Input Tax Credit Disputes Under GST: Supplier Default, ITC Reversal and Legal Remedies

When Can Input Tax Credit Be Claimed? ITC is subject to the conditions prescribed under Section 16 of the CGST Act and the applicable rules. A registered person must generally possess the prescribed tax document and satisfy the statutory conditions for availing credit. The GST framework places importance on the genuineness of the underlying transaction, the receipt of goods or services and compliance with the statutory conditions. The recipient should therefore maintain invoices, purchase orders, delivery documents, payment records, transport documents and other evidence supporting the transaction.

What If the Supplier Has Not Paid GST?

One of the most difficult ITC disputes arises when the purchaser has received goods or services and paid the supplier, but the supplier has allegedly failed to discharge the corresponding GST liability. The recipient and supplier have separate statutory obligations. A taxpayer facing an ITC dispute should therefore examine the precise allegation made by the department rather than assuming that every supplier default automatically establishes fraudulent availment by the recipient. The Supreme Court has also dealt with disputes concerning ITC and the importance of maintaining records relating to transactions, invoices and books of account.

Supplier Filed GSTR-1 but Did Not File GSTR-3B

Another common dispute occurs where the supplier has reported an invoice in GSTR-1 but has not filed the corresponding GSTR-3B or has not discharged the tax.

In such a case, the recipient may face an ITC dispute even though the purchase itself was genuine.

The taxpayer should preserve evidence showing:

• Actual purchase of goods or receipt of services
• Tax invoice
• Payment to the supplier
• Delivery or transportation records
• Stock or accounting records
• Correspondence with the supplier
• Other documents establishing the genuineness of the transaction

The exact legal position depends upon the statutory provision applicable to the relevant tax period and the factual basis of the department's allegation.

What If the Supplier's GST Registration Is Cancelled?

Cancellation of a supplier's GST registration does not by itself establish that every transaction undertaken before cancellation was fictitious.

The relevant questions may include:

• When was the supply made?
• When was the invoice issued?
• Was the supplier registered on the relevant date?
• Was the transaction genuine?
• Were the goods or services actually received?
• Was consideration paid?

What is the effective date of cancellation?

What evidence does the department rely upon?

A recipient should therefore examine the cancellation order and its effective date instead of mechanically reversing every credit connected with the supplier.

ITC Reversal When Payment Is Not Made Within 180 Days

Where a recipient has availed ITC but fails to pay the supplier the value of the supply together with the tax payable within the statutory period, the applicable ITC reversal mechanism can arise. The GST Rules provide for reversal where payment is not made within the prescribed 180-day period. The reversed credit may subsequently be reclaimed when the statutory conditions are satisfied. This should be distinguished from a permanent denial of ITC. CBIC's guidance identifies Rule 37 reversals for non-payment within 180 days as reversals that may be reclaimed after the relevant conditions are fulfilled.

Can ITC Be Denied Without Verifying the Supplier?

A recipient may challenge an ITC demand where the department proceeds merely on an assumption without properly examining the underlying transaction and the evidence produced by the taxpayer.

The taxpayer should specifically address:

• Whether the supplier was registered
• Whether the invoice is genuine
• Whether goods or services were actually received
• Whether consideration was paid
• Whether the transaction is recorded in the books
• Whether the supplier reported the transaction
• Whether the department has independently verified the alleged discrepancy
• What material supports the proposed denial
• The strength of the response will depend on the evidence available in the particular case

Fake Invoice Allegation Under GST

An allegation that an invoice is fake or that ITC has been fraudulently availed is considerably more serious than an ordinary return mismatch. The taxpayer should be able to establish the underlying transaction through contemporaneous records.

Useful evidence may include

• Purchase orders
• Tax invoices
• E-way bills
• Lorry receipts
• Goods receipt notes
• Stock registers
• Bank statements
• Ledger accounts
• Delivery challans
• Correspondence
• Proof of actual use or resale of the goods

Mere possession of an invoice may not always be sufficient where the genuineness of the underlying transaction is specifically disputed. Courts have emphasised the importance of establishing the genuineness of transactions and maintaining supporting records in ITC disputes.

Purchase From a Non-Traceable Supplier

If a supplier subsequently becomes untraceable, that fact should not automatically be treated as conclusive proof that the recipient's purchase was fictitious. The taxpayer should demonstrate what was known and done at the time of the transaction and produce evidence showing that the purchase actually occurred. The department may, however, examine whether the recipient exercised reasonable commercial diligence and whether the transaction is supported by independent evidence.

