Destination based taxation under GST: Revenue implications of Section 53 Settlements and the safeguards under Section 16(2)(c)
Introduction:
The current Destination based taxation regime under Goods and Services Act, 2017 (CGST Act, 2017), has been able to facilitate a paradigm shift in the indirect tax regime, which is different in its operation from the old origin-based taxation. The Indirect tax regime, currently in operation, aims to ensure equity between originating and consuming states, whereby the accrual of the tax revenue to a state takes place on consumption of goods or services or both rather than where they were produced/manufactured. The GST law, currently in force, ensures a seamless flow of input tax credit (ITC) but at the same time it tends to clash with the leakage of revenue to the state when taxpayers fail to pay/deposit tax. Therefore, in case of interstate supplies, implementation of the GST law has been identified as a significant challenge.
The boiling point for the above lies in implementation of Section 53 of the CGST Act, 2017 which pertains to inter-governmental revenue sharing. Whereas Section 16(2)(c) is enshrined as an important condition to avail ITC. Based on the above, the following article attempts to examine how Section 53 which operationalises the object of the GST law i.e., destination-based taxation and simultaneously how Section 16(2)(c) attempts to serve as a safeguard to shield the respective state government revenue, specifically the originating states.
Destination-Based Taxation: Conceptual Framework and Mechanism u/s 53 of CGST Act, 2017 read along with Section 17 and 18 of the IGST Act, 2017
In the erstwhile origin-based taxation regime, such as Sales Tax and State VAT facilitated the originating state to retain a significant portion of revenue. However, the current regime has changed the above position by incorporating a destination-based principle via Integration Goods and Services Tax (IGST) Mechanism [1]. Under IGST mechanism, tax is collected by the Centre and thereafter the revenue is apportioned by the centre to the location where supply has taken place (destination-based tax). The aim herein was to ensure the elimination of the cascading effect of tax. Therefore, such effort from the legislative body with the support from Section 53 of CGST Act, 2017, has been able to design a balance within the federal fiscal policy all the while ensuring a seamless flow of credit.
Further, it is important to note that Section 53 of the CGST Act, 2017 facilitates transfer of ITC in cases where credits under CGST or SGST are utilized towards payment of IGST[2]. Therefore, when the taxpayer has utilised in the manner as explained above, the Central Government is bound to transfer the amount equivalent from the Central tax account to the Integrated tax account. Therefore, the mechanism enshrined u/s 53 of the CGST Act, 2017 ensures that the IGST pool is sufficiently funded for a consequent apportionment of funds to the consumption state (emphasis is laid on GST being a destination-based tax). For ease of understanding, following examples are given below:
- Supplier: ABC in Karnataka sells products to Buyer: XYZ in Maharashtra for ₹15 lakh (IGST @18% = ₹2.70 lakh).
- ABC uses ₹1.80 lakh of their CGST ITC from purchases made locally in Karnataka to cover a portion of the IGST.
- The Centre moves ₹1.80 lakh from the CGST account to the IGST account in accordance with Section 53.
- According to the destination principle, Maharashtra eventually gets its portion of the IGST.
Therefore, based on the example above, the mechanism u/s 53 of the CGST Act, 2017 was put in place to ensure a smooth flow of revenue to the destination state. But it is pertinent to note that this mechanism u/s 53 of the CGST Act, 2017 operationalises under the presumption that the suppliers of goods or services or both have remitted the tax to the purse of the Government [3]. If there has been no remittance, then the originating state will be placed under a losing end of the system while the destination state’s revenue gets a boost.
The destination-based taxation is further operationalised via IGST Act, 2017. Specifically, Section 17 of the IGST Act, 2017[4] which relates to apportionment of IGST collected on interstate supply. It states that when IGST is paid, the destination state where the supply is located receives the remaining amount after a portion is initially given to the Central Government. The consumption-based taxation approach is given legislative effect by this clause. Similarly, Section 18 of the IGST Act, 2017 further complements principle laid down in Section 53 of the CGST Act, 2017, whereby, when a supplier utilises CGST or SGST credit for the payment of IGST, appropriate transfer is carried out between respective tax account so that the consumption state has rightfully received its appropriate share.
Therefore, the provisions, when read together, reinforces the intention of the legislature to create a comprehensive destination-based taxation. Although a robust mechanism to implement destination-based tax is ensured by law, the operationalisation of destination-based tax is contingent upon payment of tax to the Government by the supplier u/s 16(2)(c) of the CGST Act, 2017. This is where the CGST Act’s Section 16(2)(c) serves aa a crucial safeguarding function, assuring that revenue transfers under Sections 53 CGST and 17 and 18 IGST do not cause the originating States to be subject to losses because of supplier’s noncompliance.
