Sec 16(2)(c) of CGST Act, 2017 – A nightmare for taxpayers

Writing anything on clause (c) of sub-section (2) of section 16 of CGST Act, 2017 is nothing but scary. It is one of the harshest and scariest provisions of the GST laws and may prove to be a nightmare for the compliant taxpayers.

This particular provision says that availment of ITC by the recipient of a supply is contingent upon payment of tax by the supplier either in cash or through utilisation of admissible ITC in respect of the said supply.

On realising the perils involved in seemingly such an innocuous provision, a baffled taxpayer can do nothing but just scream is desperation. It is beyond his comprehension how is it possible for him to ensure that the tax collected from him is actually paid by the seller to the treasury or adjusted through utilisation of eligible ITC. A bunch of pertinent questions that instantly come to his mind are –

• Do I have any legal authority to ensure this compliance by the seller?
• Can I sue the seller for not paying the tax and get immediate justice?
• Am I placed in a superior economic position vis-a-vis the seller as far as dictating terms are concerned?
• Can I take the role of an enforcement agency?
• Can a poor buyer like me command the seller that I would pay the tax only when he proves to me that he had already paid it to the government?
• Can I hold back the payment of tax and take it upon myself to pay the same directly to the government on behalf of the seller? Even if the seller permits me do so, I will have to have his id and password. Will he provide me with that?
• Is not the physical distance between the buyer and me in a vast country like India a limiting factor to follow up?
  Do I have any mechanism framed or specified by the government by which I can know whether the tax has been paid by the seller? I can see his return filing status, but how do I confirm whether the figures reflected in the GSTR-3B and taxes paid match with GSTR-1? How do I further confirm the GSTR-3B figures include supplies made to me?

While the above questions with no plausible answers knock the buyer on the floor, his perils do not end here. He is burdened not only with the task of ensuring whether the seller has paid the tax in cash or through availment of ITC, but he is also to ensure that the ITC is admissible on part of the seller. The law clearly uses the term ‘input tax credit admissible’.

A B2B supply is required to be uploaded by the seller on the common portal through GSTR-1. The system allows the buyer to know whether the seller has recorded or registered the transaction with the portal by uploading it or not. However, if the seller does not upload the transaction, the buyer cannot even claim the ITC. Again, uploading the transactions through GSTR-1 is just a part of the story. Section 16(2)(c) does not still allow the buyer to be entitled for the ITC against the tax element of the supply which he might have already paid to the supplier. Now for argument’s sake let us presume that the supplier does not or cannot pay the tax for whatsoever reasons. Would the buyer now be required to pay the tax again for no fault of him? One is not sure whether this is the basics on which indirect taxes work. And more importantly, what kind of a justice is this?

‘Lex Non Cogit ad impossibilia’ is an age old maxim which means that ‘the law does not compel a man to do which he cannot possibly perform’. In Hughey v. JMS Development, Justice Owens of the United States Court of Appeals used these words – “Lex non cogit ad impossibilia : A body of law does not compel or forces someone to do the thing which is impossible. The law does not compel the doing of impossibilities” “Where the law creates a duty or charge and the party is disabled to perform it, without any default in him and has no remedy over it, there the law will in general excuse him”.

‘Impossibilum nulla oblignto est’ is another maxim which encapsulates the idea that nobody can be obliged to perform what he cannot perform. The onus that section 16(2)(c) puts on the buyer is almost impossible to perform. If the buyer has acted bonafide, prima facie there are no grey areas in a transaction and the buyer has paid the tax to the seller, common sense says that the buyer should be absolved of his responsibilities to ensure that the tax has been paid to the government. If the seller fails to do it, it is the duty of the tax enforcement machinery, which has the required financial resources, manpower and legal authority, to track the errant seller and realise the same from him. The restrictions put in section 16(2)(c) in respect of purchasing dealer are arbitrary, irrational and unduly harsh. It is tantamount to violation of Article 14 of the Constitution. Article 14 talks about equality before law and states that the State shall not deny any person equality before the law or the equal protection of the laws within the territory of India. Reference can be made here to the decisions made in K.T. Moopil Nair vs. State of Kerala [AIR 1961 SC 552], State of Kerala vs. Haji and Haji [AIR 1969 SC 378] and Commissioner of Customs, Amritsar vs. Parker Industries [2007 (207) ELT 658 (P&H).

