Section 16(2)(c) GST: No Automatic ITC Reversal for Genuine Buyers | Punjab & Haryana HC

Section 16(2)(c) and ITC Reversal: Punjab & Haryana High Court Protects Genuine Buyers

In short: The Punjab & Haryana High Court has confirmed that Section 16(2)(c) of the CGST Act is constitutionally valid. It has also held that tax officers cannot cancel a genuine buyer’s Input Tax Credit (ITC) only because the supplier failed to deposit tax. The officer must first examine the transaction and act against the defaulting supplier.

Why this judgment matters

Understanding Section 16(2)(c) in the Context of Buyer Protection

Many businesses have received GST notices denying ITC for a reason outside their control: the supplier did not pay the tax, or the supplier’s registration was cancelled later, sometimes with retrospective effect. The buyer paid the invoice in full, including GST, and still lost the credit.

In Shaurya Alloys Pvt. Ltd. v. State of Punjab (CWP No. 34296 of 2024 and connected matters), the High Court decided 424 writ petitions on this issue together. Its ruling is the most detailed guidance yet on how Section 16(2)(c) may and may not be applied.

What Section 16(2)(c) says

Under Section 16(2)(c), a buyer can claim ITC only if the tax charged on the supply has actually been paid to the Government. The condition is subject to Section 41. Section 155 places the burden of proving eligibility for ITC on the person claiming it.

The buyers’ argument

The petitioners, who were buyers from Punjab, Haryana and Chandigarh, argued the following:

• They held valid tax invoices, received the goods and paid the supplier through banking channels.
• The original system of invoice matching and reversal was never made operational and was omitted from 1 October 2022. Rule 37A, which allows re-claiming of reversed ITC, came into force only on 26 December 2022. A buyer therefore had no practical way to check whether a supplier had deposited tax.
• The department has direct recovery powers against the defaulting supplier under Sections 75(12), 76 and 79 and Rule 88C. A buyer should not be made to pay the same tax twice.

The department’s argument

The department argued that ITC is a statutory concession, not a vested right, and must be earned by meeting every condition. It also pointed to the Gujarat High Court’s decision in Maruti Enterprise and the Supreme Court’s decision in Bhandari Scrap Traders, both of which upheld Section 16(2)(c).

What the High Court decided

1. The provision stays. The Court held that Section 16(2)(c) is valid. Payment of tax to the Government is the basis of ITC. Following the Supreme Court’s ruling in Bhandari Scrap Traders, it also declined to read the provision down.

2. It cannot be applied mechanically. The Court found that notices were often issued only because a supplier’s registration had been cancelled. It held that supplier default can start an inquiry but cannot by itself prove the buyer is liable. Before acting against a buyer, the officer must examine:

• why the supplier failed to pay,
• whether the transaction was genuine, and
• what recovery has been attempted against the supplier.

3. Genuine buyers and fraudulent ones are treated differently. If collusion, fraud, a non-existent supplier, or non-receipt of goods is proved, ITC is still denied. A supplier’s fraud is not automatically the buyer’s fraud, and the notice must show facts that connect the buyer to it.

Key guidelines laid down by the Court

• Starting point only: Retrospective cancellation of the supplier’s registration, a nil or short return by the supplier, or an alert from another authority can start an inquiry, but none of them justifies denying ITC on its own.
• Reasoned notices: Before issuing a notice, the officer must record the particulars of the supplier, the invoices, the ITC involved and the status of recovery against the supplier. Documents relied on, such as statements, e-way bill, toll and bank data, must be given to the buyer.
• Fraud allegations: Where fraud, wilful misstatement or suppression is alleged, the notice itself must state the facts supporting it. A counter-affidavit cannot fill the gap later.
• Proving genuineness: A buyer can discharge the Section 155 burden with the tax invoice and proof of receipt, such as e-way bills, transport receipts, weighbridge slips and stock records. The officer must deal with this evidence in the order.
• No double recovery: If the tax has already been recovered from or paid by the supplier, it cannot be collected again from the buyer. The buyer may re-claim credit under Section 41(2) and Rule 37A.
• Correct time period: The law applicable to the relevant tax period must be applied. Section 16(2)(aa), effective 1 January 2022, cannot be used for earlier periods, and the lack of a re-availment mechanism before 26 December 2022 must be considered.
• No automatic cancellation of the buyer’s GST registration: A buyer’s registration cannot be cancelled just because the supplier’s was, without independent satisfaction under Section 29(2).
• Fair hearing: The buyer must get a personal hearing. Requests for cross-examination must be decided by a reasoned order, and the final order must give a finding on each disputed condition of Section 16(2).
• Deposits under protest: An amount paid during investigation, for example through Form DRC-03, does not remove the need for a proper show cause notice.

These guidelines apply to pending and future proceedings. Pending cases were sent back to the officers for fresh decisions, no coercive recovery is to be made meanwhile, and the buyer may file a reply within eight weeks where a notice is still pending.

What this means for your business

The ruling does not give buyers blanket protection. You must still prove that the supply was real, and ITC will be lost where a transaction is collusive or goods were never received. It does, however, make the department’s job harder. Some practical steps:

1. Keep a complete paper trail for every purchase: tax invoice, e-way bill, transport receipt, weighbridge slip, stock and consumption records, and bank payment proof.
2. Check supplier compliance regularly, including GST registration status and return filing.
3. Respond to notices fully and on time. Ask the officer to disclose what action has been taken against the supplier.
4. Check the tax period. Different rules applied before 1 October 2022, from that date, and from 26 December 2022, and this can strengthen your defence for earlier years.
5. Take advice before depositing any amount under protest.

Note that the guidelines are binding on authorities in Punjab, Haryana and Chandigarh. Elsewhere, including Uttar Pradesh, they carry persuasive value only. Other High Courts have taken different views, and the Supreme Court’s ruling in Bhandari Scrap Traders limits challenges to the provision itself.

How Sagar S Gupta & Co can help

Our team of Chartered Accountants in Shivpur, Varanasi has handled GST compliance and litigation for more than 1,000 businesses since 2017. We help clients with:

• reviewing ITC claims and supplier risk,
• replying to GST show cause notices under Sections 73 and 74,
• preparing documentary evidence for ITC disputes, and
• planning GST compliance so that credit stays secure.

If you have received a GST notice on ITC or want your purchase records checked, contact CA Sagar Gupta (FCA, ACS, LLB) and our team.

Disclaimer: This article is for general information and is not legal advice. Please consult a qualified professional about your specific situation.