SCN quashed for demanding ITC reversal from buyer without action against defaulting supplier

Issue

Whether the Department can initiate proceedings under Section 73 to deny Input Tax Credit (ITC) to a bona fide purchaser solely because the supplier failed to remit the tax, without first invoking the discrepancy-matching mechanism under Section 42 and taking recovery action against the supplier.

Facts

Transaction: The petitioner purchased goods from suppliers (Respondents 2 and 3) during the period 2019-20. Valid tax invoices were issued, and goods were moved with E-way bills.
Payment: The petitioner paid the tax amount to the suppliers and availed ITC in their GST returns.
The Default: The suppliers failed to report these supplies or remit the tax to the Government.
Department’s Action: Invoking Section 16(2)(c) (which conditions ITC on actual tax payment to the Govt), the Department issued a Show Cause Notice (SCN) under Section 73 directly to the petitioner proposing disallowance of the ITC. No notice was issued to the suppliers.

Decision

Statutory Sequence (Section 42): The Kerala High Court examined the scheme of Section 42 (applicable for the period).
- Section 42(3) mandates that any discrepancy (mismatch) must be communicated to both the supplier and the recipient.
- Section 42(5) allows the amount to be added to the recipient’s output liability only if the supplier fails to rectify the discrepancy after such communication.
Procedural Breach: The Department bypassed this statutory sequence. By skipping the supplier and targeting the recipient directly, the Department violated the scheme of the Act.
Binding Precedent: Relying on the principle in Suncraft Energy (affirmed by the Supreme Court), the Court reiterated that unless there is proof of collusion or the supplier is missing/bankrupt, the Department must first recover the tax from the selling dealer.
Ruling: Since no collusion was alleged and no action was taken against the supplier, the SCN issued to the petitioner was quashed.

Key Takeaways

Section 16(2)(c) is not absolute: While the law requires tax to be paid to the government for ITC eligibility, Courts generally read this provision down to protect bona fide buyers. The Department cannot enforce this provision against the buyer without first exhausting remedies against the seller.

Section 42 Protection: Even though Section 42 has been omitted/amended in recent years, for disputes relating to financial years like 2017-18 to 2019-20, the procedural safeguards regarding “communication of discrepancy” remain a valid legal defense.

HIGH COURT OF KERALA

K.V. Joshy & C.K. Paul

Assistant Commissioner

ZIYAD RAHMAN A.A., J.

WP(C) NO. 24617 OF 2024

OCTOBER 27, 2025

M.S. Sajeev Kumar, Smt. Lakshmi S Kumar and Smt. A.N.Jyothilekshmi, Advs. for the Petitioner. R. Harishankar, Adv. for the Respondent.

JUDGMENT

1. The petitioner is an assessee under the provisions of CGST Act and this writ petition is submitted by the petitioner, challenging Ext.P3 show cause notice issued under Sec.73 of the CGST Act. As per Ext.P3 notice, the petitioner was directed to show cause, as to why the input tax credit claimed by the petitioner pertaining to the assessment year 2019-2020 should not be disallowed and recovered from the petitioner. In Ext.P3, a penalty was also sought to be imposed in respect of the same.

2. The facts which led to the issuance of Ext.P3, are as follows:-

In respect of the relevant financial year, the petitioner effected certain purchases which are covered by Exts.P5 to P72 invoices from the respondents 2 and 3. According to the petitioner, those are proper tax invoices in the relevant formats in the CGST Act and the respondents 2 and 3 have collected tax from the petitioner in respect of the same. The said documents contain e-way bills corresponding to the invoices issued, indicating the transportation of the goods covered by the invoices as well. On the basis of the same, the petitioner submitted it’s returns and claimed input tax credit in respect of invoices referred to above. However, the 2^nd and 3^rd respondents failed to furnish the details of the supplies made to the petitioner as per the relevant invoices and did not pay the tax covered by the same. It was in these circumstances, Ext.P3 show cause notice was issued to the petitioner. This writ petition is submitted in such circumstances challenging Ext.P3.

3. A counter statement was submitted by the respondents 1 and 4, controverting the averments contained in the writ petition and also opposing the reliefs sought.

4. Even though notices to the respondents 2 and 3 were sent by speed post, the same could not be completed and therefore, notices were served by way of paper publication. Despite the above, there is no appearance on the part of the said respondents.

5. I have heard Sri.M.S.Sajeev Kumar, learned counsel for the petitioner and Sri.R.Harishankar, learned standing counsel for the respondents 1 and 2.

