Rule 86A of Central Goods and Services Tax Rules, 2017 (‘CGST Rules’) has been introduced by the Government vide Notification No. 75/2019-C.T. dated 26.12.2019 to empower the Commissioner or any officer authorized by the Commissioner in this behalf, not below the rank of Assistant Commissioner (‘empowered officer’), to block the Input Tax Credit (‘ITC’) reflecting in the electronic credit ledger (‘ECL’) of the assessee, if such ITC has been fraudulently availed or is ineligible.
The said Rule has been introduced by the Government to safeguard the interest of the revenue. As per this rule, where the empowered officer has reasons to believe that ITC has been wrongly availed by an assessee, then he may block such ITC of the assessee lying in the ECL so that interest of the revenue is secured during the course of such proceedings.
Though the Rule 86A has been introduced by the Department to safeguard the interest of the revenue, there is every possibility that this Rule can be used against bona fide tax payers, who may have availed the ITC on the basis of genuine invoices and yet their ITC is blocked for various reasons, for eg. ITC does not reflect in GSTR-2A.
Similar actions were taken by the Department of blocking of ITC before the introduction of Rule 86A, wherein bank accounts of assessee accused of fraud were provisionally attached and the ITC as reflecting in the ECL was blocked.
The Hon’ble Gujarat HC while hearing the plea of petitioners in the case of M/s Valerius Industries – 2019 (9) TMI 618 and M/s Alfa Enterprises – 2019 (10) TMI 156 (both pronounced in October 2019) had held that blocking of ITC by the department is illegal and without any backing of the law. Accordingly, department was directed to unblock the ITC so blocked by them.
With an intent to provide an express provision in the statute, a new Rule i.e. Rule 86A has been inserted to allow blocking of the ITC.
As per Rule 86A, the Commissioner (or any officer authorized by him) can block the ITC if they have ‘reasons to believe’ that the ITC has been fraudulently availed by the following means:
(Invoice includes debit notes and all other documents prescribed under Rule 36)
The reasons for which the ITC has been blocked should be recorded by the Commissioner in writing. Such blockage of credit shall be in effect for a maximum period of one year.
As can be seen from the above, the main purpose of introduction of Rule 86A is to curb availment of ITC on the basis of bogus purchases without payment of tax or in some cases without an invoice.
It must however be noted that the said Rule 86A does not require the Commissioner to afford the assessee an ‘opportunity to be heard’ before blocking such ITC and only requires that such reasons be recorded in writing by the Commissioner. It will be worthwhile to note that the said Rule though specifically requires the empowered officer to record the reasons in writing for blocking the credit; however, it does not mandate the empowered officer to intimate the said reasons of blocking of ITC to the assessee whose ITC has been blocked by such officer. Also, the said rule does not prescribe for a prior issue of notice/ intimation to the assessee regarding the blocking of ITC.
The combined effect of these 2 things would mean that it may lead to arbitrary action by the empowered officer and the assessee would not even know of any such action being taken against him as there is no intimation to the assessee.
Further, as prescribed in the said rule, a pre-requisite condition for blocking of ITC is that the empowered officer should have ‘reasons to believe’ that the ITC has been availed ‘fraudulently’. Now both the terms i.e. ‘reasons to believe’ and ‘fraudulently’ have not been defined anywhere in the Central Goods and Services Tax Act, 2017 (‘CGST Act’) or CGST Rules.
The Hon’ble Supreme Court while analyzing the term ‘reasons to believe’ in the phraseology of Section 147 of Income Tax Act, 1961 in the case of Aslam Mohd. Merchant – 2008 (7) TMI 852 – Supreme Court has categorically held that there has to be specific, reliable and relevant information with the assessing officer that the income has escaped assessment or wrongful information has been submitted only then the assessment can be re-opened.
The Hon’ble Supreme Court in a catena of judgements has also held that ‘fraud’ can be alleged only when there is evidence to show that there is a positive act done by the assessee to evade payment of tax or to wrongfully avail cenvat credit.
