Shaurya Alloys Pvt. Ltd. v. State of Punjab and Another

What happened

The bunch of 424 writ petitions, led by the petition of Shaurya Alloys Private Limited against the State of Punjab (CWP-34296-2024), challenged show cause notices and orders that denied or reversed input tax credit under the Central Goods and Services Tax Act, 2017 to purchasing dealers because their selling dealers had collected tax but had not deposited it with the Government, in many cases after the supplier's registration had been cancelled, often retrospectively. The question, as the Court put it, was what exactly is the obligation of a purchaser who has paid tax to the supplier to ensure that the supplier deposits it, when the purchaser has no means of finding out whether it has been deposited. The Court did not examine the facts of individual cases.

The petitioners argued that section 16(2)(c) offends the maxim that the law does not require the impossible and articles 14, 19(1)(g), 21, 265 and 300A of the Constitution, and alternatively that it should be read down so that a purchaser is made responsible only in exceptional cases such as a non-existent supplier or fraud, as the Delhi High Court had done for the Delhi VAT Act in On Quest Merchandising, left undisturbed by the Supreme Court in Arise India and Shanti Kiran India, and as the Gauhati, Tripura and Karnataka High Courts had done under the GST Act. They stressed that the original scheme of matching and verification of returns in sections 41 to 43 and the return forms, which would have told purchasers whether suppliers had paid, was never implemented, that sections 42 and 43 were omitted from 1 October 2022, and that rule 37A, which allows re-availment of reversed credit when the supplier later pays, was inserted only from 26 December 2022. The revenue argued that input tax credit is a statutory concession and not a vested right, that actual payment of tax to the Government is its foundation, that the Gujarat High Court's decision in Maruti Enterprises upholding the provision had been affirmed by the Supreme Court in Bhandari Scrap Traders, that its investigations had found many transactions not genuine despite invoices and bank payments, that utilising fraudulent credit is not payment of tax, and that the burden under section 155 lies on the claimant.

Questions before the court

• Is section 16(2)(c) of the CGST Act, 2017 valid, and can it be applied to make a purchaser who has paid tax to the supplier reverse input tax credit merely because the supplier did not deposit the tax with the Government?

Why the court ruled this way

The Court began with the scheme. Section 16(2)(c) makes credit available only if the tax charged has actually been paid to the Government, either in cash or by utilising admissible credit, and it operates subject to section 41. As enacted, the Act contemplated a system in which the supplier's outward supply details passed to the purchaser, returns were matched and mismatches were reversed or reclaimed under sections 41 to 43, so that a purchaser could know whether the supplier had deposited the tax and the burden placed on the claimant by section 155 was workable. That machinery was never fully implemented: sections 42 and 43 were omitted from 1 October 2022, section 41 was substituted to allow credit on self-assessment, and rule 37A, which allows re-availment when the supplier later pays, was inserted only from 26 December 2022 (paragraphs 69–74 and 92–97).

On validity, the Court held that the requirement that the tax has actually been paid is not extraneous to input tax credit but its foundation, that credit is a statutory concession, and that the challenge to vires was at best feeble because the petitioners' real grievance is about the way the provision is invoked. The vice of requiring the purchaser to do the impossible does not inhere in the text; it arises when the provision is torn out of the scheme and applied in a routine, mechanical way, and the possibility of improper application in individual cases is no ground to invalidate it. The Supreme Court had dismissed the special leave petition against the Gujarat High Court's decision in Maruti Enterprises, in Bhandari Scrap Traders, observing that no parity can be drawn between the Delhi VAT Act and the GST Act, so judicial discipline counselled against reading the provision down, in the manner of Gheru Lal Bal Chand and On Quest, to cases of fraud, collusion or non-existent transactions. The challenge to section 16(2)(c) read with section 155 was repelled (paragraphs 91 and 98).

The Court nevertheless held that the provision cannot operate as a stand-alone rule. Treated that way, with no means for the purchaser to ascertain the supplier's deposit, it would invite the maxim against impossible obligations and challenges under articles 14 and 19 (paragraphs 75–78); section 76, which deals with tax collected but not paid to the Government, would be rendered otiose and the burden would fall on a purchaser who has already paid the tax while the defaulting supplier is spared (paragraphs 79–82); before rule 37A there was no way to re-avail reversed credit even if the supplier later deposited the tax, and reversals years later harm business (paragraphs 83–84 and 97); and the Act contains many other provisions aimed at the defaulting supplier (paragraph 85). The position differs where there is collusion, fraud, a non-existent supplier or no actual receipt of goods or services, because the entitlement itself is then in question (paragraph 87). In many of the cases before it the provision had been invoked routinely, only because the supplier's registration had been cancelled, sometimes without even a notice to the purchaser under section 74, and rule 37A does not justify that (paragraphs 88–89). The burden under section 155 stays on the purchaser, but the proper officer must first examine, after a hearing, why the supplier did not deposit the tax, whether the transaction is genuine and what remedy exists against the supplier (paragraphs 90 and 99).

Because many of the notices invoked the extended period under section 74, the Court recalled the Supreme Court's recent decisions in G.R. Infra Projects and Tata Steel that the foundational facts from which fraud, wilful misstatement or suppression is inferred must appear in the notice itself and cannot be supplied later by an affidavit, and added that a supplier's fraud does not become the purchaser's fraud unless the notice discloses the facts connecting them (paragraphs 100–102).