6. The learned counsel for the petitioner mainly raised two grounds while challenging Ext.P3 notice. The first ground is that, since the proceedings have been initiated against the petitioner without initiating any other proceedings against the suppliers, the respondents 2 and 3, as mandated under Section 42 of the CGST Act, as stood prior to 01.10.2022, the petitioner cannot be held responsible. The second contention raised by the learned counsel for the petitioner is with regard to the limitation contemplated under Section 73 of the Act, in initiating the proceedings, which is within three years from the due date for furnishing of annual tax return for the financial year to which the tax not paid or short paid or input tax credit wrongly availed or utilized relates to or within three years from the date of erroneous refund. In this case, it is pointed out that the Assessment Year is 2019-2020, whereas, the proceedings were proposed to be initiated as per Ext.P3 on 20.05.2025 and this is beyond the time limit. The learned counsel for the petitioner also placed reliance upon the decision rendered by the Honourable High Court of Calcutta in Suncraft Energy Pvt Ltd v. Asstt. Commissioner, State Tax G.S.T.L. 55 (Cal.)/(2023) 9 Centax 48(Cal.)], which is confirmed by the Honorable Supreme Court in Asstt. Commissioner of State Tax v. Suncraft Energy Pvt.Ltd. 2024 (80) G.S.T.L. 225 (S.C.)/(2023) 13 Centax 189 (S.C), the decision rendered by the Allahabad High Court in R.T. Infotech v. Additional Commissioner GST 882 (Allahabad)/(2025) 31 Centax 204 (All.), yet another judgment rendered by the High Court of Calcutta in Lokenath Construction (P.) Ltd. v. Tax/Revenue, Government of West Bengal GST 198/86 GSTL 130 (Calcutta)/(2024) 18 Centax 97 (Cal.) and a decision rendered by the Honourable Supreme Court in Commissioner Trade and Tax Delhi v. Shanti Kiran India (P.) Ltd. (SC)/Civil Appeal No.9902/2017.

7. On the other hand, the learned standing counsel for the respondents 1 and 4 contended that, the petitioner failed to fulfill its obligation to ensure that remittance of tax by the 2^nd and 3^rd respondents, as per the invoices. It is pointed out that the petitioner was already issued with notice in this regard before the issuance of Ext.P3, but no effective steps have been taken. Therefore, going by the statutory stipulations contained in Section 16 (2) (c), the issuance of Ext.P3 cannot be found fault with. Therefore, the respondent sought dismissal of this writ petition.

8. With regard to the period of limitation, the learned standing counsel brought to the notice of this Court, Annexure R1(a), which is the notification No.56/2023-Central Tax dated 28.12.2023 issued by the Central Board of Indirect Taxes and Customs, wherein, the time limit for issuing a final order under Section 73 has been extended up to 31.08.2024. Thus, it was pointed out that, since the time limit for issuance of the final order is extended up to 31.08.2024, the show cause notice could have been issued by the respondents, three months before 31.08.2024. Thus, it was pointed out that, notice was issued within the extended time and thus legally sustainable.

9. I have carefully gone through the records and examined the relevant statutory provisions. While considering the aforesaid question, it is to be noted that, Section 16 (2) (c), as it stood at the relevant time, imposed a condition that the input tax credit as contemplated under Section 16(1) could be claimed by the purchaser, only if the tax charged in respect of such supply has been actually paid to the Government, either in cash or through utilization of input tax credit admissible in respect of the said supply. However, the procedure to be followed for realizing the said amount, was contemplated under Section 42, which reads as follows:

“Section 42. Matching, reversal and reclaim of input tax credit. –

(1) The details of every inward supply furnished by a registered person (hereafter in this section referred to as the “recipient”) for a tax period shall, in such manner and within such time as may be prescribed, be matched-(a) with the corresponding details of outward supply furnished by the corresponding registered person (hereafter in this section referred to as the – “supplier”) in his valid return for the same tax period or any preceding tax period;

(b) with the integrated goods and services tax paid under Section 3 of the Customs Tariff Act, 1975 in respect of goods imported by him; and

(2) The claim of input tax credit in respect of invoices or debit notes relating to inward supply that match with the details of corresponding outward supply or with the integrated goods and services tax paid under Section 3 of the Customs Tariff Act, 1975 (51 of 1975) in respect of goods imported by him shall be finally accepted and such acceptance shall be communicated, in such manner as may be prescribed, to the recipient.

(3) Where the input tax credit claimed by a recipient in respect of an inward supply is in excess of the tax declared by the supplier for the same supply or the outward supply is not declared by the supplier in his valid returns, the discrepancy shall be communicated to both such persons in such manner as may be prescribed.

(4) The duplication of claims of input tax credit shall be communicated to the recipient in such manner as may be prescribed.

(5) The amount in respect of which any discrepancy is communicated under sub-section (3) and which is not rectified by the supplier in his valid return for the month in which discrepancy is communicated shall be added to the output tax liability of the recipient, in such manner as may be prescribed, in his return for the month succeeding the month in which the discrepancy is communicated.