Minutes of the GST Council meetings reveal that even some of the state finance ministers were also apprehensive of the legality of this provision. The minutes of the 27th GST Council meeting states, inter alia, that “Hon’ble Minister from Tamil Nadu stated that the proposal of recovery of tax from the seller and, if it was not possible, to reverse the input tax credit of the purchaser would need careful legal scrutiny and drafting.” As minuted, even the Secretary explained that “it had been consistent stand of many that availability of input tax credit should not be linked with payment of taxes but was being opposed by the States. He added that even if the seller did not pay taxes after uploading the invoice online, the first liability of paying taxes would remain with the seller. If the seller did not pay the taxes, the State concerned following due process of issuing notice and adjudication etc. can recover the tax from the seller. However, where ultimately the seller did not pay the tax, the purchaser is not absolved of the responsibility to pay tax in the proposed model.”

It is quite clear from the above that the lawmakers had doubts about the legal strength and practical shortcoming of such a provision. The comments by Tamilnadu State Finance Minister that reversal of ITC of purchaser would need careful legal scrutiny sums up the issue. The Secretary also explained that it had been a consistent stand of many that availability of input tax credit should not be linked with payment of taxes but that was being opposed by the States. Despite agreeing to the concept that the first liability of paying taxes should remain with the seller, still the lawmakers did not absolve the buyer from the responsibility if the seller fails. This is height of arbitrariness.

Undue hardship on the buyer

It is much appreciated that the law must check tax avoidance by businesses and must come hard on the defaulters. However, an attempt to achieve this by making a systemic change on a large scale may affect all and sundry including the bona fide and compliant taxpayers. The burden on them for such change may be difficult to shoulder. It may lead to the cascading consequences and double taxation which may be undermined by the legislature. Such a restriction increases the working capital requirements of the businesses particularly the MSMEs.

This particular provision will always keep the taxpayers on tenterhooks as he would be perennially in a state of uncertainty whether the ITC would become due to him or not and he would heave a sigh of relief if the supplier pays the tax. But the question still remain how does he do that? What is the mechanism available for it? Or is he supposed to call every supplier routinely? What would happen to the economy if most of the big buyers withhold the payment to the small suppliers, refuse to pay the tax portion, demand bank guarantees to cover the possible risks? Would the economy run smoothly?

There is every possibility that section 16(2)(c) may not stand the test of law and might have to be read down, even if it is not declared unconstitutional. In the past, there were defaults by businessmen in paying the due tax after collecting the same from the buyers. Each of the legislations evolves and stables over a period of time. IT back end strength during VAT regime not being robust, it was possibly not feasible for the authorities to systematically mitigate the risk of fraud. However, GST Law with its supposed IT back end strength is in a position to provide necessary real time data and with suitable help from artificial intelligence based MIS, the authorities should be equipped to trace defaulters for recovery of tax along with harsh penalties and prosecutions. The system must make provisions where a defaulter does not remain undetected for a long time. Accordingly, the liability of a buyer must cease once he pays his taxes to the seller and GST being an indirect tax the burden of payment shifts to the seller. If there is a mismatch in the claim of input, the buyers must only be required to prove that their claim in bona fide.

Judicial pronouncement in the pre-GST regime

Talking about erstwhile state vat regime, in the case of Sri Vinayaga Agencies v.s The Assistant Commissioner, CT Vadapalani [2013 60 VST page 283], it was held by the Hon’ble Madras High Court that the authority does not have the jurisdiction to reverse the input tax credit already availed by the assessee on the ground that the selling dealer had not paid the tax.

Similarly, in the case of Assistant Commissioner (CT), presently TAC, Kolathur, Chennai vs. Infiniti Wholesale Ltd., reported in [2017] 99 VST 341 (Mad) and Ranganathar Valves (P) Ltd. vs. The Assistant Commissioner (CT) (FAC) [W.P. Nos. 38488 to 38493 of 2015], Hon’ble Madras High Court held that Input Tax Credit cannot be disallowed on the ground that the seller has not paid tax to the Government, when the purchaser is able to prove that the seller has collected tax and issued invoices to the purchaser. As such, restriction of the amount of Input Tax Credit on this ground cannot be sustained.

