Relevant provision :
i.
Section 16(2) – Eligibility and
Conditions for Taking Input Tax Credit
Second Proviso to
Section 16(2):
"Provided
further that where a recipient fails to pay to the supplier of goods or
services or both, other than the supplies on which tax is payable on reverse
charge basis, the amount towards the value of supply along with tax payable
thereon within a period of one hundred and eighty days from the date of issue
of invoice by the supplier, an amount equal to the input tax credit availed by
the recipient shall be added to his output tax liability, along with interest
thereon, in such manner as may be prescribed."
Third Proviso to
Section 16(2):
"Provided
also that the recipient shall be entitled to avail of the credit of input tax
on payment made by him of the amount towards the value of supply of goods or
services or both along with tax payable thereon."
ii.
Rule 37 of the CGST
Rules, 2017 – Reversal of ITC for Non-Payment
Text
of Rule 37 (Before Amendment on 01-10-2022):
Rule 37(1):
"A
registered person, who has availed of input tax credit on any inward supply of
goods or services or both, but fails to pay to the supplier thereof, the value
of such supply along with the tax payable thereon, within the time limit
specified in the second proviso to sub-section (2) of section 16, shall furnish
the details of such supply, the amount of value not paid and the amount of
input tax credit availed of proportionate to such amount not paid to the
supplier in FORM GSTR-2 for the month immediately following the period of one
hundred and eighty days from the date of the issue of the invoice:
Provided that the
value of supplies made without consideration as specified in Schedule I of the
said Act shall be deemed to have been paid for the purposes of the second
proviso to sub-section (2) of section 16."
Rule 37(2):
"The amount
of input tax credit referred to in sub-rule (1) shall be added to the output
tax liability of the registered person for the month in which the details are
furnished."
Rule 37(3):
"The
registered person shall be liable to pay interest at the rate notified under
sub-section (1) of section 50 for the period starting from the date of availing
credit on such supplies till the date when the amount added to the output tax
liability, as mentioned in sub-rule (2), is paid."
iii.
Rule 37 (Amended
w.e.f. 01-10-2022 by Notification No. 19/2022-CT):
Revised
Rule 37(1):
"A
registered person, who has availed of input tax credit on any inward supply of
goods or services or both, other than the supplies on which tax is payable on
reverse charge basis, but fails to pay to the supplier thereof, the amount
towards the value of such supply along with the tax payable thereon, within the
time limit specified in the second proviso to sub-section (2) of section 16,
shall pay an amount equal to the input tax credit availed in respect of such
supply along with interest payable thereon under section 50, while furnishing
the return in FORM GSTR-3B for the tax period immediately following the period
of one hundred and eighty days from the date of the issue of the invoice."
Provided that the
value of supplies made without consideration as specified in Schedule I of the
said Act shall be deemed to have been paid for the purposes of the second
proviso to sub-section (2) of section 16:
Provided further
that the value of supplies on account of any amount added in accordance with
the provisions of clause (b) of sub-section (2) of section 15 shall be deemed
to have been paid for the purposes of the second proviso to sub-section (2) of
section 16.;
Rule 37(2):
Where the said
registered person subsequently makes the payment of the amount towards the
value of such supply along with tax payable thereon to the supplier thereof, he
shall be entitled to re-avail the input tax credit referred to in sub-rule (1).
Rule 37(3): [ Omitted ]
Prior to 01-10-2022: Procedural Issues
I.
As per the second
proviso to section 16(2) read with Rule 37, a registered person who has availed
input tax credit on any inward supply of goods or services or both, but fails
to pay to the supplier thereof, the value of such supply along with the tax
payable thereon within the period of one hundred and eighty days from the date
of the issue of the invoice, shall furnish the details of such supply in FORM
GSTR-2 for the month immediately following the period of one hundred and eighty
days from the date of the issue of the invoice and such amount of ITC shall be
added to the output tax liability of the registered person for the month in
which the details are furnished in GSTR-2.
·
The amount of value not paid and the
proportionate amount of input tax credit availed shall be declared in FORM
GSTR-2 for the month immediately following the period of one hundred and eighty
days from the date of the issue of the invoice.
·
The amount of Input Tax Credit on invoices for
which consideration has not been paid shall be added to the output liability of
the registered person for the month in which details, as stated above, are
furnished by him.
II.
Now the mechanism to
furnish GSTR-2 on the GST portal has not been made operational by the
department. Therefore, details of such invoices cannot be furnished with the
GST Department.
