Supreme Court Affirms Validity Of Section 16(2)(c): ITC Is Admissible Only Where The Supplier Has Actually Remitted Tax To The Government, Provision Held Neither Arbitrary Nor Unconstitutional

BRIEF FACTS OF THE CASE

• A batch of writ petitions led by Maruti Enterprise challenged the constitutional validity of Section 16(2)(c) of the CGST Act, 2017 before the Hon’ble Gujarat High Court. The petitioners had been denied Input Tax Credit ("ITC") in cases where the supplier had failed to deposit the GST collected from them with the Government, despite the purchasers having paid the full invoice value including GST and having undertaken bona fide transactions.
• The principal challenge was directed against Section 16(2)(c) of the CGST Act, which stipulates that a recipient is entitled to ITC only where the tax charged in respect of the supply has actually been paid to the Government by the supplier. The petitioners contended that the provision was arbitrary, unconstitutional and violative of Articles 14, 19(1)(g), 265 and 300A of the Constitution, insofar as it penalised genuine purchasers for a default committed by their suppliers.
• The petitioners argued that under the GST framework, a purchaser has no statutory mechanism to verify whether the supplier has ultimately discharged its tax liability through Form GSTR-3B. It was further contended that once the transaction is genuine, duly supported by tax invoices, reflected in GSTR-2A/2B and the goods or services have been received, denial of ITC solely due to supplier default imposes an impossible burden on bona fide recipients. Reliance was also placed on precedents rendered under the erstwhile VAT regime, including the decisions in Arise India and On Quest Merchandising.
• The Revenue, on the other hand, defended the validity of Section 16(2)(c) by contending that ITC is a statutory concession subject to fulfilment of prescribed conditions and that the GST framework, particularly Sections 41, 53 and 155 of the CGST Act read with Rule 37A of the CGST Rules, contains adequate safeguards enabling reversal and subsequent re-availment of credit once the supplier discharges the tax liability. The Revenue also emphasized that the destination-based structure of GST requires actual tax payment to preserve the integrity of the credit chain and protect Government revenue.
• Upon consideration of the constitutional challenge, the Gujarat High Court upheld the validity of Section 16(2)(c) of the CGST Act and held that ITC cannot be claimed unless the supplier has actually paid the tax to the Government. Aggrieved by the said judgment, the petitioners preferred Special Leave Petitions before the Supreme Court of India in Bhandari Scrap Traders v. Union of India & Ors., wherein the Supreme Court affirmed the Gujarat High Court's ruling and dismissed the constitutional challenge to Section 16(2)(c).

KEY OBSERVATIONS OF SUPREME COURT

• The Hon'ble Supreme Court affirmed the judgment of the Gujarat High Court in Maruti Enterprise and conclusively upheld the constitutional validity of Section 16(2)(c) of the CGST Act, 2017. The Court held that the provision is neither arbitrary, ultra vires nor violative of any constitutional guarantee and, therefore, does not warrant either striking down or reading down.
• The Supreme Court endorsed the Gujarat High Court's detailed analysis of the GST framework and observed that a purchasing dealer is not entitled to avail Input Tax Credit unless the tax charged in respect of the supply has actually been paid to the Government by the supplier. The Court emphasized that the fulfilment of the conditions prescribed under Section 16(2) is mandatory and that ITC can be availed only upon satisfaction of all statutory requirements, including the condition contained in clause (c).
• Distinguishing the GST regime from the erstwhile VAT framework, the Supreme Court rejected the contention that decisions rendered under the Delhi VAT Act, including Arise India and On Quest Merchandising, could be applied to GST. The Court noted that the GST regime operates on a fundamentally different statutory architecture and incorporates distinct provisions such as Sections 41, 53 and 155 of the CGST Act, which were absent under the VAT framework.
• The Gujarat High Court, whose reasoning was expressly approved by the Supreme Court, observed that the GST system functions on a destination-based taxation model involving seamless flow of credit across State boundaries. Consequently, permitting unrestricted availment of ITC where tax has not actually reached the Government treasury would adversely impact revenue allocation mechanisms under the GST framework and undermine the integrity of the credit chain.
• The Courts further observed that Section 16(2)(c) cannot be read in isolation and must be interpreted in conjunction with Sections 41, 53, 73, 74 and 155 of the CGST Act as well as Rule 37A of the CGST Rules. The statutory scheme was found to contain adequate safeguards, including the ability to reverse ITC where the supplier defaults and subsequently re-avail such credit once the supplier discharges the tax liability. Accordingly, denial of ITC in such circumstances cannot be regarded as permanent deprivation or double taxation.
• Upholding the burden-of-proof requirement under Section 155 of the CGST Act, the Gujarat High Court held that the person claiming ITC must establish eligibility to such credit. The Supreme Court concurred with this approach and recognized that entitlement to ITC is intrinsically linked to actual payment of tax by the supplier and not merely to possession of tax invoices or reflection of the transaction in GST returns.
• While sustaining the validity of Section 16(2)(c), the Gujarat High Court acknowledged the genuine hardships faced by bona fide purchasers on account of supplier defaults. In this regard, the Court urged the Government to consider introducing suitable legislative measures and technology-driven mechanisms enabling real-time verification of supplier tax payments and to prioritize recovery proceedings against defaulting suppliers. The Supreme Court, while affirming the judgment, found no reason to interfere with these observations.
• In conclusion, the Supreme Court held that there existed no grounds to either invalidate or read down Section 16(2)(c) of the CGST Act and affirmed that availment of ITC remains conditional upon actual payment of tax into the Government treasury. Consequently, the Special Leave Petitions were dismissed and the Gujarat High Court's landmark ruling in Maruti Enterprise was upheld in its entirety.

