Section 16(2)(c) After Bhandari Scrap Traders: Can a Genuine Purchaser Still Lose Input Tax Credit?
Introduction
Input Tax Credit (ITC) is the foundation of the Goods and Services Tax (GST) framework. It ensures that tax is levied only on value addition by allowing businesses to claim credit for GST paid on purchases, thereby preventing cascading of taxes and promoting seamless commercial transactions.
One of the most debated provisions under the Central Goods and Services Tax Act, 2017 is Section 16(2)(c), which permits a registered person to avail ITC only if the tax charged on the supply has actually been paid to the Government by the supplier. Although the provision was enacted to safeguard revenue and curb tax evasion, it created a recurring challenge for genuine purchasers who had received goods or services, paid the invoice value including GST, and fulfilled every obligation within their control, yet faced denial of ITC because of the supplier’s default.
This gave rise to a fundamental question: Should a bona fide purchaser lose ITC for the supplier’s failure to deposit tax? The issue assumed national importance because a recipient has no practical control over the supplier’s post-sale compliance. While taxpayers argued that they should not be penalised for circumstances beyond their control, the Revenue consistently maintained that ITC is a statutory benefit available only upon fulfilment of every condition prescribed by Parliament.
The conflicting approaches adopted by various High Courts created considerable uncertainty until the Supreme Court, in Bhandari Scrap Traders v. Union of India, upheld the constitutional validity of Section 16(2)(c) and declined to read down its requirements. The judgment confirms that the GST framework differs materially from the earlier VAT regime and that the statutory conditions governing ITC must be enforced as enacted.
The significance of the decision extends beyond statutory interpretation. It fundamentally changes the approach businesses must adopt towards GST compliance. Vendor selection, contractual protections and supplier compliance have now become integral to safeguarding ITC. The focus is no longer confined to a taxpayer’s own compliance but also encompasses the compliance behaviour of its suppliers.
This article examines the evolution of Section 16(2)(c), analyses the Supreme Court’s decision in Bhandari Scrap Traders, and discusses its practical implications for businesses, tax professionals and contractual relationships in the post-Bhandari era.
Why Section 16(2)(c) Became the Most Litigated Provision Under GST
The controversy surrounding Section 16(2)(c) did not arise immediately after the introduction of GST. In the initial years, businesses generally believed that ITC could be claimed once they had received the goods or services, possessed a valid tax invoice, paid the consideration along with GST and complied with the statutory requirements applicable to the recipient. Supplier compliance was largely viewed as a matter between the supplier and the tax authorities.
That understanding changed as departmental audits and assessments became more rigorous. Tax authorities began denying ITC where suppliers failed to file returns, did not deposit the tax collected from customers or subsequently became non-compliant. Consequently, purchasers who had already paid GST to their suppliers were required to reverse the credit, often along with interest, despite having acted in good faith. This practical difficulty soon emerged as one of the most contentious issues under the GST law.
The dispute centred on the interpretation of Section 16(2)(c). Taxpayers argued that the provision should not be applied against a recipient who had fulfilled every obligation within his control and had no statutory mechanism to verify whether the supplier had ultimately remitted the tax to the Government. The Revenue, however, maintained that Parliament had consciously made actual payment of tax by the supplier a mandatory condition for availing ITC and that courts could not dilute the statutory requirement on equitable considerations.
Although the controversy gained prominence under GST, its roots lay in the earlier VAT regime. Under the Delhi Value Added Tax Act, the Delhi High Court in On Quest Merchandising India Pvt. Ltd. held that a purchasing dealer could not reasonably be expected to verify whether the selling dealer had deposited the tax after completing the transaction. Applying the principle that the law does not compel a person to perform an impossible act (lex non cogit ad impossibilia), the Court protected bona fide purchasers who had acted honestly and were not involved in fraud or collusion. The same reasoning was reaffirmed in Arise India Ltd., and these decisions later became the foundation for similar arguments under the GST regime.
When comparable disputes reached various High Courts under the CGST Act, judicial opinion diverged. The Tripura High Court in Sahil Enterprises v. Union of India accepted the constitutional validity of Section 16(2)(c) but held that the provision should not be applied mechanically. Recognising the practical impossibility of monitoring a supplier’s tax compliance, the Court read down the provision to protect genuine purchasers who had neither participated in nor benefited from any fraud. Likewise, the Karnataka High Court in Instakart Services Pvt. Ltd. emphasised the genuineness of the transaction and held that ITC should not ordinarily be denied where the recipient had produced authentic invoices, payment records and other supporting evidence.
A different approach was adopted by the Kerala, Andhra Pradesh, Madras, Patna and Madhya Pradesh High Courts. These Courts treated ITC as a statutory concession governed strictly by the conditions prescribed under the CGST Act. Since Parliament had expressly made payment of tax by the supplier a prerequisite for availing credit, they held that courts could not relax the legislative mandate merely because its application caused hardship to a bona fide purchaser.