Effective Destination based taxation is contingent upon a robust Anti-revenue leakage measure:
Section 16(2)(c) of the CGST Act, 2017 is a vital safeguard provision, it contemplates that no taxpayer/registered person is entitled to ITC in respect of any supply unless the suppler has “paid” the tax to the Government, on such supply, either in cash or through utilisation of ITC[5]. For easy comprehension, the illustration of complete supply chain is provided as below:
- Raw Supplier (Karnataka) supplies to ABC (Karnataka) and charges IGST ₹1.80 lakh but fails to deposit it.
- ABC avails provisional ITC and uses it to pay IGST on supplies to XYZ (Maharashtra).
- XYZ claims an ITC of ₹2.70 lakh.
Basis the illustration above, if one supposes that the XYZ (Maharashtra) is granted the right to retain the ITC without safeguards, then the centre would proceed to transfer the funds as per the law contained in provision u/s 53 of the CGST Act, 2017 read along with Section 17 and Section 18 of the IGST Act, 2017, to Maharashtra. Consequent to the above transaction, the Karnataka state would end up losing the revenue since the tax was never paid by the supplier.
To prevent this effect, to the extent of tax amount not deposited by the supplier, the law mandates that the buyer reverse the ITC along with interest as per Section 16(2)(c) read with Section 41(2) of the CGST Act, 2017 and Rule 37A of CGST Rules, 2017[6]. Further, the legislation has guarded the originating state by placing the burden of proof on the buyer/purchasing dealer as per Section 155 of the CGST Act, 2017[7], whereby the buyer has to satisfactorily prove that he is entitled to ITC by presenting relevant tax invoices, proof of receipt of goods or services and along with it, the evidence of payment made to supplier.
Anti-revenue leakage measure was further enforced and fortified by the decision rendered in Maruti Enterprise v. Union of India, 2026 (5) TMI 123[8], wherein the Hon’ble Gujarat High Court upheld the constitutional validity of Section 16(2)(c). Hereunder, it was rendered that ITC is not a vested right, but a mere concession granted by a statute. Additionally, the Hon’ble court opined that if ITC is permitted without actual payment u/s 16(2)(c) then the exchequer will have to bear the burden of significant losses due to subsequent transfer of funds u/s 53 of the CGST Act, 2017, whereby an artificial imbalance in the federal fiscal structure is augmented [9].
Conclusion and way forward:
While it cannot be ignored that Section 53 of the CGST Act, 2017 serves as a prominent mechanism to reinforce the intent of CGST Act, 2017 i.e., to implement a destination-based taxation; which is the bedrock of GST law in India. But the effective framework for seamless revenue transfer to consuming states is dependent on the actual tax collection by origin state. In light of the contingent above, Section 16(2)(c) read with Section 41(2) of the CGST Act, 2017 along with Rule 37A, is placed in the GST law to act an important safeguard that is intended to prevent the originating states from undergoing revenue loss due to default from the supplier’s end and subsequent needless settlements as regards to IGST.
[1] TG Team, GST-Origin & India Model of Destination Based Taxation, https://taxguru.in/goods-and-service-tax/gst-origin-indian-model-destination-based-taxation.html, TAXGURU, (05 Sept, 2015).
[2] Section 53 of Central Goods and Services Act, 2017, Act No. 12 of 2017.
[3] CA Mamta Chopra, TDS,TCS AND TRANSFER OF ITC UNDER GST, Tax guru, https://taxguru.in/goods-and-service-tax/tds-tcs-transfer-itc-gst-section-51-53-cgst-act-2017.html, (06 July, 2020).
[4] Section 17 of the Integrated Goods and Service Act, 2017, Act No. 12 of 2017.
[5] Section 16(2)(c) of Central Goods and Services Act, 2017, Act No. 12 of 2017. s
[6] NLF Tax and Legal, Section 16(2)(c)-ITC is a statutory concession, not a vested right, https://www.nlftaxlex.com/post/section-16-2-c-cgst-act-upheld-itc-is-a-statutory-concession-not-a-vested-right-purchasing-dea, NLF TAX & LEGAL ADVISORY, (14 May, 2026).
[7] Section 155 of the Central Goods and Services Act, 2017, Act No. 12 of 2017.
[8] 2026(5) TMI 123.
[9] Adv. Archana Shukla, Section 16(2)(c) of CGST Act and the conditional nature of ITC, Kings & Alliance LLP, https://knallp.com/section-16-2-c-of-cgst-act-and-the-conditional-nature-of-input-tax-credit-itc/.
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