ITC denial for a supplier's default: Punjab and Haryana High Court upholds section 16(2)(c) and lays down 14 guidelines

Section 16(2)(c) of the Central Goods and Services Tax Act, 2017 (CGST Act) allows input tax credit only where the tax charged on the supply has actually been paid to the Government, in cash or through admissible credit. The purchaser pays that tax to the supplier, and cannot see whether it reaches the Government. On 1 October 2026 a Division Bench of the Punjab and Haryana High Court (Chief Justice Ashwani Kumar Mishra and Justice Rohit Kapoor) decided 424 writ petitions on this point together, led by Shaurya Alloys Pvt Ltd v. State of Punjab and another, CWP-34296-2024 (O&M) and connected cases. The following covers the holding, the guidelines that now govern proper officers, and their effect on pending notices.

The question before the Court

Paragraph 1 states it: what a purchaser who has paid tax to the supplier must do to ensure the supplier deposits it, when the purchaser has no means of checking. The petitioners challenged the vires of section 16(2)(c) under the maxim lex non cogit ad impossibilia (the law does not compel the impossible) and Articles 14, 19(1)(g), 21, 265 and 300A. Alternatively, they sought a reading down confining the purchaser’s liability to fraud, a non-existent supplier or similar cases.

Most of the petitions concern the period before rule 37A of the CGST Rules, when reversed credit could not be re-availed even after the supplier paid.

Validity upheld, reading down declined

The challenge to the vires of section 16(2)(c), read with section 155 (burden of proof), was repelled. Actual payment of tax, the Court held, is the very foundation of input tax credit, and the challenge to vires was “at best, feeble”.

The Court also declined to read the provision down to cases of fraud, collusion or non-existent transactions on the lines of its own earlier Haryana VAT decision in Gheru Lal Bal Chand and the Delhi High Court’s On Quest Merchandising. Judicial discipline weighed: the Gujarat High Court in Maruti Enterprises v. Union of India, 2026 SCC OnLine Guj 4013, upheld section 16(2)(c), and the Supreme Court dismissed the special leave petition against it in Bhandari Scrap Traders v. Union of India by order dated 24 July 2026, holding that no parity can be drawn between the Delhi VAT Act and the CGST Act on this point. The Supreme Court’s order also notes that a special leave petition against the Tripura High Court’s reading down in Sahil Enterprises v. Union of India has been entertained.

The useful part is the diagnosis: the impossible burden does not lie in the text of section 16(2)(c). It arises when the provision is “torn out of the statutory scheme of which it is an integral part” and applied in a routine and mechanical manner.

Not a standalone provision

The original scheme of GSTR-2, GSTR-3 and matching under section 42 was never implemented, so section 16(2)(c) has to be read with the provisions aimed at the supplier: section 76 (tax collected but not paid), section 75(12) read with section 79 (recovery of self-assessed tax), sections 73 and 74, and rule 88C. Section 76 cannot be rendered otiose by “indiscriminate invocation” of section 16(2)(c), sparing the defaulter and taxing the purchaser twice on one transaction.

The position differs where the material shows collusion, fraud, a non-existent supplier, or goods or services not received. There the purchaser’s entitlement itself is in question.

The guidelines in paragraph 103

In many of the cases the provision had been invoked only because the supplier’s registration was cancelled. Paragraph 103 sets out guidelines for proper officers of the Central Government, Punjab, Haryana and Chandigarh, which the Court said neither dilute nor add to section 16(2). The main ones:

• Starting point, not proof. The supplier’s retrospective cancellation, a nil or short return, or an alert may start an inquiry, but none of them, by itself, justifies denying credit (guideline (i)).
• Satisfaction before notice. The officer first records the supplier’s particulars, invoices, periods and amounts; the precise default (unpaid, short paid, or paid through inadmissible credit); its circumstances; and the status of recovery against the supplier (guideline (ii)). The investigation should establish some direct link between the purchaser and the supplier (guideline (iii)).
• Disclosure. The notice states these particulars, and relied-upon documents (alert notices, panchnamas, statements, e-way bill, toll and banking data) are supplied (guideline (iv)).
• Section 74 needs facts. The notice itself must contain the foundational facts for the inference of fraud, wilful misstatement or suppression, following the Supreme Court in G.R. Infra Projects and Tata Steel Limited v. Union of India. A bald recital does not do. The supplier’s fraud is not the purchaser’s fraud unless the notice discloses facts connecting the two (guideline (v)).
• Burden and evidence. The burden under section 155 stays on the purchaser, who may discharge it with the tax invoice and proof of receipt such as e-way bills, transport receipts, weighbridge slips and stock and consumption records. The officer must deal with that material in the order (guideline (vi)).
• Retrospective cancellation. The officer examines the grounds and date of the supplier’s cancellation and whether they bear on the particular supply (guideline (vii)). The purchaser’s own registration is not cancelled merely for buying from such a supplier, without an independent ground under section 29(2) (guideline (x)).
• No double realisation. The officer records the status of proceedings against the supplier, consulting its jurisdictional officer where needed. Tax recovered from or deposited by the supplier for the same supply is taken into account, and credit may be availed or re-availed under the proviso to section 41(2) and rule 37A, subject to section 17(5)(i) (guideline (viii)).
• Hearing, order, deposits. Personal hearing under section 75(4), and a reasoned decision on any request to cross-examine (guideline (xi)). The order records a finding on each disputed condition of section 16(2) (guideline (xii)). A deposit during investigation, through Form GST DRC-03 or otherwise, does not dispense with a properly founded notice (guideline (xiii)).

The guidelines govern pending proceedings as well as new ones (guideline (xiv)).

The period-wise position

Guideline (ix) requires the officer to apply the law as it stood in the tax period:

• before 1 October 2022: original section 41 in force, sections 42 and 43 on the statute but never operational, and no mechanism to re-avail reversed credit
• from 1 October 2022: section 41 substituted, sections 42 and 43 omitted, clause (ba) inserted in section 16(2)
• from 26 December 2022: rule 37A. Credit is reversed by 30 November if the supplier has not filed GSTR-3B by 30 September after the financial year, and re-availed once it files.

A later condition, including clause (aa) of section 16(2) from 1 January 2022, cannot be applied to an earlier period. Before 26 December 2022, the absence of any re-availment route must be weighed in fixing the consequence.

What happens to the 424 petitions

The Court quashed no order and examined no individual facts. Under paragraph 105:

• at notice stage, petitioners may file a reply or supplementary reply with documents within eight weeks, and a reasoned order follows a hearing
• where the notice lacks the particulars the guidelines require, the officer must supply them
• where orders have already been passed, the officer re-visits the matter under the guidelines and passes a fresh reasoned order, and the existing orders abide by it
• amounts deposited, reversed or recovered abide by the fresh decision and are adjusted or refunded with interest where warranted
• no fresh coercive recovery is to be taken under the impugned notices or orders until the fresh decision

Pleas on merits are left open, and the Department may still pursue defaulting suppliers.

What it changes in practice

In Punjab, Haryana and Chandigarh, a notice or order denying credit only because the supplier’s registration was cancelled, or because its return showed nil or short tax, now falls short of the guidelines. A reply can test the notice against them: whether it states the precise default and the status of recovery from the supplier, whether it links the purchaser to that default, and whether a section 74 notice sets out facts rather than a recital. The evidence file matters as much, because the section 155 burden has not moved: invoices, e-way bills, transport and weighbridge records, and stock and consumption records for each disputed supply.

This article is intended for educational purposes only and should not be construed as professional advice. It is based on the law as understood on the date of publication; laws and regulations are subject to change, and it may not reflect later developments. Readers are advised to consult a qualified tax professional on their specific situation before taking any action based on it. CA. Mohit Gaba takes no responsibility for any action taken or decision made on the basis of this article.