ITC Cannot Be Denied Automatically for Supplier Default: Gujarat HC

1. Introduction

The denial of Input Tax Credit (ITC) on account of supplier default continues to be one of the most contentious issues under GST. The recent decision of the Gujarat High Court in Maruti Enterprise vs Union of India & Ors. (order dated 01.05.2026) provides important judicial observations on this issue.

2. Core Issue

The central question involved is:

Whether ITC can be denied to a purchaser solely on the ground that the supplier has not deposited GST with the Government, as mandated under Section 16(2)(c) of the CGST Act, 2017?

3. Legal Framework

• Section 16(2)(c) – ITC allowed only if tax is actually paid to the Government
• Section 41(2) – Reversal and re-availment mechanism
• Sections 73 & 74 – Recovery provisions against defaulting supplier
• Section 155 – Burden of proof on taxpayer

4. Court’s Prima Facie View on Validity of Law

The Court has observed that:

• It is not inclined to read down Section 16(2)(c)
• Consequently, the question of declaring the provision unconstitutional does not arise

This indicates that, at this stage:

The statutory requirement of actual tax payment remains intact and enforceable

5. Key Judicial Observations (Paras 87–88)

5.1 Action Against Defaulting Supplier

The Court clearly noted:

The GST law provides sufficient powers to the Department to proceed against the supplier for the recovery of tax under Sections 73 and 74.

This reflects a judicial expectation that:

• Primary enforcement should be against the defaulting supplier, not the purchaser

5.2 Adoption of “Knowledge Test” (Kittel Principle)

A significant observation made by the Court is:

ITC can be denied only if it is shown that the purchaser knew or ought to have known that the transaction was connected with tax evasion.

This introduces:

• A mens rea-based safeguard for bona fide purchasers
• Alignment with international jurisprudence (ECJ – Kittel)

5.3 Recognition of Practical Hardship

The Court acknowledged:

• Genuine purchasers face disproportionate hardship
• There is a lack of:
  • Real-time verification of supplier tax payment
  • Transparency in the GST system

5.4 Strong Recommendation to Government

The Court went a step further and observed that:

• There is a need for:
  • Legislative re-evaluation/clarification
  • Technology-driven tracking mechanism

Objective:

To protect bona fide purchasers from supplier defaults

6. Practical Implications

7. Conclusion

The Gujarat High Court, at this stage, has adopted this approach:

• √ Section 16(2)(c) is upheld
• √ Strong observations made to:
  • Protect genuine purchasers
  • Ensure action against defaulting suppliers

Most notably, by introducing the “knew or ought to have known” test, the Court has:

ITC should not be denied automatically, especially when the transaction is Bonafide.

8. Professional Insight

For Taxpayers, this judgment changes the litigation landscape. While we can no longer argue that Section 16(2)(c) is “unconstitutional” in Gujarat, we can argue against its arbitrary application.

Action Points:

1. Vendor Screening: Conduct deep due diligence on new vendors.

2. Contractual Safeguards: Ensure your purchase agreements allow you to withhold payments or seek indemnity if the supplier fails to reflect the tax in GSTR-2B/3B.

3. Documentary Trail: Maintain “Gold Standard” documentation (E-way bills, weighbridge slips, payment proofs) to satisfy the “Knowledge Test” and prove the transaction was not a paper-only fraud.

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Author’s Note: The views expressed in this article are personal and based on legal interpretations. Readers are encouraged to refer to the specific facts of their case and the latest rules, regulations and circulars before proceeding. While due care has been taken in preparing this article, certain mistakes and omissions may creep in. The author does not accept any liability for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document, nor for any actions taken in reliance thereon.