Interest Dilemma for Violation of Rule 37 of the CGST Rules’2017 / Second Proviso to Section 16(2) of The CGST Act, 2017
Summary: The second proviso to Section 16(2) of the CGST Act, 2017 requires a recipient who fails to pay the supplier the value of a taxable supply and the related tax within 180 days of the invoice to reverse or pay the corresponding input tax credit, subject to the statutory conditions. Rule 37 prescribes the mechanism, including proportionate reversal where payment is partly outstanding. This article examines a specific interpretative dispute concerning interest on such reversals after the amendments effective from 1 October 2022. Under the earlier Rule 37(3), interest was expressly linked to Section 50(1) and calculated from the date of availment until payment. The substituted Rule 37 instead refers generally to interest payable under Section 50. The Finance Act, 2023 subsequently amended the second proviso to Section 16(2) to refer to payment of the ITC amount with interest under Section 50, replacing the earlier formulation of adding it to output tax liability. The author considers whether Section 50(1), dealing with delayed payment of tax, or Section 50(3), dealing with wrongly availed and utilised ITC, provides the appropriate statutory basis. The article argues that failure to pay the supplier does not necessarily mean the credit was wrongly availed when originally taken, while a reversal obligation does not automatically establish delayed payment of tax. It calls for clarification of the applicable provision, the relevant interest period and the computation methodology. This is the author’s interpretation of an unresolved issue, not a judicial determination that interest is never payable.
GST ITC Reversal for Non-Payment Within 180 Days
The second proviso to Section 16(2) of the CGST Act, 2017 provides for reversal/payment of Input Tax Credit (ITC) where the recipient fails to pay the supplier the value of the supply along with the tax payable thereon within 180 days from the date of invoice. Rule 37 of the CGST Rules, 2017 prescribes the mechanism for giving effect to this provision.
The issue of interest in such cases has, however, undergone a significant change with effect from 01.10.2022. While the erstwhile Rule 37 expressly provided for interest under Section 50(1), the amended Rule 37 merely provides for “interest payable thereon under section 50”, without specifying the applicable sub-section.
The second proviso to Section 16(2) ibid was subsequently amended by the Finance Act, 2023 vide notification no 28/2023-C.T dated 31st July 2023 made effective from 1st October 2023 and now uses substantially the same expression. This has resulted in an important question as to the precise statutory basis and manner of computation of interest in Rule 37 cases.
Interest Under the Earlier Rule 37 Framework
Under the original second proviso to Section 16(2), where the recipient failed to make payment to the supplier within 180 days, an amount equal to the ITC availed was required to be added to the output tax liability, along with interest thereon, in such manner as may be prescribed.
The erstwhile Rule 37 was in conformity with this scheme. Rule 37(2) provided for addition of the relevant ITC to output tax liability, while Rule 37(3) specifically provided that interest would be payable at the rate notified under Section 50(1), calculated from the date of availment of ITC until the date on which the amount added to the output tax liability was paid.
Thus, under the pre-01.10.2022 regime, the statutory scheme was clear:
If recipient fails to pay supplier within 180 days → amount of Input Tax Credit was required to be added to output tax liability → Further, in such scenario interest was required to be paid under Section 50(1)→ and such interest was required to computed from date of availment till date of payment.
Amendments to Rule 37 and Section 16(2)
Substituted Rule 37 Effective 1 October 2022
Rule 37. Reversal of input tax credit in the case of non-payment of consideration.-
[(1) A registered person, who has availed of input tax credit on any inward supply of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, but fails to pay to the supplier thereof, the amount towards the value of such supply [whether wholly or partly,] along with the tax payable thereon, within the time limit specified in the second proviso to sub-section(2) of section 16, shall pay [or reverse] an amount equal to the input tax credit availed in respect of such supply [, proportionate to the amount not paid to the supplier,] along with interest payable thereon under section 50, while furnishing the return in FORM GSTR-3B for the tax period immediately following the period of one hundred and eighty days from the date of the issue of the invoice:
The earlier Rule 37(3), which expressly referred to Section 50(1), was omitted. The substituted Rule 37(1) instead provides for payment [or reversal] of an amount equal to the ITC availed in respect of the supply, along with “interest payable thereon under section 50.” The amended Rule also introduced the mechanism of proportionate reversal where the consideration remained partly unpaid, which was subsequently clarified retrospectively from 01.10.2022 (vide Notification No. 26/2022 -C.T. dated 26.12.2022).
A corresponding amendment was subsequently made to the second proviso to Section 16(2) by the Finance Act, 2023.
Section 16. Eligibility and conditions for taking input tax credit.-
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Provided further that where a recipient fails to pay to the supplier of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier, an amount equal to the input tax credit availed by the recipient shall be [paid by him along with interest payable under section 50], in such manner as may be prescribed:
The earlier expression “added to his output tax liability, along with interest thereon” was replaced by “paid by him along with interest payable under section 50.” Thus, the earlier Act–Rule mismatch regarding “addition to output tax liability” versus “payment/reversal” has substantially been resolved.
