CASH OR KILL: How One Brutal GST Rule 86B Can Destroy Your Business

A cautionary tale of modern tax compliance where paying 100% through credits can cost you everything.

Rajesh Kumar thought he had mastered the art of GST compliance. As the finance director of a thriving manufacturing company, he had built an elegant system where every rupee of output tax liability was discharged through Input Tax Credit. His cash flow was optimized, his books were clean, and his monthly GST returns filed like clockwork. What he didn’t realize was that he was walking into one of the most dangerous traps in modern tax law.

The trouble began on a humid Tuesday morning in July when Rajesh received a notice that would change everything. His company’s monthly turnover had crossed ₹50 lakhs, and with it came the application of Rule 86B of the Central Goods and Services Tax Rules, 2017. Suddenly, his perfectly legal practice of using 100% Input Tax Credit to discharge output tax liability had become a violation that could cost him his business registration and attract penalties.

Rule 86B operates like a silent predator in the GST ecosystem. Once your monthly taxable supply exceeds ₹50 lakhs, excluding exempt and zero-rated supplies, the rule mandates that you cannot use more than 99% of available Input Tax Credit to discharge your output tax liability. The remaining 1% must be paid in cash, creating an artificial cash flow burden that many businesses discover only after they’ve already violated the provision.

Rajesh’s first instinct was to approach his tax consultant, who delivered even more unsettling news. The violation of Rule 86B wasn’t just a simple compliance issue that could be rectified by paying the required 1% in cash. The department had significant powers under the law, and they could choose from a menu of enforcement actions that could devastate any business.

The most terrifying weapon in the department’s arsenal is Rule 21(g), which specifically states that registration granted to a person is liable to be cancelled if the person violates the provisions of Rule 86B. Registration cancellation in GST is akin to a business death sentence, as it effectively strips away your ability to conduct taxable transactions and can trigger a cascade of compliance issues with vendors and customers.

But registration cancellation wasn’t the only threat Rajesh faced. The department could also initiate penalty proceedings under Section 122 read with Section 127 of the CGST Act. Since Rule 86B doesn’t specify a particular penalty amount for violations, the authorities often invoke Section 125, which provides for a general penalty up to ₹25,000 for contravention of any provisions where no specific penalty is provided.

What made Rajesh’s situation even more complex was the question of what would happen if he decided to pay the required 1% in cash retrospectively. Would the Input Tax Credit he had already utilized be lost forever, creating a double taxation scenario? This question had been troubling tax practitioners across the country, as it touched upon fundamental principles of equity in taxation.

The answer came from an unlikely source – a legal precedent established by the Madras High Court in the case of Arise Steels Pvt. Ltd. v. Assistant Commissioner (ST). The court had ruled that Input Tax Credit wrongly blocked under similar provisions must be unblocked or re-credited if the taxpayer rectifies the procedural non-compliance. This principle suggested that once Rajesh paid the required 1% cash, the equivalent ITC already utilized should be restored to avoid double taxation.

The mechanism for such restoration lies in Rule 86(4A) of the CGST Rules, which specifically provides for re-credit of amounts wrongly debited from the electronic credit ledger. The rule states that where any amount is wrongly debited from the electronic credit ledger, the same shall be re-credited to such ledger on the order of the proper officer in FORM GST PMT-03. This provision became Rajesh’s lifeline, offering hope that compliance could be achieved without suffering permanent financial loss.

However, understanding the law was one thing, but navigating the practical realities of dealing with tax authorities was entirely different. The Assistant Commissioner or Deputy Commissioner who would handle Rajesh’s case had discretionary powers, and the outcome would depend largely on how the case was presented and the approach taken by the department.

The procedural requirements provided some comfort. The proper officer was bound to give reasonable opportunity of being heard before imposing any penalty, and any penalty imposed had to be commensurate with the degree and severity of the breach. This meant that Rajesh’s case wouldn’t be decided arbitrarily, and there would be scope for presenting his side of the story.

What became clear through this ordeal was that the department couldn’t simply compel taxpayers to pay 1% in cash without following proper legal procedures. They had to choose between initiating cancellation proceedings under Rule 21(g) or imposing penalties under the relevant sections of the CGST Act. The arbitrary demand for cash payment without due process would be legally untenable.

Rajesh’s story illustrates a broader challenge facing Indian businesses today. Rule 86B represents a fundamental shift in GST philosophy, moving away from a pure credit-based system toward a hybrid model that ensures minimum cash collection by the government. This change caught thousands of businesses off-guard, particularly those operating in capital-intensive industries where Input Tax Credit optimization was crucial for cash flow management.

The implications extend beyond individual cases like Rajesh’s. The rule has forced businesses to completely restructure their tax planning strategies, budgeting for minimum cash outflows even when they have sufficient credits available. Companies have had to modify their accounting systems, update their cash flow projections, and often renegotiate payment terms with vendors and customers to accommodate this new reality.

For businesses currently facing Rule 86B violations, Rajesh’s experience offers valuable lessons. Immediate compliance going forward is essential, but equally important is the proactive approach to dealing with past violations. Voluntary disclosure to the department, maintaining comprehensive documentation showing willingness to comply, and engaging experienced tax advisors for penalty negotiations can make the difference between business survival and closure.

The broader lesson from Rajesh’s encounter with Rule 86B is that modern tax compliance requires constant vigilance and adaptability. Rules that seem straightforward can have profound implications, and businesses must invest in robust compliance systems that can adapt to changing regulatory requirements. The cost of non-compliance in today’s tax environment extends far beyond simple penalties; it can threaten the very existence of the business.

As Rajesh discovered, prevention truly is better than cure in the world of GST compliance. Businesses exceeding the ₹50 lakh monthly turnover threshold must immediately restructure their tax payment mechanisms to ensure at least 1% cash component, rather than waiting for enforcement action that could prove fatal to their operations. In the high-stakes game of modern tax compliance, staying ahead of the curve isn’t just good practice—it’s the difference between thriving and merely surviving.

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About the Author: Advocate Rabinarayan Sahu is the Proprietor of R N Legal, specializing in GST, indirect tax litigation, and regulatory compliance. He has extensive experience in appellate proceedings before various tax tribunals, with particular expertise in indirect tax proceedings, administrative and constitutional law matters. R N Legal is a full-service law firm providing comprehensive legal solutions in taxation, and regulatory matters. The firm represents clients across various industries in complex tax litigation and advisory matters. Beyond professional commitments, Advocate Sahu is actively involved in legal awareness programs, seminars, and community initiatives, fostering a better understanding of the law among the citizens.