In the case of On Quest Merchandising India Pvt. Ltd. vs. Government of NCT of Delhi and others [W.P.(C) 6093/2017] as well as Arise India Limited vs. Commissioner of Trade & Taxes, Delhi & Others [W.P.(C) 2106/2015] and many other writs in a batch on the same subject matter, the petitions raised a challenge to the constitutional validity of section 9(2)(g) of the Delhi Vat Act, 2014 as being violative of Article 14 and 19(1)(g) of the Constitution of India. Section 9(2)(g) of the Delhi Vat Act, 2014 states that no tax credit shall be allowed to a dealer unless the tax paid by the purchasing dealer has actually been deposited by the selling dealer with the Government or has been lawfully adjusted against output tax liability and correctly reflected in the return filed for the respective tax period. This has complete semblance with the provision stated in section 16(2)(c) of the CGST Act, 2017. It is also pertinent to mention here that section 9(2)(g) was inserted w.e.f. 01.04.2010 which means that such a restriction was not in the original frame of things.

In these cases, Hon’ble Delhi High Court held that section 9(2)(g) requires the purchasing dealer to ensure, for the purposes of claiming ITC, that the selling dealer has deposited VAT with the Government or has lawfully adjusted it against such selling dealer’s output tax liability which is not within the control of the purchasing dealer. The Court further added that In the event that the selling dealer has failed to deposit the tax collected by him from the purchasing dealer, the remedy for the Department would be to proceed against the defaulting selling dealer to recover such tax and not deny the purchasing dealer the ITC.

While delivering the judgement on the above case, Hon’ble Delhi Court touched upon many pertinent issues. One of them is the distinction between bona fide dealers and others who are not. Citing the cases of Shri Ram Krishna Dalmia vs. Shri Justice S. R. Tendolkar [(1959) 1 SCR 279], K.T. Moopil Nair vs. State of Kerala, Budhan Chaudhury vs. State of Bihar [(1955) 1 SCR 1045], the Court observed that in the present case there is a singular failure by the legislature to make a distinction between purchasing dealers who have bona fide transacted with the selling dealer by taking all precautions and those that have not. Therefore, there was need to restrict the denial of ITC only to the selling dealers who had failed to deposit the tax collected by them and not punish bona fide purchasing dealers. The latter cannot be expected to do the impossible. It is trite that a law that is not capable of honest compliance will fail in achieving its objective. If it seeks to visit disobedience with disproportionate consequences to a bona fide purchasing dealer, it will become vulnerable to invalidation on the touchstone of Article 14 of the Constitution.

In Indroyal Furniture Company (P) Ltd. vs. The Assistant Commissioner (CT) [W.P. 14777 of 2016], the Hon’ble Madras High Court referred to the judgement in the case of Vinayaga Agencies vs. The Assistant Commissioner, CT Vadapalani held that the authority is not empowered to revoke the ITC availed on the plea that the selling dealer had not paid the tax.

In the case of Shanti Kiran India Pvt. Ltd. vs. Commissioner, Trade & Tax Department [(2013) 57 VST 405 (Delhi)], Hon’ble Delhi High Court held that in the absence of any mechanism enabling a purchasing dealer to verify if the selling dealer deposited tax, for the period in question the benefit of input credit, cannot be denied. The VAT authorities observed that the scanty amounts deposited by the selling dealers were incommensurate with the transactions recorded, and straightaway proceeded to hold that they colluded with the appellant. Such a priori conclusions are based on no material, or without inquiry, and accordingly unworthy of acceptance.

In the case of Gheru Lal Bal Chand vs. The State of Haryana and another [W.P. No. 6573 of 2007], the constitutionality of section 8 of the Haryana Vat Act was challenged before the Hon’ble High Court of Punjab & Haryana which was also drafted on a similar line. In their judgement dated 23rd September 2011, although the Court did not hold section 8 as ultra vires but categorically stated that no liability can be fastened on the purchasing registered dealer on account of non-payment of tax by the selling registered dealer in the treasury unless it is fraudulent, or collusion or connivance with the registered selling dealer or its predecessors with the purchasing registered dealer is established.

