Protecting Revenue Without Penalising Purchasers: Is Section 16(2)(c) Crossing the Line?

An analysis of Section 16(2)(c) of the CGST Act, examining the denial of input tax credit to purchasers due to supplier defaults, constitutional challenges, judicial approaches to protecting bona fide purchasers, and Australia’s contrasting GST framework.

Introduction

The Central Goods and Services Tax Act, 2017 (CGST Act), came into force with the intention of making lives easier for both the Government and the citizens.

However, the CGST Act, inadvertently, might have created liability on the persons who are not at fault. Section 16(2)(c)¹, in particular, remains a controversial provision, not because it may not be constitutionally valid, but because it remains as one of the harshest and penalising provisions for the purchaser claiming input tax credit (ITC) of the goods or services against a valid invoice under the CGST Act.

This article aims to discuss the pitfalls of Section 16(2)(c) and why it has been a thorn in the side for buyers. Furthermore, this article will draw a comparative analysis between India and Australia, another common law country that has implemented their own A New Tax System (Goods and Services Tax) Act, 1999 (GST Act, 1999).

Input tax credit and Section 16(2)(c)

Section 2(62), CGST Act, defines input tax as so defined under the respective Integrated Goods and Services Tax Act, 2017, Central Goods and Services Tax Act, 2017, State Goods and Services Tax Act, 2017 or Union Goods and Services Tax Act, 2017.

The main idea behind the corresponding input tax sections is that any supply of goods or services will be liable for tax on a reverse charge basis under the respective Act and will be borne by the person who purchases such goods or services. The purchaser in due course pays the tax to the supplier of such goods or services on the basis of an invoice provided by the supplier. ITC has been defined as credit of input tax as defined under Section 2(63), CGST Act.

Section 16 puts forth several conditions on the basis of which one may be eligible to avail the ITC. One of the conditions which is elaborated in the CGST Act, 2017 is provided under Section 16(2)(c), CGST Act, whereby a purchaser may be eligible to avail the ITC only in cases where the input tax has actually been paid to the Government by the supplier. Therefore, a purchaser, even in cases where they have paid the applicable tax, under the CGST Act, may not be able to avail the benefit of ITC, and would have to pay the same amount of tax to the Government again.

Section 16(2)(c), unfortunately, for the same reason, along with Rule 36(4), Central Goods and Services Tax Rules, 2017, has been subject to several constitutional challenges in the High Courts of Tamil Nadu, Karnataka, Kerala, Tripura and Delhi. The judgments of all the High Courts vary considerably on principle. There are two separate lines of thought when analysing the constitutionality of Section 16(2)(c): 1) that the provision as a whole is valid under the Constitution, and 2) that the provision is valid but must be read down to protect bona fide purchasers under the law.

In the case of D.Y. Beathel Enterprises v. State Tax Officer², the Madras High Court opined that despite having the option to pursue the seller for the non-payment of goods and services tax (GST) to the Government, concrete steps had been taken against the purchaser and the purchaser was denied any ITC. The court was of the opinion that any steps of such nature must be taken only in cases where the State has first tried to pursue remedies against the supplier. In the case of Baby Marine (Eastern) Exports v. Union of India³, the Madras High Court upheld the validity of Section 16(2)(c) and denied that the provision was violative of Article 14 of the Constitution of India. The Gujarat High Court had the opportunity to comment on the same subject in the case of Maruti Enterprise v. Union of India⁴. The Gujarat High Court, in the said case, determined upon the constitutional validity of Section 16(2)(c) and whether the provision should be read down. The Gujarat High Court placed consideration upon the judgment of the Tripura High Court in Sahil Enterprises v. Union of India⁵ (Sahil Enterprises), and refused to read down the provision, further stating that Section 16(2)(c) is to be read in consonance with statutory provisions of the CGST Act. The Gujarat High Court relied upon Section 155, CGST Act, which also states that the burden of proving that a person is eligible for ITC relies on the person itself, also enshrined under Section 16(2)(c), CGST Act. This was further affirmed by the Supreme Court in Bhandari Scrap Traders v. Union of India⁶, where the court emphasised that GST framework is distinct and treats ITC as a conditional statutory concession rather than an absolute right.

