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Navigating Input Tax Credit (ITC) Disputes: Key Legal Defenses for Businesses

Businesses operating under the Goods and Services Tax (GST) regime often face scrutiny regarding Input Tax Credit (ITC) availment. This summary outlines common legal challenges and robust defenses against allegations of wrongful ITC claims, drawing insights from a detailed reply to a show cause notice.

Core Allegations and Initial Rebuttal

Demand notices for ITC reversal frequently stem from allegations that a supplying entity is "non-existent" or "fake," leading to claims that the recipient business availed ITC without actually receiving goods. Such demands often propose substantial interest and stringent penalties, applicable in cases of proven fraud or willful misconduct.

A fundamental rebuttal to such claims asserts that the demand notice is flawed and legally untenable. This is often based on:

• An incorrect understanding of the factual matrix.

• A misinterpretation and misapplication of prevailing GST law and judicial precedents.

• Unwarranted reliance on uncorroborated, untested, and inadmissible evidence.

• A failure to consider substantial documentary proof possessed by the recipient business.

The case against a recipient business might rest precariously on the alleged status of a single supplier and statements from one third-party individual, which may be insufficient to level charges of fraud against the business proprietor.

Bona Fide Transactions and Actual Receipt of Goods

A primary defense against ITC reversal demands is the unequivocal assertion that all transactions were bona fide commercial transactions, conducted in the ordinary and legitimate course of business, supported by the actual physical receipt of goods.

Comprehensive Documentary Evidence: Businesses typically possess a strong body of evidence to prove the genuineness of transactions and compliance with statutory conditions for ITC availment:

• Valid Tax Invoices: Original invoices from the supplier, conforming to GST rules (Rule 46 of CGST Rules, 2017), including all prescribed particulars like supplier and recipient details, GSTINs, goods description, quantity, value, and tax amounts.

• E-way Bills: Where applicable (for movement of goods above thresholds), details of e-way bills corroborate the actual movement of consignments, including vehicle and transporter details.

• Weighment Slips ('Kanta Parchis'): These are critical, contemporaneous documents in bulk commodity trades like metal scrap, providing robust and often independently verifiable evidence of the actual quantity of materials received. Their evidentiary significance, especially when correlated with other documents, has been widely acknowledged.

• Stock Register Entries: Systematic and contemporaneous recording of received goods in inventory records demonstrates that the goods became part of the business's legitimate assets.

• Proof of Payment through Banking Channels: All payments for supplies, including the tax component, made exclusively through traceable banking channels (e.g., NEFT, RTGS, cheques), providing a clear and auditable trail.

• Subsequent Sale of Procured Goods: Evidence of onward sales, including sales invoices, e-way bills for outward supplies, proof of payments from customers, and GSTR-1 filings, demonstrates that the goods were part of the business's active commercial inventory and revenue-generating activities, countering allegations of mere paper transactions.

• Transportation Documents: Further supporting the physical logistics and movement of materials.

Compliance with Section 16(2) of the CGST Act

The fundamental entitlement to ITC is subject to conditions outlined in Section 16(2) of the CGST Act. A strong defense demonstrates meticulous compliance with each clause:

• Section 16(2)(a) - Possession of Tax Invoice: The business holds valid, compliant tax invoices from the supplier, who was registered under GST at the time of supply.

• Section 16(2)(aa) - Supplier Details in GSTR-1 & Communication (e.g., GSTR-2B): While this clause (effective 01.01.2022) links ITC to supplier reporting, courts have consistently held that GSTR-2A/2B mismatches cannot be the sole ground for denying ITC if other substantive conditions of Section 16(2) are met (valid invoice, actual receipt, payment to supplier). The primary onus of correct and timely invoice uploading rests with the supplier.

• Section 16(2)(b) - Receipt of Goods or Services: Actual physical receipt of goods is crucial, substantiated by weighment slips, stock registers, and evidence of subsequent sales. Importantly, the Explanation to Section 16(2)(b) introduces "deemed receipt," where goods delivered by the supplier to a third party (e.g., the recipient's customer or a designated godown) at the recipient's direction are still considered received by the recipient. This provision is vital for common logistical practices like "goods crossing" in bulk trading, where goods don't necessarily pass through the registered office.

• Section 16(2)(c) - Tax Charged Actually Paid to Government: The recipient business makes full payment, including tax, to the supplier via legitimate banking channels. A consistent line of judicial rulings protects bona fide recipients who have fulfilled their obligations, holding that ITC cannot be denied if the supplier subsequently defaults in remitting the collected tax to the government. The primary recovery action should be against the defaulting supplier.

• Section 16(2)(d) - Furnishing of Return under Section 39: The business duly and regularly files its GSTR-3B returns, where the ITC was availed.

