Section 16(2)(c) of CGST Act, 2017: Constitutional Battle over Input Tax Credit

Summary: Section 16(2)(c) of the Central Goods and Services Tax Act, 2017 conditions a recipient’s entitlement to input tax credit upon the supplier’s actual payment of tax to the Government, creating a continuing constitutional and practical controversy for bona fide purchasers who have paid the full invoice value including GST. The dispute has its roots in the pre-GST Delhi VAT jurisprudence protecting genuine purchasers from consequences arising solely from seller defaults. Under GST, however, the High Courts have divided. Decisions including D.Y. Beathel Enterprises, Suncraft Energy Private Limited and Sahil Enterprises adopted taxpayer-protective approaches, while Aastha Enterprises, M. Trade Links, Nahasshukoor and Thirumalakonda Plywoods reflect stricter application of the statutory conditions. In 2026, the Supreme Court in Bhandari Scrap Traders v. Union of India agreed with the Gujarat High Court’s decision in Maruti Enterprise concerning direct supplier default, while Prime Metals left issues concerning an upstream supplier’s default open. Rule 37A provides for reversal and subsequent re-availment when the supplier ultimately complies. The resulting position exposes recipients to supplier-related compliance risk and makes vendor due diligence, GSTR-2B reconciliation, contractual protection, documentary evidence and preservation of appropriate statutory and constitutional remedies important.

Synopsis

Section 16(2)(c) of the Central Goods and Services Tax Act, 2017 conditions a recipient’s entitlement to input tax credit upon the supplier’s actual payment of the tax to the Government. This article examines, in turn: (i) the statutory design of that condition and the allocation of risk it effects; (ii) its pre-GST lineage in the bona fide purchaser jurisprudence under the Delhi Value Added Tax Act, 2004; (iii) the divergent approaches of the High Courts under the GST regime; (iv) the two orders of the Supreme Court in 2026 in Bhandari Scrap Traders and Prime Metals; and (v) the practical consequences and the remedies available to an aggrieved recipient. It concludes that, while the validity of the provision has been upheld for the ordinary case of a direct supplier’s default, the question of liability for an upstream default remains open.

I. Introduction

Of all the conditions Section 16 of the Central Goods and Services Tax Act, 2017 (“the CGST Act”) attaches to a registered person’s entitlement to input tax credit (“ITC”), none has generated as much litigation, nor as much genuine doctrinal difficulty, as clause (c) of sub-section (2): the requirement that “the tax charged in respect of such supply has been actually paid to the Government” before the recipient may claim credit. The difficulty is structural rather than incidental. A recipient who has paid full consideration, including the GST component, to a validly registered supplier against a proper tax invoice, and who has no visibility into and no legal means of compelling that supplier’s downstream compliance, may nonetheless find its own credit denied — and a demand for reversal with interest raised against it — solely because the supplier failed to remit the tax collected. Whether this arrangement is constitutionally permissible, and if so within what limits, has now been litigated across at least seven High Courts and, in the course of 2025 and 2026 alone, has produced two Supreme Court orders pointing in materially different directions. This article traces that battle from its pre-GST origins to its unresolved present state.

II. The Statutory Design and the Underlying Grievance

A. The Cumulative Conditions under Section 16(2)

Section 16(2) makes ITC available only where four conditions are cumulatively satisfied: possession of a valid tax invoice, receipt of the goods or services, filing of the return under Section 39, and, under clause (c), actual payment of the tax to the Government by the supplier — reinforced since 2021 by clause (aa), which additionally requires that the invoice details appear in the recipient’s Form GSTR-2B. The practical effect is that a recipient’s credit is contingent not merely on its own compliance but on an event entirely within a third party’s control and largely outside the recipient’s power to verify at the time of transaction, since GST registration can be, and often is, obtained fraudulently or abandoned after a period of apparently genuine trading.

B. Rule 37A and the Allocation of Risk

Where the supplier defaults — whether through insolvency, fraud, or mere non-filing — Rule 37A of the Central Goods and Services Tax Rules, 2017 (“the CGST Rules”) requires the recipient to reverse the corresponding credit, with interest, if the supplier has not filed its return by the 30th of September following the end of the financial year, though the recipient may re-avail the credit once the supplier subsequently complies. It is this allocation of risk — placing the initial burden of a stranger’s default on the bona fide recipient, subject only to a conditional right of subsequent recovery — that has been under constitutional challenge since well before the GST regime itself came into force.

