Section 74 of the CGST Act requires proof of fraud, not just suspicion based on a supplier’s actions or unverified intelligence reports.
Issue
Can the GST authorities validly invoke the harsh provisions of Section 74 of the CGST Act, 2017, and deny Input Tax Credit (ITC) based on an unverified intelligence report and the subsequent cancellation of a supplier’s registration, without any specific finding of fraud, wilful misstatement, or suppression of facts by the taxpayer themselves?
Facts
- A taxpayer (the Petitioner), a pharma company, had claimed ITC on purchases from a supplier who was fully registered at the time of the transaction.
- The taxpayer had a complete and clear paper trail to prove that the transaction was bona fide. This included tax invoices, e-way bills, transporter documents, proof of bank payments, and their own GST filings.
- The GST department issued a show-cause notice under Section 74, which is the provision used for cases involving fraud.
- The department’s entire case against the taxpayer was built on two points: (1) an unverified intelligence report about some general irregularities (this report was not even shared with the taxpayer), and (2) the fact that the supplier’s GST registration was cancelled at a later date.
- The department did not bring any specific evidence on record to disprove the taxpayer’s documents or to prove that the taxpayer themselves had acted with a fraudulent intent (mens rea).
Decision
The Allahabad High Court ruled decisively in favour of the assessee.
- The court held that Section 74 can only be invoked in cases where there is clear evidence of fraud, wilful misstatement, or suppression of facts with a specific intent to evade tax on the part of the taxpayer being accused.
- It found that general intelligence reports and the compliance failures of a supplier are not sufficient grounds to invoke the extended limitation period and harsh penalties of Section 74 against the purchaser. There must be a clear finding of misconduct or a guilty mind (mens rea) on the part of the purchaser.
- Since the taxpayer had produced all the necessary documents to prove that their transaction was genuine, and the department had failed to rebut this evidence or prove any fraudulent intent on their part, the invocation of Section 74 was illegal. The adverse orders were quashed, and the taxpayer’s ITC was restored.
Key Takeways
- Section 74 Requires a Guilty Mind (Mens Rea): The most crucial ingredient for invoking the serious charge of fraud under Section 74 is the element of a guilty mind. This means there must be proof of fraud, a wilful misstatement, or a deliberate suppression of facts with the clear intent to evade tax. A simple mistake or a compliance failure by a third party is not enough.
- Unverified Intelligence is Not Evidence: An “intelligence report” is merely a starting point for an investigation. It is not, by itself, credible evidence. An order cannot be legally passed based on a report that has not been independently verified and has not even been shared with the taxpayer against whom it is being used.
- The Sins of the Supplier are Not the Crime of the Buyer: A purchasing dealer who has done their due diligence and has all the documents to prove a genuine transaction cannot be automatically penalized for the later compliance failures of their supplier. The ITC of the buyer cannot be denied solely because the supplier later defaulted on their taxes or had their registration cancelled.
- The Burden of Proof for Fraud is on the Department: When the tax department alleges fraud, the burden of proof is heavily on them to prove it with concrete and specific evidence against the taxpayer being accused. This burden is not discharged by relying on vague reports or the actions of unrelated third parties.