United Timber, a registered business, purchases raw material worth ₹10,00,000 from its GST-registered supplier. The raw material attracts GST at 18%, and United Timber accordingly pays ₹1,80,000 as tax to its supplier. The purchase is supported by genuine invoices, payment is made through established banking channels, and documents evidencing delivery of the goods, such as goods receipt, toll receipts, bill of lading and weighment slips, are available with the buyer. United Timber claims the Input Tax Credit (ITC). However, several months later, the Department discovers that the supplier had failed to deposit the tax collected from United Timber with the Government.

The question that arises is simple: Can United Timber now be asked to give up the ITC which it had legitimately claimed? This question assumes significance in a GST regime which seeks to eliminate the cascading effect of taxation.

GST was introduced in 2017 as a unified tax structure replacing the multiple indirect taxes that existed earlier. One of the central features of the GST regime is the mechanism of Input Tax Credit, under which a registered person can set off the tax paid on its inward supplies against its outward tax liability. The mechanism is intended to ensure that tax is imposed only on the value added at each stage of the supply chain, rather than allowing a tax-on-tax effect to accumulate.

The difficulty arises when the supplier, despite collecting the tax from the purchaser, fails to deposit it with the Government. The purchaser may have done everything within its control, paid the supplier, received the goods, maintained the requisite documentation and claimed ITC but may have no effective means of knowing

whether the supplier has subsequently discharged its tax liability. The original GST framework contemplated a system of matching and reconciliation through which a purchaser could verify the tax details reported by its supplier. However, that mechanism was never operationalised in the manner originally envisaged.

It is against this backdrop that the Punjab and Haryana High Court's recent decision in Shaurya Alloys Pvt. Ltd. v. State of Punjab & Anr., along with the connected matters, assumes significance. The judgment, pronounced on 1 October 2026, arose from a batch of 424 writ petitions concerning the scope and application of Section 16(2)(c) of the CGST Act, 2017. The dispute before the Court was not merely whether a supplier had defaulted in depositing the tax collected from the purchaser. The larger question was whether such a default could prejudice the purchaser's entitlement to ITC or require a purchaser, who had otherwise availed ITC on a genuine transaction, to reverse the credit on account of the supplier's subsequent default.

The petitioners challenged the constitutional validity of Section 16(2)(c), contending that the law cannot compel a purchaser to ensure compliance with an obligation which is within the control of another person. This argument was founded, inter alia, on the well-settled maxim lex non cogit ad impossibilia meaning the law does not compel the impossible.

Section 16 of the CGST Act, 2017 lays down the eligibility and conditions for claiming Input Tax Credit. Broadly, a registered person is entitled to claim credit of the tax charged on goods or services which are used or intended to be used in the course or furtherance of business. For instance, if A purchases cotton fabric from B for ₹1,00,000 and pays ₹5,000 as GST, A can claim the eligible ITC on such purchase, provided the statutory conditions are fulfilled. When A subsequently supplies the finished goods, the tax payable on such outward supply can be set off against the eligible ITC.

Section 16(2)(c), however, lays down an additional condition that the tax charged in respect of the supply must have actually been paid to the Government, either in cash or through utilisation of admissible ITC. Thus, on a literal reading, the provision creates a statutory link between the purchaser's entitlement to ITC and the supplier's discharge of its tax liability. This is where the difficulty arises: while the purchaser has control over his own transaction, he does not have control over the subsequent conduct of the supplier.

It was this difficulty that formed the foundation of the petitioners' challenge to Section 16(2)(c). Relying on the maxim lex non cogit ad impossibilia, the petitioners argued that a purchaser cannot be compelled to ensure compliance with an obligation which is entirely within the control of the supplier. The purchaser can protect his own transaction by maintaining genuine invoices, proof of movement and delivery of goods, banking records and other supporting documents. However, he cannot ordinarily access or ascertain whether the supplier has subsequently deposited the tax collected from him with the Government.

The petitioners further argued that the original GST framework contemplated a system of matching and reconciliation between the returns of the supplier and the purchaser. This mechanism was intended to enable discrepancies to be identified and rectified through the statutory system. However, the mechanism was not operationalised in the manner originally contemplated due to technical nuances or reluctance of business to adapt to new provisions, leaving the purchaser without an effective means of verifying the supplier's actual payment of tax.

The petitioners also relied upon the subsequent changes to the statutory framework. According to them, the amendment brought into effect from 1 October 2022 further demonstrated the practical difficulty in requiring a purchaser to ensure the supplier's actual tax payment. The purchaser could rely upon the supplier's return for availing ITC without having any independent means of verifying the correctness of the supplier's tax discharge.

It is therefore contended that Section 16(2)(c), read with Section 155, effectively required the purchaser to establish something which was beyond his control. They argued that such an obligation offended the principle that the law cannot compel a person to perform an impossible act, besides raising constitutional concerns under Articles 14, 19(1)(g), 21, 265 and 300A of the Constitution. In the alternative, they submitted that even if Section 16(2)(c) was upheld, it should be applied only in exceptional circumstances involving fraud, collusion, a non-existent supplier or similar circumstances, rather than being mechanically invoked against every bona fide purchaser whose supplier had defaulted.

