Arbitrariness in the GST Credit Chain-A Constitutional Challenge to Recipient-Side Disallowance under Section 16(2)(c)
I. Introduction: Input Tax Credit and the Architecture of GST
The Goods and Services Tax was conceptualised as a destination-based value-added tax that would eliminate cascading and ensure tax neutrality across the supply chain. Input Tax Credit (“ITC”) is not an incidental feature of this system; it is its structural core. Without seamless credit, GST risks degenerating into a multi-point turnover tax, embedding tax costs into prices and distorting market behaviour. This foundational logic is explicitly acknowledged in official GST design documents issued by the Central Board of Indirect Taxes and Customs (CBIC) that emphasize uninterrupted credit as one of the cornerstones of the GST framework.
Yet, the ITC under GST has increasingly become a site of coercive enforcement rather than facilitative neutrality. Section 16(2)(c) of the Central Goods and Services Tax Act, 2017 (“CGST Act”)-which conditions ITC on the tax charged having been “actually paid to the Government”-has emerged as a focal point of controversy. Administratively, this provision has often been invoked to deny ITC to recipients for supplier-side defaults, even where the recipient has acted bona fide.
This paper argues that such recipient-side disallowance, as operated in practice, gives rise to serious concerns of arbitrariness within the meaning of Article 14 of the Constitution. The use of divergent High Court interpretations further exacerbates the problem through causing legal uncertainty and disparate fiscal outcomes. The divergence is not merely doctrinal; it reflects different conceptions of GST itself-whether GST is a value-added tax cabined by constitutional fairness or a compliance-driven regime that shifts enforcement risk downstream.
II. Conceptual Status of Input Tax Credit: Beyond the “Concession” Narrative
A recurring justificatory trope in the cases involving ITC disputes is that credit is a “concession” granted by statute and therefore subject to strict conditions. It is certainly right that ITC is statutorily regulated, but otherwise this characterisation is analytically incomplete. In a credit is a mechanism through which tax neutrality is operationalised; its denial has systemic consequences far beyond the individual taxpayer.
Scholarship has increasingly warned against any dispensation of ITC as an expendable fiscal privilege. It has been observed in both academic and practitioner assessments that denial of ITC to a compliant recipient reinstitutes cascading and defeats the underlying economic justification of GST. To say the least, even assuming any given benefit is conditioned, such conditions must be reasonable, proportionate, and capable of compliance. A statutory condition operating in a manner divorced from taxpayer conduct invites Article 14 scrutiny.
III. Section 16(2)(c): Legislative Purpose and Interpretive Indeterminacy
Section 16(2)(c) provides, inter alia, that the taxable consideration on a supply should have actually been “paid to the Government” for ITC eligibility. The legislative intent underpinning this is uncontroversial: avoid revenue leakage engendered by fake invoicing and/or a supplier failure to remit to the treasury. The statutory text makes no express provision, however, regarding the sequencing of enforcement. It says nothing as to whether the supplier failing necessarily disentitles the recipient nor imposes any express obligation on the latter to seek verification of treasury remittance.
This silence has produced interpretive indeterminacy. A literal reading that treats supplier non-payment as fatal to recipient ITC effectively transforms Section 16(2)(c) into a strict liability provision, despite the absence of clear legislative intent to that effect. Commentators analysing Section 16 have warned that such an interpretation risks weaponizing a safeguard provision into a punitive instrument against recipients.
IV: Administrative Practice and the Rise of Proxy Liability
Operationalising GST has been characterised by an increasing use of technology, data analytics, and automated compliance indicators. While these make the system more efficient, they also enable the use of proxies in enforcement. Instead of pursuing the defaulting supplier, ITC to recipients has been denied often based on indirect signals such as non-reflection of invoices or data mismatches.
Policy analyses have noted that this has the effect of shifting enforcement risk from the state onto the taxpayer, notably downstream recipients who already have borne the economic incidence of tax. Administrative convenience, however, cannot displace statutory design. When facilitative data tools are elevated into determinative criteria for denying substantive entitlements, the result is regulatory overreach rather than effective compliance.
The inner contradiction in the GST scheme becomes clearer when the incorporation of Rule 36(4) of the CGST Rules, 2017 is evaluated against its statutory backdrop. Rule 36(4), introduced in 2019, limited the availment of input tax credit in cases where supplier invoices were not fully reflected in the supplier’s outward supply declarations, by allowing credit only up to a certain margin. Notably, upon its promulgation, the CGST Act lacked an express enabling provision empowering such a quantitative limitation through delegated legislation.
