[By Madhu Murari K]
The author is a student of Rajiv Gandhi National University of Law, Punjab.
The Goods and Service Tax (GST) laws have been enacted to overcome the difficulties of the multiple tax regimes and to get away from the tariff and non-tariff barriers which would hinder the free flow of trade throughout the Country. The structure of GST is of a destination-based consumption tax with input tax credit (ITC) of the tax paid on goods or services at each stage available in the next stage of value addition for avoiding cascading effects irrespective of the destination, be it an inter-state supply or intra-state supply.
Section 16 of the Central Goods and Service Act, 2017 (CGST Act) lays down the conditions in which ITC can be claimed. One of the conditions under Section 16(2)(c), which denies ITC to buyers/recipients if the sellers have not remitted the tax to the government. Denying of ITC to the purchaser dealer for default of supplier dealer over whom the purchaser dealer has no control, is an arbitrary and irrational exercise of powers.
While earlier commentaries on the impugned provision have primarily focused on drawing comparisons between various judicial decisions from the former tax regimes, current academic discourse on the issue appears limited. Recent judicial decisions demonstrate that courts have either favoured the revenue’s position by upholding the provision or have directed the authorities to conduct thorough investigations before holding a recipient liable for non-payment of tax. Nevertheless, none of these discussions offer a substantive alternative to resolve the present legislative dilemma, leaving a significant gap in the policy analysis on the issue.
The prime tenets which would be delved into this particular piece are: firstly, the contention that the impugned provision violates the equality guaranteed under Article 14 of the Constitution, secondly, an analysis of this provision through the lens of doctrine of impossibility, and thirdly, proposal of potential solution that could benefit both the bonafide recipients and the government.
Arbitrary classification under Article 14
The principle of equality, is enshrined in Article 14 of the Constitution of India. The guiding principle of this article is that everyone should be treated equally by the state and its essence lies in the prohibition of unequal treatment to individuals who are equal and at the same time it permits valid classification made by the state to avoid arbitrary denial of rights to equals.
The Supreme Court (SC) in the EP Royappa v. State of Tamil Nadu, duly held that classification must be based on an intelligible differentia that is bona fide and meaningful, and must serve a legitimate legislative goal. A valid classification does not require mathematical nicety and perfect equality. If there is a similarity or uniformity within a group, the law will not be discriminatory.
Analyzing the issue at hand, the Section 16(2)(c) lays a prerequisite for claiming ITC that if the sellers have not transferred the tax amount to the government, then the recipients of goods are not eligible for ITC credit. It draws no distinction between the bonafide purchasers and culpable purchasers who are in collusion with defaulting sellers. This arbitrariness is further aggravated by the fact that while the Government reverses the ITC availed by the buyer and simultaneously demands tax, interest, and penalty from the seller. The effect of such parallel actions is that the revenue secures a double recovery of tax, which is wholly inconsistent with the equitable principles of fiscal law.
Precedents can be referred from the earlier Value Added Tax (VAT) regimes, such as Arise India Ltd v Commissioner of Trade & Taxes (Arise India), wherein, the court struck down a materially similar provision under the Delhi VAT Act, holding that law cannot complied in good faith if it imposes disproportionate consequences upon a bona fide purchasing dealer for mere non-compliance of the seller, it risks falling foul of the equality guarantee enshrined in Article 14 of the Constitution. In a very recent pronouncement, the SC in the Commissioner Trade and Tax Delhi v. M/S Shanti Kiran India, also ruled that ITC under the Delhi VAT Act, cannot be denied to bona fide purchasers when sellers fail to deposit VAT. By following the decision in Arise India, it emphasized that at the time of transaction the sellers were duly registered, invoices were genuine and there was no collusion between parties, hence paving the way for equitable treatment to the bonafide purchasers.
Even though revenue protection is a legitimate legislative objective, fraudulent, and innocent transactions cannot attract the same punitive measure. However, to impose the same penalties on a bona fide purchaser who has fulfilled all his legal requirements but cannot control the supplier’s compliance is an unjustifiable burden that goes against the constitution and defeats the purpose of the GST framework.
This analysis proves that Section 16(2)(c) is ultra vires the quintessential Article 14 of the Constitution by treating both the guilty and the innocents at par.