III.
It was held in the
case of COMMISSIONER OF INCOME-TAX, BANGALORE VERSUS BC SRINIVASA SETTY (AND
OTHER APPEALS) [1981 (2) TMI 1 - SUPREME COURT] that if the machinery or
mechanism is not provided to comply with the provisions of statute, the
charging section shall fail. The charging provisions and the corresponding
mechanism together constitute a integrated code. When there is a case that the
corresponding mechanism cannot apply it all, it is evident that such a case was
not intended to fall within the charging section. It must be borne in mind that
the legislative intent is presumed to run uniformly through the entire
conspectus of provisions.
IV.
It can be argued that
since the mechanism of declaring invoices on which credit has been availed
(GSTR-2) has not been made available to the assessee and the output tax
liability declared by him does nor demarcate and earmark the liability on
account of nonpayment of consideration (as no such column has been provided in
GST Returns) therefore we cannot be asked to pay any amount on account of
interest. It is settled principle that the taxpayer cannot be made to suffer
for no fault VISION DISTRIBUTION PVT. LTD. VERSUS COMMISSIONER, STATE GOODS
& SERVICES TAX & ORS. [2019 (12) TMI 1048 - DELHI HIGH COURT] wherein
it has been held that the taxpayer cannot be made to suffer on account of the
failure of the Government in devising smooth GST systems).
V.
Hence, before the
Oct-22, it is led to practical challenges to compliance with procedure. The
lack of functionality rendered the compliance procedure unworkable. Thus,
department has made amendment in Rule 37 vide Notification No. 19/2022- CT
dated 28.09.2022. [Amendment Provision provided in aforesaid para] to change
the Word “GSTR-2” to “GSTR-3B”.
After Amendment
Even after amendment it is to be noted that The input
tax credit is indefeasible right of taxpayers and it is the property of
taxpayer, the Government by inserting proviso to S. 16(2) and rule 37 i.e., for
reversal of ITC in case of nonpayment of consideration within 180 days made an
apparent absurdity is the GST law which is over riding the mutual agreements
between supplier and recipient which may not be in line with the intention of
the GST law which was to enable ITC to taxpayers.
Further, we
would like to mentioned various parameter analysing the second proviso to
Section 16(2);
I.
Contractual
obligation to pay vendors is beyond 180 days
·
The second proviso to
Section 16(2) uses the term “fails to pay,” which indicates that the
recipient has the intention to pay the supplier for the value of the supply
along with the applicable tax but, for some reason, fails to do so within the
stipulated time. Notably, the proviso does not use the term “non-payment.”
There is a significant distinction between “failure to pay” and “non-payment.”
·
Non-payment
arises only when a contractual obligation to make the payment exists, but the
recipient is unable or unwilling to fulfill that obligation. In contrast, failure
to pay presupposes that there was an agreed timeline for payment within 180
days, which the recipient neglected to meet.
·
This raises an
important question: What if both the supplier and recipient have
contractually agreed on a credit period that extends beyond 180 days? In
such cases, can it truly be said that the recipient has "failed to
pay"?
·
The Hon. Allahabad
High Court in the case of Badri Prasad v. District Judge, Gonda (1983) All
LJ 41 at 42 held that the parties can be said to have “failed to pay”
only if it can be said that they neglected to do something which they were
expected to do, or they left some possible or expected action unperformed.
Further, several High Courts have analysed the meaning of “failure” in various
cases viz.
“Failure”
means that there is an omission on the part of the person to do something which
it is possible for him to do – High Court of Karnataka in the case of THATTESSARA
SUBBARAYA VERSUS CHINNE GOWDA AND ORS. - 1971 (9) TMI 193 - MYSORE HIGH COURT
“Failure”
means non-fulfillment of an obligation imposed - High Court of Calcutta in the
case of ROYAL CALCUTTA TURF CLUB VERSUS COMMISSIONER OF WEALTH-TAX - 1983
(5) TMI 17 - CALCUTTA HIGH COURT
"Failure”
means not doing something that one is expected to do - High Court of Kerala in
the case of KAVUNGAL KOOPPAKKATTU ZEENATH VERSUS MUNDAKKATTU SULFIKER ALI -
2008 (3) TMI 776 - KERALA HIGH COURT
·
By virtue of the
above interpretations provided for the term 'failure', it is possible to
contend that a failure can occur only in the presence of an obligation to do or
perform an act. Accordingly, since the words used in the proviso are “fails to
pay”, it is possible to contend that the above provision would only be
triggered when contractually there is an obligation on the recipient to pay the
amount within 180 days and the recipient subsequently fails to pay the amount
within 180 days.