However, neither the amended Rule 37 nor the amended Section 16(2) specifies whether the interest is to be charged under Section 50(1) or Section 50(3).
Does Section 50(1) or Section 50(3) Govern Interest?
The ambiguity assumes significance because the two provisions operate in materially different circumstances.
Section 50(1) applies where a person liable to pay tax fails to pay such tax or part thereof to the Government within the prescribed period. If interest in a Rule 37 case is sought to be levied under Section 50(1), it must therefore be established that the amount arising from the Rule 37 consequence constitutes tax remaining unpaid to the Government within the meaning of Section 50(1).
On the other hand, Section 50(3) applies where ITC has been wrongly availed and utilised. Violation of Rule 37, however, arises because the recipient fails to pay the supplier within 180 days. The ITC may have been validly availed when originally taken and may become liable for reversal only because of the subsequent failure to make payment to the supplier. Therefore, subsequent reversal under Rule 37 does not automatically establish that the ITC was wrongly availed and utilised for the purposes of Section 50(3).
The legislative history is also significant in this regard. The erstwhile Rule 37(3) expressly referred to Section 50(1) and prescribed interest from the date of availment till payment. The said provision was omitted with effect from 01.10.2022. The amended Rule 37 deliberately uses the broader expression “interest payable under section 50.” Therefore, the earlier formula of mechanically charging interest as per Section 50(1) from the date of availment of ITC till reversal/payment cannot simply be carried forward into the amended regime merely by reference to Rule 37. On the other hand, applicability of Section 50(3) cannot be established when the fact of the matter is that Input Tax Credit was not availed wrongly and only when condition of 2nd proviso to Section 16(2) of the CGST Act’2017 is not fulfilled, such ITC become ineligible for availment.
Accordingly, the generic reference to “interest under Section 50” cannot, by itself, be treated as an independent charging provision or as an automatic reference to Section 50(1) or to Section 50(3). It would need to identify the applicable sub-section and establish that its statutory conditions are satisfied.
Conclusion: Need for Clarity on Rule 37 Interest
The post-01.10.2022 statutory framework has resolved the earlier inconsistency between Section 16(2) and Rule 37 regarding “addition to output tax liability” versus “payment/reversal of ITC.” However, a separate and substantive ambiguity remains regarding the applicability and computation of interest.
In view of the amendments made with effect from 01.10.2022 and the subsequent amendment to Section 16(2), the precise provision of Section 50 applicable to interest arising from a Rule 37 default remains unclear. The amended Rule 37 no longer specifically refers to Section 50(1), as was the position under the erstwhile Rule 37(3), but merely provides for interest payable under Section 50. This appears to indicate a conscious departure from the earlier statutory treatment.
For a Rule 37 case, the mere fact that ITC is required to be reversed or paid does not, by itself, determine the applicable interest provision. If Section 50(1) is invoked, it should be established that there is a statutory basis for treating the Rule 37 amount as tax remaining unpaid to the Government. If Section 50(3) is invoked, it must establish that the ITC was wrongly availed and utilised, with the amount and period of utilisation determined in accordance with the applicable provisions of Rule 88B.
Consequently, the pre-01.10.2022 position that determines interest from the date of availment of ITC till the date of reversal/payment, which was expressly supported by the erstwhile Rule 37(3), should not be mechanically applied to the post 01.10.2022 regime. The applicable provision of Section 50 must first be identified and the corresponding statutory conditions and computation mechanism must be satisfied.
Significantly, the earlier scheme contemplated addition of the amount of ITC to the output tax liability, which provided a basis for treating the amount as tax liability and applying Section 50(1). Post 01.10.2022, the terminology and mechanism were changed to payment/reversal of ITC, and the corresponding provision in Section 16(2) was subsequently amended to align the Act with this changed mechanism. The legislative change from “addition to output tax liability” to “reversal/payment of ITC” therefore warrants consideration as a conscious departure from the earlier legal position.
In this background, it would be appropriate for the GST Council to issue a specific clarification as to the legislative intent behind this departure and, in particular, to clarify whether interest in cases covered by Rule 37 is intended to be governed by Section 50(1) or Section 50(3).
If the amended scheme is intended to operate as a reversal of ITC, rather than as an addition to output tax liability, invocation of Section 50(1) would require careful examination, since Section 50(1) is attracted in cases of failure to pay tax to the Government, whereas the Rule 37 default essentially arises from non-payment of consideration to the supplier. Conversely, application of Section 50(3) would require examination of the statutory requirement of wrong availment and utilisation of ITC.
It is expected that the GST Council should take up the matter and specifically clarify whether the change in terminology and mechanism was intended to alter the earlier legal position and, if so, prescribe the appropriate statutory basis and methodology for interest in Rule 37 cases. Such clarification would ensure uniformity in practice, avoid divergent interpretations by taxpayers and tax authorities, and provide certainty regarding the applicable provision for determining rate, commencement date and period for computation of interest in Rule 37 cases.