This gap motivated the subsequent legislative intervention through the insertion of Section 16(2)(aa) which statutorily linked ITC eligibility with supplier invoice reporting. The conceptual tension, however, persisted even beyond this amendment. While Section 16(2)(c) has often been read as enabling total denial of ITC if the tax is not paid by the supplier, Rule 36(4), by providing for partial credit despite supplier-side non-compliance, embodies a sharply contrasting regulatory philosophy. This divergence is normatively significant. It signals that the legislative scheme does not uniformly regard supplier default as justifying absolute disqualification of the recipient. On the contrary, it is representative of a conscious shift towards calibrated restrictions. In this backdrop, interpretations that require total ITC denial against the recipient solely by reason of supplier default appear inconsistent not only with the principles of proportionality under Article 14 but also with the differentiated approach that the legislature itself takes to compliance risk within the GST framework.
V. Inter-High Court Divergence on Section 16(2)(c)
A. The Strict Compliance Approach
One strand of High Court reasoning adopts a literal and compliance-centric interpretation of Section 16(2)(c). Courts following this approach emphasize that ITC is a statutory benefit and that the conditions prescribed by Parliament must be strictly satisfied. Supplier payment of tax is treated as an objective precondition, irrespective of the recipient’s conduct. The often used Rationale behind this is – why should the authorities give back ITC if it hasn’t received the tax in the first place, but thereby overlooking the economic reality that the Recipient has already borne the tax.
The obiter from this line of cases suggests that however unfortunate the hardship to recipients, it cannot override statutory text. Revenue protection and legislative supremacy are the priorities, even if it means that recipients have to bear the risk of supplier default. In fact, this reasoning normalises recipient-side strict liability.
B. The Substantive Fairness Approach
In contrast, an increasing number of High Courts have and continue to embrace a contextual and constitutionally informed interpretation of Section 16(2)(c). The steadfast judiciary theme in this regard is that a bona fide recipient-one who has paid consideration including tax, received goods or services, and maintained valid documentation-cannot be penalized for supplier-side failures absent fraud, collusion, or ineligibility.
The obiter reasoning in these decisions emphasizes that:
- Automatic ITC denial is impermissible,
- Recovery needs to be pursued against the defaulting supplier first and
- Recipient liability requires a demonstrable nexus to wrongdoing.
This approach implicitly invokes Article 14, proportionality, and the principle that statutory conditions cannot compel the impossible.
C. The Effects of Fragmentation
These two approaches have, thus far, generated a jurisdiction-specific outcome. Identically placed assesses face radically different consequences, depending on the forum, thereby denting the equality before law and predictability in fiscal governance. Commentators have explicitly identified this inter-High Court conflict as one of the most significant unresolved issues in GST jurisprudence.
VI. Constitutional Evaluation under Article 14
Article 14 proscribes arbitrary state action and insists on rational, non-discriminatory exercise of authority under the law. While tax laws enjoy latitude in the field of legislation, tax administration enjoys no insulation against constitutional norms. The Supreme Court has repeatedly opined that arbitrariness is antithesis to equality and executive discretion can be exercised only on objective relevant considerations.
Application of these principles denotes that the denial of ITC to the recipient under Section 16(2)(c) is fundamentally vulnerable to constitutional attack. When compliant recipients are treated no differently from fraudulent claimants only because of supplier default, the state engages in equal treatment of unequals—a classic Article 14 infirmity. Further, such mechanical denial based on indirect indicators lacks a rational nexus to the objective of curbing tax evasion.
VII. Impossibility, Proportionality, and Compliance Burdens
There is a well-settled rule of statutory interpretation: lex non cogit ad impossibilia-the law does not compel the impossible. Recipients, under GST, have no legal right or actual ability to enforce supplier tax remittances. Conditioning ITC upon such verification places an impossible burden.
Even assuming regulatory breach, proportionality has to dictate the response. Wholly denying ITC is a harsh fiscal penalty, often disproportionate to the assumed revenue risk. Doctrinal analyses of impossibility and proportionality warn against constructions which turn regulatory conditions into penal consequences for third party conduct.
VIII. Towards a constitutionally sustainable interpretation of s. 16(2)(c)
A constitutionally coherent reading of Section 16(2)(c), on the other hand, would have non-payment by suppliers as merely an investigatory trigger and not an automatic disqualification. Recipient-side denial ought to be reserved to cases of fraud, collusion, or demonstrable ineligibility, when supplier-side recovery remains the primary enforcement mechanism.
Such an interpretation preserves revenue interests while aligning enforcement with GST’s value-added logic and Article 14 requirements. Similarly, policy think tanks have argued that resolving the ITC crisis requires recalibrating enforcement priorities rather than expanding recipient liability.
IX. Conclusion: Re-anchoring GST in Constitutional Fairness
GST’s validity is based on neutrality, predictability, and faith in the credit chain. Recipient-side disallowance under Section 16(2)(c), if applied mechanically, breaks that faith and turns GST into a regime of downstream risk allocation. The inter-High Court conflict in this respect reflects a deeper constitutional unease.
Overcoming this dissonance demands recognition that the quest to safeguard revenues cannot be at the altar of arbitrariness. Reading Section 16(2)(c) harmoniously with Article 14 is not judicial overreach; it is constitutional fidelity. Only then can the GST regain its foundational promise as a true value-added tax.
****
Author: Jith
Author Bio