·
In case of payment
terms beyond 180 days, it can be said that the proviso doesn't apply, and
ideally there is no requirement of reversal in such cases.
II.
Privity of
Contract
·
The second proviso to
Section 16(2) of the CGST Act, 2017, appears to undermine the principle of
Privity of Contract between the recipient and supplier—a principle that is
fundamental in contract law. In simple terms, Privity of Contract refers
to the relationship between the parties involved in a contract, giving them the
right to enforce contractual obligations against each other while preventing
third parties from interfering or having any enforceable rights under that
contract.
·
This raises a
critical question: Does the second proviso to Section 16(2) override the
principle of Privity of Contract and allow the government to interfere in a
purely commercial transaction?
·
In essence, when the
government imposes an obligation on the recipient to reverse ITC due to
non-payment to the supplier (even though the tax has already been paid to the
government by the supplier), it disrupts the commercial terms agreed upon
between the parties. Such interference seems to go beyond the scope of taxation
and ventures into the realm of private contracts, which ideally should remain
governed by the contractual agreement between the supplier and recipient.
III.
No Locus Standi of the Government
·
According to Section
16(2)(c) of the CGST Act, 2017, a recipient is eligible to claim final
Input Tax Credit (ITC) only if the tax on the corresponding supply has been actually
paid to the government by the supplier. Thus, once the government has
received the tax amount from the supplier, it should have no locus standi
in determining whether the recipient has paid the supplier or not.
·
As discussed above,
the Privity of Contract is between the Supplier and Recipient and the
Government has no role to play in case it has received due taxes.
·
The rationale behind
the second proviso to Section 16(2) seems to be to prevent colorable
devices—where a person with surplus ITC might attempt to transfer it
without actual supply of goods or services. However, the provision, in its
current form, often causes undue hardship to genuine business transactions,
especially in cases of legitimate commercial delays or when businesses agree on
extended payment terms. In such situations, the remedy of ITC reversal
becomes worse than the problem it seeks to address, affecting numerous bona
fide transactions.
IV.
Contracts in Which Monies Are Retained
·
In large
construction contracts and other similar agreements, it is a common
practice for a certain percentage of the bill amount to be retained by
the recipient until the successful completion of the project or the expiry of
the warranty period. Additionally, deductions from the bill amount may
be made for various reasons, such as penalties, quality-related issues, or
delay in project timelines.
·
Under the existing
provisions of Section 16(2) and Rule 37, the recipient is required to
reverse proportionate Input Tax Credit (ITC) if the payment, including
the retained amount, is not made to the supplier within 180 days from the
invoice date. This causes significant hardship to taxpayers, as the
reversal of ITC is mandated even though the retention of monies is
contractually agreed upon and not due to non-payment or default.
·
Even when retention
money is withheld, the government has already received the tax from the
supplier. Therefore, forcing ITC reversal does not serve the purpose of
safeguarding government revenue but instead increases compliance costs for
businesses without any corresponding benefit.
Interest on reversal of ITC
I.
Section 50(1) of the
CGST Act, 2017, deals with interest on delayed payment of tax, which
states:
"Every
person who is liable to pay tax in accordance with the provisions of this Act
or the rules made thereunder, but fails to pay the tax or any part thereof to
the Government within the period prescribed, shall pay interest at a notified
rate for the period during which the tax remains unpaid."
However, Rule
37(1) requires a registered person to pay or reverse an amount equivalent to
the input tax credit availed if payment to the supplier is not made within
180 days. It is essential to note that reversal of ITC under Rule 37 is not
the same as non-payment of tax to the government.
·
Section 50(1) applies
when a taxpayer fails to pay the tax to the government within the prescribed
time. This failure results in a direct revenue loss to the government, and
interest is charged to compensate for the delay.
·
Rule 37(1) does not
involve a failure to pay tax but rather a temporary reversal of ITC, which is
eventually re-availed upon payment to the supplier. Since the tax has already
been paid by the supplier to the government, no revenue loss occurs, making
Section 50(1) inapplicable to this situation.
The reversal
of ITC under Rule 37 cannot be equated with "failure to pay tax"
as envisaged under Section 50(1). Therefore, charging interest on such
reversals under Section 50(1) is legally unwarranted and contradicts the
purpose of the interest provision, which is meant to compensate for delayed
payment of tax, not for delayed commercial settlements between contracting
parties.
