Introduction

In the recent past, the Government has unearthed multiple cases of fraudulent Input Tax Credit (hereinafter referred to as ‘ITC’) being availed, due to issuance of fake invoices, issuance of invoice without supply, and other fraudulent activities, which has caused a leakage of revenue of the exchequer. In order to prevent such misuse, with effect from 26.12.2019, Rule 86A was inserted in the CGST Rules, 2017.

Rule 86A of CGST Rules provides wide powers to the Commissioner or an officer authorized by him, not below the rank of Additional Commissioner[1], to impose restrictions on ITC available in the credit ledger in a case where he has reason to believe that the ITC has been fraudulently availed or is ineligible. Such officer can unblock the same if conditions for disallowance no longer exist or if one year has lapsed from the date of imposition of such restriction.[2]

Brief History of the insertion of Rule 86A

A writ petition was filed in 2019 in Alfa Enterprise v. State of Gujarat[3], against the blocking of credit ledger in the High Court of Gujarat. The Hon’ble High Court held that the blocking of the credit is not backed by any statutory provision under the CGST Act or Rules prescribed and directed the revenue to unblock the credit ledger. Soon after this decision, the CGST Rules were amended and Rule 86A was inserted to empower a Proper Officer to block a credit ledger on the basis of the grounds provided therein.

Cases in which a credit ledger can be blocked by an officer

A Commissioner or Officer Authorized in his behalf, not below the rank of Additional Commissioner can restrict the use of Input Tax Credit from the credit ledger of an assessee in the following circumstances:[4]

• Where Officer has a reason to believe that Credit has been fraudulently availed or is ineligible to avail Credit
• Where credit has been availed on the basis of Tax Invoices or Debit Notes or other documents prescribed in Rule 36 of the CGST Rules by a registered supplier who has been found to be non-existent or not to be conducting business from his place of registration.
• Where credit has been availed on the basis of documents prescribed under Rule 36 without the receipt of goods or services or both.
• Where credit has been availed on the basis of documents prescribed against which no tax has been paid to the government.
• Where credit has been availed on the basis of documents prescribed by Rule 36 of the CGST Rules by a recipient who is found to be non-existent or not to be conducting business from his place of registration.
• Where the registered person availing any credit of input tax is not in possession of a tax invoice or debit note or any other document prescribed under Rule 36.

Remedies available to a taxpayer

It is very surprising that the CGST Act and Rules do not provide a remedy to taxpayers for the unblocking of their credit ledger. This is left to the whims of the department of revenue and their discretion. Thus, a question arises as to the remedies available to taxpayers in such cases where department is not unblocking the credit ledger.

It has been established by the Supreme Court in Whirlpool Corporation v. Registrar of Trade Marks, Mumbai and Ors[5], that in absence of alternative remedy, petitioners may take recourse to the Writ jurisdiction of the Supreme Court and High Courts of competent jurisdiction under Article 32 & Article 226 of the Constitution.[6]

As the SC is reluctant to admit writ petitions under Article 32, approaching a High Court of competent jurisdiction under Article 226 should first be done vide Writ Petition.

Grounds for challenge

Rule 86A is ultra vires to the CGST Act

Conditions under Section 16 of CGST Act restrict the availment of credit, and warrant reversal in cases where credit has been wrongly availed. The right to avail and utilize ITC for discharging tax liability is a legal right arising from the statute and it is trite in law that this right can be curtailed only with the specific power of the law and not otherwise.[7]  None of the provisions contained in Section 16 or any of the other sections under the CGST Act empower the government to block ITC under any circumstances. The Act provides for the provisional taking of credit on a self-assessment basis, and the blocking of credit goes against the scheme of the Act.

Thus, Rule 86A does not draw validity from any provisions of the CGST Act. The powers prescribed vide Rule 86A does not flow from the CGST Act, and hence can be challenged on the ground that it is ultra vires to the CGST Act.