The conflicting judicial approaches created significant uncertainty for businesses operating across multiple States. Depending upon the jurisdiction, an identical transaction could produce different legal outcomes. While some courts protected bona fide recipients on equitable considerations, others insisted upon strict adherence to the statutory language. This divergence eventually led to the challenge before the Gujarat High Court, whose decision was later affirmed by the Supreme Court in Bhandari Scrap Traders. The Supreme Court has now settled the legal position by holding that Section 16(2)(c) must be applied as enacted and cannot be read down on equitable considerations
The Supreme Court Speaks: Understanding Bhandari Scrap Traders
The conflicting decisions of various High Courts ultimately reached the Supreme Court in Bhandari Scrap Traders v. Union of India. The central issue before the Court was whether Section 16(2)(c) of the CGST Act should either be declared unconstitutional or read down to protect a bona fide purchaser who had paid GST to the supplier but was denied Input Tax Credit (ITC) because the supplier failed to deposit the tax with the Government.
Affirming the judgment of the Gujarat High Court, the Supreme Court held that there was no constitutional infirmity in Section 16(2)(c) and no justification for reading down its language. The Court expressly agreed with the Gujarat High Court that the GST regime is materially different from the earlier VAT framework and, therefore, principles evolved under the Delhi VAT Act cannot automatically govern the interpretation of the CGST Act.
A significant factor that weighed with the Court was the comprehensive statutory framework enacted under the CGST Act. The Gujarat High Court had analysed the interplay of Sections 41, 73 and 74 and observed that the legislation itself provides a mechanism for reversal and subsequent re-availment of ITC where the supplier later discharges the tax liability. Accepting this reasoning, the Supreme Court held that where Parliament has consciously devised a complete statutory scheme, courts cannot modify it through judicial interpretation merely because its application may cause hardship in individual cases.
The decision therefore marks a departure from the approach adopted by courts such as the Tripura High Court in Sahil Enterprises, which had sought to protect bona fide purchasers by reading down Section 16(2)(c). The Supreme Court clarified that the relevant constitutional question was not whether the provision operated harshly in a particular case, but whether the legislative condition itself was constitutionally valid. Having answered that question in the affirmative, the Court declined to substitute equitable considerations for the clear statutory mandate enacted by Parliament.
The judgment reinforces a settled principle of tax jurisprudence that Input Tax Credit, although fundamental to the GST framework, remains a statutory entitlement governed by the conditions prescribed by the Legislature. Courts may interpret those conditions, but they cannot rewrite them on grounds of commercial hardship or equity. If any relaxation is considered necessary, the remedy lies with the Legislature and not with judicial interpretation.
Equally important, the judgment should not be understood as authorising automatic denial of ITC whenever a supplier defaults. The Supreme Court has upheld the validity of Section 16(2)(c), but it has not diluted the obligation of the tax authorities to establish the factual foundation for denying credit in a particular case. The department must still examine whether the statutory requirements are attracted, whether proper procedure has been followed and whether the principles of natural justice have been observed. Consequently, disputes concerning factual verification, procedural lapses and evidentiary issues remain open for adjudication notwithstanding the constitutional validity of the provision.
The practical consequence of Bhandari Scrap Traders is that the focus of GST litigation is likely to change. Challenges to the constitutional validity of Section 16(2)(c) are now unlikely to succeed. Future disputes will instead centre on factual issues, including whether the supplier actually defaulted, whether the department has followed the prescribed statutory procedure and whether the recipient has satisfied the remaining conditions for availing ITC.
For businesses, the judgment conveys a broader message. GST compliance is no longer confined to maintaining proper documentation and timely filing of returns. Since the recipient’s entitlement to ITC is directly linked to the supplier’s compliance, businesses must increasingly integrate tax compliance into vendor evaluation and commercial risk management. Supplier compliance has become an important commercial consideration alongside price, quality and delivery.
Beyond the Judgment: What Businesses Should Do Now
The Supreme Court’s decision in Bhandari Scrap Traders extends beyond the interpretation of Section 16(2)(c); it fundamentally changes the manner in which businesses must approach GST compliance. Until now, many taxpayers believed that their responsibility ended once they had obtained a valid tax invoice, received the goods or services, paid the supplier including GST and maintained the prescribed records. The judgment makes it clear that this assumption no longer holds good. A recipient’s entitlement to Input Tax Credit (ITC) now depends not only on its own compliance but also on the supplier’s fulfilment of the statutory conditions.
This does not mean that every purchaser is expected to investigate the internal affairs of its suppliers. The law does not require forensic audits or continuous monitoring of a supplier’s business. What it demands is reasonable commercial prudence. Businesses should therefore incorporate GST compliance into their vendor selection and procurement processes. Periodic verification of GST registration, reconciliation of purchase invoices with GSTR-2B, review of the compliance history of significant suppliers and prompt resolution of discrepancies are practical safeguards that can substantially reduce the risk of ITC disputes.
The judgment also expands the role of tax professionals. GST advisory can no longer be confined to return filing and reconciliation. Chartered Accountants and GST practitioners are increasingly expected to assist clients in designing vendor due diligence procedures, identifying high-risk suppliers and strengthening internal compliance systems. In many organisations, GST advisory has evolved from a compliance function into an exercise in risk management.
