Tax Evasion Through Fake Invoices & Actions by Government

You would have heard many GST fake invoice fraud news in recent time, in spite of many checks and balances introduced in GST laws such as GSTR-2A, Rule 36(4), e-invoicing, e-way bill etc. In a release, the CBIC said that it has so far registered about 12,000 cases of ITC fraud and arrested 365 people, yet it is a challenge for the government to curb the fake invoice as usually fake invoices are raised in a more sophisticated and organized manner making it harder to detect. The government in recent months has taken a few more stringent steps to counter Goods and Services Tax (GST) fake invoice frauds. [discussed in the later part]

It necessary for a professional to be completely aware of the fake invoice fraud and its nitigrities, to identify the risk of such activity while conducting the audit or non-audit assignments to take timely and right action to save his clients or himself from the consequences associated with this fraud.

What is a fake invoice?

The “Invoices” are called as ‘fake’ where the GST invoices are raised by an entity without actual supply of goods or services or payment of GST. Fake invoices are raised for the following purposes:

(a) Claiming undue excess ITC

(b) For showing excess turnover

(c) Transferring credit from one registration to another without any actual supply

(d) Other reasons.

Let’s understand fake invoice with help of the below diagram

The Equation of fake invoice: Fake Invoice = Original Invoice + Absence of transaction

There are three ways in which such fake invoices could be misused in the GST Regime:

I. Issue invoice without the supply of goods or services where payment of tax is made by using input tax credit

II. Issue invoice to one party and divert the goods to another party. The person who purchases invoices may utilize the credit for payment of taxes at the time of export of goods and claim a refund of the said tax paid, resulting in loss of revenue.

III. Routing of invoices through a series of shell companies/dummy companies and transfer of input tax credit from one company to another in a circular fashion to increase the turnover.

 Now let’s understand that the Working mechanism of fake invoices

Working mechanism of fake invoices

Stage I

Steps:

A fake company registered with GST using an unknown person’s identity and proofs then identifies a retailer [such as departmental stores, super markets] who usually supplies goods or services to end consumers where such consumers do not require/ask for an invoice and also, they will not claim the credit [popularly known as B2C supplies].

• The retailer supplies goods or services to the final consumer for cash and no GST invoice is issued for such supply.
• The retailer subsequently issues a valid tax invoice to the fake company, however, there will be no supply of goods or services.
• The fake company makes payments via NEFT/Bank payment.
• Now in turn the retailer pays back the amount in cash [Amount collected from final consumer] to a fake company.
• Retailer files GST returns and discharges the tax liability considering the said supply as B2B instead of B2C.
• The fake company avails the credit based on the GSTR-2A in its GSTR-3B and accumulates the credit.

In the first stage, the retailer gets his commission and the fake company accumulates the input tax credit in its GST registration. Let’s move on to the second stage.

Stage II

Steps:

In this stage, the fake company tries to pass on the credit already accumulated and also pass the cash to another company [ XYZ Company] which is genuinely registered under various laws, such XYZ with the intention to evade the taxes by utilizing fake credit for discharging its output liability.

• Fake company issues a tax invoice to XYZ company without any supply of goods or services.
• XYZ company makes bank payments to the fake company and claims the input tax credit while discharging its output liability and also claims such purchases under the Income Tax Act 1961 to reduce its tax liability.
• The fake company in turn pays back the cash [which is already collected from retailer in stage 1] to XYZ company after deducting its commission percentage.
• The fake company utilizes the credit accumulated to discharge its liability and pass the credit to XYZ.
• Soon after the transaction is completed or a set of transaction completed as targeted the fake company would dissolve.
• There would be no invoice mismatch between GSTR-2A and GSTR-3B of the fake company as well as XYZ company.

Benefits to various parties

Retailers/First Party:

• Gets commission for issuing an invoice to the fake company
• No sales variance issues invoice equal to cash sales [less risk]
• May be wanted to inflate his sales to convert black money to white
• Increased bank transaction which would indirectly help the retailer to get many of banking facilities such as loan, OD, cash credit, etc.,
• No mismatch between GSTR-2A and GSTR-3B as the retailer has uploaded the invoices by filing his GSTR-1.