Due Diligence Exercised

A prudent business exercises reasonable due diligence at the time of transactions. This includes:

• Verification of GST Registration: Confirming the supplier's active GST registration status on the official GST portal at the material time of each transaction.

• Insisting on Proper Tax Invoices: Ensuring invoices are compliant with GST rules.

• Payments through Banking Channels: Avoiding cash transactions for such supplies to maintain a clear audit trail.

• Weighment of Goods: Standard practice for quantity verification in bulk trade.

• Maintenance of Statutory Records: Diligently recording transactions in books of accounts and stock registers.

The GST law does not impose an impractical burden on recipients to conduct a forensic audit of their supplier's operations or tax compliance for every transaction. Such an expectation would stifle commerce. The business cannot be retrospectively penalised for information not available or discoverable at the time of the transactions.

Challenging Evidence, Burden of Proof, and Penalties

Impermissible Reliance on Uncorroborated Third-Party Statements and Violation of Natural Justice

Demand notices often rely heavily on statements purportedly made by third parties, such as associates or employees of the recipient business, or even other individuals linked to the supplier.

• Non-binding Nature of Third-Party Statements: Familial relationships or operational assistance do not automatically confer authority on an individual to make admissions of fraudulent activities or impute mens rea (guilty mind) that would legally bind the proprietor of a business, especially for severe charges like fraud under Section 74 of the CGST Act. Proof of direct knowledge, consent, participation, or express direction from the proprietor is required. Statements concerning other entities or general industry practices cannot be extrapolated to impute fraud on a specific business's distinct transactions without specific, corroborated evidence.

• Contradictory Statements: If a key witness's statements contain significant contradictions regarding the same transactions, their overall reliability and credibility are severely undermined. The Department cannot selectively rely on portions that suit its narrative while ignoring contradictions.

• Violation of Natural Justice: Right to Cross-Examination: Relying on statements obtained from third parties without affording the recipient business an opportunity to cross-examine these individuals constitutes a flagrant breach of the principles of natural justice (audi alteram partem – hear the other side). Untested, uncorroborated, and potentially biased statements cannot legitimately be used against an assessee and can vitiate the entire proceedings.

Admissibility and Probative Value of Electronic Evidence

Demand notices may reference electronic evidence, such as WhatsApp chats or audio recordings. The admissibility of such digital evidence is subject to stringent conditions:

• Mandatory Compliance with Section 65B of the Indian Evidence Act, 1872: For electronic records to be admissible as secondary evidence, a certificate under Section 65B(4) is mandatory, unless the original device is produced and its authenticity proven. Failure to provide this statutory certification renders the evidence inadmissible.

• Authenticity and Non-Tampering: Even with a certificate, the authenticity of recordings and chats, and proof that they have not been tampered with, must be rigorously established. The chain of custody and data integrity are crucial.

• Relevance and Direct Implication: The content of digital evidence must directly, unequivocally, and independently implicate the proprietor in alleged fraudulent activities. Vague references or third-party conversations do not automatically prove personal collusion or fraudulent intent.

Unjustified Invocation of Section 74 of the CGST Act

Section 74 of the CGST Act, which allows for higher penalties and an extended limitation period, applies only when tax evasion or wrongful ITC availment is "by reason of fraud, or any willful misstatement or suppression of facts".

• High Threshold for Mens Rea: Invocation of Section 74 necessitates a clear, unambiguous, and irrefutable establishment of mens rea (a guilty mind or fraudulent intent) on the part of the assessee. Mere suspicion, procedural errors, differences in interpretation, or the alleged fraudulent actions of a third-party supplier (without proven collusion by the assessee) are insufficient.

• Burden of Proof for Fraud: The burden of proving fraud lies heavily and squarely on the Department. This burden is significantly higher and more onerous than that required for demands under Section 73 (non-fraud cases). The Department must provide concrete, specific, and compelling evidence of the proprietor's active and knowing collusion, contemporaneous knowledge of fraud, and deliberate intent to evade tax.

• No Suppression or Willful Misstatement: If a business has duly recorded all transactions in its books, maintained supporting documents, and accurately reflected these in its GST returns, there is no concealment or intentional non-declaration, thus negating allegations of "suppression of facts" or "willful misstatement".

• Bona Fide Belief: Transactions undertaken based on a bona fide belief that the supplier was genuine and registered (e.g., active GSTIN on the official portal at the time) cannot be retrospectively tainted by subsequent discoveries or allegations about the supplier's status.

• Section 73 as an Alternative: If any ITC is deemed technically ineligible despite a business's bona fide actions (due to reasons outside its control or knowledge), such a situation, devoid of fraudulent intent, would fall under Section 73, which has a shorter limitation period and milder penalties.