AUGUST - COURT ROOM SERIES
Bhandari Scrap Traders v. Union of India: Section 16(2)(c) of the CGST Act and the ITC Risk for a Bona Fide Recipient
Background:
The Supreme Court's decision in Bhandari Scrap Traders v. Union of India & Ors., arising out of Special Leave Petitions (Civil) Nos. 23931/2026, 24088/2026 and 24103/2026, marks an important development in the continuing controversy surrounding Section 16(2)(c) of the Central Goods and Services Tax Act, 2017 ("CGST Act").
The controversy concerns a fundamental question under the GST regime: Can a bona fide recipient be denied Input Tax Credit ("ITC") merely because the supplier, after collecting GST from the recipient, has failed to deposit the tax with the Government?
The Supreme Court has now affirmed the constitutional validity of Section 16(2)(c), thereby making it clear that actual payment of the tax charged on a supply to the Government is a statutory condition for availment of ITC.
However, the judgment also brings into sharp focus a larger policy concern: while the supplier controls the payment of tax to the Government, the recipient bears the immediate consequence if that payment does not take place.
The decision therefore requires to be examined not merely from the perspective of constitutional validity, but also from the perspective of commercial certainty, vendor due diligence, evidentiary burden and the practical administration of GST.
Facts of the Case
The litigation arose from a batch of petitions led by Maruti Enterprise before the Gujarat High Court challenging the constitutional validity of Section 16(2)(c) of the CGST Act.
The petitioners were recipients who had entered into genuine commercial transactions with their suppliers. They had:
- received valid tax invoices;
- paid the consideration, including GST, to the suppliers;
- received the goods or services;
- possessed documentary evidence supporting the transactions; and
- found the relevant invoices reflected in the GST system.
The difficulty arose because the suppliers had allegedly failed to discharge the corresponding GST liability to the Government.
Consequently, the recipients were denied or called upon to reverse ITC on the ground that the statutory requirement contained in Section 16(2)(c) had not been satisfied.
The grievance of the recipients was fundamental. They had paid the tax component to the supplier and had no statutory mechanism to compel the supplier to deposit that tax with the Government.
Nor, under the GST architecture as it presently operates, does the recipient have complete and conclusive visibility into whether the supplier has actually discharged the tax liability in respect of a particular transaction.
This created an apparent asymmetry: the supplier is legally responsible for payment of tax, but the recipient suffers the consequence of the supplier's default in the form of denial or reversal of ITC. That tension formed the foundation of the constitutional challenge.
The Legal Provision
Section 16(2) of the CGST Act prescribes conditions that must be fulfilled before a registered person can avail ITC.
Clause (c) requires, in substance, that the tax charged in respect of the supply should have been actually paid to the Government, either in cash or through utilisation of admissible ITC, subject to the statutory framework.
Thus, possession of an invoice is not, by itself, sufficient.
The statutory scheme proceeds on the principle that ITC is not an unconditional entitlement arising merely because GST has been charged on an invoice.
The controversy therefore centred on whether Parliament could constitutionally make the recipient's entitlement to ITC dependent upon an act performed by another person—the supplier—which may be outside the recipient's control.
Issues Before the Court
The principal issues may be stated as follows:
Arguments by the Taxpayers
The petitioners advanced a strong case based on fairness, constitutional protection and practical impossibility.
1. Bona fide recipient should not suffer for supplier's default
The principal argument was that a genuine purchaser who has:
- purchased goods or services;
- received the supply;
- paid the supplier the entire invoice value including GST; and
- complied with all requirements within his control,
should not lose ITC merely because the supplier subsequently defaults in depositing the tax.
The recipient has no control over the supplier's GSTR-3B filing or payment of tax.
Therefore, making supplier payment an essential condition for recipient ITC allegedly imposes an obligation which the recipient cannot perform or control.
The principle of lex non cogit ad impossibilia—the law does not compel a person to do what is impossible—was relied upon in support of this proposition.
2. Violation of Article 14
It was contended that Section 16(2)(c) may operate identically against:
- a fraudulent or collusive purchaser; and
- a completely innocent purchaser.
According to the petitioners, such equal treatment of materially different classes of taxpayers renders the provision arbitrary.
The genuine purchaser has no intention to evade tax and has already paid the GST component to the supplier. Nevertheless, the purchaser suffers the same ITC consequence as a person who knowingly participates in a fraudulent transaction.
3. Violation of Article 19(1)(g)
The denial of ITC increases the effective cost of business and therefore imposes a serious burden upon carrying on trade or business.
The petitioners consequently contended that the provision imposes an unreasonable restriction on the freedom guaranteed under Article 19(1)(g).
4. Violation of Articles 265 and 300A
The petitioners also invoked Article 265, contending that tax cannot be collected except by authority of law, and Article 300A in relation to deprivation of property.
The essential grievance was that ITC, once the recipient had paid GST to the supplier in a genuine transaction, should not be effectively forfeited merely because of a subsequent act or omission of the supplier.