III. The Pre-GST Lineage: Bona Fide Purchaser Protection under VAT

A. The Delhi VAT Regime and On Quest Merchandising

The doctrinal battle predates GST. Section 9(2)(g) of the Delhi Value Added Tax Act, 2004 (“the DVAT Act”) contained a substantially identical bar, denying input credit where the selling dealer had not deposited the tax collected. In On Quest Merchandising India Pvt. Ltd. v. Government of NCT of Delhi (2017), the Delhi High Court read down the phrase “dealer or class of dealers” in that provision to exclude bona fide purchasing dealers who had transacted with a validly registered seller against a genuine invoice, absent any finding of collusion or fraud, holding that a contrary reading would be manifestly arbitrary and would fall foul of Article 14. The Court held that the Department’s remedy for the seller’s default lay against the seller — including through the specific machinery for collusive transactions under Section 40A of the DVAT Act — and not through visiting the consequence of that default on an innocent purchaser.

B. Affirmation by the Supreme Court: Shanti Kiran

That position was affirmed by the Supreme Court in dismissing the Department’s special leave petition, and was reaffirmed as recently as the second half of 2025 in Commissioner, Trade and Tax, Delhi v. M/s Shanti Kiran India (P) Ltd. (Civil Appeal Nos. 2042–2047 of 2015), where the Court dismissed a fresh batch of departmental appeals raising the identical point, holding that the purchasing dealers had bought from sellers who were validly registered at the time of the transactions, against genuine tax invoices, with no allegation of collusion, and that there was accordingly no reason to interfere with the bona-fide-purchaser protection the High Court had articulated. Coming as it did within months of the GST-era battle described below, Shanti Kiran kept the pre-GST doctrine of buyer protection very much alive as an interpretive touchstone, even as the Revenue sought to distinguish it from the CGST scheme.

IV. The GST-Era Divide between the High Courts

A. The Taxpayer-Protective Line

Once the identical structural question was transplanted into Section 16(2)(c), the High Courts divided sharply. On the taxpayer-protective side, the Madras High Court in D.Y. Beathel Enterprises v. State Tax Officer (2021) quashed orders that had reversed the ITC of seventeen purchasing dealers without any recovery action being taken against the defaulting sellers who had admittedly collected the tax, holding that where a seller has collected tax from a purchaser, “the omission on the part of the seller to remit the tax… must have been viewed very seriously,” and that revenue authorities cannot bypass the actual defaulter to proceed directly against the buyer; the matters were remitted for fresh inquiry with a direction that the sellers be examined and recovery pursued against them.

The Calcutta High Court, in Suncraft Energy Private Limited v. Assistant Commissioner, State Tax (2023), went further, holding that a mismatch between Form GSTR-2A and the recipient’s claimed credit cannot, by itself, sustain a demand for reversal, since GSTR-2A operates only as “a facilitator for self-assessment” and not as a conclusive determinant of eligibility; drawing on the Supreme Court’s reasoning in Union of India v. Bharti Airtel Ltd. and the Delhi VAT line culminating in Arise India Ltd. v. Commissioner of Trade and Taxes, Delhi, the Court held that the Department must first investigate and, where warranted, proceed against the supplier, and that direct action against the recipient is appropriate only in exceptional circumstances such as proven collusion or the supplier’s disappearance.

Comparable protective reasoning has since found favour in the Gauhati High Court and, most recently, in the Tripura High Court’s decision in Sahil Enterprises v. Union of India (6 January 2026), which followed the On Quest line in reading down the provision’s application to genuinely bona fide recipients.

B. The Strict Line

Ranged against this is a no less considered line of authority. The Patna High Court, in Aastha Enterprises v. State of Bihar (2023), rejected the constitutional challenge and held that the four conditions in Section 16(2), including clause (c), operate cumulatively and must each be independently satisfied; the burden lies on the recipient to establish that tax has in fact reached the Government, and until it does, no credit accrues — the Court observing that the Government retains its recovery action against the defaulting supplier, and that a recipient who has already paid the tax component to that supplier may, in an appropriate case, seek recourse against the supplier or a refund once recovery is effected, but has no independent constitutional entitlement to credit in the interim.

