GST Alert: Disallowance of ITC Because of Supplier’s Default

The Goods and Services Tax framework faces mounting challenges as legitimate businesses encounter Input Tax Credit denials due to supplier non-compliance. Section 16(2)(c) of the CGST Act mandates actual tax payment by suppliers before recipients can claim ITC, creating unforeseen complications for compliant taxpayers across India.

GST departments nationwide have issued demand notices targeting recipients whose suppliers failed to file returns or remit taxes to the government. Even businesses with valid invoices, timely payments, and proper documentation face ITC reversals and penalty demands under Sections 73-74A, despite having no control over supplier compliance behaviour.

Recent judicial pronouncements reveal conflicting approaches to this contentious issue. The Himachal Pradesh High Court in Himalaya Communication case protected genuine buyers from retrospective supplier registration cancellations, while the Allahabad High Court in Trendships Online case upheld ITC denial when suppliers defaulted on tax payments.

Recipients face practical challenges including inability to track real-time supplier tax payments and reliance on GSTR-2B data based on supplier GSTR-1 filings rather than actual tax deposits. This puts businesses at risk that involve occasional or small-volume suppliers who can then fail in their commitments.

Legal professionals suggest extraordinary due diligence such as frequent GSTR-2B reconciliations, supplier contract indemnity clauses and constant checks on vendor GSTIN status. Such measures do not, however, guarantee the risk of ITC denial in the event that the suppliers do not comply with their statutory duties.

The conflict between the principle of compliance enforcement and equity must be solved through immediate legislative intervention. Until Section 16(2)(c) is amended to consider recipient due diligence rather than supplier behaviour alone, businesses remain exposed to unpredictable liabilities despite following all prescribed procedures and maintaining proper documentation.

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