CA Karthik SP
Introduction
Section 16(2)(c) of the CGST Act creates an impossible situation for businesses. The provision says you can claim Input Tax Credit only if your supplier has paid the tax to the Government. But here’s the problem: there’s no way for you to verify whether your supplier actually paid the tax. You can check if they filed GSTR-1. You can see if the invoice appears in your GSTR-2B. But you cannot check if they deposited the tax with the Government.
This has triggered constitutional challenges across multiple High Courts. As GSTAT becomes operational (with state benches being established and a 4.8 lakh appeal backlog to clear by June 2026), this will be one of the first major interpretative questions the Tribunal faces. The core issue is simple: can the law penalize a bona fide purchaser for something entirely beyond their control?
How the provision actually works
Section 16(2)(c) requires that the tax must be “actually paid to the Government, either in cash or through utilisation of input tax credit.” This works alongside Section 16(2)(aa), introduced in the Finance Act 2021, which requires the supplier’s invoice details to appear in your GSTR-2B.
Rule 36(4) made things worse. Before January 1, 2022, you could claim provisional ITC up to 5% beyond what appeared in GSTR-2B. The amendment killed that. Now you can claim ITC only to the extent reflected in GSTR-2B. Nothing more.
Here’s what this means in practice. Your supplier delivers goods in August 2025. You receive the goods, pay the full amount including GST, and hold a valid tax invoice. But the supplier files GSTR-1 late, in October 2025. Under Rule 36(4) as it stands now, you cannot claim ITC in September 2025 when you actually received the goods and made payment. The invoice won’t be in your September GSTR-2B because the supplier hasn’t filed yet. You have to wait until November 2025 GSTR-2B (which captures the supplier’s October GSTR-1 filing). That’s a two-month working capital hit. Minimum.
The worse scenario is when the supplier collects the tax from you but doesn’t deposit it with the Government. Section 16(2)(c) denies you ITC even though you did everything right. You verified the supplier’s GSTIN. You received genuine goods. You have valid tax invoices. You paid the full consideration. The transaction appears in GSTR-2B. But you still lose the ITC because the supplier defaulted.
GSTR-2B tells you the supplier filed GSTR-1. It doesn’t tell you whether the supplier paid tax. There’s no field in GSTR-2B that says “tax actually deposited: yes/no.” You’re being held responsible for verifying something the system doesn’t let you verify.
The constitutional problem
The challenge invokes Article 14 (Right to Equality). The provision doesn’t distinguish between bona fide purchasers and fraudulent ones. It treats everyone the same. You complied with every requirement the law puts on you. Your supplier defaulted. You lose ITC anyway.
Three problems stand out. First, the law asks you to do something impossible. You cannot ensure supplier compliance with tax deposits because you have no access to that information. Second, the law treats fraud and genuine transactions identically. No distinction. Third, the consequences are disproportionate. You suffer the economic loss (ITC denial) while the remedy against the defaulting supplier remains theoretical.
The Delhi VAT precedent
The Delhi High Court dealt with this exact issue in Arise India Limited vs. Commissioner of Trade & Taxes, Delhi (October 26, 2017). Section 9(2)(g) of the Delhi VAT Act used almost identical language to Section 16(2)(c). The Court held it was unconstitutional to the extent it denied ITC to bona fide purchasing dealers for seller defaults.
The Court’s reasoning was straightforward. The Legislature failed to distinguish between purchasing dealers who acted in good faith and those who didn’t. You can’t punish the bona fide purchaser for the supplier’s failure. The remedy has to be against the defaulting supplier. The Court read down Section 9(2)(g) to exclude bona fide purchasers who: verified supplier registration, received genuine supplies, had proper invoices, and showed no mismatch in returns data.
The Revenue appealed to the Supreme Court. On January 10, 2018, the Supreme Court dismissed the Special Leave Petition in Commissioner of Trade & Taxes, Delhi vs. Arise India Limited. This affirmed the High Court’s reading.
Recent cases under GST
High Courts have split on Section 16(2)(c). Some upheld it without reading it down. But recent decisions show courts are increasingly protecting bona fide purchasers.
Tripura High Court (January 2026)
M/s. Sahil Enterprises vs. Union of India (January 6, 2026) applied the Arise India principle to GST. The Court upheld Section 16(2)(c) as constitutionally valid but read it down. Where the recipient paid GST to the supplier, there’s no allegation of collusion or fraud, and the transaction is genuine, you cannot deny ITC just because the supplier failed to remit tax.
The Court was clear about the impossibility problem. Quote: “The purchasing dealer cannot be expected to do the impossible, specifically, to identify a selling dealer who will not deposit the tax collected from purchasing dealers with the government.” The Department’s remedy is against the defaulting supplier. Not the purchaser.
Karnataka High Court (February 2026)
Two weeks later, the Karnataka High Court followed Tripura’s approach in M/s. Instakart Services Private Limited vs. Union of India (February 9, 2026). Justice S.R. Krishna Kumar read down both Section 16(2)(c) and Rule 36(4). The key holding: “The impugned provisions are hereby read down in a manner that allows the benefit of ITC to bona fide recipients which have complied with all other conditions under Section 16(2) despite any fault/lapse or non-payment of tax to the government by the suppliers.”
The Court limited ITC denial to cases involving actual fraud, collusion, or non-genuine transactions. Where the supplier hasn’t deposited tax but the purchaser acted in good faith, the Department goes after the supplier.
Supreme Court guidance on related provisions
The Supreme Court hasn’t ruled directly on Section 16(2)(c)’s constitutional validity. But related decisions provide guidance. In Brij Systems Private Limited vs. Commissioner of GST (2025), the Court examined time limits under Section 16(4) and stressed the need for reasonable interpretation. In Suncraft Energy Private Limited vs. Union of India (2023), the Court said GST provisions must be read consistently with constitutional principles and business realities.
