ITC denial for supplier default: What Maruti Enterprise means for bona fide purchasers

The Gujarat High Court’s answer was clear and emphatic. It held that Section 16(2)(c) is constitutionally valid and cannot be read down. Actual payment of tax by the supplier remains a necessary condition for availing ITC. The Court also rejected the argument that once the purchaser establishes the genuineness of the transaction through invoices, proof of receipt, return disclosures, and payment to the supplier, the enquiry should end there. In the Court’s view, the conditions prescribed in Section 16(2) are cumulative, and Section 16(2)(c) cannot be severed from the broader provision.

The Court’s reasoning was rooted in the wider architecture of GST. It emphasised that Section 16(2)(c) must be understood together with the broader statutory framework governing ITC.² In particular, the Court placed significant weight on the destination-based structure of GST and the inter-state fiscal consequences of credit flow. It observed that permitting ITC despite non-payment by the supplier could require the originating State to transfer to the destination State amounts that were never actually realised. According to the Court, this materially distinguishes GST from the earlier Value Added Tax (VAT) framework, which operated through State-wise credit chain. Since VAT was confined to intra-State transactions, the corresponding ITC also remained within the same State’s fiscal system. The Court held that the decisions rendered under the Delhi Value Added Tax (DVAT) regime, including On Quest Merchandising India,³ where the provisions restricting ITC on account of supplier default were read down to protect bona fide purchasers, had limited precedential applicability in the GST context.

The Court also reiterated the established position that ITC is not an absolute constitutional right, but a statutory concession. It further relied on Section 155, which places the burden of proving eligibility on the person claiming ITC, and concluded that “eligibility” necessarily includes satisfaction of the conditions under Section 16(2)(c), and not merely proof that the underlying transaction was genuine.

Yet the judgment does not eliminate the underlying difficulty that gave rise to the challenge in the first place. The issue is not whether the State can insist that the tax must ultimately reach the government before ITC is secured. The issue is whether the law can shift the consequences of a supplier’s default onto a recipient that has no practical means of ensuring compliance. That is why the “impossibility” objection has carried weight across courts, and why the conclusion in Maruti Enterprise does not fully resolve the operational realities of GST compliance.

For instance, the Tripura High Court in Sahil Enterprises v Union of India⁴ held that Section 16(2)(c) effectively places an impossible burden on a bona fide purchaser, since there is no statutory mechanism enabling the recipient to verify whether the supplier has actually deposited the tax with the government. The Court recognised that a purchasing dealer cannot reasonably be expected either to foresee which supplier will default or to ensure post facto compliance by the supplier. Similar reasoning had also informed the jurisprudence developed under the earlier VAT regime, where courts were generally reluctant to deny credit to bona fide purchasers solely on account of supplier default.

The significance of Maruti Enterprise lies less in doctrinal novelty than in the direction it signals. The Court has firmly aligned itself with the line of authority that treats ITC as a conditional statutory entitlement requiring strict compliance with every prescribed condition. At the same time, it has strengthened the Revenue’s position by distinguishing GST from the earlier VAT jurisprudence on structural grounds. That is likely to make the judgment an important reference point in future litigation involving supplier default and denial of ITC.

For the Revenue, the ruling provides a detailed judicial basis for arguing that proof of invoice, receipt of goods or services and payment to the supplier does not exhaust the enquiry into entitlement. So long as Section 16(2)(c) remains in its current form, actual payment of tax to the government remains part of the statutory framework governing ITC eligibility. For taxpayers, the judgment is a reminder that transaction genuineness alone may not be enough.

A significant aspect of the Court’s reasoning is that the statutory scheme does not permanently deprive the purchaser of ITC. Under Section 41(2) and Rule 37A, ITC may be reversed where the supplier has failed to pay tax, but it may subsequently be re-availed once the supplier discharges the liability. Formally, this mechanism represents the statutory scheme’s response to the charge of unfairness.

However, this response fails to redress commercial disruption. Re-availment is necessarily post facto relief. It does not prevent the immediate reversal of credit, blockage of working capital, disruption of cash flow, possible adjudication proceedings, exposure to interest, or the burden of appellate pre-deposit requirements. For many businesses operating on tight margins, that interim disruption may itself constitute the actual commercial injury. In practical terms, later restoration of ITC does not fully undo the immediate financial consequences of losing it.

More fundamentally, the existence of a later re-credit mechanism does not entirely address the fairness objection in principle. The concern is not merely that credit may later be restored. It is that the recipient must first suffer the consequences of a breach that it could not realistically prevent. In that sense, the judgment resolves the constitutional challenge without removing the structural imbalance that continues to define Section 16(2)(c).

Perhaps the most interesting aspect of Maruti Enterprise is not the Court’s affirmation of Section 16(2)(c), but its recognition of the larger policy difficulty underlying the dispute. The Court expressly acknowledged that the government possesses sufficient power to proceed against defaulting suppliers under Sections 73 and 74 of the CGST Act. It also indicated that the present system may require reconsideration, including legislative clarification and technology-based mechanisms that would allow recipients to verify supplier-level tax payment in real time.

This acknowledgement matters because it demonstrates that, even while upholding the law, the Court recognised that the compliance burden imposed on bona fide purchasers is difficult to justify on policy grounds. In other words, while the legal reasoning ultimately favours the Revenue, the judgment itself accepts that the existing framework remains imperfect.

For taxpayers, the immediate lesson is practical as much as legal. Businesses can no longer afford to treat supplier compliance as a secondary issue. The sensible response is preventive: stronger vendor onboarding, periodic GSTR-2A and GSTR-2B reconciliation, closer monitoring of supplier behaviour, preservation of invoice, transport and payment records and contractual safeguards such as indemnity or reimbursement clauses for tax default. None of these steps can eliminate the statutory risk entirely, but they can materially improve the taxpayer’s position in assessment and appellate proceedings.

At the same time, the debate is far from over. The issue remains alive before other High Courts, and the judicial position has not been entirely uniform. While Maruti Enterprise now provides a detailed and influential ruling in favour of the validity of Section 16(2)(c), earlier judicial approaches were more protective of bona fide purchasers. The controversy, therefore, still awaits a conclusive nationwide resolution.

That final word will almost certainly have to come from the Supreme Court. When it does, the real question will not merely be how Section 16(2)(c) is to be interpreted. It will be how the GST system balances protection of revenue with the credibility of seamless credit for bona fide taxpayers. If GST is to function as a true value-added tax, the law may ultimately have to move towards a framework in which fraud is punished, defaulting suppliers are pursued, but genuine purchasers are not left carrying a risk they have no real power to control.