Supreme Court Affirms ITC Condition When Supplier Fails to Deposit GST

What the Supreme Court decided

The Supreme Court dismissed the batch of special leave petitions challenging the Gujarat High Court judgment. It agreed with the High Court that no ground existed to declare Section 16(2)(c) unconstitutional or to read down its language.

The Court noted that the Gujarat High Court had examined the complete GST structure and had carefully distinguished it from the Delhi Value Added Tax Act, 2004. The Court affirmed and upheld that reasoning.

The practical effect is that a purchaser cannot establish ITC entitlement merely by showing that GST was paid to the supplier. The statutory condition concerning actual payment of tax to the Government by the supplier continues to apply.

Why Section 16(2)(c) was challenged

The petitioners argued that genuine purchasers should not lose ITC because of a default committed by their suppliers. A purchaser may possess a valid invoice, receive the goods or services, pay the full consideration with GST and find the invoice reflected in GSTR-2A or GSTR-2B, but still lack access to the supplier's detailed tax-payment position.

According to the challenge, making the purchaser's credit dependent on an event controlled by the supplier was arbitrary and unfair. The petitioners relied on constitutional protections and sought either invalidation of Section 16(2)(c) or a restricted interpretation protecting bona fide transactions without fraud or collusion.

The challenge referred to decisions under the Delhi VAT system where courts had protected genuine purchasing dealers against defaults committed by sellers.

Why the VAT decisions did not control the GST dispute

The Supreme Court accepted that the CGST Act and the earlier Delhi VAT Act operate through materially different statutory structures.

GST is a destination-based tax involving the movement and settlement of credit and revenue across jurisdictions. The availability of credit is linked to the tax reaching the Government and to the statutory system governing its transfer and utilisation.

Because of these differences, the Court found that the treatment of a bona fide purchaser under the Delhi VAT Act could not automatically be applied to a recipient claiming ITC under the CGST Act when the supplier failed to pay the tax.

Role of Section 41 and Rule 37A

Section 41 addresses availment and reversal of input tax credit. Where the supplier fails to pay tax on the relevant supply, the recipient may be required to reverse the corresponding credit with applicable consequences.

The statutory framework also allows the recipient to re-avail the reversed credit after the supplier pays the tax. Rule 37A contains the operational mechanism connected with supplier non-payment reflected through return compliance.

The Supreme Court referred to the Gujarat High Court's consideration of Section 41 and Sections 73 and 74 while examining the purchaser's ability to re-avail reversed ITC after the supplier discharges the liability.

What Section 16(2)(c) requires

Section 16 contains the eligibility conditions for taking ITC. Clause (c) of subsection (2), subject to Section 41, requires the tax charged on the supply to have been actually paid to the Government, either in cash or through utilisation of admissible input tax credit.

The condition operates in addition to other requirements, including possession of the prescribed document, receipt of goods or services, communication of invoice details and filing of the recipient's return, as applicable.

The Supreme Court's order confirms that courts cannot remove the supplier-payment condition merely because its operation may cause hardship to a genuine purchaser.

Does the judgment permit automatic ITC denial

The judgment confirms the validity of the statutory condition. It does not remove the Department's obligation to establish the factual basis of an ITC demand or to follow the procedure prescribed by law.

Before credit is denied, the taxpayer should receive a proper notice, the transactions and suppliers in dispute should be identified, relevant evidence should be considered and a reasonable opportunity to respond should be provided.

Questions such as whether the supplier actually defaulted, whether the credit was properly matched, whether the recipient reversed or re-availed it correctly and whether limitation or procedural requirements were followed can still be examined in the appropriate proceedings.

Impact on genuine buyers

A genuine purchase, payment through banking channels and reflection in GSTR-2B remain important evidence. However, those facts alone may not satisfy Section 16(2)(c) if the supplier has not deposited the corresponding tax.

The recipient may face reversal, interest exposure and working-capital blockage until the supplier regularises the default. Recovery from the supplier and re-availment of credit can also take considerable time.

Businesses should therefore treat the supplier's GST compliance history as part of commercial risk assessment, not merely as a tax-department concern.

Vendor due diligence after this decision

• Verify the supplier's active GST registration before onboarding and at reasonable intervals.
• Reconcile purchase registers with GSTR-2B every tax period.
• Investigate missing invoices, repeated return delays and unexplained amendments promptly.
• Retain tax invoices, e-way bills, goods-receipt records, transport documents, payment evidence and correspondence.
• Assign higher-risk suppliers shorter credit periods or additional compliance conditions.
• Obtain periodic confirmations that outward supplies have been reported and tax liabilities discharged.
• Pause further purchases where a supplier repeatedly fails to correct GST mismatches.
• Document the steps taken to verify the transaction and follow up on supplier defaults.

Contractual safeguards for purchasers

• Include a clause requiring timely reporting of invoices and payment of the corresponding GST.
• Permit withholding of the GST component until the invoice is properly reflected, where commercially and legally suitable.
• Obtain an indemnity for ITC loss, interest, penalty and professional costs caused by supplier non-compliance.
• Allow adjustment of ITC losses against future supplier payments.
• Require immediate notice if the supplier's registration is suspended, cancelled or placed under investigation.
• Specify a time-bound process for correction of GSTR-1, GSTR-3B and invoice-reporting errors.
• Preserve the purchaser's right to recover amounts if credit cannot be re-availed within the agreed period.

Difference between ITC eligibility and fraud allegation

Denial under Section 16(2)(c) does not necessarily mean that the purchaser participated in fraud. The statutory condition can become relevant even where the transaction itself is genuine but the supplier failed to deposit tax.

A proceeding alleging fraud, wilful misstatement or suppression requires its own legal and evidentiary foundation. Authorities should not treat every supplier default as proof of collusion by the recipient.

Taxpayers should carefully examine whether the notice invokes Section 73 or Section 74, the period involved and the exact allegation made against them.

Key takeaways

• The Supreme Court order was passed on 24 July 2026 in SLP(C) No. 23931 of 2026 and connected matters.
• The Bench comprised Justice Sanjay Kumar and Justice Sanjeev Sachdeva.
• The Court affirmed the Gujarat High Court judgment dated 1 May 2026.
• Section 16(2)(c) was not declared unconstitutional and was not read down to create a general exception for bona fide purchasers.
• The GST framework was held to be materially different from the Delhi VAT regime.
• ITC remains conditional on actual payment of the relevant tax to the Government by the supplier.
• Reversed credit may be re-availed after the supplier pays the tax, subject to the statutory mechanism.
• The Department must still establish the facts and comply with notice, hearing and adjudication requirements.
• Businesses should strengthen supplier screening, GSTR-2B reconciliation, documentation and contractual indemnities.

Conclusion

Bhandari Scrap Traders is a major GST ruling for every business claiming input tax credit. It confirms that ITC protection depends not only on the recipient's own records and payment but also on compliance by the supplier.

The safest response is preventive. Strong vendor selection, regular reconciliation, rapid mismatch follow-up and clear recovery clauses can reduce the financial impact of a supplier default. Where a demand is issued, the taxpayer should examine both the factual allegation and the Department's compliance with the statutory procedure before deciding the appropriate reply or appeal.