In a nutshell, the empowered officer can proceed to block the ITC of an assessee only if he has specific, reliable and relevant information that an assessee has willingly or knowingly done an act so as to wrongfully avail ITC, which would otherwise not be available to him i.e. bogus sales and purchases or without any invoices. These reasons have to be recorded in writing before the blocking of credit.
Right to avail input tax credit:
As per Section 16(1) of CGST Act, an assessee who has paid tax on inward supplies used by him in the course or furtherance of business can avail the input tax credit of such tax paid. Conditions for availment of such ITC have been laid down in Sub sections (2), (3) and (4) of Section 16 and certain restrictions have been laid down in Section 17 of the CGST Act. Therefore, the right to avail and utilize the ITC for discharging tax liability is a legal right arising from the statute and it is trite in law that this right can be curtailed only with the specific power of the law and not otherwise.
None of the provisions contained in Section 16, Section 17 or any other Section under the CGST Act give the power to the Government to restrict / block the ITC of the assessee under any circumstances. Therefore, this power given by the Government to the empowered officer does not flow from the CGST Act and hence, is ultra vires the CGST Act.
As per Section 74 of CGST Act, where it appears to the assessing officer that an assessee has short paid or not paid any tax or has wrongfully availed input tax credit by reason of fraud or willful misrepresentation or suppression of facts, then a show cause notice should be issued to the assessee for recovery of such tax along with interest and penalty.
Therefore, it is clear that as per the Provisions of Section 74 of CGST Act, the due procedure of adjudication and appeal should be followed for recovery of any ITC which has been fraudulently availed by the assessee. And if any amount is found recoverable from the assessee after following this due procedure of law, then the same maybe recovered as per the Provisions of Section 79 of CGST Act. Also, Section 79 does not grant the power to block the ITC directly from the electronic credit ledger.
Introduction of Rule 86A will lead to bypassing the due process of justice as laid down in Section 74 and may also lead to parallel proceedings on the same cause of action i.e. on the allegation of fraudulent availment of ITC. Once a provision is given in law to deal with a particular cause of action, a parallel Rule to deal with the same cause of action would lead to ambiguous situation and curtailment of the premise of the other provision. By virtue of Rule 86A, if the department proceeds to block ITC of the assessees, the same would be in the teeth of the premise and the procedure laid down under Section 74 of the CGST Act, which cannot be the intention of the law.
Principles of Natural Justice:
It is trite in law that whenever any right of a taxpayer is curtailed or a demand is to be raised against such taxpayer, an opportunity of being heard must be afforded to the taxpayer before raising the demand or taking away the right.
As per the Rule 86A, the empowered officer is not required to give the assessee an opportunity of being heard before blocking of the ITC, which is a right of the assessee under the CGST Act.
It has been held in a catena of judgements that an opportunity of personal hearing or representation is required to be given to the assesses in circumstances wherein their legal or vested rights have been curtailed or taken away, even in the cases where the express provision contained in the statute does not require it to do so. The Hon’ble Supreme Court in the case of Kesar Enterprises Ltd. – 2012 (12) TMI 828 relying on an earlier judgement in the case of Swadeshi Cotton Mills v/s Union of India – 1981 (1) TMI 250 – Supreme Court has held that the Principles of Natural Justice require that an opportunity of being heard is afforded to the assessee before passing an order irrespective of whether the requirement of hearing has been mandated in the law or not.Therefore, the operation of Rule 86A in itself tantamount to violation of Principles of Natural Justice insofar as it does not mandate that an opportunity be given to the assessee to be heard before the ITC is blocked and therefore, any action taken by the Department arbitrarily under said Rule is in violation of Principle of Natural Justice.
Section 164 of CGST Act:
Section 164 of CGST Act gives the Government the power to make Rules for carrying out the provisions of the CGST Act as prescribed therein. Notification 75/2019 – C.T. which notifies Rule 86A has been issued by the Government under the powers conferred under Section 164 of the CGST Act.
