Ending Bogus GST Input Tax Credit Through Reverse Charge Mechanism

Summary: The article examines the recurring problem of bogus input tax credit and fake invoices under GST, particularly where genuine purchasers face demands because suppliers or upstream dealers fail to deposit tax. Although Section 16(2)(c) of the CGST Act links credit eligibility to actual payment of tax to the Government, purchasers have limited means of verifying or compelling such payment. The article discusses the practical limitations of re-availment under Section 41, the impact of retrospective registration cancellation, and the burden of tax, interest, penalties and litigation on bona fide buyers. It examines the judicial approaches reflected in Safecon Lifescience Private Limited v. State of U.P., On Quest Merchandising India Pvt. Ltd. v. Government of NCT of Delhi and Commissioner, Trade and Taxes, Delhi v. Shanti Kiran India Pvt. Ltd. The author argues that litigation remedies do not adequately address the structural opportunity for invoice fraud arising when suppliers collect GST but fail to remit it. As a preventive measure, the author proposes expanding the reverse charge mechanism to selected business-to-business transactions in fake-invoice-prone sectors, including metal scrap. Under this approach, registered purchasers would deposit GST directly and claim corresponding eligible credit, rather than paying tax to suppliers who might disappear. The proposal also contemplates automated reconciliation of reverse charge liability and credit, along with a refund mechanism for suppliers accumulating input credit. Drawing on European VAT arrangements, the article presents reverse charge as a possible means of reducing fraudulent credit chains and protecting genuine businesses without changing the underlying GST rates.

Ending Bogus Input Tax Credit at Its Source – The Case for Reverse Charge in Fake-Invoice-Prone Sectors

Every week, honest traders in Western Uttar Pradesh receive notices that have little to do with anything they did. A dealer two or three tiers up the supply chain turns out to be a paper company, his registration is cancelled from a back date, and the buyer who paid him in good faith is asked to repay the credit he took, with interest and penalty. The buyer has done nothing wrong. He paid the tax on his purchase, and the Government never received it. Yet the law places the loss on him.

This article explains why the present system leaves the honest purchaser so exposed, why the remedies available to him are weaker than they appear, and why a simple change in who pays the tax could end much of this litigation without amending the CGST Act.

The Gap That Fake Invoices Exploit

Under forward charge, the supplier collects tax from the buyer along with the price and deposits it with the Government. The buyer takes credit for that tax as soon as he holds a valid invoice. The difficulty is timing. The credit reaches the buyer before anyone checks whether the tax has been deposited.

A fake invoice works because of this gap. The issuer shows tax as charged, the buyer takes the credit, and the issuer disappears without depositing anything. On a credit purchase, the buyer can claim the credit in the same month and then has 180 days to show payment. Fraudulent chains use that window to move money through a series of bank accounts before the paper trail catches up.

Section 16(2)(c) of the CGST Act addresses this by allowing credit only when the tax actually reaches the Government. The provision is sound in principle. The trouble is that the buyer has no means to verify, compel or secure that deposit. The safeguard that was meant to supply this verification, invoice matching through GSTR-2 and GSTR-3 under Sections 42 and 43, was never made operational and was later omitted. GSTR-2B tells the buyer that his supplier filed GSTR-1. It does not tell him whether the supplier paid the tax in GSTR-3B, and it tells him nothing about whether the supplier’s own credit was genuine.

Why the Remedies Do Not Help the Honest Buyer

The Supreme Court, in its judgment of 24.07.2026, upheld the validity of Section 16(2)(c), treating credit as a statutory concession that good faith cannot override. The Court relied on Section 41, under which credit reversed because the supplier has not paid can be availed again once he pays. On paper, that is a remedy. In practice it rarely reaches the buyer.

Consider the three situations that arise most often:

(a). The supplier does not exist. He will never pay, so re-availment under Section 41(3) never arises.

(b). The default lies further up the chain. The immediate supplier may well have paid, but the defaulter is one or two tiers above him. Section 41(3) applies only when the supplier pays, and the Act provides no route when the defaulter is the supplier’s supplier.

(c). The supplier pays later. The buyer has no way to compel payment, and the portal does not tell him when it happens. Even where re-availment is allowed, the interest he paid on reversal under Section 41(2) is not restored, and the penalty under Section 74 stands.

The other remedies are equally thin. A reply to a notice can narrow the demand, for instance by arguing that Section 74 requires the buyer’s own fraud, or that interest under Section 50(3) is not payable on credit never utilised. But the tax itself remains payable. A civil suit against a supplier who cannot be found is futile. A criminal complaint may punish the fraudster if he is traced, but it does not return the money. An appeal requires a pre-deposit of 10 per cent, and in the meantime the buyer’s bank account may be attached under Section 79.

The honest buyer is therefore left without an effective remedy for a loss caused entirely by someone else. The only person who could cure the default is the person who has vanished.

Courts and Officers Reading the Same Facts Differently

The law is also unsettled. The Allahabad High Court, in Safecon Lifescience Private Limited v. State of U.P., Writ Tax No. 743 of 2023, held that Section 74 cannot be used to deny credit to a bona fide purchaser merely because the supplier’s registration was later cancelled, or because of irregularities in the supplier’s upstream purchases. The Revenue’s Special Leave Petition was dismissed on 17.07.2026.

