Section 16(2)(c), Rule 37A and Tripura HC’s Protection of Bona Fide Recipients in GST

Section 16(2)(c), Rule 37A and the Tripura High Court’s Protection of Bona Fide Recipients in GST

1. Statutory framework: Section 16(2)(c) and Rule 37A

Section 16(2)(c) of the CGST Act makes ITC conditional on the tax charged in respect of the supply being “actually paid to the Government” by the supplier, which on a literal reading permits denial or reversal of ITC to the recipient if the supplier does not pay tax, even though the recipient has paid full consideration plus GST.

Rule 37A of the CGST Rules (inserted by Notification No. 26/2022‑CT) operationalises this idea by mandating ITC reversal where the supplier fails to furnish the corresponding GSTR‑3B by 30 September following the end of the financial year.

Key features of Rule 37A include the following conditions and consequences:

• It applies where the supplier has reported the invoice in GSTR‑1, the recipient has availed ITC in GSTR‑3B, but the supplier has not filed GSTR‑3B for that tax period by 30 September of the next financial year.
• The recipient must reverse such ITC in GSTR‑3B on or before 30 November of the following financial year; if not, the amount is treated as tax payable with interest under Section 50.
• If the supplier subsequently files the pending GSTR‑3B and pays tax, the recipient is expressly allowed to re‑avail the ITC in a later GSTR‑3B.

Professional articles describe Rule 37A as one of the toughest ITC provisions because it effectively shifts the risk and monitoring burden of the supplier’s GSTR‑3B compliance onto the recipient, even when the recipient has received the goods/services and paid GST in full.

2. Tripura High Court judgment: Section 16(2)(c) read down

In January 2026, the Tripura High Court (Division Bench of Chief Justice M. S. Ramachandra Rao and Justice S. Datta Purkayastha) delivered a landmark judgment in Sahil Enterprises v. Union of India, upholding the constitutional validity of Section 16(2)(c) but reading it down to protect bona fide purchasers.

Core holdings of the Court are:

• Parliament can impose conditions on ITC, but literal, mechanical application of Section 16(2)(c) “places an onerous burden on a bona fide purchasing dealer” who has no control over the supplier’s tax deposit.
• Section 16(2)(c) “ought not to be interpreted to deny ITC to purchasers in a bona fide transaction” and must be applied only where the transaction is not bona fide or is collusive/fraudulent to defraud the revenue.
• A buyer “cannot be asked to do the impossible” of identifying in advance a selling dealer who will not deposit GST, and punishing such a buyer with ITC denial would be vulnerable to invalidation under Article 14 as arbitrary and disproportionate.
• On the facts (about ₹1.11 crore ITC), the Court found no fraud or collusion; the supplier alone defaulted, so the denial order was set aside and the department was directed to allow the ITC.

The Court thus preserved Section 16(2)(c) on the statute book but narrowed its application: it remains available against fake, collusive or fraudulent transactions, but cannot be used to deny ITC to genuine, bona fide recipients who have fulfilled the statutory conditions.

3. Impact on Rule 37A when the supplier defaults in GSTR‑3B

Rule 37A is subordinate legislation framed under Sections 16 and 41; it must operate within the boundaries of the parent Act as interpreted by constitutional courts. After the Tripura High Court’s reading down of Section 16(2)(c), several important consequences follow for Rule 37A:

• Rule 37A cannot be used to permanently deny ITC to a bona fide recipient merely because the supplier did not file GSTR‑3B or pay tax, where the recipient:
  • holds a valid tax invoice,
  • has actually received the supply, and
  • has paid full value including GST through banking channels.
• At most, Rule 37A can be seen as a machinery provision permitting provisional reversal (with interest only for the period of actual delay), coupled with a clear and effective right of re‑availment as soon as the supplier discharges tax via GSTR‑3B.
• Where the department mechanically demands reversal with full interest and treats ITC as permanently lost, without alleging collusion or fake invoices, such action is now open to challenge as inconsistent with the Tripura High Court’s interpretation and as arbitrary under Article 14.

Post‑judgment commentary emphasises that courts favour bona fide buyers, and that Rule 37A must now be applied narrowly, ensuring that genuine taxpayers are not effectively punished for the supplier’s non‑compliance.

4. Retrospective cancellation, GSTR‑1 vs GSTR‑3B and supplier’s credit ledger

A frequent and serious problem is the retrospective cancellation of supplier registrations in situations where:

• The supplier’s registration is active when supplies are made and GSTR‑1 is filed, so outward supplies appear on the portal and recipient ITC is auto‑populated.
• Later, the department cancels the supplier’s registration with retrospective effect, after which the supplier cannot file GSTR‑3B for those earlier periods, even though GSTR‑1 is already filed.

This creates multiple mismatches and legal issues:

• The buyer’s ITC is based on genuine transactions, fully supported by invoices, e‑way bills and bank payments, and matched in GSTR‑2B; yet Rule 37A flags such ITC as “at risk” because the supplier’s GSTR‑3B is missing.
• The supplier may have unutilised ITC in his electronic credit ledger, but after retrospective cancellation there is no clear mechanism on the portal for utilising that credit to discharge tax for the retrospectively cancelled period.
• Professional analyses recognise this as a grey area, noting that the combination of retrospective cancellation and portal constraints makes it practically impossible for the supplier to comply, while notices are then issued to recipients under Rule 37A, effectively shifting the entire financial burden onto bona fide buyers.

In light of the Tripura High Court judgment, strong arguments arise that where non‑payment is due to departmental action (retrospective cancellation) or procedural portal blocks rather than supplier choice, the department must either:

• regularise the supplier’s returns (by revoking/limiting retrospective cancellation or allowing filing of GSTR‑3B and utilisation of credit ledger), or
• refrain from invoking Rule 37A against bona fide recipients, because the shortfall is not attributable to any fault of the buyer.

5. Practical implications and suggested title for publication

For taxpayers currently facing Rule 37A‑based ITC reversal where suppliers have defaulted or their registrations were retrospectively cancelled:

• Document bona fides: maintain and produce invoices, e‑way bills, transport documents, payment proofs, stock records and GSTR‑2B to demonstrate genuine receipt and payment.​
• Rely on the Tripura High Court judgment to argue that Section 16(2)(c) cannot be used against bona fide purchasers, and that Rule 37A must be read consistently, allowing at best temporary reversal with assured re‑availment.
• Challenge demands that seek permanent loss of ITC or heavy interest in cases of supplier default without any allegation of collusion or fraud, as being contrary to the constitutional reading of Section 16(2)(c) and arbitrary under Article 14.
• Raise the issue of supplier credit‑ledger balances and request that the department first explore adjustment/utilisation of such credits or regularisation of the supplier’s returns, instead of targeting compliant recipients.