Disallowance of ITC due to Supplier’s Default under GST

Introduction

Input Tax Credit (ITC) is the backbone of the Goods and Services Tax (GST) framework, enabling the seamless flow of credit across the value chain. However, the right to avail ITC is subject to various conditions stipulated under Section 16 and Section 17 of the CGST Act, 2017. Among these, Section 16(2)(c) has become a focal point of GST litigation. It mandates that ITC can be availed by the recipient only if the GST has actually been paid to the Government by the supplier.

In recent years, numerous registered persons have faced demand notices from the GST department seeking reversal of ITC on the ground that their suppliers either failed to file GSTR-3B or did not remit the tax to the GST department or their GST registration has been cancelled retrospectively. This raises a fundamental question of “whether a bona fide buyer should be penalized for the default of supplier” particularly where the buyer has paid the consideration along with tax and possesses a valid tax invoice.

Departmental Stand and Current Practice

GST officers across jurisdictions have issued notices alleging excess or wrongful ITC claims based on mismatches between GSTR-2B and GSTR-3B. The common grounds cited include:

• Supplier has not filed their GSTR-3B.
• Supplier’s registration is cancelled retrospectively.
• Supplier not traceable or declared as bogus.
• Invoice not reflecting in recipient’s GSTR-2B.

Even in cases where the recipient has:

• Paid the full amount along with tax.
• Possessed a valid invoice.
• Filed his returns on time.
• And had no control over the supplier’s filing and tax payment.

The department has proceeded with reversal and interest/demand under Section 73/74/74A.

Key Judicial Pronouncements

1. M/s Himalaya Communication Pvt Ltd Vs. Union of India And Others – HP High Court

ITC denied solely due to retrospective cancellation of supplier’s GST registration. It was held that ITC cannot be denied merely on this ground, unless the genuineness of the transaction and documents are examined.

 2. D.Y. Beathel Enterprises Vs. STO – Madras High Court

Held that the primary action must be taken against the supplier who failed to remit tax. Denying ITC to the buyer without exhausting remedies against the seller was unjustified.

3. LGW Industries Ltd. Vs. UOI – Calcutta High Court

Allowed the department to proceed against buyers in case of supplier default, noting that conditions of Section 16 must be fulfilled strictly.

4. Trendships Online Services Private Limited Vs Commissioner Commercial Taxes U.P. at Lucknow And Another – Allahabad High Court

ITC was claimed on purchases from a registered supplier, but the supplier failed to deposit the GST with the government. The court upheld ITC denial and imposed a penalty, emphasizing that the recipient could not prove the supplier had deposited the tax as required under Section 16(2)(c) of the GST Act

Practical Challenges for the Recipient

1.No real-time tracking of whether the supplier has paid the tax.

2. GSTR-2B is based on supplier GSTR-1, not their GSTR-3B (actual tax payment).

3. Risk of ITC denial even for genuine transactions.

4. Vendor due diligence is difficult in cases involving one-time or small-volume suppliers.

Suggested Due Diligence Measures for Taxpayers

Given the legal uncertainty, recipients must adopt robust compliance practices, including:

• Deal only with vendors filing regular GSTR-1 and GSTR-3B.
• Perform regular GSTR-2B reconciliation.
• Insert protective clauses in supplier agreements (e.g., indemnity for ITC loss).
• Monitor supplier GSTIN status on the portal.
• Obtain declarations from suppliers confirming tax payment.

Legislative and Administrative Way Forward

1.Amendment to Section 16(2)(c) is required to shift the burden only in cases where fraud, collusion, or gross negligence by the recipient is established.

2.  Introduce a supplier compliance score, as envisaged in Section 149, to help buyers assess risk.

3. Allow credit on the basis of recipient’s due diligence, not supplier’s behaviour.

4. GSTN should integrate GSTR-1 and 3B to show actual tax paid status in GSTR-2B.

5. Until such reforms are brought in, bona fide recipients will remain exposed to unpredictable liabilities.

Conclusion

The denial of ITC due to supplier default presents a classic conflict between compliance enforcement and principles of equity. While the statute requires actual tax payment as a condition for availing ITC, enforcing this against a diligent buyer without remedy against the actual defaulter defeats the very purpose of input credit.

The judiciary must step in to balance this conflict and lay down definitive principles. Until then, businesses must strengthen their vendor management and internal controls to mitigate exposure.