Battle Over ITC: The Conflict Between Courts And Tax Authorities

Introduction 

One of the objectives in the implementation of Goods and Services Tax (‘GST’) was to eliminate the cascading effect of taxes and create a seamless flow of credit across the supply chain. The Input Tax Credit (‘ITC’) mechanism under the GST framework ensures that tax is levied only on the value added at each stage of a transaction, thereby reducing the overall tax burden on businesses and enhancing economic efficiency. 

Over the past nine years of GST regime, we have seen a sharp disconnect between the approach of tax departments and courts towards ITC. Revenue authorities continue to stick to a rigid, literal reading of the given pre-requisites under the GST laws governing ITC. Conversely, the judiciary consistently prioritizes commercial actuality, fairness, and the rights of genuine buyers. These diverse views of the GST authorities and judiciary have led to litigation dominated by disputes over ITC, defaults of supplier in GST compliances, retrospective registration cancellations, and ITC blocks. 

Conditions of Section 16 of the CGST Act 

The GST authorities frequently issue notices requiring taxpayers to reverse ITC, along with interest and penalty. This gives rise to significant litigation, as compliance with the conditions under Section 16(2) of the CGST Act is a prerequisite for availing ITC. 

Most of these disputes centre on specific compliance friction points where the department routinely denies ITC: 

• Supplier defaults: Failure by the supplier to deposit the collected tax with the Government; 

• Return mismatches: Discrepancies between the outward supplies reported by the supplier and the input tax credit claimed by the recipient; 

• Retrospective cancellation: cancellation of supplier’s GST registration retroactively by the department; 

• Documentary backups: non-availability of documents to substantiate the genuineness of transactions such as transport records, e-way bills, or delivery proofs; 

• Limitation: Availment of ITC beyond the period prescribed under GST laws.  

Therefore, it is noted that such lapses in compliance sometimes lead to demands under tax, interest and penalty. Such financial liabilities make ITC as one of the key issues for the industry today. 

Prevention of Fraud Vs Protection of Bonafide Taxpayers 

GST authorities contend that enforcement of statutory requirements is meant to prevent ITC claims based on fraudulent invoices, circular invoicing, and safeguard of public exchequer collections. From their perspective, the right to claim ITC by industry on invoices remains denied unless every statutory condition under the GST law is satisfied in its entirety. 

On the other hand, businesses contend that genuine recipients of goods /services cannot be penalized for structural or compliance defaults committed by third-party suppliers. This is particularly important where the recipient establishes the genuineness of the transaction through sufficient supporting documentary evidences confirming the receipt of goods or services, alongside proof of consideration paid to the supplier including the GST element. 

As a result, bona fide taxpayers consistently face demands for the reversal of ITC, accompanied by interest and penalty, despite having acted in good faith and fulfilling its obligations. 

So, there's a real need for a solid mechanism that can tell bona fide recipients apart from fraudulent entities. This would let tax authorities go after tax evasion and fake invoicing without hurting genuine businesses that carried out legitimate transactions and exercised reasonable diligence. 

Retrospective Cancellation of Supplier Registration 

Another persistent area of litigation involves the retrospective cancellation of supplier registrations under Section 29(2) of the CGST Act. 

Tax authorities have often tried to deny ITC to recipients simply because the supplier's registration was cancelled later. Courts, though, have pushed back on this, questioning how fair it is when the supplier was properly registered at the time of the transaction, and the buyer had no reason to suspect anything was wrong. 

The judiciary in its judgements have established that retrospective cancellation of GST registration of suppliers cannot automatically invalidate a recipient's ITC claim. It is of the utmost importance that the underlying transaction is verified as genuine and carried out in good faith. Further, it has been held that the burden is of the revenue authority to independently examine the evidence supplied by the parties rather than relying entirely on subsequent GST registration cancellations. 

Section 17(5): Another Arena of Litigation 

While much of the litigation under Section 16 of the CGST Act revolves around supplier compliance and procedural requirements, Section 17(5) of the CGST Act has generated a separate stream of disputes relating to blocked credits. 

Some of the major contentious issues include: 

• Works Contract and Construction Credits - Businesses frequently challenge denial of ITC on construction-related goods and services, particularly where the resulting immovable property is used for taxable business operations. 

• Employee Welfare Expenses - Disputes concerning the availability of ITC for canteen services, transportation facilities, health insurance, and employee welfare measures mandated under labour laws. 

• Motor Vehicle Credits – The scope of exceptions relating to the transportation of passengers, training services, and further supply of motor vehicles remains a recurring source of dispute. 

While tax authorities usually stick to a strict reading of blocked credit provisions, courts often take a more practical view when a clear link to business operations is shown. 

Judicial Pushback Against Mechanical Denial of ITC 

In recent years, courts across the country have stepped in more and more to protect genuine taxpayers from losing ITC because of defaults on the supplier's end. 

Several High Courts have held that genuine purchasers should not be denied ITC merely because a supplier failed to deposit tax with the government after collecting it. A notable example is decision of the Madras High Court in M/s. D.Y. Beathel Enterprises1, wherein the High Court quashed the assessment order passed by the officer levying the entire tax liability on the purchasing dealer without taking any recovery action against the supplier. 

Similarly, the Gauhati High Court in M/s. Mcleod Russel India Ltd2., Karnataka High Court in Instakart Services Pvt. Ltd3. and the Tripura High Court in Sahil Enterprises4 emphasized that the tax department should proceed against the defaulting supplier rather than penalize an innocent recipient who has complied with all reasonable requirements.  

The intention of the judiciary through these judgments, is very clear. GST was conceived as a value-added tax system, and ITC is integral to its functioning. Denial of credit through a rigid or mechanical application of statutory provisions risks defeating the very purpose for which GST was introduced. 

Substance over Procedure 

Courts have consistently prioritized substantive compliance over procedural formalities and have repeatedly held that ITC cannot be denied solely based on the absence of ancillary documentation, provided that the genuineness of the underlying transaction is established by contemporaneous records. 

A recent example is the decision of the Madras High Court in Akal Trade Links5. In this case, the tax department sought to deny ITC because of the taxpayer’s failure to produce certain documents, such as lorry receipts, weighment slips, and other transport records. The High Court discarded this approach and held that authorities should consider the entire transaction and all available evidence. If the transaction is genuine and the tax has been paid, ITC should not be denied merely because some documents are missing. 

This decision emphasizes that GST compliance should be assessed based on the overall facts and circumstances of a transaction, rather than on the absence of a few documents. 

Conclusion 

The ongoing disputes over ITC show the challenge of balancing the interests of tax authorities and businesses. While the tax department aims to prevent tax evasion and protect government revenue, courts have repeatedly stressed that genuine businesses should be treated fairly and should not be denied benefits without proper justification. 

As GST law continues to develop, the focus is increasingly on finding a balance between ensuring compliance and supporting legitimate business activity. Courts have stressed on the view that while businesses complying with GST requirements should not suffer because of the issues that are beyond their control. The way these ITC disputes are handled in the future will play an important role in determining whether the GST system remains efficient and business-friendly, as originally intended at the time of its inception. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.