Fake Company:

• Gets commission on a fake invoice by passing the credit to genuine company
• No identity & dissolves soon after target transaction done
• Under GST presence all over India, it makes fake companies work PAN India basis

XYZ Company:

• Utilises the ITC and pays less tax to the government saving in the outflow of cash.
• Makes bank payment claims as the expense of purchase invoice and receives back the cash thereby saves income tax liability.
• Converting excess ITC into cash
• No mismatch between GSTR-2A and GSTR-3B credit as the fake company has loaded the invoices by filing GSTR-1

Measures were taken by the Government

Through the insertion of various provisions:

The government with a motive to curb fake invoicing is taking stringent steps by making changes in GST Law, which has created chaos among the traders.

Section 16(2) Conditions:

A registered person can claim ITC of tax paid on supply of goods or services or both only if:

• he is in possession of Tax invoice, debit note or any other taxpaying document,
• he has received the goods or services or both,
• the tax charged by the supplier has been paid to the government, and
• he has furnished the return.

Let us analyze the above conditions from the fake invoice prospective

In the above-discussed mechanism, the XYZ company [Genuine company] will be in the possession of a valid tax invoice. Therefore this condition is satisfied.

The second condition is not satisfied has XYZ has not actually received the goods or services, assessee himself make sure he has received the goods or services before taking the credit. But there is no mechanism with the department to identify the non-compliances in this regard. In the absence of such a mechanism, fraudsters will continue to evade taxes through fake invoicing.

The third condition is that tax has been paid to the government on such supply is also satisfied by the mechanism discussed above.

In the said example retailer paid the taxes to the government after utilizing the available genuine credit and the Fake company and XYZ company utilized the credit and discharge the liability allowed under the law.

The fourth condition is satisfied by all the 3 parties involved by filing GSTR-3B to claim the input tax credit.

As there is no mechanism to make sure compliance of section 16(2) by the department, the taxpayer would comply on a self-assessment basis, therefore fraudsters would still take advantage of this and continue with fake invoicing

Rule 36(4) – restriction of Availment of credit

Rule 36(4) of CGST Rules provides restriction on availment of eligible ITC wherein the recipient could avail eligible ITC in GSTR-3B, not in excess of 20% [from 09th October to 31st December 2019] or 10% [from 01st January 2020] further amended to 5%[from 1st Jan 2021] vide Notification No. 94/2020 CT dated 23rd December 2020 as applicable of eligible ITC appearing in the GSTR-2A of such recipient.

This rule has failed to curb the fake invoice scam as in all the stages of the fake invoice scam the parties GSTR-2A and GSTR-3B credit agree each level and there would be no difference as these involved parties GSTR-2A and GSTR-3B match 100%.

E-Invoicing provisions

The Government of India has made e-invoicing provisions compulsory for taxpayers having turnover greater than Rs. 500 Cr w.e.f. 1st October, 2020 vide N/No. 61/2020 – CT dated 30th July, 2020. Further, another notification namely, N/No. 88/2020 – CT dated 10th November, 2020, has made E-Invoicing compulsory for taxpayers having turnover greater than Rs. 100 Cr w.e.f. 1st January, 2020.

Will the E-Invoicing eliminate the fake invoicing fraud?

Usually retailers issues a post dated tax invoice to fake company once all the cash sales concluded for the month for the same value he would issue tax invoice to fake company. As E-invoicing should be done on real time basis we may think it would eliminate or reduce the fake invoicing. In fact B2C supplies out of the E-invoicing abmit and need not be raised on real time basis.

In later date say near to month end retailer may issue a B2B invoice to fake company by way of E-invoice and based on the same fake company may avail the credit. However department may look for huge invoices issued at month end or short period to identify the fake invoicing transactions. But definetly it would be tediuse job for department.

Tax evasion by moving the goods without invoice could be eliminated or reduced by E-invoicing provisions however E-invoicing may not be effective for eliminating or rediucing the fake invoicing as E-invoice could be generated without movement of goods. Therefore fraudster would continue to operate under E-invoice regime also.

