Legal Analysis of condition of payment of tax by seller for availing ITC by buyer [Section 16(2)(c)]

Legal Analysis of the condition of payment of tax by the seller for availing ITC by buyer [Section 16(2)(c)]

Input Tax Credit is the soul of the GST Law. Ever since the enactment of the Goods and Services Tax Act, 2017 conditions for availment of input tax credit has been the subject matter of debate. Seamless flow of input tax credit is the essence of the GST Law and the point where it breaks, it goes against this very principle. On one side, the Act promotes seamless flow of ITC and on the other side the Government is making all attempts to break this chain so as to increase their revenues.

Section 16 of the CGST Act, 2017 lists out various conditions with regards availment of Input Tax Credit by buyer of goods. In this article, we shall restrict our discussion to the legal validity of Clause (c) of Sub Section 2 of Section 16 of the Act which reads as under:

“subject to the provisions of section 41 or section 43A, 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; and”

Thus, analysis of Section 16(2)(c) of the Act leads us to the following conclusions with regards to the conditions for availment of ITC:

i) That the buyer of goods has to ensure that the seller of goods has paid the GST charged by the seller in the Tax Invoice to the Government.

ii) That in case, the seller does not pay the tax to the Government, ITC cannot be availed by the buyer of goods who has lawfully purchased goods from the seller who is a registered dealer under the CGST Act, 2007 and has been awarded a valid registration under the Act.

iii) That the buyer of goods has to bear the loss of GST Input which should lawfully belong to him and for which he has made payments to the registered supplier.

Further, Rule 36(4) as inserted by Notification No. 49/2019-Central Tax dated 09-10-2019 has been further amended by the Central Board of Indirect Taxes and Customs vide Notification No. 75/2019 – Central Tax dated 26-12-2019, operative part of which reads as under:

“2. In the Central Goods and Services Tax Rules, 2017 (hereinafter referred to as the said rules), with effect from the 1st January, 2020, in rule 36, in sub-rule (4), for the figures and words “20 per cent.”, the figures and words “10 per cent.” shall be substituted.”

Thus, the amended Rule 36(4) of the CGST Rules, 2017 leads us to the following conclusions with regards to the conditions for availment of Input Tax Credit (ITC):

> That in case the supplier of goods does not upload the invoice or debit notes as per Section 37(1) or erroneously uploads the invoice in such a way that the invoice does not get reflected in GSTR 2A of the buyer of such goods, ITC of the same cannot be availed by the buyer.

> That the Rule 36(4) read with Circular No. 123/42/2019– GST dated 11-11-2019 states as under:

♦ The recipient of goods may claim additional ITC to the extent of 10% of ITC reflected in his auto populated GSTR 2A.

♦ The balance ITC can be claimed once the same gets reflected in his auto populated GSTR 2A.

A conjoint reading of the above provisions makes it amply clear that it is the buyer of goods who shall be ultimately held responsible for any wrongdoings on the part of the supplier. The Government grants GST Registration after various checks and balances specified under the Act and once it grants registration to any dealer it allows to collect GST on its behalf and deposit taxes as per the provisions of the Act failing which stringent/ coercive actions can be taken by them. Of late, the Govt. has also issued instructions to the field formations for verification of premises in cases of new registrations. So the registration under GST is granted only after submitting necessary documents and verification of the registrant by the officers appointed by the Government only. It is not automatic. Thus, every registered dealer is an agent of the Government whereby it collects GST on behalf of the Government on sales made by them.

The Government has all the mechanisms in place for recovery of tax evaded, if any, by taxpayers. There are provisions for harsh penalties and prosecutions which can be resorted to by the revenue authorities and the law enforcement agencies are duty bound to help them. However, instead of using these mechanisms and taking into task the erring the taxpayers, the Government is imposing unnecessary obligations on innocent taxpayers and in turn causing undue harassment to them. However, the innocent buyer does not have any such liberty at his disposal. The provision is an unjust obligation cast upon the taxpayers who does not have any means to compel the supplier of goods to pay tax so that they can get their rightful ITC. The liability of the buyer ceases once payment is made to the seller by him. The only responsibility of the buyer is to ensure that the seller is holding a valid GST Registration Number. The said restriction increases the working capital requirements of the business houses for no fault of theirs and may also lead to total denial of ITC available to them due to the fault of dishonest taxpayers.

Further, it is also a well known fact that the basic intent behind enacting Rule 36(4) was to stop the menace of fake invoices and thereby block revenue leakages. However, the author is of the view that the Government will not be successful in its purpose since the person who is engaged in the business of issuing fake invoices shall always be regular in filing his GST Returns and consequently the same shall be reflected in the GSTR 2A of the buyer and thus ITC can be claimed by him very easily. Thus, the very premise behind the rule will be defeated. Further, the manner in which Government is adopting ways and means to block illegitimate claim of ITC, it is causing more problems to the honest taxpayers than those with malafide intentions.

