Bhandari Scrap Traders and Retrospective GST Cancellation: When the Department Creates the Default Section 16(2)(c), Section 29(2), Rule 37A, and the Protection of Bona Fide Buyers
Summary: The article discusses the implications of the Supreme Court’s decision in Bhandari Scrap Traders v. Union of India & Ors. on Section 16(2)(c) of the CGST Act, 2017, particularly in cases involving retrospective cancellation of GST registration under Section 29(2). It states that while the judgment upholds the constitutional validity of Section 16(2)(c), it does not automatically justify denial of input tax credit in every case or approve retrospective cancellation without proper reasons or compliance with natural justice. The article distinguishes between deliberate supplier non-payment of tax and situations where a supplier is unable to file GSTR-3B following retrospective cancellation of registration. It explains the statutory framework under Sections 16, 29, 67, 69, 73, 74, 83, 122 and 132 of the CGST Act and Rule 37A, discusses the position of bona fide buyers supported by documentary evidence, provides illustrative examples of genuine and deliberate defaults, reviews the judicial approach to retrospective cancellation, and outlines practical litigation strategies. The article concludes that enforcement should distinguish between actual supplier default and defaults arising from retrospective administrative action, while recognising Rule 37A as a mechanism for re-availment where tax is subsequently paid.
Introduction
The recent decision in Bhandari Scrap Traders v. Union of India & Ors. has reignited an old but deeply important debate under the GST regime: when can input tax credit be denied, and on whom should the burden finally fall when the supplier fails to remit tax to the Government? The Supreme Court has upheld the validity of section 16(2)(c) of the CGST Act, 2017, thereby confirming that the recipient’s credit is conditional and may be reversed where the supplier has collected tax but not paid it to the exchequer. Yet the legal position is not as simple as many departmental notices suggest. The judgment does not license mechanical reversal in every case, nor does it authorise the department to convert every administrative suspicion into a retrospective tax default.
The real controversy arises where the supplier’s inability to file GSTR-3B is not a case of deliberate non-payment, but the consequence of a retrospective cancellation of registration, suspension without notice, or an NGTP-style classification unsupported by tangible material. In such cases, the question is not merely whether tax was paid to Government. The deeper question is whether the department itself has created the default and then used that default to burden the bona fide buyer. That distinction lies at the centre of natural justice in indirect tax administration.
The statutory scheme
Section 16 of the CGST Act is the foundation of input tax credit. It creates a structured entitlement, not an absolute right. The recipient must satisfy the conditions prescribed by law, and one of the most important conditions is that the tax charged on the supply must actually reach the Government. Section 16(2)(c) embodies that principle. The Supreme Court has now validated this statutory condition. In practical terms, therefore, the legislature is entitled to say that credit cannot be enjoyed where the tax has remained unpaid upstream.
But the GST law does not stop there. The Act contains a complete enforcement architecture. Sections 73 and 74 provide machinery for recovery in non-fraud and fraud cases. Section 122 imposes penalty. Section 132 permits prosecution in serious cases. Section 67 authorises inspection, search, and seizure. Section 69 deals with arrest in grave situations. Section 83 provides provisional attachment in appropriate cases. Rule 37A provides a specific mechanism for reversal and re-availment where the supplier later pays the tax. The scheme is therefore not one-dimensional. It contemplates both recovery and correction, both deterrence and restoration.
That structure matters. If the supplier is the actual wrongdoer, the law has enough force to proceed against him. The Act does not require the department to bypass the real defaulter and attack the most compliant person in the chain.
What Bhandari Scrap Traders decides
The importance of Bhandari Scrap Traders lies in what it clearly affirms and what it carefully does not decide. It affirms that section 16(2)(c) is constitutionally valid. That means the recipient cannot claim that the provision is ultra vires merely because it places the burden of supplier compliance on the buyer. The Supreme Court has accepted that the legislature can impose such a condition on ITC.
However, the judgment should not be stretched beyond its facts. It is most directly concerned with the situation where the supplier has genuinely collected tax from the buyer and has then failed to deposit it with the Government. In that kind of case, the denial or reversal of ITC is legally supportable until the statutory condition is satisfied. If the supplier later pays, Rule 37A becomes relevant for re-availment.
What the judgment does not automatically approve is a retrospective cancellation order issued without proper reasons, without objective material, or in disregard of natural justice. It does not say that every supplier flagged as NGTP must be presumed dishonest. It does not say that every buyer must suffer merely because an officer has chosen a backdated cancellation route. And it does not say that a supplier who was validly registered at the time of invoice can be treated as if he had never been registered, unless the legal requirements for retrospective cancellation are met.
That distinction is crucial for practitioners.