Rule 86B restriction on availing ITC to discharge 100% output tax liability [newly introduced w.e.f. 01.01.2021]

Payment of taxes through the utilization of balance from electronic credit ledger has been restricted up to 99% of such tax liability in the case where the value of taxable supply other than exempt supply and zero-rated supply, in a month, exceeds Rs. 50 lakh w.e.f 1^st January 2021

• This rule overrides all other rules
• This rule applicable only on in case taxable supply exceeds Rs. 50 Lakhs in a month [exports and exempt supply not included]
• 1% of such output liability should be paid in cash
• Such liability does not include the tax liability under the reverse charge mechanism [RCM liability has to be discharged 100% in cash]

Proviso to Rule 86B – Said rule not to Apply in certain cases: –

(a) The said person or the proprietor or karta or the managing director or any of its two partners, whole-time Directors, Members of Managing Committee of Associations or Board of Trustees, as the case may be, have paid more than one lakh rupees as income tax under the Income-tax Act, 1961(43 of 1961) in each of the last two financial years for which the time limit to file return of income under subsection (1) of section 139 of the said Act has expired; or

Notes:

• Income tax paid includes Advance tax paid, self-advance tax paid, and also tax deducted at the source which is adjusted for total income tax payable.
• The intention of this provision is where the fake company is created with the use of fake profiles or fake proofs, said unknown profiles would not have paid any tax liability. However fake invoice normally involves the huge amount for them paying tax of 1 lakh would difficult.
• A further condition that tax should be paid for 2 preceding financial year is a great move because creating the fake profiles with two years of records would difficult for fraudsters and definitely a move towards curbing fake invoicing.

(b) the registered person has received a refund amount of more than Rs. 1 lakh in the preceding financial year under clause (i) of first proviso of section 54(3) ; or (ii) of first proviso of section 54(3)

Notes:

• Exporters claiming refund of ITC on zero-rated supplies or inverted duty structure of more than Rs. 1 lakh in preceding financial year need not apply the rule 86B.
• Here few of the companies even though there are involved in the fake invoices could be get excluded just because there are getting a refund of tax in preceding the year. It is pertinent to note one of the potential motive behind fake invoices is the encashment of ITC by way of IGST refund or unutilized ITC refunds.
• Because of this exclusion still, fraudsters continue to get the refund on fake invoices. The government had put this exclusion with the intention not to create chaos to the genuine exporters.

(c) The registered person has discharged his liability towards output tax through the electronic cash ledger for an amount which is in excess of 1% of the total output tax liability, applied cumulatively, up to the said month in the current financial year; or

Notes:

• This condition to be applied cumulative for the financial say example April and may taxpayer has made a cash payment and now in the June month taxpayer would require to utilize the ITC for 100% payment. Now he has cumulative take the tax paid and total output tax if the said cash payment is more than 1% of total output tax then the rule 86B need not to be applied for that month.
• Here paying 1% of output tax liability would not be a great deal for a fake company it may still continue to issue the fake invoices.

(d) The registered person is –

i. Government Department; or

ii. a Public Sector Undertaking; or

iii. a local authority;or

iv. a statutory body:

Notes:

This category of persons are out of the ambit of rule 86B as these government branches would not engage in fake invoicing.

The government using rule 86B as a tool to curb tax evasion, however in this process definitely it troubles the genuine taxpayers, increases the compliance cost by employing more resources to apply rule 86B.

• Rule 86B is not going to fully curb the fake invoicing as there were few exclusions given may make fraudsters to continue the fake invoicing, however, definitely it discourages the fraudsters to engage in such activities.

Biometric-based Aadhaar authentication and taking photographs

The rule of verification has been amended vide notification 94 No. 94/2020 – Central Tax dated 22nd December 2020 to verify the application as follows

(a) Biometric-based Aadhaar authentication and taking photograph, unless exempted under subsection (6D) of section 25, if he has opted for authentication of Aadhaar number;

(b) taking Biometric information, photograph and verification of such other KYC documents, as notified, unless the applicant is exempted under sub-section (6D) of section 25, if he has opted not to get Aadhaar authentication done.

(c) verification of original copy of the documents uploaded would be done with the application in FORM GST REG-01at one of the Facilitation Centres notified by the Commissioner and the application shall be deemed to be complete only after completion of the process laid down under this subrule.

Insertion of this rule is a great initiative to curb fake invoicing as fake companies are floated with fake proofs or profiles. However, now it would not be possible as GST registration requires Bio-metric based Aadhaar verification, or who is not able to undergo the bio matric aadhaar verification then he has to provide the biometric information, photograph and verification of such other KYC documents and also original documents are verified at facilitation centres.

However additional option has been provided for registration other than Aadhaar Authentication is a cumbersome process to visit the facilitation centre for verification of original documents has been an additional burden. This option could be explored by fraudsters to obtain registration however the number may reduce due to the cumbersome process.