The Kerala High Court, in M. Trade Links v. Union of India (2024) and earlier in Nahasshukoor v. State Tax Officer (2023), and the Andhra Pradesh High Court in Thirumalakonda Plywoods v. Assistant Commissioner (2023), have taken a similarly strict view, and this stricter current draws additional support from the Supreme Court’s evidentiary ruling in State of Karnataka v. Ecom Gill Coffee Trading Pvt. Ltd. (2023) 18 SCC 809, which placed the burden of proving the genuineness of a claimed input credit — actual movement of goods, genuineness of the transaction, and payment of tax — squarely on the claimant, rather than treating a facially valid invoice as sufficient in itself.

V. The Supreme Court in 2026: Two Orders, Two Directions

A. Bhandari Scrap Traders: Validity Upheld

The conflict reached a head in 2026. In Bhandari Scrap Traders v. Union of India, the Supreme Court dismissed a batch of special leave petitions on 24 July 2026, expressing “complete and respectful agreement” with the Gujarat High Court’s detailed judgment in Maruti Enterprise v. Union of India (1 May 2026), which had rejected the argument that Section 16(2)(c) is ultra vires Articles 14, 19(1)(g), 265 and 300A of the Constitution. The Gujarat High Court’s reasoning, endorsed by the Supreme Court, drew a critical distinction between the CGST scheme and the Delhi VAT scheme that had produced On Quest and Shanti Kiran: under Sections 41, 73 and 74 of the CGST Act read with Rule 37A, a recipient whose credit is reversed for a supplier’s default is not permanently deprived of it, but may re-avail the credit once the supplier eventually pays — a conditional, recoverable deprivation rather than the permanent forfeiture that had troubled the Delhi High Court in the VAT context. On this reasoning, the classification drawn by clause (c) bears a rational nexus to the legitimate object of protecting the exchequer against a genuine risk of revenue loss, and ITC itself remains, as a matter of settled tax jurisprudence, a statutory concession rather than a vested or constitutionally guaranteed right, subject to whatever conditions Parliament chooses to impose.

B. Prime Metals: The Upstream-Default Question Left Open

Barely two months earlier, however, a different bench had approached a structurally similar but factually distinct question with conspicuously greater caution. In M/s Prime Metals v. Central Board of Indirect Taxes and Customs, the Supreme Court issued notice on 22 May 2026 and listed the matter for further hearing on 29 May 2026, declining to summarily dispose of the special leave petition against a Rajasthan High Court order that had relegated the petitioner to its statutory appellate remedy. What distinguished Prime Metals was the specific default alleged: it was not the petitioner’s own, immediate supplier who had failed to pay tax, but a supplier one level further removed in the supply chain — an “upstream” entity with which the petitioner had no direct transaction, no invoice, and no contractual relationship whatsoever. The Court framed the live question as whether Section 16(2)(c), applied to penalise a recipient for a default several tiers removed from any party it actually dealt with, imposes a condition impossible of performance — invoking, in substance, the maxim lex non cogit ad impossibilia. Rather than deciding that question, the Court permitted the taxpayer to pursue a statutory appeal, directed that it not be dismissed on limitation grounds, and — critically — expressly reserved “all legal remedies available to the petitioner, including issues relating to the validity of Section 16(2)” for future determination. The special leave petition against the Tripura High Court’s taxpayer-favourable ruling in Sahil Enterprises remains independently pending before the Supreme Court as well.

C. The Position as It Presently Stands

The result, read together, is that the constitutional validity of Section 16(2)(c) has been affirmed by the Supreme Court on one specific fact pattern — direct supplier default within a scheme that permits eventual re-availment — while the sharper and arguably more compelling question of liability for an upstream, unknowable default remains formally undecided and is very much alive in a separate, still-pending proceeding. The “battle” of this article’s title is accordingly not a settled chapter of GST history but an ongoing one, with the outcome for any individual taxpayer still substantially dependent on which High Court’s jurisdiction governs the dispute and precisely where in the supply chain the default occurred.

VI. Consequences and Practical Fallout

A. The Residual Exposure of the Recipient

For a business operating today, the consequence of this unsettled state is that ITC on any given purchase carries a residual, non-eliminable compliance risk tied to the tax history of every supplier in the chain, mitigated only partially by the Rule 37A re-availment mechanism and by the protective jurisprudence that continues to prevail in the Calcutta, Madras, Gauhati and Tripura jurisdictions. A reversal demand, once raised, carries interest at 18% per annum for the intervening period regardless of the recipient’s own good faith, and the practical burden of recovering that cost from a defaulting supplier — through civil suit, arbitration if a contract so provides, or a fresh purchase relationship — falls entirely on the recipient in the first instance.

