Non-compliance with CGST Rule 86B: 99% ITC Restriction & 1% Cash Payment Mandate

99% ITC restriction and 1% cash payment mandate

Rule 86B was introduced into the CGST Rules, 2017, through Notification No. 94/2020-Central Tax, dated December 22, 2020, and came into effect on January 1, 2021. The rule imposes a significant restriction on the use of Input Tax Credit (ITC) for certain taxpayers. It begins with a non-obstante clause, “Notwithstanding anything contained in these rules,” which gives it an overriding effect on other provisions of the CGST Rules concerning the utilization of the electronic credit ledger.

The core mechanism of the rule is to limit the use of the amount available in the electronic credit ledger for discharging output tax liability to a maximum of 99%. This restriction applies to registered persons whose value of taxable supply in a month exceeds ₹50 lakh. Consequently, such taxpayers are mandatorily required to pay a minimum of 1% of their output tax liability through the electronic cash ledger, regardless of the ITC balance available to them.

The overriding nature of this rule is a critical legal aspect. It means that a taxpayer cannot simply argue that they have sufficient ITC available under the general provisions of Section 49 of the CGST Act to cover their entire liability. Rule 86B carves out a specific exception to this general principle, making compliance with its 1% cash payment mandate a separate and compulsory legal obligation. Therefore, any defence against its non-compliance must either challenge the validity of the rule itself or prove that the taxpayer falls within one of its specific exemptions.

Calculation of the ₹50 Lakh monthly turnover threshold

The term “value of taxable supply” for the purpose of this ₹50 lakh threshold explicitly excludes:

1. Exempt Supplies: These are supplies of goods or services which attract a nil rate of tax or are wholly exempt from tax under Section 11 of the CGST Act or under Section 6 of the IGST Act.

2. Zero-Rated Supplies: These primarily include exports of goods or services and supplies to a Special Economic Zone (SEZ) developer or unit.

Therefore, a registered person must assess their turnover on a monthly basis by aggregating the value of all their taxable supplies within India (both intra-state and inter-state) and excluding the value of any exempt or zero-rated supplies made during that month. If this calculated value surpasses ₹50 lakh for a particular month, the provisions of Rule 86B become applicable for that tax period. This monthly check is a mandatory compliance step before the filing of each GSTR-3B return.

Comprehensive review of ALL exemption clauses

Suspension and cancellation of GST registration (Rule 21(g))

By far the most severe and business-critical consequence of non-compliance with Rule 86B is the potential for the suspension and subsequent cancellation of the firm’s GST registration. Rule 21 of the CGST Rules, which lists the grounds for cancellation of registration, was amended to include a new clause (g), which explicitly states that a registration is liable to be cancelled if the registered person “violates the provision of rule 86B”.

This provision is often described as a “business death sentence” because a cancelled GST registration makes it illegal for the firm to make taxable supplies, issue tax invoices, and claim ITC. It effectively paralyzes the business, disrupting supply chains and leading to a complete loss of operations. The threat of invoking Rule 21(g) is the department’s most potent tool to enforce compliance with Rule 86B.

Potential for prosecution in cases of willful default

Section 132 of the Act provides for imprisonment and fines for offenses committed with a deliberate intention to evade tax. If the department were to allege that the non-compliance with Rule 86B was a willful and fraudulent act aimed at evading tax, prosecution proceedings could theoretically be initiated. However, for this to occur, the department would need to establish mens rea, or a guilty mind, which would be difficult if the firm has accurately reported its turnover and paid its full liability via ITC. The primary defence against this remote possibility is to consistently demonstrate that the non-compliance was a bona fide error and not a deliberate act of defiance.

Himachal Pradesh High Court Ruling in A.M. Enterprises

In the landmark case of A.M. Enterprises v. State of Himachal Pradesh & Ors., the Himachal Pradesh High Court conducted a detailed analysis of the statutory framework and concluded that Rule 86B lacks the necessary statutory backing in the CGST/HPGST Act. The Court held that the rule appears to be ultra vires the Act.

Key observations from the judgment that can be cited are:

• The power to frame rules under Section 164 does not extend to creating provisions that impose severe restrictions on ITC usage without a clear legislative mandate from the Act itself.
• The Electronic Credit Ledger represents the taxpayer’s own funds, and restricting its use when tax obligations have been met is unjustified.
• The Court also commented on the disproportionality of penalties like registration cancellation for such a violation, especially when no actual harm was caused to the revenue authorities.