ITC on Capital Goods

GST paid on eligible capital goods used in the course or furtherance of business may qualify for ITC subject to the statutory conditions. However, special rules apply where capital goods are used partly for business and partly for other purposes or partly for taxable and exempt supplies. The taxpayer should maintain proper asset records and be able to establish the business use of the capital goods. Rule 43 prescribes the mechanism for attribution and reversal in specified circumstances.

ITC on Employee Expenses

Not every expenditure incurred by an employer automatically qualifies for ITC. The taxpayer must examine the nature and purpose of the expenditure, the applicable provisions of the CGST Act and whether any specific restriction applies. Employee-related expenditure should therefore be examined invoice-by-invoice rather than treating all employee expenses as either automatically eligible or automatically blocked.

ITC on Motor Vehicles

GST law contains specific restrictions concerning motor vehicles and certain related expenses. Eligibility can depend upon the type of vehicle, its seating capacity, its use and the nature of the taxpayer's business. Businesses should therefore determine eligibility based on the specific statutory exception applicable to their activity rather than assuming that every vehicle purchased for business purposes qualifies for full ITC.

ITC on Repairs, Construction and Renovation

Businesses frequently face disputes concerning ITC on construction, renovation, repair and improvement of immovable property. The treatment depends upon the nature of the expenditure, the property, the manner in which the goods or services are used and the specific statutory restrictions applicable to the transaction. This issue should be examined separately from the general principle that an expense is incurred “for business purposes.”

Rule 42: Reversal for Exempt and Taxable Supplies Where common inputs and input services are used for both taxable and exempt supplies, the eligible ITC has to be apportioned in accordance with the prescribed mechanism.

Rule 42 provides the methodology for determining the portion attributable to exempt supplies and non-business use.

Businesses having both taxable and exempt turnover should therefore maintain appropriate records and undertake the required periodic and annual calculations.

Rule 43: Reversal Relating to Capital Goods Rule 43 deals with ITC relating to capital goods that are used partly for taxable supplies and partly for exempt supplies or partly for business and non-business purposes.

The reversal mechanism is different from the treatment of ordinary inputs and input services and operates over the prescribed residual life of the capital goods.

Proper classification of capital goods and maintenance of asset records are therefore important for defending an ITC claim.

Can a Bona Fide Purchaser Lose ITC Because of the Supplier's Default?

This is one of the most important questions in GST litigation.

A purchaser may have:

• Purchased genuine goods
• Paid the supplier
• Paid the invoice value including GST
• Recorded the transaction in its books
• Received and used the goods
• Maintained the relevant documentation

If the supplier subsequently defaults, becomes non-compliant or is investigated, the recipient may nevertheless face a demand.

The recipient should then examine the precise statutory condition allegedly violated and the evidence relied upon by the department. The defence should be based on the actual transaction and documentary evidence rather than merely asserting that the purchaser acted in good faith. The Supreme Court has recognised the importance of transaction records, invoices and books in determining ITC entitlement, while GST law itself places statutory conditions on the availment of credit.

What Should You Do If ITC Is Proposed to Be Reversed?

If the GST department proposes to deny ITC, the taxpayer should:

Identify the exact invoices and tax periods involved. Examine the statutory provision cited by the department. Reconcile the purchase register, GSTR-2B and returns. Verify the supplier's registration status for the relevant period. Collect invoices, payment records and proof of receipt. Produce transportation and stock records where applicable. Examine whether the supplier actually reported the transaction. Respond to the notice with invoice-wise evidence. Challenge factual assumptions that are unsupported by material. Consider the appropriate appellate or judicial remedy if an adverse order is subsequently passed.

What Documents Should a Business Maintain?

For ITC defence, businesses should ideally maintain a complete transaction trail consisting of:

• Tax invoices
• Purchase orders
• Goods receipt records
• E-way bills
• Transport documents
• Stock registers
• Supplier ledgers
• Bank payment records
• GSTR-2B/GSTR-3B records
• Supplier correspondence
• Contracts and work orders
• Evidence showing actual use of the goods or services

A strong documentary trail can become particularly important when the supplier subsequently becomes non-compliant or the transaction is questioned during departmental proceedings.

Conclusion

ITC disputes cannot always be reduced to a simple question of whether an invoice appears in a GST return. Supplier default, non-filing of returns, cancellation of registration, alleged fake invoices, non-payment within 180 days, capital goods, common credit and exempt supplies can each involve different statutory requirements. Businesses should therefore examine the transaction, the statutory condition, the evidence and the department's specific allegation before reversing ITC or accepting a GST demand. Where a genuine transaction is questioned, a detailed invoice-wise response supported by contemporaneous records may be important in defending the credit and pursuing appropriate appellate or judicial remedies.