In an ongoing case, Kalpsutra Gujarat v. Union of India,[8] the applicant which is a partnership firm, through one of its partners had asked the High Court to issue a writ of mandamus or any other appropriate writ, direction or order, striking down Rule 86A of CGST Rules in so far as it gives power to block ITC through no fault of the registered bonafide recipient, as ultra vires of section 16 of the CGST Act. The applicant further also asked for a direction allowing it to utilize the ITC till the time it is proved that the supplier did not honour his tax liability. It is an ongoing case. The question that the Court put before the respondents in this case, is whether omission on part of the supplier will be sufficient to block the input tax credit of the applicant. The decision of the Court is awaited.

Issuance of a Show Cause Notice

It is established law that if any penal action is taken against an assessee, irrespective of whether there is provision under the Act or not, the minimum requirement is that the principles of natural justice must be followed.[9] These minimum requirements include a show cause notice and an opportunity of being heard.[10] In GST, same is ensured by Section 73 of the CGST Act which provides a mechanism to allow for the revenue to provide a notice and opportunity of hearing to an assessee.[11]

In ICICI Bank Limited vs Union of India & Anr^[12], the Bombay High Court held that that if it is the view of the Revenue that the petitioners though liable to pay service tax are evading payment of service tax, they can very well take recourse to Section 73 and determine the amount of service tax payable on them. However, demand/recovery notice without adjudication are illegal and unlawful.

However, in cases pertain to Rule 86A, department is not issuing a show cause notice to the assessee under Section 73. Thus, Rule 86A appears to bypass the provisions of Section 73, which mandates a notice and an opportunity of hearing. Therefore, an action of blocking credit ledger is violative of principles of natural justice.

It has been held in Mahadeo Construction Co. v. Union of India, that any order passed under Section 73, without giving an opportunity of hearing to the assessee is null and void under the principles of natural justice.^[13]

A similar issue was also before the Gujarat High Court in the cases of Valerius Industries v. Union of India^[14] and M/s Alfa Enterprise v. State of Gujarat^[15] was whether the ITC can be blocked by the Revenue authorities. The Court held that blocking of ITC without issuing a show cause notice and opportunity of hearing, was patently illegal and arbitrary and therefore asked the Department to accordingly unblock the ITC so blocked. However, both of these cases were decided prior to the introduction of Rule 86A in the CGST rules.

In a recent case, Savan Retailers Private Limited v. Union of India,^[16] the appellants filed a writ petition to ask for unblocking of the ITC of the petitioner with a prayer to issue direction to the Department to unblock the ITC of the petitioner which has been blocked by it without any reasons and without issuing any show cause notice or granting any opportunity of hearing to them. In this case notice was issued.

Opportunity of being heard

Rule 86A is is unilateral as it allows officers to take penal action without giving the assessee an opportunity to be heard. In case a bonafide taxpayer is subjected to such blockage of credit, it can only be called grossly unjust, as no chance to defend oneself is given. 

The SC, in Kesar Enterprises Ltd. v. State of U.P, by relying on a previous judgement in Swadeshi Cotton Mills v. UOI, has held that the Principles of Natural Justice require that an opportunity of being heard is afforded to an assessee in circumstances wherein their legal or vested rights have been curtailed or taken away, even in the cases where the express provision contained in a statute does not require it to do so.[17]

Under Rule 86A of the CGST Rules, the empowered officer is not required to give the assessee an opportunity of being heard before blocking of their credit ledger. Therefore, the operation of Rule 86A in itself tantamount to violation of principles of natural justice, insofar as it does not mandate that an opportunity be given to the assessee to be heard before the credit ledger is blocked and therefore, any action taken by the revenue arbitrarily under the said Rule is in violation of Principle of Natural Justice.