Canon India Private Limited vs. Commissioner of GST, Delhi (2021) applied Arise India directly to GST. ITC cannot be denied to purchasers for supplier defaults absent evidence of collusion. K.V. Joshy vs. Commissioner, CGST Kerala (2025) recognized the same impossibility issue and directed remedies against defaulting suppliers, not purchasers.
What this means for litigation
If you’re facing ITC denial under Section 16(2)(c), you need to establish bona fides. Courts protect purchasers who can show they acted in good faith. Here’s what you need.
Documentation requirements
Valid tax invoices from registered suppliers (correct GSTIN, all required details). Payment proof through banking channels showing you paid consideration plus GST. Goods receipt evidence (transport documents, weighment slips, delivery challans). GSTR-2B showing the transaction (confirms supplier filed). Commercial records establishing genuine business purpose.
Also show due diligence. You verified supplier registration on the GST portal when you did the transaction. Invoice details matched GSTIN. You have correspondence showing the business relationship. No investigation findings suggest collusion, benami arrangements, or accommodation entries.
Litigation strategy for GSTAT
GSTAT will have to reconcile divergent High Court decisions. Here’s the approach.
First, lead with Arise India. The Supreme Court affirmed it. The constitutional problem identified in the VAT regime applies equally to GST. Section 16(2)(c) creates the same impossible burden the Delhi High Court struck down.
Second, rely on Sahil Enterprises and Instakart. These are recent High Court decisions directly interpreting Section 16(2)(c) under GST. They provide the most current judicial thinking.
Third, distinguish the cases that upheld Section 16(2)(c) without reading it down. Look at the facts. Did those cases involve allegations of collusion? Non-genuine transactions? Failure to demonstrate bona fides? The reading down principle protects genuine purchasers specifically. It doesn’t validate fraud.
Fourth, challenge mechanical denials. Show cause notices that deny ITC without examining your bona fides or giving you a chance to prove transaction genuineness are procedurally defective. Section 73 and 74 proceedings must consider the constitutional reading of Section 16(2)(c).
When the reading down doesn’t apply
The cases discussed above don’t protect fake invoices. Where investigation shows no genuine supply occurred, or the transaction was designed solely to pass ITC without tax liability, constitutional protection doesn’t apply.
Courts consistently deny ITC when: the supplier is non-existent or a shell entity; the goods or services were never actually supplied or consumed; the purchaser knew about or participated in the fraudulent arrangement; or documents are forged or fabricated.
In these cases, the Department uses Section 16(2)(c) alongside Sections 122 and 132 (penalty and prosecution). The burden of proof shifts. In supplier default cases with genuine transactions, the Department must prove collusion or knowledge. In fake invoice cases, once the Department establishes the supply was bogus, you have to prove it was genuine.
What needs to change
The litigation exposes a policy choice. Should GST prioritize revenue protection through strict ITC conditions, or business facilitation through protections for bona fide taxpayers? Right now it tries both. The result is practical impossibilities and constitutional challenges.
Legislative fixes
The GST Council could amend Section 16(2)(c) to explicitly exclude bona fide purchasing dealers. The provision would operate only where collusion or fraud is proven. That would align the law with how courts are already reading it.
Better yet, create a verification mechanism. Let the GST portal show purchasing dealers whether their supplier deposited the tax (without disclosing the supplier’s overall liability). This addresses the impossibility argument directly. You can verify before claiming ITC. Suppliers face immediate visibility if they default.
Or differentiate enforcement. Don’t treat genuine businesses the same as fraudsters. Rule 86A (ITC blocking) and Section 73/74 proceedings could be risk-based. High-risk transactions (new suppliers, large amounts, specific sectors) get stricter scrutiny. Established relationships with clean compliance records get expedited processing.
Technology solutions
Real-time invoice reporting through e-invoicing already reduced mismatches. Extend this to payment verification. When the supplier pays tax, trigger automatic ITC availability for the recipient. This makes Section 16(2)(c) work without impossible burdens.
Use predictive analytics to identify high-risk transactions for manual review. Let low-risk ITC claims process automatically. Flag suspicious patterns (sudden turnover spikes, GSTIN mismatches, supplier defaults) for investigation. Don’t blanket-deny ITC to all purchasers of a defaulting supplier.
Conclusion
Section 16(2)(c) creates a real problem for honest taxpayers. The provision tries to prevent revenue leakage. But it does this by penalizing businesses for actions beyond their control. You can do everything right and still lose ITC because your supplier defaulted.
Courts are converging on a solution. The Tripura and Karnataka High Courts read down the provision to protect bona fide purchasers. This follows the Supreme Court’s affirmation of Arise India. The approach balances revenue protection with constitutional requirements. It upholds the provision but prevents application where the purchaser fulfilled all reasonable obligations.
The distinction matters. Genuine transactions get protection. Fraud gets enforcement. That’s the right line.
GSTAT will shape how this plays out. The Tribunal’s decisions will determine compliance practices, investigation procedures, and business confidence. Until the Legislature acts, the reading down principle offers the most workable solution.
GST was supposed to be a good and simple tax. That promise breaks down when legitimate businesses get caught in anti-evasion measures. Section 16(2)(c) can prevent abuse without creating impossible compliance burdens. But this requires recognizing that punishing one taxpayer for another’s default is neither fair nor constitutional.
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CA Kartik SP is the Founder of Enclaro Consulting, a boutique advisory firm based in Hyderabad. With over 8 years of experience including prior roles at KPMG and Indeed.com, he works on GST advisory, compliance, litigation, and transaction structuring. He can be reached at cakarthiksp@gmail.com or advisors@enclaro.in