(6) The amount claimed as input tax credit that is found to be in excess on account of duplication of claims shall be added to the output tax liability of the recipient in his return for the month in which the duplication is communicated.

(7) The recipient shall be eligible to reduce, from his output tax liability, the amount added under sub-section (5), if the supplier declares the details of the invoice or debit note in his valid return within the time specified in sub-section (9) of Section 39.

(8) A recipient in whose output tax liability any amount has been added under sub-section (5) or sub-section (6), shall be liable to pay interest at the rate specified under sub-section (1) of Section 50 on the amount so added from the date of availing of credit till the corresponding additions are made under the said sub-sections.

(9) Where any reduction in output tax liability is accepted under sub-section (7), the interest paid under sub-section (8) shall be refunded to the recipient by crediting the amount in the corresponding head of his electronic cash ledger in such manner as may be prescribed:

Provided that the amount of interest to be credited in any case shall not exceed the amount of interest paid by the supplier.

(10) The amount reduced from the output tax liability in contravention of the provisions of sub-section (7) shall be added to the output tax liability of the recipient in his return for the month in which such contravention takes place and such recipient shall be liable to pay interest on the amount so added at the rate specified in subsection (3) of Section 50.”

10. When coming to Sub Section (3) of Section 42, it can be seen that, there is an obligation imposed upon the assessing authority, to issue a notice communicating the discrepancy, to both such persons, in case a short supply is found. Evidently, before issuing Ext.P3 show cause notice, no such proceedings have been followed. Sub Section (5) of Section 42 is also relevant in this regard, which would indicate that, the amount in respect of which any discrepancy is communicated under sub-section (3) and which is not rectified by the supplier in his valid return for the month in which discrepancy is communicated, shall be added to the output tax liability of the recipient, in such manner as may be prescribed, in his return for the month succeeding the month in which the discrepancy is communicated. Thus, consequence of issuance of notice to both parties, particularly in respect of the supplier thereof, is specifically contemplated in Sub Section 5 and only in the absence of the supplier failing to rectify the discrepancy, the output tax liability can be imposed upon the recipients. Therefore, going by the scheme contemplated under Section 42, as it stood at the relevant time, no proceedings should have been initiated against the petitioner in the nature of Ext.P3, without issuing a notice to the supplier.

11. Apart from the above, the question whether the recipient can be proceeded against, before initiating proceedings against the supplier, in a case where, the supplier failed to remit the tax or submit the returns was specifically considered in Suncraft Energy’case (supra) by the High Court of Culcatta. After referring to the various statutory stipulations contained in the CGST Act, it was held as follows:

“8. In the reply submitted by the appellant to the said show cause notice the appellant had clearly stated that they are in possession of the tax invoice, they had received the goods and services or both and the payment has been made to the supplier of the goods or services or both. The reason for denying the input tax credit is on the ground that the detail of the supplier is not reflecting in GSTR 1 of the supplier. The appellant had pointed out that they are in possession of a valid tax invoice and payment details to the supplier have been substantiated by producing the tax invoice and the bank statement. The appellant also referred to the press release dated 18.10.2018. What we find is that the first respondent has not conducted any enquiry on the fourth respondent supplier more particularly when clarification has been issued where furnishing of outward details in Form GSTR 1 by a corresponding supplier and the facility to view the same in Form GSTR 2A by the recipient is in the nature of tax payer facilitation and does not impact the ability of the tax payers to avail input tax credit on self-assessment basis in consonance with the provisions of Section 16 of the Act. Furthermore, it was clarified that there shall not be any automatic reversal of input tax credit from buyer on non-payment of tax by seller. Further it is clarified that in case of default in payment of tax by the seller www.majestylegal.in recovery shall be made from the seller however, reversal of credit from the buyer shall also be an option available with the revenue authorities to address the exceptional situations like missing dealer, closure of business by supplier or supplier not having adequate assets etc.

9. The first respondent without resorting to any action against the fourth respondent who is the selling dealer has ignored the tax invoices produced by the appellant as well as the bank statement to substantiate that they have paid the price for the goods and services rendered as well as the tax payable there on, the action of the first respondent has to be branded as arbitrarily. Therefore, before directing the appellant to reverse the input tax credit and remit the same to the government, the first respondent ought to have taken action against the fourth respondent the selling dealer and unless and until the first respondent is able to bring out the exceptional case where there has been collusion between the appellant and the fourth respondent or where the fourth respondent is missing or the fourth respondent has closed down its business or the fourth respondent does not have any assets and such other contingencies, straight away the first respondent was not justified in directing the appellant to reverse the input tax credit availed by them. Therefore, we are of the view that the demand raised on the appellant dated 20.02.2023 is not sustainable.”

