GST Rule 86B on Tobacco Traders: Section 49(12), RSP Valuation & Constitutional Challenge

Summary: Rule 86B of the CGST Rules restricts specified taxpayers with monthly taxable supplies exceeding Rs. 50 lakh from discharging more than 99% of output tax liability through the electronic credit ledger, ordinarily requiring at least 1% payment in cash. This article examines the rule’s application to pan masala, cigarettes and specified tobacco products brought under retail sale price (RSP)-based valuation from 1 February 2026 under Section 15(5) of the CGST Act. Because successive suppliers of these notified goods may be taxed on the same RSP-derived value, the article argues that input tax credit restricted by Rule 86B may remain permanently unutilised instead of merely being deferred, effectively turning a payment restriction into an additional cash burden. It examines whether that consequence exceeds the enabling scope of Section 49(12), amounts to an unauthorised levy under Article 265, or creates unequal and arbitrary treatment under Article 14 by applying the same restriction to transaction-value traders and RSP-value traders despite materially different credit consequences. The article therefore advances an as-applied challenge to Rule 86B for supplies valued under Section 15(5), while also considering Revenue arguments concerning fiscal-policy latitude, the statutory nature of input tax credit, accumulated credit and the exceptions already contained in Rule 86B.

Rule 86B And The Tobacco Trader: When A Payment Rule Becomes A Levy Under Section 49(12)

Introduction

Since 1st February 2026, a trader who deals in pan masala, cigarettes or manufactured tobacco pays GST on the printed retail sale price, and so does every other supplier in the chain. The value does not grow from one hand to the next. The trader’s output tax is therefore exactly equal to the tax he has already paid on his purchases, and in a world of seamless credit his net cash liability should be nil.

Rule 86B of the CGST Rules, 2017 does not see it that way. Once the trader’s taxable supplies in a month cross Rs. 50 lakh, the rule forbids him from discharging more than 99% of his output tax through the electronic credit ledger. One per cent must be paid in cash. For an ordinary dealer this is a nuisance of timing: the credit held back is used up in later months as his margin generates fresh output tax. For the tobacco trader it is something else altogether. His credit can never be absorbed, because there is no margin on which tax is charged, and it can never be refunded, because the law gives no refund for it.

The result is that a rule framed to regulate the manner of payment has become, for one class of dealers, an additional tax of one per cent at every stage of distribution. This article examines whether that result survives scrutiny under Section 49(12) of the CGST Act, 2017, under Article 265, and above all under Article 14 of the Constitution. My answer is that it does not, and that the challenge is best framed not as a facial attack on Rule 86B but as a challenge to the rule as applied to goods notified for retail sale price valuation under Section 15(5).

The legal framework

Rule 86B

Rule 86B was inserted by Notification No. 94/2020 CT dated 22.12.2020, with effect from 01.01.2021. It provides that a registered person whose value of taxable supply, other than exempt and zero-rated supply, exceeds Rs. 50 lakh in a month shall not use the amount in the electronic credit ledger to discharge more than 99% of his output tax liability for that month.

The first proviso lifts the restriction in four situations:

where the proprietor, Karta, managing director, or any two partners, whole-time directors or members of the managing committee (or the proprietor alone, as the case may be) have paid income tax of more than Rs. 1 lakh in each of the two preceding financial years;

where the registered person has received a refund of more than Rs. 1 lakh in the preceding financial year on account of unutilised credit, for zero-rated supplies without payment of tax or for an inverted duty structure;

where the registered person has already paid more than 1% of his total output tax liability in cash, cumulatively, up to the month in question in the current financial year;

where the registered person is a Government department, a public sector undertaking, a local authority or a statutory body.

The second proviso allows the Commissioner, or an officer authorised by him, to remove the restriction after such verification and safeguards as he thinks fit. No guidance has been prescribed for the exercise of that discretion.

Section 49(12)

When Rule 86B was made, the Act contained no provision that spoke in terms of a ceiling on the proportion of liability that could be paid from the credit ledger. Section 49(12) was inserted later by Section 110 of the Finance Act, 2022, and brought into force from 01.10.2022 by Notification No. 18/2022 CT. It provides that, notwithstanding anything in the Act, the Government may, on the recommendations of the Council and subject to such conditions and restrictions, specify the maximum proportion of output tax liability under the CGST Act or the IGST Act which may be discharged through the electronic credit ledger by a registered person or a class of registered persons.

Two features of the subsection deserve attention. First, it is enabling: it does nothing until the Government acts under it. Second, it expressly contemplates that the ceiling may be fixed for a class of registered persons and subject to conditions. Parliament plainly foresaw that one ceiling would not suit every dealer.