As stated hereinabove, there is no provision under the CGST Act which specifically allows the Government to restrict the right to ITC of the assessee by resorting to blocking of the same on the common portal. Therefore, introduction of Rule 86A by using the powers under Section 164 is clearly ultra vires the powers conferred under Section 164.
Section 49(4) of CGST Act:
Section 49 of the CGST Act, as evident from its heading itself, specifically deals with manner of payment of tax, interest, penalty and other amounts. Thus, it is imperative to note that this section only deals with the manner in which the GST and other associated liabilities of the assessee are to be discharged.
As per Section 49(4) of CGST Act, ITC available in ECL maybe utilised towards discharging outward tax liability in such manner and subject to such conditions as may be prescribed. It is to be noted that Section 49 (4) only limits itself to prescription of manner and conditions for utilising the ITC available in the ECL for payment of outward GST liabilities. It does not delve into prescription of conditions subject to which the ITC lying in the ECL shall not be available for utilisation more so because this portion of the statute only concerns itself with the manner and mechanism for payment of GST liabilities.
Here, it will also be imperative to note that w.e.f. 01.02.2019, Section 49A of the CGST Act has been introduced, which provides for ‘Utilisation of input tax credit subject to certain conditions’. Section 49A prescribes that the input tax credit on account of central tax, State tax or Union territory tax shall be utilised towards payment of integrated tax, central tax, State tax or Union territory tax, as the case may be, only after the input tax credit available on account of integrated tax has first been utilised fully towards such payment. Thus, even Section 49A of the CGST Act does not provide for prescription of conditions subject to which the ITC lying in the ECL shall not be available for utilisation i.e. will be blocked.
Thus, neither Section 49 (4) nor the newly introduced Section 49A of the CGST Act provide for prescription of conditions for blocking the ITC, as is provided in Rule 86A of CGST Rules.
Further, it is noteworthy that the heading of Rule 86A is ‘Conditions of use of amount available in electronic credit ledger’. The term ‘condition’ in general parlance would mean that on the occurrence of an event or on carrying out an act, a person may become eligible or ineligible for something. It can also mean to set or stipulate prior requirements on something before it can be done.
However, from the wordings of the Rule 86A, it is clearly evident that it does not prescribe the conditions for using the amount available in the ECL; however, on the other hand, only prescribes the circumstances in which the empowered officer can block the usage of ITC reflecting in the ECL of the assessee.
Thus, the power to prescribe conditions for blocking of ITC by introduction of Rule 86A does not flow from Section 49 (4) or for that matter, Section 49A or any other section of the CGST Act as well. Thus, Rule 86A of the CGST Rules appears to be running ultra vires to the provisions of the CGST Act and accordingly, is required to be struck down.
The validity of Rule 86A has been challenged before the Hon’ble Gujarat High Court in the case of Jariwala Sales Pvt. Ltd. (SCA 5781 of 2020) in March 2020. The matter is yet to be heard by the Hon’ble Court.
As can be seen from the above discussions, the introduction of Rule 86A is without the authority of the law and is ultra vires the CGST Act and also in violation of the Principles of Natural Justice. It is also not clear whether the power of Rule 86A flows from Section 49(4) or not, and even if it does, whether it is in the right spirit of Section 49(4). Though the intention behind the introduction of the Rule may be to curb the practice of Bogus Purchases and to safeguard the revenue, there is every chance that an honest taxpayer may be put to disadvantage due to operation of this provision.
Whether or not Rule 86A survives the scrutiny of Courts remains to be seen.
This article is the personal opinion of the writer and has been issued with the sole interest of academic furtherance of the readers. It should not be construed as a legal opinion. The views stated herein are subject to change due to judicial pronouncements, better understanding of the law or change in the facts of the case.
Earnest feedback, suggestions, discussions and contrary opinions on this topic are welcome.