In the case of Instakart Services (P) Ltd. v. Union of India⁷ (Instakart Services), the Karnataka High Court observed and remarked that a bona fide purchaser cannot be made liable for the non-payment of tax by the supplier, effectively reading down the provision of Section 16(2)(c), CGST Act. The court drew inspiration from the Sahil Enterprises case⁸, wherein the Tripura High Court had effectively read down the provision of Section 16(2)(c) to exclude bona fide purchasers from the denial of ITC. The courts, in both cases upheld the validity of Section 16(2)(c) with respect to the Constitution of India, citing that reading down would effectively make the provisions as valid under the Constitution of India.

The author believes that a purchaser, once depositing the appropriate tax to the supplier, cannot be made liable for the non-payment of tax to the Government by the supplier. As per the principle of lex non cogit ad impossibilia, law cannot compel a man to do an act which is not possible. The Supreme Court in the case of E.P. Royappa v. State of T.N.⁹, had categorically stated that any State action that is irrational, capricious, or lacks a determining principle is considered inherently arbitrary and unconstitutional under Article 14 of the Constitution of India. Forcing someone to achieve the impossible is recognised as the epitome of irrationality. Therefore, the judgments that completely validate Section 16(2)(c) cannot be considered to have taken the best interests of all the stakeholders in mind. However, the analysis of the High Courts in the case of Instakart Services or Sahil Enterprises cannot be considered to have effectively addressed the issue.

There are two problems with the observations made by the court in the cases of Instakart Services and Sahil Enterprises. Firstly, the court never defines who or what a bona fide purchaser is. The court effectively relies on the judgment of the Delhi High Court in the case of On Quest Merchandising India (P) Ltd. v. State (NCT of Delhi)¹⁰, where the Delhi High Court had the opportunity to examine Section 9(2)(g), Delhi Value Added Tax Act, 2004 (DVAT Act). The Delhi High Court in the said judgment had carved out an exception for bona fide purchasers under the DVAT Act, defining bona fide purchasers as purchasers who comply with Section 50¹¹ and there is no case of mismatch of transactions in Annexures 2-A and 2-B. The lack of a definition of bona fide purchasers under the CGST Act in both the cases of Instakart Services¹² and Sahil Enterprises¹³ will lead to a haphazard implementation and may lead to arbitrary classifications by the respective tax authorities while determining a purchaser as a bona fide purchaser.

Secondly, the courts do not discuss the exceptions of B.R. Enterprises v. State of U.P. (B.R. Enterprises).¹⁴ While the case of B.R. Enterprises discussed the mechanism of reading down and that it may be applicable in cases where the statute may be saved from being declared unconstitutional, it also stated that the mechanism of reading down will not be applicable in cases where the plain and bare reading of the text shows that it confers arbitrary and unbridled power to the Government. By not disclosing the factors that may be applied to determine the status of the purchaser as bona fide, the court has allowed the State to have greater scope of repeatedly declining ITC to genuine purchasers, since the State will itself determine whether the purchaser was bona fide or not, on the basis of criteria set by the State itself. The fact that the State also has the ability to itself decide which purchaser will be bona fide and which will not be bona fide is in itself arbitrary and unbridled power. The author believes that the provision, even after being read down, remains violative of Article 14 of the Constitution of India, as manifestly unjust until and unless bona fide purchasers are defined.