B. Commercial Mitigation

The unsettled position has accordingly driven increasingly careful vendor due diligence, systematic GSTR-2B reconciliation before payment release, and the growing use of contractual indemnity and tax-gross-up clauses that shift the ultimate economic risk of a counterparty’s default back onto that counterparty by agreement, since the statute itself no longer reliably does so.

VII. Legal Remedies

The remedies available to an aggrieved recipient turn principally upon two factors: the High Court whose jurisprudence governs the dispute, and the position of the defaulting party in the supply chain. They may be summarised as follows.

1. Protective jurisdictions — writ remedy.Where a demand for reversal is raised without any investigation into or action against the defaulting supplier, and the taxpayer falls within the jurisdiction of a High Court following the Suncraft Energyor D. Y. Beathel line, a writ petition challenging the demand on that specific procedural ground remains a strong and well-precedented remedy.

2. Strict jurisdictions — building the evidentiary record.Where the taxpayer instead falls within a jurisdiction following the stricter Aastha Enterprisesor Ecom Gill Coffee Trading line, the more productive course is to build, well before any dispute arises, the evidentiary record that discharges the burden those rulings place on the claimant — proof of actual receipt of goods, banking-channel payment of the full invoice value including the tax component, and independent verification of the supplier’s registration status at the time of transaction — since a claim resting on invoice-and-payment documentation alone is increasingly unlikely to survive scrutiny on its own.

3. Upstream default — preserving the impossibility plea.Where the default in question is that of an upstream supplier with which the taxpayer never directly transacted, the impossibility argument preserved in Prime Metalsshould be expressly raised and kept alive in any statutory appeal or writ, since the Supreme Court has left that specific question open rather than foreclosed it, and a taxpayer who fails to plead it now may find the point waived by the time the Supreme Court comes to decide it.

4. Recovery against the defaulting supplier.Independently of the foregoing, a recipient who has paid the tax component to a supplier who then defaulted retains, following D. Y. Beathel, a strong basis to insist that the department pursue recovery against that supplier in the first instance, and a corresponding civil remedy of its own to recover the loss from the supplier directly.

VIII. Concluding Observations

Section 16(2)(c) cannot presently be described, in the way some commentary has suggested, as a settled question following the Supreme Court’s disposal of Bhandari Scrap Traders. That ruling settles the constitutional position for the ordinary case of a direct supplier’s default within a scheme of conditional, recoverable deprivation; it does not resolve, and the Court has taken care in Prime Metals not to foreclose, the more troubling case of liability for a default several tiers removed from the taxpayer’s own knowledge or control. Until that question, and the pending challenge to the Tripura High Court’s contrary ruling, are finally determined, practitioners advising on GST compliance and litigation should treat the position as genuinely unsettled, calibrate their strategy to the specific High Court whose jurisprudence governs, and ensure that every available constitutional argument is preserved on the record rather than assumed to have been lost.

References

• “Supreme Court affirms the constitutional validity of Section 16(2)(c) of the CGST Act,”CAclubindia, on Bhandari Scrap Traders v. Union of India
• “Supreme Court Leaves Constitutional Challenge to Section 16(2)(c) Open; Relegates Taxpayer to Statutory Appeal,”online, on M/s Prime Metals v. CBIC
• “Supreme Court has formally entertained a challenge to the constitutional validity and interpretation of Section 16(2)(c),”online, 25 May 2026
• “ITC cannot be denied to recipient without due investigation of supplier: Calcutta HC,”TaxGuru, on Suncraft Energy Pvt Ltd v. Assistant Commissioner
• “GST Credit not available to purchaser on supplier’s default – Patna HC,”VATupdate, on Aastha Enterprises v. State of Bihar
• “Madras HC on recovery of ITC from Buyer without initiating any action against seller,”TaxGuru, on Beathel Enterprises v. State Tax Officer
• Ayush Shukla, “Supreme Court Reaffirms Protection To Bona Fide Purchasers In VAT Transactions,”Mondaq/IndiaLaw LLP, on Commissioner, Trade and Tax, Delhi v. Shanti Kiran India (P) Ltd