Penalties for Fake invoicing

New Sub-section (1A) inserted to Sec 122 of CGST Act [W.E.F 01.04.2020]- Any person who retains the benefit of a transaction covered under clauses (i), (ii), (vii) or clause (ix) of sub-section (1) and at whose instance such transaction is conducted, shall be liable to a penalty of an amount equivalent to the tax evaded or input tax credit availed of or passed on.”

with respect to clause (i), (ii), (vii) or clause (ix) of sub-section (1) of Sec 122

SITUATION	Section 122(1A) of GST Act’ 2017.
(i) Supplies any goods or services or both without issue of any invoice	The person can be held as beneficiary of a transaction covered under Clause (i) of Section 122(1) and hence liable for penalty equivalent to the amount of tax evaded u/s 122(1A)
(ii) Invoice in respect of supply or receipt of goods or services or both issued by the person or any other person without actual supply or receipt of such goods or services or both.	The person can be held as beneficiaryof a  transaction covered under Clause (ii) of Section 122(1) and hence liable for  penalty equivalent to the amount of tax evaded u/s 122(1A)
(iii) Takes or utilises input tax credit without actual receipt of goods or services or both either fully or partially, in contravention of the provisions of this Act or the rules made there under;	The person can be held as beneficiary of a transaction covered under Clause (vii) of Section 122(1) and hence liable for penalty equivalent to the amount of ITC availed u/s 122(1A).
(iv) Forged or falsified documents such as a false invoice or, in general, a false piece of documentary evidence	The person can be held as beneficiary of a transaction covered under Clause (i) of Section 122(1) and hence liable for penalty equivalent to the amount of tax evaded u/s 122(1A)

The intention of the amendment to include the Beneficiary of transactions and at whose instance transactions are conducted for imposing penalty.

Further, Section 132 has been amended to covers many offences

• Supplies any goods or services or both without issue of any invoice, in violation of the provisions of this Act or the rules made thereunder, with the intention to evade tax
• issues any invoice or bill without supply of goods or services or both in violation of the provisions of this Act, or the rules made thereunder leading to wrongful availment or utilisation of input tax credit or refund of tax;
• avails input tax credit using the invoice or bill referred to in clause (b) or fraudulently avails input tax credit without any invoice or bill
• collects any amount as tax but fails to pay the same to the Government beyond a period of three months from the date on which such payment becomes due;
• evades tax, or fraudulently obtains refund and where such offence is not covered under clauses (a) to (d);

Offence Involving	Amount Involved (in Rs.)	Punishment (Imprisonment min 6 months in the absence of special and adequate reasons  to the contrary to be recorded in the judgment of the Court and extending to –)
Tax evaded or  input tax credit wrongly availed or utilised or refund wrongly taken	> 5 crores	5 Years and with fine
	Exceeds 2 crores but ≤ 5 crores	3 Years and with fine
	Exceeds 1 crores but ≤ 2 crores	1 Years and with fine1 Years and with fine
For  second  and  every subsequent offence under section 132	No limit	5 Years and with fine

Further offences with regard to fake invoicing is considered as Cognizable Offence and Non-Bailable where amount of tax evaded or input tax credit wrongly  availed or utilised or refund wrongly taken exceeding 5 crores.

Conclusion:

• There is no doubt that government has to curb fake invoicing however in that process creating trouble to the genuine taxpayer is making the compliance process cumbersome for honest taxpayers.
• Government moto towards ease of doing business would look like just an assurance if the government puts many more restrictions to claims the input tax credit paid genuinely.
• The government should ensure that the genuine taxpayer shall remain harmless of such provisions an the necessity of these provisions is only for the fraudsters.
• Fake invoicing fraud in India maybe 1-5% however increasing problems for the genuine taxpayers (huge in number) is highly unreasonable and obnoxious.
• Instead of putting more and more blanket restrictions on all the taxpayers’, government should come up with some policy to identify the fraudsters without restricting the credit to genuine taxpayers.

Special mention to CA Mayank A Jain for vetting this article.

Important Note: – Author in no manner through this article encourage any person to indulge in such activities. This is only meant to create awareness among the professionals about Fake invoices and help the government curb such activities.

For any further clarifications reach at E-Mail – [email protected]