In the case of Commissioner of Central Excise, Jalandhar vs. M/s Kay Kay Industries [Civil Appeal No. 7031 of 2009], Hon’ble Apex Court was deciding on the issue whether deemed MODAVT can be taken by the manufacturer of the final product when the duty was not paid on the inputs by the suppliers. A proviso was there in rule 57A(6) of the Central Excise Rules 1944 that the manufacturer shall take all reasonable steps to ensure that the inputs acquired by him are goods on which the appropriate duty of excise as indicated in the documents accompanying the goods, has been paid under section 3A of the Central Excise Act, 1944. The Court held that the proviso postulates and requires reasonable care and not verification from the department whether the duty stands paid by the manufacturer-seller. When all the conditions precedent have been satisfied, to require the assessee to find out from the departmental authorities about the payment of excise duty on the inputs used in the final product which have been made allowable by the notification would be travelling beyond the notification, and in a way, transgressing the same. This would be practically impossible and would lead to transactions getting delayed.

In the case of M/s Mahalaxmi Ginning Pressing and Oil Industries, Kolhapur vs. The State of Maharashtra & Other [W.P. 33 of 2012], the Hon’ble Bomaby High Court took a different stand. The Hon’ble Court reasoned that a plea of hardship for buyers could not result in the invalidation of a statutory provision in a fiscal enactment, which is otherwise lawful. Further, the purpose of an input is to obviate the cascading effect of taxes; and this must be balanced with the need to secure tax compliance and ensure zero loss of legitimate revenue to the government. This balance is drawn by ensuring that while input is available against tax paid on purchase of goods, the set-off is based on the actual deposit of tax into the government treasury. If the legislature, as in the present case, prescribes that a set off should be granted only to the extent to which tax has been deposited in the treasury on the purchase of goods, it is within a reasonable exercise of its legislative power in so mandating. This does not offend Article 14.

However, if one goes by the operative part of the order of the Bombay High Court, it reveals that the Bombay High Court ordered authorities to prosecute the selling dealers who are defaulters and details of such defaulters were to be uploaded on its website. In addition, where there was a final recovery of the tax from the seller, refund would be granted to the buyer. Obvious implication of the same that even though the Court did not explicitly read down the provision, it did nevertheless uphold the buyer’s right to input credit.

GST regime

In the case of LGW Industries Limited and Others vs. Union of India and others [W.P. 23512(W) of 2019], Hon’ble Calcutta High Court has issued notice to Centre and State Government on 08.01.2020 wherein the petitioner has challenged the constitutional validity of Section 16(2)(c) of the CGST Act / WBGST Act, which seeks to deny ITC to a buyer of goods or services, if the tax charged in respect of supply of goods or services has not been actually paid to the Government by the supplier of goods or services. It was argued that denying ITC to a buyer of goods and services would tantamount to treating both the ‘guilty purchasers’ and the ‘innocent purchasers’ at par whereas they constitute two different classes. The petition further stated that denying ITC to a buyer of goods or services for default of the supplier of goods or services would tantamount to shifting the incidence of tax from the supplier to the buyer, over whom it has no control whatsoever, is arbitrary and irrational & therefore violative of the Article 14, Article 19(1)(g) and Article 300A of the Constitution of India. It would also clearly frustrate the underlying objective of removal of cascading effect of tax as stated in the Statement of object and reasons of the 122nd Constitution Amendment Bill, 2014. On the second issue in the petition, it was stated that in the absence of any finding about petitioners mala fide intention, connivance or wrongful association with the suppliers, no liability can be imposed on it on the principle of vicarious liability on account of fraudulent conduct of the suppliers, who have obtained registration on the basis of fictitious documents.

In the case of Bharti Telemedia Ltd. vs. The Union of India and others [W.P. (C) 6293/2019], section 16(2)(c) has been challenged before the Hon’ble Delhi High Court on the ground that the provision is violative to Article 14 of the Constitution of India. The Department has been vested with all the powers to recover any revenue lost due to non-payment of taxes by the erring suppliers, the credit cannot be denied to the recipient for the default on part of the suppliers. Hon’ble High Court had issued a notice to the Union of India.