The Court's Approach: Balancing statutory obligations with ground realities

The Hon'ble Court was, in essence, required to strike a balance between two competing considerations. On one side was the statutory requirement that the tax charged must ultimately reach the Government, on the other was the need to protect a bona fide purchaser from being penalised for a default beyond his control. The Court sought to maintain this balance by upholding the constitutional validity of Section 16(2)(c), while holding that the provision cannot be invoked against a purchasing dealer in a routine or mechanical manner.

The Court achieved this balance by examining Section 16(2)(c) within the wider statutory scheme of the GST Act. The original GST framework contemplated a system of matching and reconciliation of the returns of the supplier and purchaser. Section 42 provided for matching, reversal and reclaim of ITC. However, this mechanism was never operationalised in the manner originally contemplated and the statutory framework was subsequently amended in 2022.

The Court therefore held that Section 16(2)(c) cannot be construed in isolation from the other provisions governing the liability of the supplier and the consequences of non-payment of tax. In particular, the Court considered Section 76, which provides a mechanism for recovery where a supplier collects tax but fails to pay it to the Government. If Section 16(2)(c) were mechanically applied to the purchaser without considering the statutory remedy against the supplier, it could result in the person who collected the tax being left untouched while the purchaser, who had already paid the tax to the supplier, bears the consequence.

The Court also considered Rule 37A, which provides a mechanism for reversal and subsequent re-availment of ITC in specified circumstances where the supplier has not furnished the corresponding return. The Court emphasised that the statutory framework applicable to the relevant tax period must be kept in view, particularly because no corresponding mechanism for re-availment existed for periods preceding the introduction of Rule 37A in the year 2022.

The Court further examined the consequences of invoking Section 74 and relying upon retrospective cancellation of the supplier's registration. Where fraud, wilful misstatement or suppression is alleged against the purchaser, the foundational facts supporting such allegation must be disclosed in the show cause notice. The mere fraud of the supplier cannot automatically be attributed to the purchaser. Similarly, retrospective cancellation of the supplier's registration, by itself, cannot justify denial of ITC. The proper officer must examine the reasons and effective date of cancellation and whether they have any bearing on the genuineness of the particular transaction.

The Court, therefore, did not strike down Section 16(2)(c), but placed it within the larger statutory scheme of the GST regime. Having examined the provision through the wider lens of the scheme and the different circumstances in which it may be invoked, the Court held that it cannot be applied in isolation from the provisions governing the supplier's liability, recovery of tax and reversal and re-availment of ITC. It was in this context that the Court laid down detailed guidelines to ensure that Section 16(2)(c) is not invoked mechanically.

What Must the Department Establish Before Denying ITC?

The Court made an important distinction between a trigger for inquiry and a ground for denial of ITC. Cancellation of the supplier's registration, including retrospective cancellation, a nil or short tax return, an alert or complaint may justify the Department examining the transaction, but none of these circumstances, by themselves, can justify reversal of ITC.

Before proceeding against the purchaser, the proper officer must examine the identity and particulars of the supplier, the relevant invoices and tax periods, the amount of ITC involved, the nature and circumstances of the supplier's default and the proceedings, if any, initiated against the supplier for recovery of the tax. The Court has thus shifted the focus from the mere existence of a supplier default to the circumstances surrounding that default.

Most importantly, the Court requires the investigation to establish some direct link between the purchaser and the alleged wrongdoing. A purchaser who has dealt with a validly registered supplier and possesses documents showing actual receipt and movement of goods, genuine invoices and payment through banking channels cannot automatically be treated as fraudulent merely because the supplier subsequently defaults. The fraud of the selling dealer does not become the fraud of the purchasing dealer unless the Department can establish the connecting facts.

At the same time, the judgment does not grant an unconditional shield to purchasers. Section 155 continues to place the burden of establishing ITC eligibility on the purchaser. The Court has, however, clarified what a purchaser can place before the Department to discharge that burden such as-:

a) tax invoices

b) e-way bills

c) transport records

d) weighment slips

e) toll receipts

f) stock and consumption records

and other evidence establishing the genuineness of the transaction.

The Show Cause Notice Must Tell the Purchaser Why the ITC Is Wrong

The safeguards are not limited to the merits of the transaction. The Court has also placed significant emphasis on the manner in which proceedings are initiated. A show cause notice cannot merely state that the supplier failed to pay tax and, therefore, the purchaser's ITC is liable to be reversed. The notice must disclose the material relied upon, the particulars of the supplier and the manner in which the ITC is alleged to be wrongly availed.

Where Section 74 is invoked alleging fraud, collusion or concealment, the notice must contain the foundational facts from which fraud, wilful misstatement or suppression is alleged. A bald recital of these allegations are not sufficient. The purchaser must also be given an opportunity of personal hearing, and the final order must deal with the material and explanation placed on record.