The fourteen guidelines in paragraph 103 are addressed to the proper officers of the Central Government, Punjab, Haryana and Chandigarh. First, section 16(2)(c) must not be used routinely, and the supplier's cancellation, including retrospective cancellation, a nil or short liability in its return or an alert may start an inquiry but cannot by themselves justify denying or reversing credit. Second, before a notice the officer must apply his mind and record satisfaction on the supplier, invoices, periods and amount, the precise nature of the default, why the supplier failed to deposit and what proceedings exist against the supplier. Third, the investigation should establish a direct link between the purchaser and the supplier. Fourth, the notice must disclose these particulars, the material relied on and the details of the suppliers, and the documents relied on must be supplied. Fifth, where section 74 (or section 74A where it applies) is invoked the notice must itself contain the foundational facts of fraud, wilful misstatement or suppression, and the fraud of the supplier is not attributed to the purchaser unless the notice connects them. Sixth, the burden under section 155 lies on the purchaser, who can discharge it with the invoice and proof of receipt such as e-way bills, transport receipts, weighbridge slips and stock and consumption records, and the officer must consider them. Seventh, where denial rests on retrospective cancellation of the supplier's registration, the officer must examine the grounds and the date of cancellation and whether they bear on the particular supply. Eighth, the officer must record the status of proceedings against the supplier, communicate with the supplier's jurisdictional officer, avoid realising the same tax twice, and allow credit or re-availment to the extent permitted by section 41 and rule 37A, subject to section 17(5)(i). Ninth, the law as it stood in the tax period must be applied in three phases, before 1 October 2022, from 1 October 2022 and from 26 December 2022, and later amendments such as clause (aa) of section 16(2) from 1 January 2022 must not be applied to earlier periods. Tenth, the purchaser's own registration must not be cancelled merely because it took credit on purchases from a supplier whose registration was later cancelled, without independent satisfaction under section 29(2). Eleventh, a personal hearing under section 75(4) must be given, and a request to cross-examine third persons whose statements are relied on must be decided by a reasoned order. Twelfth, the order must set out the facts and the basis of the decision, deal with the reply and documents and record a finding on each disputed condition of section 16(2), and on fraud, wilful misstatement or suppression where section 74 is invoked. Thirteenth, a deposit made during investigation, whether through Form DRC-03 or otherwise, does not dispense with a notice disclosing the foundational facts. Fourteenth, the guidelines apply to pending proceedings and to those started later.

Controlling point

Section 16(2)(c) read with section 155 of the CGST Act is valid and is not read down to cases of fraud alone, but it must be applied in harmony with the rest of the scheme, and it cannot be invoked in a routine or mechanical manner against a purchaser who has paid tax to the supplier merely because the supplier defaulted or its registration was cancelled; the proper officer must follow the fourteen guidelines.

Order and next steps

Declining to examine the facts of each case, because many notices and orders appeared to rest solely on the supplier's default or retrospective cancellation while the revenue asserted that some transactions are not genuine, the Court disposed of the petitions with directions (paragraph 105). Where a show cause notice is pending, the petitioners may file a reply or supplementary reply with supporting material within eight weeks, and the proper officer must decide by a reasoned and speaking order after a hearing, keeping the guidelines in view; a notice that lacks the particulars or material the guidelines require must be supplemented, and any supplementary notice or corrigendum introducing a new ground may be objected to and the objection decided in the new order.

Where an order has already been passed, the proper officer must revisit the matter after a personal hearing and pass a reasoned order, and may issue a supplementary notice or corrigendum with the required particulars, giving the petitioner a proper opportunity to reply. The impugned orders are not interfered with, but they abide by the new orders. Any amount deposited or recovered, including by reversal of credit or by debit to the electronic credit or cash ledger, abides by the new decision and is to be adjusted or refunded with admissible interest where warranted. No fresh coercive recovery action may be taken under the impugned notices or orders until the proper officer decides, all pleas on merits are left open, and the department may proceed against defaulting selling dealers. The Court commended to the Government and the GST Council several suggestions, including real-time verification of a supplier's tax payment by the recipient and alerts on a supplier's cancellation proceedings, without issuing any mandamus on those policy matters (paragraph 104).

Practical implications

A purchaser that receives a notice denying or reversing credit because its supplier defaulted can test it against the guidelines: whether it identifies the supplier, the default and the material relied on, whether it discloses foundational facts if section 74 is invoked, and whether a hearing was given. It should assemble proof of the receipt of goods and of payment, and the period-wise framework before 1 October 2022, from that date and from 26 December 2022 may matter to the outcome.

Limits of this ruling

• The Court did not decide any individual case or the revenue's allegations that particular transactions were not genuine, which are for the proper officers, and all pleas on merits were left open.
• The guidelines are directed to the proper officers of the Central Government, the States of Punjab and Haryana and the Union Territory of Chandigarh, and the Court said they neither dilute nor add to the conditions in section 16(2). Where there is collusion, fraud, a non-existent supplier or no actual receipt of goods or services, or where the purchaser fails to establish its entitlement, the consequences in section 16(2)(c) follow in accordance with law.
• The Court upheld the provision as the Gujarat High Court did in Maruti Enterprises, whose special leave petition was dismissed by the Supreme Court, and did not read it down as some other High Courts had done; later decisions or the outcome of other pending matters may affect the position.