In the case of Sahil Enterprises vs. The Union of India [W.P. (C) 531/2021] before the Hon’ble Tripura High Court, the petitioner submitted that their ITC account has been attached by the Department that the tax has not been paid by the supplier. The Petitioner contended that after paying taxes to the seller at the time of purchases, the Petitioner has no control over the seller to ensure that such tax is deposited with the Government. Denying ITC to the Petitioner where they have already paid tax would amount to double taxation. The Hon’ble High Court held that the issue needs consideration and notice was issues to the Union of India.

In the recent case of M/s D.Y. Beathel Enterprises vs. The State Tax Officer (Data Cell), Tirunelvelli [W.P. (MD) No. 2127 of 2021, The Madurai Bench of the Hon’ble Madras High Court in their judgement dated 24.02.2021 held that “if the tax has not reached the kitty of the Government, then the liability may have to be eventually borne by one party, either the seller or the buyer.”

Is section 16(2)(c) arbitrary or violative of Article 14 ? Is it liable to be read down ?

While delivering their judgement on section 9(2)(g) of Delhi Vat Act in the case of Arise India Ltd. vs. Commissioner of Trade & Taxes, Delhi and other, Hon’ble Delhi High Court had stated that In the situation envisaged by Section 9 (2) (g) itself, clearly the defaulting party is the selling dealer. He has collected the VAT from the purchasing dealer and failed to deposit it with the Government or failed to lawfully adjust it against his output tax liability and has failed to correctly reflect that in his return. For all these defaults committed by the selling dealer, the purchasing dealer is expected to bear the consequence of being denied the ITC. It is this that is being questioned as violative of Article 14 of the Constitution. The precarious condition faced by the purchasers under section 16(2)(c) of the CGST Act is not different.

While commenting upon the arbitrariness of section 9(2)(g) of the Delhi Vat Act, Hon’ble Delhi Court had stated that there is some uncertainty as of today on whether a law can be struck down only on the ground of arbitrariness thereby attracting Article 14 of the Constitution. This doubt has been created by the decision of the Supreme Court in Rajbala vs. State of Haryana and Binoy Viswam vs. Union of India (2017) 7 SCC 59 the correctness of both of which has been doubted by the Supreme Court in its recent 3:2 decision in the case of Shayara Bano vs. Union of India [2017(9) SCALE 178]. Accordingly, both the cases i.e. Rajabala vs. State of Haryana as well as Binoy Viswan vs. UOI mentioned above which held that a legislation cannot be challenged on the ground of arbitrariness are no longer good law. In view of the uncertainty on this issue, the Court does not propose to examine it further. However, the Court has concluded that the failure of Section 9 (2) (g) of the DVAT Act to make a rational classification between purchasing dealers who are bona fide and those that are not renders it vulnerable to invalidation under Article 14 of the Constitution.

In respect of ‘reading down’ of the provision, the Hon’ble Delhi High Court first mentioned the judgement given by a Constitution Bench of the the Apex Court in the case of Delhi Transport Corporation vs. Mazdoor Congress [AIR 1991 SC 101] which stated that the doctrine of reading down or of recasting the statute can be applied in limited situations. It is essentially used, firstly, for saving a statute from being struck down on account of its unconstitutionality. The Courts, though, have no power to amend the law by process of interpretation, but do have power to mend it so as to be in conformity with the intendment of the legislature. Doctrine of reading down is one of the principles of interpretation of statute in that process. But when the offending
language used by the legislature is clear, precise and unambiguous, violating the relevant provisions in the constitution, resort cannot be had to the doctrine of reading down to blow life into the void law to save it from unconstitutionality or to confer jurisdiction on the legislature.”

In light of the above legal position, the High Court held that the expression “dealer or class of dealers” occurring in Section 9 (2) (g) of the DVAT Act should be interpreted as not including a purchasing dealer who has bona fide entered into purchase transactions with validly registered selling dealers who have issued tax invoices in accordance with Section 50 of the Act where there is no mismatch of the transactions. Unless the expression “dealer or class of dealers” in Section 9(2)(g) is “read down” in the above manner, the entire provision would have to be held to be violative of Article 14 of the Constitution.

Going by the above, it is ample clear that there seems to be light at the end of the tunnel and although not unanimous but still the overwhelming view amongst the judiciary is that the burden of the seller to pay the tax to the treasury cannot be shifted to the buyer. However, a clear pronouncement of the same would take some time. Till then, nightmare continues courtesy some over enthusiastic department officials.