Retail sale price valuation under Section 15(5)

Section 15(5) allows the Government, on the recommendations of the Council, to notify supplies whose value shall be determined in a prescribed manner, notwithstanding the transaction value rule in Section 15(1). By Notification No. 19/2025 CT dated 31.12.2025, amending Notification No. 49/2023 CT, the Government notified retail sale price-based valuation for the following goods with effect from 01.02.2026:

The retail sale price is the maximum price declared on the package at which the goods may be sold to the ultimate consumer, inclusive of all taxes. Where more than one price is declared, the highest applies; where the price is altered upward at any stage, the altered price applies; and where different prices are declared for different areas, the price for the area of sale applies. The taxable value is derived by taking the tax element out of that inclusive price, under Rule 31D inserted alongside. At the same time, the rate on most of these goods was raised, and the compensation cess was reduced to nil.

The crucial point is that the notification governs every supply of the specified goods, by whoever makes it. It is not a single-point levy at the manufacturer’s gate. The manufacturer, the super stockist, the distributor, the wholesaler and the retailer each pay tax, but every one of them pays it on the same value.

How the two regimes interact

The effect is easiest to see in figures. Take a distributor of chewing tobacco taxed at 40%, whose monthly sales, valued on the printed retail sale price net of tax, come to Rs. 1.25 crore. He bought the same goods during the month, and his purchases were valued on the same printed price.

In an ordinary trade the Rs. 50,000 left in the ledger would be consumed next month, because the dealer’s margin generates output tax in excess of his input tax. Here the next month produces exactly the same picture. The residue simply stacks up: Rs. 6 lakh at the end of the year, Rs. 12 lakh at the end of the second, with no month in which it can ever be drawn down.

The third exception in Rule 86B does not rescue him. It applies only where the cash paid exceeds 1% of the liability cumulatively up to the month. A dealer who pays a little more than 1% in one month buys himself a lighter month later, but over the year the rule still extracts one per cent of his output tax in cash. The exception redistributes the burden; it does not remove it.

The burden repeats at every stage

Because every supplier in the chain is valued on the same printed price, each one who crosses the threshold suffers the same lock. If the goods pass from manufacturer to super stockist to distributor to wholesaler before reaching the retailer, and three of those intermediaries are caught by the rule, the State collects three extra slices of one per cent of the same tax on the same packet. None of it is ever matched by any output that could absorb it.

The threshold is measured on a deemed value

The Rs. 50 lakh test in Rule 86B looks to the value of taxable supply. For these goods that value is no longer the price the trader actually charges; it is the value derived from the printed retail price. A distributor whose trade price, exclusive of tax, adds up to Rs. 40 lakh in a month may find that the same quantity, valued at the retail sale price net of tax, comes to Rs. 57 lakh. He never sold goods worth Rs. 50 lakh at the price he received, yet he is within the rule. The valuation fiction, introduced for an entirely different purpose, pulls into Rule 86B dealers whom the rule was never designed to reach.

Does Rule 86B contradict Section 49(12)?

It is tempting to say that Rule 86B and Section 49(12) are in conflict where tobacco traders are concerned. On their face they are not. Section 49(12) permits the Government to fix the maximum share of liability that may be paid from the credit ledger; Rule 86B fixes it at 99%. If the argument is put as a bare contradiction, the Revenue’s answer writes itself: the rule does precisely what the section allows.

The real tension lies a level deeper, between what Section 49(12) is and what Rule 86B does when it meets retail sale price valuation.

A payment provision cannot create a levy

Section 49 sits in Chapter X of the Act, under the heading “Payment of Tax”. It deals with ledgers, the order of utilisation and the mode of discharge. The charge is in Section 9, and the liability of a dealer after credit is worked out under Sections 9 and 16 read with Section 49. Section 49(12) authorises a ceiling on the mode by which a liability is discharged. It does not, and could not without saying so, enlarge the liability itself.

For an ordinary dealer the ceiling only changes the timing. Credit held back today is used tomorrow, and over the life of the business the total tax paid is the same. For a trader in goods valued under Section 15(5) the ceiling changes the quantum. The credit held back is never used. The cash paid is never adjusted against anything. What the dealer bears is not a deferment but a permanent extra payment equal to one per cent of his output tax.

At that point the rule has crossed from regulating payment into imposing tax. Article 265 permits no tax except by authority of law, and the authority must be found in a charging provision that clearly identifies the taxable event, the person, the rate and the measure: Mathuram Agrawal v. State of M.P., (1999) 8 SCC 667. Nothing in Section 9 charges a trader to one per cent of his output tax over and above his net liability. Nothing in Section 49(12) purports to. A tax that arises only from the interaction of a valuation notification and a payment rule is a tax by inference, which Article 265 does not allow.