12. Observations and findings in Suncraft Energy Pvt.Ltd (supra) were challenged before the Honourable Supreme Court by the Department of Revenue and as per the decision rendered by the Honourable Supreme Court, in Suncraft Energy Pvt.Ltd.(supra), the SLP was dismissed and thus, the judgment of the High Court of Calcutta was upheld. The decision in Suncraft Energy Pvt.Ltd (supra) was followed in Lokenath Construction Pvt.Ltd. (supra),. The High Court of Allahabad has also taken the same view in R.T. Infotech (supra). The Honourable Supreme Court considered a similar provision in Delhi VAT Act, in Shanti Kiran India (P) Ltd (supra). From the observations in the said decision, it is discernible that, Section 9 of the DVAT Act, contained a specific stipulation that the input tax credit could be claimed by the purchaser only if the supplier had paid the said tax and filed the relevant returns. In Santi Kiran India (P) Ltd. (supra), the Honourable Supreme Court took note of the observations made by the High Court of Delhi in On Quest Merchandising India Pvt. Ltd. v. Government of NCT of Delhi GSTL 182 (Delhi)[2017 SCC Online Delhi 11286] in respect of the very same provisions of the DVAT Act, wherein, the Delhi High Court read down the statutory stipulations contained in Section 9 and held that unless the supplier is proceeded against first and if such proceedings did not materialise, the recovery proceedings can be initiated against the purchaser. The decision of the High Court in On Quest Merchandising India Pvt Ltd’s case, was challenged before the Honourable Supreme Court but the SLP was rejected. The same issue was taken up in Santi Kiran India (P) Ltd’s case and no interference was made in the decision of the Delhi High Court and thus, the decision rendered by the High Court of Delhi under Section 9 was upheld, after referring the observation in On Quest Mechandising India Pvt Ltd. (supra) In this regard, the observations made by the High Court of Delhi in On Quest Merchandising India Pvt.Ltd (supra), extracted in Santi Kiran India (P) Ltd’s case (supra), is relevant which reads as follows:

“In light of the above legal position, the Court hereby holds that the expression ‘dealer or class of dealers’ occurring in Section 9 (2) (g) of the DVAT Act should be interpreted as not including a purchasing dealer who has bona fide entered into purchase transactions with validly registered selling dealers who have issued tax invoices in accordance with Section 50 of the Act where there is no mismatch of the transactions in Annexures 2A and 2B. Unless the expression ‘dealer or class of dealers’ in Section 9(2) (g) is ‘read down’ in the above manner, the entire provision would have to be held to be violative of Article 14 of the Constitution.

The result of such reading down would be that the Department is precluded from invoking Section 9(2)(g) of the DVAT to deny ITC to a purchasing dealer who has bona fide entered into a purchase transaction with a registered selling dealer who has issued a tax invoice reflecting the TIN number. In the event that the selling dealer has failed to deposit the tax collected by him from the purchasing dealer, the remedy for the Department would be to proceed against the defaulting selling dealer to recover such tax and not deny the purchasing dealer the ITC. Where, however, the Department is able to come across material to show that the purchasing dealer and the selling dealer acted in collusion then the Department can proceed under Section 40A of the DVAT Act.

13. Thus, in the light of the aforesaid principles, I am of the view that the petitioner is entitled to succeed. This is particularly because, as rightly pointed by the learned counsel for the petitioner, it is an admitted position that, no proceedings have been initiated against the suppliers, who are 2^nd and 3^rd respondents herein, before the issuance of Ext.P3 notice under Section 73. This amounts to the failure on the part of the official respondents in following the statutory stipulations contained in Section 42. Apart from the above, said proceedings is not at all justifiable, in the light of the principles laid down in Suncraft Energy Pvt.Ltd. (supra), to which I am in full agreement with. As observed above, in the said decision, it was held that the recovery proceedings can be initiated against the supplier, only if the proceedings initiated against the purchaser did not materialize. It was further held that, such proceedings would be justified against the purchaser, only in a case where the Department is able to to show that the purchasing dealer and the selling dealer acted in collusion, however, none of the situations referred to above are admittedly in existence in this case. Therefore, the only conclusion possible is that, the proceedings initiated against the petitioner is not legally sustainable.

14. As regards the contentions raised by the learned counsel for the petitioner, relating to the limitation, I am of the view that, the same need not be considered, since I have already held that, the proceedings initiated against the petitioner as per Ext.P3 before issuing notice to the supplier is not sustainable.

In such circumstances, this writ petition is disposed of quashing Ext.P3, holding that, as there are no proceedings so far initiated against the 2^nd and 3^rd respondents, the notice in nature of Ext.P3 could not have been issued to the petitioner. However, it is clarified that, any observation made by this Court will not preclude the authority concerned from initiating proceedings against the 2^nd and 3^rd respondents.