Doctrine of Impossibility
The maxim, “Lex non Cogit Ad Impossibilia” means that the does not compel one to impossible things. This is foundational principle in contract law providing relief to parties when the performance becomes impossible wholly due to reasons out of their control. Over the course of time, this principle has expanded to taxation law across globe, especially when the statutory framework places responsibilities on taxpayers to perform an impossible act.
Addressing the issue at hand, the Section 16(2)(c) postulates such a scenario where the recipient of goods has to not only to fulfil his duties, but also to ensure that the supplier of goods remits the tax to government to claim ITC. Also, statutorily the recipient is not required to ensure compliance of tax remittance to the government by the supplier.
Further in Arise India, the court observed that purchasing dealer cannot reasonably be expected to perform the impossible task of foreseeing which selling dealer may eventually default in remitting the tax collected to the Government and to accordingly refrain from transacting with such sellers.
Consequently, the denial of ITC ought to be confined to those selling dealers who have failed to deposit the tax collected by them, rather than extending punitive consequences to bona fide purchasers who have acted in good faith and fulfilled their statutory obligations.
The GST system is structured in such a way that the recipient does possess any control over the supplier’s action. A dealer’s responsibility for due diligence is fulfilled by obtaining valid tax invoices, verifying that the supply has actually been made, and ensuring payment of the tax amount to the supplier.
Rather than confirming whether tax has been paid to the exchequer, forms like GSTR-2A and the GST portal are just passive displays showing that the supplier has filed returns. Due to this, the recipient is financially compliant but gets penalized for a default over which they had no control whatsoever. Therefore, it becomes next to impossible to fulfil the legal prerequisite in practice for submitting a claim of input tax credit.
Hence, it is not sound to punish a taxpayer for an act or omission by something which is totally out of their control by applying Section 16(2)(c) in a very mechanical way without looking at how the GST setup works.
Way Forward
To ensure full benefit of GST laws to the businesses, it is incumbent upon the government to employ targeted methods to prevent ITC fraud, rather than a sweeping denial of ITC to all recipients.
A nuanced solution can be found in the “Kittel Principle” formulated by the European Court of Justice (‘ECJ’) in the case of Axel Kittel & Recolta Recycling SPRL. Under this doctrine, the entitlement to deduct input VAT may be denied only if it is shown that the recipient knew or ought to have known that their purchase was connected with a fraudulent evasion of tax. In such circumstances, the recipient is deemed to be complicit in the fraud, and the profitability or otherwise of the transaction is irrelevant in determining liability.
It is incumbent on the tax authorities to provide clear evidence that a tax loss has actually occurred as a result of the transactions in question before denying VAT benefits to the recipient. Tax authorities have the right to scrutinize the whole supply chain to determine if the dealings are authentic. Business on its own has the responsibility to exercise due diligence by checking on the reputation of its suppliers, being sensitive to abnormal patterns in transactions, maintaining clear and complete records, and immediately verifying any red flag indicators that might be raised during previous dealings. Such an approach will balance fairness with a safeguard against fraud.
Though this doctrine is conceptually sound, certain practical problems may arise out of its application. The primary fear is about enforcement authorities’ overreach because expansive and inconsistent interpretation could lead to an increased number of dealings flagged as fraudulent transactions. This approach might require more judicial intervention. Therefore, this principle should be applied in a measured and proportionate manner by the standards of evidence. The ITC should only be denied in cases of proven fraud, collusion, or willful non-compliance. The requirement that executive discretion must be exercised within the bounds of reasonableness and proportionality will sustain the nuanced relationship between the legitimate objective of revenue protection and the equally compelling necessity for the protection of taxpayer rights as a component of economic governance.
Conclusion
It is essential that Section 16(2)(c) receives a purposive interpretation that serves the purpose of GST as a business-friendly regime. Indiscriminate denial of ITC to recipients acting in good faith erodes the legitimate expectations of compliant taxpayers and distorts the intended operation of the scheme. The author hopes that such a change is either brought through judicial ruling or an amendment by incorporating Kittel Principle which would ensure that only those recipients who are complicit in or wilfully blind to supplier fraud are subject to penalty. The adoption of the Kittel principle has resulted in a considerable success across EU, UK and Singapore. Adopting this in India would primarily, safeguard the rights of bona fide purchasers who have exercised due care in their transactions, thereby protecting their legitimate ITC and commercial operations from arbitrary or inequitable reversals, thus ensuring GST’s legitimacy as a modern tax reform.