Retrospective cancellation under section 29(2)
Section 29(2) permits cancellation of registration with retrospective effect. But this power is exceptional and must be exercised with caution. It is not a mechanical weapon. The consequence of retrospective cancellation is severe. It may invalidate the supplier’s apparent status during the earlier period, block filing of GSTR-3B for those periods, and expose the buyer’s ITC to challenge. That is why the courts have repeatedly insisted that retrospective cancellation must be supported by objective reasons and proper notice.
A retrospective cancellation order cannot be reduced to a mere administrative convenience. If the show-cause notice does not fairly put the taxpayer on notice that retrospective effect is proposed, the order becomes vulnerable. If the order does not disclose why a backdated cancellation is necessary, it is open to challenge. If the cancellation is based on a vague report, a generic suspicion, or an NGTP label without tangible material, the order becomes even more suspect.
This is not a technical objection. It goes to the heart of fairness. A backdated cancellation can distort completed commercial transactions. It can transform a valid supply into a disputed one. It can prevent filing of returns. It can unsettle the position of buyers who acted in good faith. That is why courts have repeatedly warned against casual use of retrospective cancellation.
When the department creates the default
The most important practical issue arises in a situation where the supplier was filed in GSTR-1, the invoice was valid, the supply was genuine, and the buyer’s portal reflected the transaction in GSTR-2B, but the department later intervenes, suspends the registration, and cancels it retrospectively.
In such a case, the supplier may become unable to file GSTR-3B for the relevant period, not because he voluntarily chose not to comply, but because the portal itself blocks the return after retrospective cancellation. The effect is severe. A dealer who was visible as a registered person on the date of supply is later treated as though he had no registration at all. The department then argues that tax was not paid and the buyer’s ITC must be reversed.
That approach is legally problematic. Where the inability to file GSTR-3B is caused by the department’s own retrospective action, the notion of “supplier default” becomes less straightforward. The default may not be a deliberate evasion. It may be a consequence of an administrative order that is itself under challenge. In such a case, the department cannot automatically shift the full burden to the buyer without first examining whether the cancellation was lawful, reasoned, and proportionate.
This is exactly where natural justice becomes the decisive principle. The law cannot permit the State to create a tax disability and then use that disability as proof of default against the very person affected by its action.
Bona fide buyers and documentary proof
The position of a bona fide buyer is materially different from that of a collusive purchaser. If the recipient has a valid tax invoice, has paid consideration through banking channels, has received the goods or services, and the transaction is reflected in GSTR-2B, the buyer has a strong factual foundation to contest denial of ITC. The case is even stronger where there is no allegation of collusion, bogus billing, or sham transaction.
In such cases, the buyer should argue that he has done everything the law requires of him. He cannot be expected to verify the supplier’s internal tax remittance in real time. He cannot control the supplier’s future compliance, nor can he anticipate a retrospective cancellation order passed years later. If he has acted on the legal status visible on the date of supply, fairness demands that he should not be punished for a later administrative reclassification over which he had no control.
This is not an argument against the statute. It is an argument for proper application of the statute. Section 16(2)(c) must be interpreted in a manner that preserves the integrity of the credit chain without destroying commercial certainty.
Example one: genuine supply, later retrospective cancellation
Suppose Supplier A sells scrap in April 2024. He issues a proper tax invoice, receives payment, and files GSTR-1. The transaction reflects in Buyer B’s GSTR-2B. Buyer B avails credit on that basis. Two years later, the department passes an order retrospectively cancelling Supplier A’s registration from April 2024 on the basis of a vague NGTP report, without clear reasons and without proving fraud.
Now Supplier A cannot file GSTR-3B for April 2024 because the portal blocks the return for the cancelled period. The department then seeks to deny Buyer B’s ITC, saying tax was not paid to the Government.
In such a case, Buyer B can strongly contend that the transaction was genuine when made, the supplier was registered on the date of supply, the buyer acted on the official portal position, and the retrospective cancellation cannot be used to convert a lawful transaction into a fictional default. Buyer B should further contend that the cancellation order itself is vulnerable because it was based on inadequate material and violated natural justice.
Example two: deliberate tax diversion by supplier
Now consider a different case. Supplier X issues invoices, collects GST from customers, but knowingly fails to file GSTR-3B and diverts the tax amount for his own use. The department has evidence of bogus invoicing, absence of actual movement of goods, and diversion of funds. Here the legal position is very different. This is not a case of department-created default. It is a case of actual non-compliance by a delinquent supplier.
In such a situation, section 16(2)(c) operates with full force. The buyer may face reversal of ITC until the statutory requirement is satisfied. Rule 37A becomes relevant if and when the supplier later remits the tax. The department is also justified in initiating recovery, penalty, and prosecution proceedings against the defaulter. This is the factual matrix in which Bhandari Scrap Traders has its strongest operation.