Delegated legislation must stay within its parent

A rule must conform to the Act under which it is made and cannot travel beyond it: Kunj Behari Lal Butail v. State of H.P., (2000) 3 SCC 40. Subordinate legislation is also open to challenge on the ground of manifest arbitrariness, a ground not available against a statute in the same breadth: Indian Express Newspapers (Bombay) Pvt. Ltd. v. Union of India, (1985) 1 SCC 641.

The statutory backing for Rule 86B has already attracted judicial doubt. In M/s A.M. Enterprises v. State of H.P., CWP No. 1517 of 2024, decided on 20.09.2024, the Himachal Pradesh High Court observed that the rule appeared to lack support in Section 49(4) and in Sections 49A and 49B, and that the general rule making power in Section 164 could not supply what the Act did not provide. The Court described the credit ledger as the taxpayer’s own money. It must be read with care: the operative relief was the setting aside of a registration cancellation as disproportionate, and the Court does not appear to have examined Section 49(12). It remains a useful indication that the rule does not enjoy unquestioned footing.

There is also a temporal point. Rule 86B operated from 01.01.2021, while Section 49(12) came into force only on 01.10.2022 and was not made retrospective. For the intervening period the rule had to stand on Section 49(4), which speaks of conditions and restrictions on the use of credit but says nothing of capping the proportion of liability payable from it. That issue is distinct from the tobacco question, since retail sale price valuation began only in February 2026, but it shows that the rule was not drafted with Section 49(12) in view, still less with Section 15(5) goods in view.

The Article 14 case

The strongest ground is equality. It can be put in four ways, each reinforcing the others.

Unequals treated as equals

Article 14 forbids not only unreasonable classification but also the failure to classify where a real difference exists. The Supreme Court held in Venkateshwara Theatre v. State of A.P., (1993) 3 SCC 677, a taxation case, that just as equals may not be treated unequally, unequals may not be treated alike; to do so is itself a denial of equality.

Rule 86B treats every dealer above Rs. 50 lakh the same way. Yet the trader in goods valued on transaction value and the trader in goods valued on retail sale price are differently placed in the one respect that matters to the rule. For the first, the held back credit is recovered through future value addition. For the second, it is lost for good. A single ceiling, applied to both, produces a timing effect for one and a permanent levy for the other. The difference is not of degree but of kind, and the rule takes no notice of it.

No nexus with the object

A classification, or the refusal to make one, must bear a rational relation to the object of the measure: Ram Krishna Dalmia v. Justice S.R. Tendolkar, AIR 1958 SC 538. The declared purpose of Rule 86B, when introduced, was to check the use of credit generated through fake invoices by entities that pay almost nothing in cash.

In the retail sale price chain that mischief has little room. Every supplier pays tax on the same printed value, the manufacturer’s liability is fixed on that value at the very first stage, and the trader’s credit equals tax actually charged upstream on identical goods at an identical value. Compelling the trader to pay one per cent in cash detects no fraud and prevents none. It merely collects money. A burden that does nothing to advance the object of the rule, while imposing a permanent cost, fails the nexus test.

Manifest arbitrariness

Since Shayara Bano v. Union of India, (2017) 9 SCC 1, it is settled that a law which is capricious, irrational or without adequate determining principle is manifestly arbitrary and void under Article 14. The standard applies with greater force to delegated legislation, which does not carry the presumption that attends an Act of Parliament.

A rule that leaves a dealer with credit he is entitled to under Section 16, but can never use and can never recover, lacks any determining principle. It does not ration the credit; it confiscates a slice of it every month, in amounts that bear no relation to any risk the dealer poses. That is the very definition of a measure which operates irrationally upon the class it touches.

Non application of mind after 01.02.2026

Section 49(12) itself shows how the problem should have been handled. It allows the ceiling to be fixed for a class of registered persons and subject to conditions. When the Government, on the Council’s recommendation, chose under Section 15(5) to value tobacco goods on the printed price at every stage, it changed the economics of Rule 86B for that class completely. It made no corresponding condition, exception or separate ceiling under Section 49(12). The power to tailor the rule existed and was left unused.

The failure to consider an obviously relevant matter is a recognised ground of invalidity in administrative and delegated action. Here the relevant matter was created by the Government’s own notification. It cannot be said to have been unforeseeable.

Proportionality and Article 19(1)(g)

For completeness, the same facts support a challenge under Article 19(1)(g). A restriction on the right to carry on trade must be proportionate: it must pursue a legitimate aim, use a means suitably connected to it, be necessary in the sense that no less restrictive means would do, and strike a fair balance: Modern Dental College and Research Centre v. State of M.P., (2016) 7 SCC 353. A narrower rule, excluding Section 15(5) goods or permitting a periodic refund of locked credit, would serve the revenue’s legitimate interest equally well. The existence of that obvious, less burdensome alternative is fatal on the necessity limb.