Though ITC is not a vested right of the taxpayer and has always been subject to some conditions or restrictions. But satisfaction of such conditions should be prima facie within the reach of the tax payers. The Govt. cannot demand an impossible condition to be satisfied by a tax payer. Now, if we talk about the condition of the provision of section 16(2)(c),  the Govt. has not yet framed any mechanism whereby a person who has availed ITC can verify whether its supplier has paid due taxes on the sales made to him. So in absence of such mechanism in place it is too harsh and impractical to penalise a buyer by disallowing ITC. In this respect it is worthwhile to discuss some past judicial precedents under the VAT regime on the subject matter of ITC.

The Hon’ble Delhi High Court in the case of Arise India Limited vs Commissioner of Trade & Taxes, Delhi And Ors., TS-314-HC-2017(Del)-VAT (which was subsequently upheld by the Hon’ble Supreme Court of India, TS-2-SC-2018-VAT), taking a view in favour of the assessee held as under:

“41. The Court respectfully concurs with the above analysis and holds that in the present case, the purchasing dealer is being asked to do the impossible, i.e. to anticipate the selling dealer who will not deposit with the Government the tax collected by him from those purchasing dealer and therefore avoid transacting with such selling dealers. Alternatively, what Section 9 (2) (g) of the DVAT Act requires the purchasing dealer to do is that after transacting with the selling dealer, somehow ensure that the selling dealer does in fact deposit the tax collected from the purchasing dealer and if the selling dealer fails to do so, undergo the risk of being denied the ITC. Indeed Section 9 (2) (g) of the DVAT Act places an onerous burden on bonafide purchasing dealer.”

53. In light of the above legal position, the Court hereby holds that the expression ‘dealer or class of dealers’ occurring in Section 9 (2) (g) of the DVAT Act should be interpreted as not including a purchasing dealer who has bona fide entered into purchase transactions with validly registered selling dealers who have issued tax invoices in accordance with Section 50 of the Act where there is no mismatch of the transactions in Annexures 2A and 2B. Unless the expression ‘dealer or class of dealers’ in Section 9 (2) (g) is “read down” in the above manner, the entire provision would have to be held to be violative of Article 14 of the Constitution.

54. The result of such reading down would be that the Department is precluded from invoking Section 9 (2) (g) of the DVAT to deny ITC to a purchasing dealer who has bona fide entered into a purchase transaction with a registered selling dealer who has issued a tax invoice reflecting the TIN number. In the event that the selling dealer has failed to deposit the tax collected by him from the purchasing dealer, the remedy for the Department would be to proceed against the defaulting selling dealer to recover such tax and not deny the purchasing dealer the ITC. Where, however, the Department is able to come across material to show that the purchasing dealer and the selling dealer acted in collusion then the Department can proceed under Section 40A of the DVAT Act.”

The Hon’ble High Court of Punjab And Haryana in M/s Gheru Lal Bal Chand vs The State of Haryana and another, (2011) 45 VST 195, states as under:

“In legal jurisprudence, the liability can be fastened on a person who either acts fraudulently or has been a party to the collusion or connivance with the offender. However, law nowhere envisages imposing any penalty either directly or vicariously where a person is not connected with any such event or an act. Law cannot envisage an almost impossible eventuality. The onus upon the assessee gets discharged on production of Form VAT C-4 which is required to be genuine and not thereafter to substantiate its truthfulness by running from pillar to post to collect the material for its authenticity. In the absence of any malafide intention, connivance or wrongful association of the assessee with the selling dealer or any dealer earlier thereto, no liability can be imposed on the principle of vicarious liability. Law cannot put such onerous responsibility on the assessee otherwise, it would be difficult to hold the law to be valid on the touchstone of Articles 14 and 19 of the Constitution of India. The rule of interpretation requires that such meaning should be assigned to the provision which would make the provision of the Act effective and advance the purpose of the Act. This should be done wherever possible without doing any violence to the language of the provision. A statute has to be read in such a manner so as to do justice to the parties. If it is held that the person who does not deposit or is required to deposit the tax would be put in an advantageous position and whereas the person who has paid the tax would be worse, the interpretation would give result to an absurdity. Such a construction has to be avoided.

In other words, the genuineness of the certificate and declaration may be examined by the taxing authority, but onus cannot be put on the assessee to establish the correctness or the truthfulness of the statements recorded therein. The authorities can examine whether the Form VAT C-4 was bogus and was procured by the dealer in collusion with the selling dealer. The department is required to allow the claim once proper declaration is furnished and in the event of its falsity, the department can proceed against the defaulter when the genuineness of the declaration is not in question. However, an exception is carved out in. The event where fraud, collusion or connivance is established between the registered purchasing dealers or the immediate preceding selling registered dealer or any of the predecessors selling registered dealer, the benefit contained in Form VAT C-4 would not be available to the registered purchasing dealer. The aforesaid interpretation would result in achieving the purpose of the rule which is to make the object of the provisions of the Act workable, i.e., realization of tax by the revenue by legitimate methods.”