Why the department should use stronger powers against the real defaulter
One of the most legitimate criticisms in GST administration is that the department often takes the shortest route rather than the most just one. Where a supplier has genuinely collected tax and failed to remit it, the law already provides powerful enforcement tools. Sections 73 and 74 permit recovery. Section 122 enables penalty. Section 132 permits prosecution. Section 67 permits search and seizure. Section 69 enables arrest in grave cases. Section 83 permits provisional attachment where legally justified.
If the department believes a supplier has deliberately defaulted, those provisions exist for that very purpose. There is no legal need to rely primarily on downstream ITC denial against the buyer unless the facts genuinely warrant it. A tax system that targets the most compliant actor first risks undermining both fairness and compliance culture. GST is built on a credit chain. If the chain is broken by administrative overreach rather than genuine evasion, the entire system loses credibility.
This is why many practitioners rightly ask why the department does not more effectively use the serious weapons already available against the actual wrongdoer. The answer should not be convenience. It should be law, evidence, and due process.
Judicial trend on retrospective cancellation
Although the Supreme Court has now settled the validity of section 16(2)(c), the law on retrospective cancellation is still developing through High Court jurisprudence. Several High Courts have held that retrospective cancellation cannot be ordered mechanically and that the reasons must be clear, objective, and legally sustainable. Courts have also recognised that backdated cancellation has serious civil consequences, particularly for genuine taxpayers and their buyers.
The emerging judicial theme is plain. Retrospective cancellation is not forbidden, but it is exceptional. It must be justified by the facts. Where the cancellation is based on a vague report, where the show-cause notice is defective, or where the order lacks reasons, courts have not hesitated to interfere. In appropriate cases, registration has been restored or the cancellation has been limited to a later date.
For practitioners, this line of cases is highly significant. It means that the validity of the cancellation order itself often becomes the foundation of the entire ITC dispute. If the cancellation is legally unsound, the consequential denial of ITC to buyers may also be vulnerable.
Rule 37A and re-availment
Rule 37A introduces an important balancing mechanism. It recognises that where ITC has been reversed because the supplier has not paid tax, the credit may be re-availed once the supplier does pay. This shows that the law does not always intend permanent deprivation. It contemplates restoration where compliance is eventually achieved.
This mechanism supports the broader proposition that the GST regime is not meant to punish honest trade forever because of a supplier’s temporary or disputed default. The existence of Rule 37A is a reminder that the law values correction, not just punishment. It also reinforces the argument that where non-payment arises from a legal dispute, especially one linked to retrospective cancellation, the department should proceed carefully before denying the buyer’s credit in a final and irreversible manner.
Practical litigation strategy
In drafting a reply, appeal, or writ petition in these matters, the correct strategy is to separate the legal issues with precision.
First, accept that Bhandari Scrap Traders confirms the constitutional validity of section 16(2)(c). It is unwise to attack the provision itself when the Supreme Court has upheld it.
Second, challenge the factual foundation of the alleged default. Ask whether the supplier was validly registered on the date of supply. Ask whether GSTR-1 was filed. Ask whether the buyer’s GSTR-2B reflected the transaction. Ask whether the cancellation was retrospective, reasoned, and preceded by a proper notice.
Third, attack retrospective cancellation where it is unsupported by objective material. If the cancellation order is vulnerable, the downstream ITC denial becomes vulnerable as well.
Fourth, establish bona fides through documentary proof: tax invoice, e-way bill, proof of payment, proof of receipt, correspondence, stock records, and ledger entries. A well-documented transaction is the best answer to a mechanical notice.
Fifth, insist that the department should first proceed against the actual supplier with the full range of statutory powers before penalising the buyer.
Conclusion
Bhandari Scrap Traders is an important judgment, but it must be read with care and legal discipline. It confirms that section 16(2)(c) is valid and that ITC can be denied where the supplier collects tax and does not pay it to the Government. But the judgment does not authorise the department to ignore natural justice, to use retrospective cancellation casually, or to create a default by its own administrative action and then pass the burden downstream to the bona fide buyer.
The true distinction is between a real defaulter and a department-created defaulter. Where the supplier deliberately collects tax and withholds it, the law can be strict. Where the supplier’s inability to file GSTR-3B arises because registration was retrospectively cancelled without lawful foundation, the matter is fundamentally different. In such cases, the buyer should not be made to suffer twice for a transaction that was valid when made.
The GST regime will remain credible only if enforcement is directed against the real wrongdoer, not against the easiest target. That is the deeper lesson of section 16(2)(c), section 29(2), Rule 37A, and the constitutional promise of fairness in tax administration.