Arguments of the Revenue
The Revenue adopted a fundamentally different approach.
1 ITC is a statutory benefit
The central argument was that ITC is not a fundamental or inherent constitutional right.
It is a statutory benefit created by Parliament.
Therefore, Parliament is entitled to prescribe conditions governing its availment.
A taxpayer cannot claim ITC merely because tax has been charged on an invoice. The taxpayer must satisfy every condition prescribed by the statute.
This was one of the principal reasons why the constitutional challenge did not succeed.
2 Section 16(2)(c) cannot be considered in isolation
The Revenue contended that Section 16(2)(c) must be read with the larger statutory scheme.
Particular reliance was placed upon:
- Section 41;
- Section 53;
- Section 73;
- Section 74;
- Section 155; and
- Rule 37A.
The Revenue argued that the statutory scheme does not necessarily result in permanent loss of credit.
Where the supplier subsequently discharges the tax liability, the recipient may, subject to the statutory conditions, re-avail the ITC.
Thus, the Revenue's position was that the provision does not amount to permanent deprivation or double taxation.
Reference:
The Gujarat High Court Judgment in Maruti Enterprise
The Gujarat High Court upheld the constitutional validity of Section 16(2)(c).
The Court declined both:
- the prayer to strike down the provision; and
- the alternative prayer to read it down.
The Court examined Section 16(2)(c) together with the broader GST statutory framework and recognised that the GST credit mechanism is fundamentally different from the earlier VAT regime.
The Court also acknowledged the genuine difficulties faced by bona fide recipients.
Importantly, however, it concluded that such difficulties could not justify judicially rewriting a provision which Parliament had enacted and which was found constitutionally valid.
The reasoning was substantially based upon the statutory architecture of GST, including Sections 41, 53, 73, 74 and 155 and Rule 37A.
The Supreme Court's Decision in Bhandari Scrap Traders
The Supreme Court dismissed the Special Leave Petitions and affirmed the Gujarat High Court's decision.
The constitutional challenge to Section 16(2)(c) therefore failed.
The Court accepted the fundamental proposition that ITC can be availed only upon satisfaction of the statutory conditions prescribed under Section 16(2).
The mere existence of:
- a tax invoice;
- payment to the supplier;
- receipt of goods or services; or
- reflection of the invoice in the GST system,
does not, by itself, establish fulfilment of Section 16(2)(c).
Actual payment of the tax to the Government remains an essential statutory condition.
The Supreme Court also declined to treat the GST regime as merely an extension of the earlier VAT regime.
Analysis:
1. 1.Why the VAT Decisions Were Not Applied
One of the most significant aspects of the decision is the Court's treatment of Arise India and On Quest Merchandising.
Under the Delhi VAT regime, judicial protection had developed in favour of bona fide purchasers in circumstances where the purchasing dealer had acted without fraud or collusion.
The petitioners sought to rely upon this jurisprudence.
However, the Supreme Court distinguished the VAT regime from GST.
GST operates within a fundamentally different statutory architecture.
It is a destination-based tax system with an integrated credit mechanism and inter-State settlement implications.
The Gujarat High Court had therefore considered that permitting unrestricted ITC where the corresponding tax had not reached the Government could affect the integrity of the credit chain and the settlement mechanism.
The Supreme Court accepted this distinction.
The important lesson is that VAT jurisprudence cannot automatically be transplanted into GST merely because both systems contain an input-tax-credit mechanism.
The statutory architecture governing the credit is decisive.
2. Section 155 and the Burden of Proof
Another important aspect of the judgment is the significance attached to Section 155 of the CGST Act.
Section 155 places the burden of proving eligibility to ITC upon the person claiming the credit.
The Supreme Court's reasoning therefore reinforces the principle that a taxpayer claiming ITC must be capable of establishing not merely the existence of an invoice but compliance with the statutory requirements.
This is consistent with the approach adopted in Ecom Gill Coffee Trading Pvt. Ltd., where the Supreme Court emphasised that merely producing invoices or proof of payment is not necessarily sufficient to establish a genuine ITC claim.
The taxpayer must be able to establish the underlying transaction and its statutory eligibility.
Consequently, the evidentiary standard for ITC claims assumes even greater importance.
3. The Significance of Section 41 and Rule 37A
Perhaps the most practically significant aspect of the present statutory framework is the mechanism under Section 41 read with Rule 37A.
The framework contemplates reversal of ITC in specified circumstances where the supplier fails to discharge the tax liability, with the possibility of re-availment after the supplier subsequently pays the tax.
This was an important part of the Revenue's defence and the Court's acceptance of the statutory scheme.
However, an important temporal issue deserves attention.
The substituted Section 41 came into force only from 1 October 2022, while the source material also notes the later introduction of the relevant Rule 37A mechanism.
Therefore, the legal position applicable to earlier periods cannot necessarily be assumed to be identical to the present statutory framework.