Wider latitude in tax classification

The Revenue will rely on R.K. Garg v. Union of India, (1981) 4 SCC 675 and Federation of Hotel and Restaurant Association of India v. Union of India, (1989) 3 SCC 634, which recognise that the legislature has greater freedom in fiscal measures and that courts will not strike down a taxing law merely because it bears harder on some than on others.

The answer is that the latitude belongs to the legislature in choosing what to tax and at what rate. It does not extend to a rule maker who, through a payment provision, produces a tax that the legislature never chose to levy. Nor does the latitude excuse a measure without any rational connection to its object. The petitioner does not quarrel with the rate on tobacco or with retail sale price valuation. He objects to an unlegislated extra levy that arises by accident of two notifications operating together.

Input tax credit is a concession

The Revenue will cite Jayam & Co. v. Assistant Commissioner, (2016) 15 SCC 125 and ALD Automotive Pvt. Ltd. v. Commercial Tax Officer, (2019) 13 SCC 225 for the proposition that credit is a concession, and that the legislature may attach conditions to it.

The answer is twofold. First, the petitioner does not claim an unconditional right to credit. The credit in question has been validly taken under Section 16 and sits in the ledger as admitted credit. Once lawfully taken, credit has been treated as indefeasible: Eicher Motors Ltd. v. Union of India, (1999) 2 SCC 361. Second, the cases on conditions concern conditions of eligibility. Rule 86B does not deny eligibility. It allows the credit and then makes it permanently useless, which is a different and far less defensible thing.

VKC Footsteps and accumulated credit

The most serious authority against the challenge is Union of India v. VKC Footsteps India Pvt. Ltd., (2022) 2 SCC 603. The Supreme Court there upheld the refund formula for inverted duty structure and declined to extend refund of accumulated credit to input services, holding that the grant of refund is a matter of legislative policy and that courts will not rewrite the formula.

The distinction is real. VKC Footsteps concerned the design of a refund that Parliament had chosen to give in a limited form; the Court refused to enlarge a benefit. The present challenge does not ask the Court to create a refund. It asks the Court to hold that a payment rule may not be applied so as to exact cash beyond the liability fixed by the charging section. One is a claim to a larger concession; the other is a defence against an unauthorised levy. Article 265 was not in issue in VKC Footsteps in this form.

The rule has its own exits

The Revenue will point out that Rule 86B is not absolute. A dealer whose proprietor or partners pay more than Rs. 1 lakh in income tax for two years is outside it, and the Commissioner may lift the restriction.

This answer has force in a particular case, and a petition must be chosen with it in mind. The ideal petitioner does not qualify under the income tax exception and has applied to the Commissioner and been refused, or received no decision. But the exits do not cure the constitutional defect. Whether the rule applies depends on the income tax paid by the proprietor, a circumstance entirely unrelated to the reason the credit is locked. And an unguided discretion in the Commissioner to relieve some dealers from an arbitrary burden makes the scheme more arbitrary, not less.

One per cent is trivial

Finally, it may be said that one per cent of the output tax is too small to matter. The answer is that Article 265 has no de minimis exception. In any event, the figure is not small in this trade: at a 40% rate, one per cent of tax is 0.4% of the taxable value, recurring every month, at every stage, on margins in tobacco distribution that are often thin. Over a year it can exceed a meaningful part of the trader’s entire profit.

Conclusion

Rule 86B was written for a world in which value grows as goods move, and in that world a one per cent cash requirement is a matter of timing. The retail sale price regime for tobacco has created a different world, in which value is frozen from factory to shop and credit equals tax at every stage. Applied there, the same rule ceases to regulate payment and begins to exact tax.

The objection is not that tobacco is taxed heavily; that is a policy choice the Constitution leaves to Parliament and the Council. The objection is that a slice of additional tax is being collected without any charging provision, from one class of dealers, by the unexamined interaction of two notifications. That offends Article 265, because no law levies it. It offends Article 14, because it treats unlike dealers alike, serves no purpose of the rule, and operates without any determining principle. And it was avoidable, because Section 49(12) itself invited the Government to fix the ceiling class by class.

Until the Council acts, the question will have to be answered by the High Courts. The case for reading down Rule 86B, so that it does not reach supplies valued under Section 15(5), is a strong one.

Sources

• Notification No. 19/2025 Central Tax
• RSP-based valuation for notified tobacco products
• GST Council newsletter, December 2025
• Section 49 amendment history, Finance Act 2022
• M. Enterprises v. State of H.P.

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Author: Ravindra Kumar Rastogi, Advocate, High Court, Allahabad, Chamber No. 5. Mobile: 9897493155 | Email: [email protected]