Though the above stated judgements were delivered under VAT regime, however the question of law touched upon in the above judgements remains valid even under the GST Law. Further, a close analysis of both the above judgements reveals that the essence of these judgements is violation of Article 14 of the Indian Constitution. In the following paras, we shall discuss as to how Article 14 gets violated in the above provisions.

Article 14 reads as under:

“14. Equality before law:

The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India. Prohibition of discrimination on grounds of religion, race, caste, sex or place of birth.”

Article 14 of the Indian Constitution is very large in scope. In the instant case, treating unequals as equal is also violative of the Article since it fails to pass the “test of arbitrariness” as laid down by various court judgements.

In Ajay Hasia Etc vs Khalid Mujib Sehravardi & Ors. Etc (1981) AIR 487, the Hon’ble Supreme Court of India patiently dealt with this ‘test of arbitrariness’. It reads as under:

“It must therefore now be taken to be well settled that what Article 14 strikes at is arbitrariness because any action that is arbitrary, must necessarily involve negation of equality. The doctrine of classification which is evolved by the courts is not para-phrase of Article 14 nor is it the objective and end of that Article. It is merely a judicial formula for determining whether the legislative or executive action in question is arbitrary and therefore constituting denial of equality. If the classification is not reasonable and does not satisfy the two conditions referred to above, the impugned legislative or executive action would plainly be arbitrary and the guarantee of equality under Article 14 would be breached. Wherever therefore there is arbitrariness in State action whether it be of the legislature or of the executive or of “authority” under Article 12, Article 14 immediately springs into action and strikes down such State action. In fact, the concept of reasonableness and non- arbitrariness pervades the entire constitutional scheme and is a golden thread which runs though the whole of the fabric of the Constitution.”

The Hon’ble Supreme Court in E. P. Royappa vs State Of Tamil Nadu & Anr,  1974 AIR  555, stated as under:

“Equality is a dynamic concept with many aspects and dimensions and it cannot be “cribbed cabined and confined” within traditional and doctrinaire limits. From a positivistic point of view, equality is antithetic to arbitrariness. In fact equality and arbitrariness are sworn enemies; one belongs to the rule of law in a republic while the other, to the whim and caprice of an absolute monarch. Where an act is arbitrary it is implicit in it that it is unequal both according to political logic and constitutional law and is therefore violative of Art. 14.”

In the instant case, the section very clearly treats guilty sellers and innocent purchasers alike which is clearly arbitrary and thus against the essence of Article 14. The innocent buyers are forced to take responsibility of the illegal acts of the guilty sellers over whom they have no control. Further, it is also observed that in many cases the Government on the one hand reverses ITC of the buyer and levies interest from him and on the other hand, recovers due tax from the seller with interest and penalty. Thus, there is double recovery of tax by the revenue. Further, it is very much justified to penalise buyers by not allowing them ITC in case a nexus is established between the erring seller and buyer in a manner that the entire transaction was done to avoid tax liability with a malafide intention.

Thus, from the above analysis we come to a broad conclusion that Section 16(2)(c) of the CGST Act, 2017 is unjustified in treating guilty and innocent taxpayers alike and thus there is complete arbitrariness in this section and clearly violative of Article 14 of the Constitution of India. Tax collection and enforcement is the primary responsibility of the State and Article 14 does not allow the State to cast a liability on its citizens for which they have no control and for which the state is primarily responsible. Further, it is very well understood that the intention of the Government is noble and to check tax evasion by unscrupulous elements, but the manner in which steps are taken, it is causing problems for honest taxpayers and mainly Small and Medium Sized Entities.

In view of the above analysis, the author is of the firm view that ITC cannot be denied to taxpayers in genuine cases i.e. where the buyer has genuinely purchased goods, but either the tax is not deposited by the seller (intentionally or unintentionally) or it is due to some other technical or non-technical reasons and there is no unholy nexus between them and the same will firmly stand in the court of law. The only thing which must be ensured by the buyer is to verify the validity of GST Registration number of the seller and should be prima facie satisfied about the credentials of the seller. However, in case any sort of nexus is established between the buyer and the seller and it is proved that the transaction was made with an intent to evade taxes, the taxpayers shall have face the wrath of law.

Note: The views expressed are the personal views of the author only. Therefore, the same should not be considered as final opinion on the subject matter. There may be other views also. So, the readers are advised to consider all the points before relying upon the above write ups.