While the reading down of the provisions of Section 16(2)(c), CGST Act remains as a welcome step, it is not sufficient to ensure that the rights of the bona fide purchasers are protected. The implementation of the judgment still remains a difficult prospect, in lieu of a press release given by the Government¹⁵, whereby the Government has opined that there shall be no automatic reversal of credit. The recovery will be made by the seller only; however, in exceptional cases, the liability may as well be extended to the purchaser. Such instances may include missing supplier, closure of business by the supplier or the supplier not having adequate assets to ensure recovery. While the judiciary may be present to protect the genuine purchasers in cases where they have been denied ITC, there should be provisions under law to ensure that the purchasers are not denied ITC in the first place. This is because a provision which allows for the denial of ITC to purchasers will lead to unnecessary harassment and litigation for the purchasers, eventually leading to loss of income or loss of faith in the system. A better method which may be adopted by the Indian system is to follow a method as is done in Australia.

Australia: Only supplier is liable to be denied input tax credit

Australia, a common law country, has the provisions for the application of GST in the country, like India. As per Division 11 under the GST Act, 1999¹⁶, a person may be able to avail ITC for creditable acquisitions on the basis of four conditions: 1) the goods or services are acquired for a creditable purpose; 2) the supply of the goods or services is a part of a taxable supply; 3) the buyer is liable to provide consideration for the supply; and 4) the buyer is a registered party under the GST Act, 1999. The law further states that a buyer is entitled to ITC for any creditable acquisition that has been made by the buyer. There are no provisions in the Australian law, whereby the buyer at any point of time is made liable for the non-payment of the tax by the supplier.

On the basis of Section 29—10 of the GST Act, 1999¹⁷, a buyer is eligible for an ITC upon the production of a valid tax invoice for a creditable acquisition. In case a valid tax invoice is not available, the buyer may still be eligible for ITC if it may be so determined by the GST Commissioner.

Australia does not have a provision like Section 16(2)(c); however, they do have Division 165¹⁸, whereby any steps taken by an entity to categorically avoid GST will attract penal provisions.

This provision provides relief to the buyer, especially in cases where the buyer has given the applicable tax to the supplier, but the supplier has not deposited the applicable tax to the Government. Australian regime places strict emphasis on documentary compliance, and ensures that a bona fide buyer has not been made liable on non-payment of tax by the supplier.

One of the major reasons for the implementation of Section 16(2)(c) in India is due to the persistence of fraud, existence of a much larger taxpayer base, multiple layers of intermediaries, and fake invoicing to avoid taxes. But all of these concerns can be addressed through both Sections 73 and 74, CGST Act, whereby the State Tax Officer has the ability to issue notice on the non-payment of tax to the Government, amongst other reasons. Therefore, while the ITC may be availed by the purchaser and the seller, the Government has the ability to ensure that fraudulent claims are adequately addressed.

Keeping such stringent provisions, both at the pre-claim and post-claim stage of ITC, will ultimately lead to harassment for businesses.

Suggestion moving forward

In light of the discussion above, India should do away with the requirement of involving the purchaser while ensuring that the tax is actually received by the Government. If the purchaser has the ability to produce a tax invoice as detailed under the CGST Act, then there should be no need to involve the purchaser to ensure that the tax is actually received by the Government. In case there are concerns regarding fraud or misrepresentation by the purchaser, the Government has the option to exercise its powers under Section 74, CGST Act, whereby the State Tax Officer may impose penalty upon the wrongdoers under Section 74(3), CGST Act.

It is suggested that Section 16(2)(c) be amended to be read as follows: “with respect to the supplier – subject to the provisions of [Section 41 [***]], the tax charged in respect of such supply has been actually paid to the Government, either in cash or through utilisation of input tax credit admissible in respect of the said supply by the supplier”.

Such a provision would lead to a more holistic approach towards the objectives of the CGST Act.

Conclusion

Section 16(2)(c) remains one of the most controversial provisions relating to indirect taxation. The ability of the State to block ITC, for both the buyer and the supplier on the non-payment of the tax to the Government, despite several other provisions safeguarding the interests of the Government, remains a grave concern. While some judgments have tried reading down the provision, there is still some cause for concern and therefore it will be better that the provision may be overhauled in the coming future to prevent unnecessary harassment of the buyers.