Another significant takeaway is the need to revisit contractual documentation. Many commercial agreements merely state that GST shall be charged “as applicable” without addressing the consequences of supplier default. In the post-Bhandari era, supply agreements should expressly require suppliers to comply with GST law, file returns within the prescribed time and deposit the tax collected from customers. They should also contain appropriate indemnity clauses enabling the purchaser to recover any financial loss arising from denial of ITC due to the supplier’s non-compliance. Although such clauses cannot compel the tax authorities to grant ITC contrary to Section 16(2)(c), they can provide an effective contractual remedy against the defaulting supplier.
Businesses should also broaden the scope of their internal GST audits. Apart from verifying invoices and reconciliations, periodic reviews should identify suppliers with recurring return filing defaults, cancelled registrations or persistent compliance deficiencies. Detecting such risks at an early stage is often more effective than contesting ITC reversals through prolonged litigation.
The broader message emerging from Bhandari Scrap Traders is that GST compliance has become an integral part of commercial governance. Supplier compliance is no longer merely a regulatory concern; it has become a business risk capable of directly affecting a purchaser’s working capital and profitability. Businesses that integrate compliance into procurement, contracting and internal controls will be better placed to safeguard their ITC and minimise avoidable disputes.
Can a Purchaser Recover the ITC Loss from the Defaulting Supplier?
While Bhandari Scrap Traders settles the legal position under Section 16(2)(c), it leaves open an equally important commercial question: who should ultimately bear the financial loss when a supplier collects GST but fails to deposit it with the Government?
The denial of ITC under the GST law does not necessarily exhaust the purchaser’s remedies. Although the CGST Act governs the entitlement to ITC, the contractual relationship between the purchaser and the supplier continues to be regulated by the general law of contracts. Where a supplier’s default results in denial of ITC, the purchaser may, depending upon the terms of the agreement and the facts of the case, seek compensation or damages under ordinary contractual principles.
For this reason, GST clauses in commercial agreements should no longer be treated as standard boilerplate provisions. Suppliers should expressly undertake to comply with GST law, file returns within time and deposit the tax collected from customers. Equally important are indemnity clauses requiring the supplier to compensate the purchaser for any loss of ITC, interest, penalty or litigation costs arising from its non-compliance. While such clauses do not affect the statutory operation of Section 16(2)(c), they significantly strengthen the purchaser’s contractual right to recover the resulting financial loss.
Businesses should also preserve comprehensive documentation, including purchase orders, tax invoices, proof of payment, transport records and correspondence with suppliers. These documents are not only essential for establishing the genuineness of the transaction before the GST authorities but may also become critical evidence in any subsequent contractual proceedings against the supplier.
At the same time, denial of ITC does not automatically give rise to a claim against the supplier. In some cases, the supplier may subsequently discharge the tax liability, enabling the recipient to re-avail the credit under the statutory mechanism. In others, the denial may arise from deficiencies attributable to the recipient rather than the supplier. Whether a civil remedy is available will therefore depend upon the contractual terms and the facts of each case.
Ultimately, Bhandari Scrap Traders encourages businesses to adopt a preventive approach. Careful vendor selection, robust contractual safeguards and effective compliance systems are likely to offer greater protection than litigation after ITC has already been denied.
Conclusion
The Supreme Court’s decision in Bhandari Scrap Traders marks a significant milestone in the evolution of GST jurisprudence. By affirming the constitutional validity of Section 16(2)(c), the Court has resolved the long-standing judicial conflict regarding the recipient’s entitlement to Input Tax Credit where the supplier fails to deposit the tax collected from the purchaser. The judgment reinforces that ITC is a statutory benefit governed by the conditions enacted by Parliament and that courts cannot dilute those conditions on equitable considerations alone.
At the same time, the decision does not diminish the importance of ITC within the GST framework. Instead, it reshapes the compliance landscape by making supplier compliance an essential component of the recipient’s tax risk management. Businesses can no longer view GST compliance as a function confined to accounting or return filing. Vendor due diligence, periodic compliance reviews, robust contractual safeguards and effective internal controls have become indispensable tools for protecting valuable ITC.
The judgment also broadens the role of tax professionals. Their responsibility now extends beyond statutory compliance to advising clients on vendor risk assessment, contractual protection and preventive compliance strategies. As GST matures, professional advice will increasingly focus on mitigating commercial risk rather than merely resolving tax disputes after they arise.
While the constitutional debate surrounding Section 16(2)(c) has largely come to an end, practical disputes will continue. Future litigation is likely to focus on factual issues such as the existence of supplier default, adherence to statutory procedures and the availability of contractual remedies against defaulting suppliers. The emphasis, therefore, must shift from challenging the validity of the provision to adopting business practices that minimise the risk of ITC denial.
Ultimately, Bhandari Scrap Traders is more than a judgment on Input Tax Credit. It signals a broader transformation in GST compliance, where tax discipline, commercial prudence and contractual risk management must operate together. Businesses that proactively strengthen their vendor management systems and contractual framework will be better positioned to protect their working capital and reduce avoidable litigation.
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( the views expressed in this article are strictly personal and author of this article can be reached at prudhvi@cavikramaditya.com)