This distinction may assume considerable significance in pending disputes relating to earlier financial years.
The constitutional validity of Section 16(2)(c) may now be settled, but the manner in which that principle applies to different tax periods and different statutory versions remains a matter requiring careful examination.
4. The Court Recognised the Genuine Difficulty of the Bona Fide Recipient
The judgment should not be read as though the Court was oblivious to the hardship caused to genuine purchasers.
The Gujarat High Court specifically recognised the practical difficulty faced by bona fide recipients in verifying whether their suppliers had actually discharged the tax liability.
The Court suggested that the Government should consider legislative and technology-based solutions, including mechanisms enabling better or real-time verification of supplier tax payment and more effective recovery from defaulting suppliers.
This observation is important.
The Court has effectively separated two questions:
5. Does IMS Solve the Problem?
The introduction of the Invoice Management System ("IMS") is an important development in this context.
IMS gives the recipient greater control over invoice-level matching by enabling invoices to be accepted, rejected or kept pending.
It therefore strengthens the recipient's ability to establish:
- genuineness of the transaction;
- invoice-level reconciliation; and
- commercial diligence.
However, IMS by itself does not establish that the supplier has actually paid the tax to the Government.
Acceptance of an invoice through IMS is not necessarily equivalent to confirmation that the supplier has filed GSTR-3B and discharged the corresponding tax liability.
The distinction is crucial.
The GST portal may provide increasingly sophisticated visibility over invoice reporting and return compliance, but visibility of compliance is not necessarily equivalent to proof of tax remittance.
That is precisely the gap which the judgment has brought into sharper focus.
6. My Analysis: Is the Position Fair to the Bona Fide Recipient?
In my view, the judgment settles the constitutional question, but it does not completely resolve the fairness and policy question.
There is a fundamental commercial asymmetry.
The supplier:
- collects GST;
- is legally responsible for depositing it; and
- controls the filing and payment of the tax.
The recipient:
- pays the GST component;
- relies upon the supplier's compliance;
- has limited ability to compel payment; and
- nevertheless bears the immediate ITC consequence of the supplier's default.
From a pure statutory perspective, the Supreme Court's reasoning is understandable.
If ITC is a statutory benefit, Parliament can prescribe conditions for its availment.
But from a practical GST perspective, the question remains whether the recipient should bear the entire risk of an act which is substantially outside his control.
The answer, in my view, should be no—not without corresponding statutory and technological safeguards.
If the Government expects the recipient to bear supplier-compliance risk, the recipient should simultaneously be provided with a meaningful mechanism to verify supplier tax payment.
Otherwise, the law effectively converts a recipient's commercial due diligence obligation into an obligation to monitor an event which the recipient cannot conclusively verify.
7. The Axel Kittel Principle and Bona Fide Recipients
An interesting aspect emerging from the judicial discussion is the reference to the principle in Axel Kittel.
The underlying principle is that denial of credit is particularly justified where the recipient knew, or ought to have known, that the transaction was connected with fraudulent tax evasion.
This provides an important conceptual distinction.
There is a difference between:
- a recipient who knowingly participates in a fraudulent transaction; and
- a recipient who enters into a genuine commercial transaction, pays the supplier including GST, receives the goods or services and acts on the information available on the GST portal.
The present judgment does not make the constitutional validity of Section 16(2)(c) dependent upon proving fraud by the recipient.
Nevertheless, this distinction remains highly relevant in individual proceedings concerning the facts of a particular transaction.
The constitutional validity of the provision should therefore not be confused with the proposition that every recipient facing an ITC dispute is necessarily guilty of fraud or collusion.
8. Section 74 Should Not Automatically Follow
The judgment should also not be interpreted as authorising the Department to invoke Section 74 mechanically whenever supplier tax payment is disputed.
Section 74 concerns fraud, wilful misstatement or suppression of facts with intent to evade tax.
A bona fide purchaser who:
- disclosed the transaction;
- paid the supplier;
- received the goods or services;
- maintained supporting records;
- reconciled the invoice; and
- acted on the information available through the GST system,
cannot automatically be treated as having committed fraud merely because the supplier subsequently failed to discharge the tax.
The ingredients of Section 74 must independently be established.
Therefore, failure of the supplier to pay tax and fraud on the part of the recipient are two different legal questions.
Conclusion
Bhandari Scrap Traders represents an important point in the evolution of GST jurisprudence.
The Supreme Court has effectively settled the constitutional challenge to Section 16(2)(c): ITC is a conditional statutory benefit, and actual payment of tax by the supplier is a condition prescribed by Parliament for its availment.
The judgment also makes clear that the GST regime cannot simply be equated with the erstwhile VAT regime and that decisions such as Arise India and On Quest Merchandising cannot automatically govern the interpretation of Section 16(2)(c).
However, the judgment should not be understood as saying that a recipient has no defence in every ITC dispute. The factual matrix remains crucial.
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