AURTUS COMMENTS

• This decision of the Hon'ble Supreme Court settles a long-standing divergence of judicial opinion on the constitutional validity of Section 16(2)(c) of the CGST Act. While several High Courts, including the Patna High Court (in Aastha Enterprises), Kerala High Court (in M. Trade Links) and Madhya Pradesh High Court (in Shree Krishna Chemicals), had upheld the provision, the Gauhati High Court (in National Plasto Moulding) and Tripura High Court (in Sahil Enterprises) had taken a divergent view by extending protection to bona fide recipients and reading down Section 16(2)(c), principally relying upon the jurisprudence evolved by the Delhi High Court (subsequently affirmed by the Supreme Court ) in On Quest Merchandising India Pvt. Ltd. and Arise India. The Supreme Court's affirmation of the Gujarat High Court's ruling in Maruti Enterprise presently resolved this judicial conflict and settled the legal position in favour of the Revenue by upholding the constitutional validity of Section 16(2)(c).
• From a practical perspective, the ruling assumes significance because Section 16(2)(c) must now be read in conjunction with the amended framework under Section 41 and Rule 37A. While the judgment reinforces that ITC is contingent upon actual payment of tax by the supplier, the statutory scheme simultaneously permits re-availment of credit once the supplier discharges the tax liability.
• Interestingly, a significant part of the judicial reasoning rests on the amended framework of Section 41 and Rule 37A, which contemplates reversal of ITC upon supplier default coupled with a statutory right to re-avail the credit once the supplier subsequently discharges the tax liability. Since the substituted Section 41 was brought into force only from 01.10.2022, this safeguard was not available in the same form for earlier tax periods. Therefore, while the constitutional validity of Section 16(2)(c) now stands settled, questions may still arise regarding the applicability of the Court's reasoning to disputes relating to periods preceding the amendment, where the statutory mechanism for re-availment did not exist in its present form.
• The judgment further emphasizes on the significance of Section 155 of the CGST Act, which places the burden of establishing eligibility to ITC upon the claimant. In this backdrop, taxpayers would be well advised to maintain comprehensive documentation evidencing the genuineness of transactions, actual receipt of goods or services, payment of consideration and tax, as well as appropriate vendor due diligence measures. This aligns with the Supreme Court's observations in M/s Ecom Gill Coffee Trading Private Limited, wherein it was held that mere possession of tax invoices or proof of payment may not, by itself, be sufficient to substantiate an ITC claim; rather, the claimant must be in a position to demonstrate the authenticity and legitimacy of the underlying transaction.
• Significantly, the Gujarat High Court recognized the genuine difficulties faced by bona fide recipients in verifying supplier tax compliance. While recipients may presently track whether suppliers have filed their GSTR-3B based on information available within the GST ecosystem, such compliance indicators do not conclusively establish that the tax collected by the supplier has been duly deposited with the Government. The judgment therefore highlights the continuing gap between compliance visibility and tax remittance verification and may prompt renewed consideration of technology-driven solutions to better balance revenue protection with commercial certainty for taxpayers.
• In essence, the controversy has now moved from constitutional validity to compliance preparedness. Businesses would be well advised to revisit their vendor governance frameworks, reconciliation processes and contractual safeguards to proactively manage ITC risks arising from supplier noncompliance.