Recipient should not suffer on account of a supplier’s default

Rule 86A subjects a bonafide assessee to undue hardship by the blockage their credit ledger, were credit was rightfully claimed, due to the default of their supplier. This is tantamount to equating the default of the recipient with that of the supplier. As per the CGST Act, no notified provision allows for the same.

Section 43A was inserted into the CGST Act vide the CGST (Amendment) Act, 2018.[18] Section 43A(6) provides that the supplier and the recipient of a supply shall be jointly and severally liable to pay tax or to pay the input tax credit availed, as the case may be, in relation to outward supplies.[19] However, the said section has not been notified yet. Therefore, same shall not apply.

Further as contemplated by Section 42 & 43 of CGST Act read with Rule 69 and 71 of CGST Rules, there is a specific mechanism for reversing the credit in case of the discrepancy in the ITC availed by the recipient against the output liability of the supplier.  However, such provisions have been kept in abeyance. The facility to furnish GSTR- 2 and GSTR3 is also not available. Accordingly, there is no system-based matching of ITC being carried out presently and till the time such provisions are given effect, the recipients shall be restricted to claim ITC provisionally.

It has been held in a catena of judgments that a bonafide recipient cannot be made to suffer on account of a supplier’s default. In Quest Merchandising India Pvt. Ltd. v. Govt. of NCT of Delhi,[20] the assessee had duly paid the tax to the supplier but the supplier did not deposit the tax to the Government. The assessee argued that the purchasing dealer can check on the web portal of the department if the selling dealer is a fictitious person or a person whose registration stands cancelled. Also, the purchasing dealer does not have access to the returns of the seller.

In the said case, the Court held that the purchasing dealer was being asked to do the impossible, i.e. to anticipate the selling dealer who will not deposit with the Government the tax collected by him from those purchasing dealers and therefore avoid transacting with such selling dealers The Delhi High Court read down the concerned provision to not include a buyer who has bona fide entered into purchase transactions with validly registered dealers who have issued tax invoices against the transaction. The Court explained that such provision, if not read down, is violative of Article 14 of the Constitution for being inherently arbitrary. The only case when such provision applies is if the tax authorities comes across some material to show that the purchasing dealer and the selling dealer acted in collusion in detriment to the exchequer. However, in the event that the selling dealer has failed to deposit the tax collected, the remedy for the authorities is to proceed against the defaulting selling dealer to recover such tax and not deny the purchasing dealer his input. The Supreme Court affirmed the said case and dismissed the Revenue’s petition seeking special leave to appeal against this decision.

In Sri Vinayaga Agencies v. The Assistant Commissioner,[21]Madras High Court held that law could not empower tax authorities to reverse the ITC availed on a plea that the selling dealer has not deposited the tax. It can revoke input credit only if it relates to the incorrect, incomplete or improper claim of such credit by a dealer. Similarly, Madras High Court in Infiniti Wholesale Ltd. v. The Assistant Commissioner[22], was of the view that the ITC availed by the Petitioner could not have been proposed to be reversed or reversed on the ground that selling dealer has not filed return or not paid taxes. A similar view has been taken by various other high courts throughout India.

Conclusion

An analysis of Rule 86A of the CGST Rules reveal the same subjects a bonafide assessee to undue hardship by the blockage their credit ledger, were credit was rightfully claimed, due to the default of their supplier. The intention of the government may be legitimate for the need to curb fraudulent availment of credit but may not be legal as Section 86A provides no procedure to be followed in such cases of disallowance of credit. The Rule also does not talk about compensatory interest to be granted in case the assessee is found to be bonafide and honest.

Further, it is very intimidating to witness that the selection of assessees for blocking ITC is being done based on algorithms and data analytics of sales and purchases, mismatches between GSTR 1, GSTR 2A and GSTR 3B, analysis of over-invoicing, cancellation of invoices, rather than being based on any evidence depicting wrongful availment of ITC. 

In light of the few of the grounds discussed above, sufficient grounds exist for a challenge against an order passed under Rule 86A in jurisdictional High Court.