II.
Section 50(3)
of the CGST Act, 2017, applies in cases where input tax credit (ITC) has
been wrongly availed and utilised, stating:
"A taxable
person who makes an undue or excess claim of input tax credit under sub-section
(10) of section 42 or undue or excess reduction in output tax liability under
sub-section (10) of section 43 shall pay interest at a rate not exceeding
twenty-four percent as notified by the Government."
However, in
the case under discussion, ITC was neither wrongly availed nor improperly
utilised. The ITC was correctly availed at the time of receipt of goods or
services, meeting all the conditions under Section 16(2), including the
supplier having paid the tax to the government. The reversal mandated under Rule
37 arises solely due to non-payment to the supplier within 180 days,
which is a temporary adjustment rather than an indication of wrongful
ITC claim or misuse.
· Section
50(3) is triggered when ITC is wrongly claimed
or utilised beyond what is lawfully allowed. This typically occurs in cases of fraud,
misstatement, or errors leading to an undue credit claim.
· Rule
37 reversal does not constitute a wrongful
claim—the ITC was initially valid but is temporarily reversed due to
a condition on payment terms. Once the payment is made, the same ITC is re-availed,
demonstrating that there was no wrongful intent or excess utilisation.
Since the ITC
was correctly availed and utilised in accordance with the law at the
time of its availment, Section 50(3) does not apply to situations of ITC
reversal under Rule 37. Charging interest under this provision would be misplaced
and legally unjustified, as it is designed for undue or fraudulent
credit claims, which is not the case here.
III.
Rule 88B of the CGST
Rules deals with the manner of calculating interest on delayed payment of tax.
However, it does not cover the specific situation under discussion here, as the
reversal of ITC under Rule 37 is not due to delayed payment of tax but rather
due to the non-payment to the supplier within 180 days, triggering a temporary
adjustment.
In the absence of clear provisions for
calculating interest on such reversals, there is no method prescribed under
Section 50(1) read with Section 50(2) or under Section 50(3) that would apply
to this particular scenario. While Section 50(1) pertains to interest on
delayed payment of tax, and Section 50(3) addresses interest on wrongfully
availed or utilised ITC, neither section directly applies to situations like
the one being discussed, where the ITC was initially valid but is reversed due
to non-payment to the supplier.
·
Rule 88B governs
interest calculation on delayed tax payments but does not encompass ITC
reversals under Rule 37.
·
Sections 50(1) and
50(2) relate to delayed payment of tax, and Section 50(3) applies to wrongful
ITC claims, neither of which apply to the temporary reversal under Rule 37.
·
No prescribed method
exists for calculating interest in the case of ITC reversals due to non-payment
within the 180-day period, creating a gap in the rules.
Until a specific provision is made to
address this situation, it would be inappropriate to apply the interest
calculation methods from Section 50(1), Section 50(2), or Section 50(3) to ITC
reversals under Rule 37. The current legal framework does not prescribe a
method to calculate interest in such circumstances, and any interest charge
would not align with the legislative intent behind these sections.
IV.
Interest is intended
to be compensatory in nature. There has been no loss to the government, as the
supplier has not been paid. Therefore, the government should not charge
interest. If interest is levied, it would result in the recipient paying
interest twice: once to the government and again to the supplier. Additionally,
the interest paid by the recipient upon reversal of credit is not refundable
when the invoice is paid to the supplier, even though the recipient can
re-avail the input tax credit. If the levy of interest cannot be waived.
Revenue Neutrality
I.
In a situation where
a registered person has not made any adjustments in their books of accounts or
returns filed with the department, and no output tax has been paid, despite the
fact that the consideration has been paid subsequently, it raises important
questions regarding the consequences and treatment of such cases.
II.
The concept of revenue
neutrality becomes relevant here. As per Rule 37(4), a registered person is
entitled to re-avail the input tax credit (ITC) that was earlier reversed,
provided the consideration for the goods or services has been paid. This
provision suggests that the reversal is not final, and the ITC can be
reinstated once the condition of payment is fulfilled.
III.
The revenue
neutrality concept ensures that, despite the reversal of ITC, the overall
tax impact remains neutral when the consideration is eventually paid. If the
consideration is paid after the ITC has been reversed, the registered person
can treat the date of payment as the point when they are eligible to re-avail
the ITC. This adjustment is based on the principle that the ITC was originally
availed in good faith, and once the payment condition is met, the reversal
becomes neutral.