 states. Read together, the three paragraphs say that a dealer who knows and continues may be denied credit, and a dealer who neither knew nor could have known may not.

Where the order of rejection goes wrong

A rejection that disposes of a chain supply appeal by citing Bhandari Scrap Traders commits a series of identifiable errors, and each is a separate ground of challenge.

A further point concerns the use of precedent. The Gujarat High Court is not a Court of superior jurisdiction over the authorities in Uttar Pradesh, and its judgment operates as persuasive authority. The Supreme Court’s order carries the weight of Article 141, but only for what it decides. An adjudicating authority that elevates a vires decision into a rule of adjudication for every chain case applies it beyond its ratio.

It should be acknowledged that an appellate authority may also reject an appeal on grounds that have nothing to do with any of this, such as limitation under Section 107(1) and (2), the pre deposit under Section 107(6), or a deficiency in the documents filed. Before the arguments in this article are deployed, the order must be read to identify the ground actually taken, since a rejection on limitation is met by a different answer altogether.

What the dealer must place on record

The argument succeeds on documents, not on adjectives. The file should establish the transaction, the immediate supplier’s discharge of tax, and the absence of knowledge, in that order.

On the transaction itself:

1. The tax invoice issued by the immediate supplier, carrying its GSTIN, and the corresponding e-way bill where applicable.

2. The Form GSTR-2B of the relevant period showing the invoice, with no mismatch and no restriction communicated under Section 38.

3. Proof of receipt of the goods, such as the goods receipt, transport documents, weighment slips, and the entry in the stock register.

4. Proof of payment to the supplier through banking channels, which also answers the second proviso to Section 16(2) on payment within one hundred and eighty days.

5. The supplier’s registration status on the date of supply, taken from the portal, with the date of any later cancellation noted.

On the immediate supplier’s discharge of tax, which is the decisive material in a chain case:

1. The supplier’s Form GSTR-1 disclosing the outward supply to the dealer.

2. The supplier’s Form GSTR-3B for the tax period of that supply, showing the tax paid, and showing whether the payment was made in cash or by utilisation of credit.

3. Where payment was by utilisation of credit, any material showing that the credit so utilised has not been held inadmissible or reversed.

4. Any intimation under Rule 37A received by the supplier, and the action taken on it.

On bona fides and the absence of knowledge:

• The absence of any allegation of collusion or connivance in the show cause notice, and the absence of any proceeding under Section 74 against the dealer.
• The absence of any communication from the Department, before the transactions, alerting the dealer to the supplier’s non compliance.
• The commercial history with the supplier, the correspondence, and any indemnity or tax compliance clause in the agreement, which answers paragraph 76 of the Gujarat judgment on its own terms.

Two cautions are in order. The dealer’s own Form GSTR-3B and the manner in which it discharged its output liability will be examined, so the file must be internally consistent. And where the dealer has itself sold the goods onward, the Department may invoke paragraph 71 of the Gujarat judgment, which requires the knowledge point under paragraph 87 to be pleaded with particular care.

Conclusion

The constitutional battle over Section 16(2)(c) is, for the present, over. The provision stands, and an appeal that opens by asking an adjudicating authority to read it down will not travel far after 24 July 2026. The battle that remains is about the reach of the provision, and there the dealer’s position is strong.

Bhandari Scrap Traders decided that a purchaser cannot escape clause (c) when its own supplier collected tax and kept it. It did not decide that a purchaser forfeits credit when its own supplier paid and a stranger further up the chain did not. The Department has taken a holding about an immediate supplier and applied it to a chain, and in doing so it has read into a taxing provision a tracing requirement that Parliament did not enact and that the Gujarat High Court’s own canon of construction forbids.

There is a wider point, and the Gujarat High Court made it rather than the Bar. At paragraph 88 the Court recorded that it is high time the Government undertook a comprehensive re-evaluation of the dicey situation purchasers face, that there is a pressing need for legislative amendment or clarification to relieve the disproportionate burden placed on purchasers with an honest claim, that a robust technology driven mechanism should enable verification of supplier payments against specific invoices in real time, and that the Government must take prompt steps to recover from erring suppliers rather than compel purchasers into cumbersome remedies. The Court added that in the absence of stringent oversight, unscrupulous sellers could enrich themselves at the expense of both the exchequer and honest buyers.

That observation is an indictment of administration, not of the dealer. Until the mechanism it calls for exists, an authority that denies credit to a compliant purchaser for a default it could not have seen, in a chain it cannot audit, is not enforcing Section 16(2)(c). It is enforcing something Parliament did not write.

Sources

Supreme Court of India, SLP(C) No. 23931/2026, Bhandari Scrap Traders v. Union of India & Ors., with SLP(C) Nos. 24088/2026 and 24103/2026, order dated 24 July 2026.

High Court of Gujarat at Ahmedabad, R/Special Civil Application No. 18080 of 2023, Maruti Enterprise v. Union of India & Ors., common CAV judgment dated 1 May 2026.

High Court of Tripura at Agartala, WP(C) No. 688 of 2022, M/s Sahil Enterprises v. Union of India & Ors., judgment dated 6 January 2026.

Note on verification

Paragraph references above are drawn from the texts of the three judgments. They should be checked against certified copies before the article is published or the arguments are carried into a memorandum of appeal. Two matters in particular require independent verification: the present status of the special leave petition against the Tripura judgment in Sahil Enterprises, which the Supreme Court’s order records as having been entertained and did not dispose of; and whether any High Court has since ruled directly on the position of a purchaser whose immediate supplier has paid.