Field officers, appellate authorities and the Tribunal continue to decide identical facts in opposite ways. A trader in Bijnor or Amroha cannot know, when he places an order, whether the credit he takes will survive scrutiny. That uncertainty is itself a cost of doing business, and it falls hardest on small units with no access to senior counsel.

A Problem Older Than GST

This dispute is not new. In the VAT era, the Delhi High Court in On Quest Merchandising India Pvt. Ltd. v. Government of NCT of Delhi read down a provision of the Delhi VAT Act and held that the Department must proceed against the defaulting selling dealer. The Supreme Court did not disturb that view and reaffirmed it in Commissioner, Trade and Taxes, Delhi v. M/s Shanti Kiran India Pvt. Ltd., decided on 09.10.2025.

Under GST, the same question has returned in every year since 2017. The Council’s recent steps to reduce litigation are welcome: no notice for small amounts, withdrawal of pending small notices, decriminalisation, and faceless assessment. But none of these addresses one of the largest sources of GST disputes, the denial of credit to bona fide purchasers for the defaults of others.

The Proposal: Let the Buyer Pay the Tax Directly

The remedy I propose is to change the point at which tax is paid, not the rate or the Act. Under reverse charge, the buyer pays the tax to the Government by challan and then takes credit. The supplier collects only the price.

The Central Government may notify categories of supply under reverse charge under Section 9(3) of the CGST Act, on the recommendation of the Council, and Section 5(3) of the IGST Act provides the parallel power. Such a notification could begin with iron and steel scrap and other metal scrap, where fake invoicing is most common and where suppliers often buy from unregistered collectors. The proposal would also contain three safeguards:

Three Safeguards for Sector-Specific Reverse Charge

1.. Business to business only. Consumers take no credit, so reverse charge would not apply to them.

2.. A portal lock. Reverse charge credit claimed in Table 4 of GSTR-3B should not exceed the reverse charge tax actually paid in Table 3.1(d) of the same return.

3.. A refund route. A supplier whose input credit builds up because his outward supplies carry no tax should be allowed to claim a refund of it.

The machinery already exists. Rule 46 requires every invoice to state whether tax is payable on reverse charge. The reverse charge flag appears on GSTR-1 and the electronic invoice, GSTR-2B shows such supplies separately, and Table 3.1(d) of GSTR-3B takes the liability. No new return or new form is needed.

How the Arithmetic Works

Take a purchase of Rs. 1,00,000 at 18 per cent. Under both systems, the buyer’s total outflow is Rs. 1,18,000. The difference is only in who receives the Rs. 18,000.

Now take the same buyer under the present system after a chain default. Four years later, a Section 74 demand may arrive for the reversed credit, interest at 18 per cent for four years (Rs. 12,960) and a penalty equal to the tax (Rs. 18,000). The total is Rs. 48,960, and that is before the pre-deposit, the bank attachment and the litigation. Reverse charge costs the honest buyer nothing beyond the tax he has already paid once.

Anticipating Objections

Will the Government Lose the Fraction That Suppliers Retain Today?

In these sectors, the fraction is kept by the fake supplier. Under reverse charge, the same amount is paid in cash by a traceable buyer.

Will Buyers Lose Working Capital?

Their total outflow does not change. They lose only the credit for tax not yet paid on credit purchases, which is the very benefit that fake chains exploit.

Will Suppliers Accumulate Unusable Credit?

Sectors should be chosen where suppliers mostly sell to registered buyers, and a refund route should be provided, as noted above.

What If a Buyer Does Not Pay the Reverse Charge Tax?

An automatic match between the supplier’s GSTR-1 and the buyer’s GSTR-3B would detect the shortfall. Tax declared but unpaid is recoverable directly under Sections 75(12) and 79.

Does This Solve Income Tax Fraud?

No. Fake invoices used to inflate purchases for income tax purposes remain a matter for the income tax authorities. But they cause no loss of GST revenue under reverse charge.

Lessons From Abroad

The European Union faced a similar problem, known as missing trader fraud, under its VAT system. Articles 199 and 199a of Council Directive 2006/112/EC permit member states to apply a domestic reverse charge to supplies prone to fraud, such as scrap metal, mobile phones and computer chips. Several member states have used this option. India need not copy the European design, but the principle is the same: when the buyer pays the tax, the fraud loses its value.

Why This Matters Now

Reverse charge in notified sectors would do four things. It would bring tax into the Government’s account in cash, from a known and traceable person. It would make fake invoices in those sectors worthless. It would remove the conflict between the Supreme Court’s 2026 judgment and the Allahabad High Court’s decision in Safecon for future periods. And it would relieve officers, appellate authorities, the Tribunal and the High Courts of a large category of disputes, many of which concern tax the Government has already collected from someone else.

The honest trader asks for little. He does not ask to escape tax or to keep credit for tax he never paid. He asks for a rule under which the tax he pays reaches the Government, and under which he is not made to pay it twice. That rule can be put in place by notification, without waiting for an Act of Parliament.