The Court has therefore attempted to ensure that Section 16(2)(c) remains a substantive safeguard for the revenue without becoming a mechanism for mechanically transferring the supplier's default to the purchaser.

Critical Analysis: What does Shaurya Alloys leave unanswered?

The real significance of Shaurya Alloys lies not merely in the guidelines laid down by the Court, but in the distinction it draws between the manner in which Section 16(2)(c) is to be invoked and the recipient's ultimate entitlement to ITC. The Court did not read down the provision to create a general exemption for bona fide purchasers. Instead, it upheld the constitutional validity of the provision while holding that it cannot be invoked mechanically, without examining the circumstances surrounding the supplier's default and the genuineness of the transaction.

The judgment places considerable emphasis on the manner in which the Department must proceed. It requires an investigation into the supplier's default, examination of the transaction, consideration of the statutory recovery mechanism, disclosure of the material relied upon and a reasoned decision. At the same time, the burden under Section 155 of the Act, 2017 continues to lie upon the purchaser claiming ITC. The purchaser must, therefore, be able to establish the genuineness of the transaction through a consistent documentary record. This may include invoices, proof of receipt and movement of goods, transport records, payment details and stock or consumption records.

Consider a purchaser who establishes that the supplier was registered when the transaction took place, that the goods were actually received, that payment was made through banking channels and that the transaction is supported by genuine invoices and transport records. If the supplier subsequently defaults in depositing the tax and becomes untraceable, the Department cannot mechanically require the purchaser to reverse ITC merely on the basis of that default. The proper officer must examine the surrounding circumstances and the purchaser's eligibility under the statutory framework applicable to the relevant period. On the contrary, documentary evidence of a transaction does not, by itself, establish entitlement to ITC if a statutory condition remains unfulfilled.

The distinction is crucial: a procedural safeguard against arbitrary denial of ITC is not the same as an unconditional substantive right to retain ITC. Paragraph 105 of the judgment reinforces this position. The Court left the merits of the individual cases open and directed that they be reconsidered in accordance with the guidelines. The judgment, therefore, restrains mechanical action but does not guarantee that every purchaser who claims to have acted in good faith will ultimately succeed.

What does “Direct Link” actually mean?

An important question arises from Guideline 103(iii), which requires an investigation to establish “some direct link” between the purchaser and the supplier in order to establish the alleged violation of Section 16(2). The requirement is significant, but its scope remains open to interpretation.

Does a “direct link” require the Department to establish the purchaser's connection with the supplier's default or alleged wrongdoing? Or does it require an evidence-based connection between the purchaser, the disputed transaction and the alleged breach of the statutory conditions governing ITC?

The distinction matters. In paragraph 98, the Court upheld the condition that tax must actually have been paid to the Government and declined to restrict Section 16(2)(c) to cases involving fraud, collusion or non-existent transactions. If the requirement of a direct link were interpreted to mean that the purchaser's involvement must be established in every case, it could effectively introduce the very limitation that the Court declined to read into the provision. On the other hand, if the Department can produce clear evidence showing how the transaction violated the conditions for claiming ITC, the credit may still be denied even if the purchaser was not involved in fraud.

The judgment has thus raised an important question about the relationship between the purchaser's conduct and the statutory condition of actual tax payment. While the Court has rightly held that the supplier's fraud cannot automatically be attributed to the purchaser, the precise scope of the “direct link” requirement remains open for clarification in subsequent cases.

Must the department proceed against the supplier first?

The Court's reliance on Section 76, which provides for recovery where a supplier collects tax but fails to pay it to the Government, raises another important issue. The Court emphasised that the statutory mechanism against the supplier cannot be ignored while examining the purchaser's ITC claim. It also directed the proper officer to ascertain and record the status of proceedings and recovery against the supplier.

However, the judgment does not expressly establish an absolute rule that recovery proceedings against the supplier must be exhausted before the Department can proceed against the purchaser. The existence of a recovery mechanism against the supplier and the purchaser's entitlement to ITC remain distinct questions under the statutory scheme.

The issue becomes particularly difficult where the supplier is insolvent, untraceable or otherwise incapable of paying the tax. In such circumstances, the Department may be unable to recover the amount from the supplier, while the purchaser may have no effective control over the supplier's default. The judgment requires the Department to consider the supplier-side recovery mechanism, but it does not conclusively settle how the department should proceed in every such case. The relationship between Section 76 and Section 16(2)(c) therefore remains an important area for future adjudication.

The unsettled gap in re-availment of ITC

Rule 37A, introduced in December 2022, provides for reversal and subsequent re-availment of ITC in specified circumstances where the supplier has furnished the outward-supply details but has not furnished the corresponding GSTR-3B within the prescribed period. The difficulty is that non-filing of the return and non-payment of tax are not necessarily the same thing.

A supplier may furnish GSTR-3B but fail to discharge the tax liability or may purport to discharge it by utilising ITC that is subsequently found to be inadmissible. Such situations may not fall within the specific trigger contemplated by Rule 37A, even though they can raise a dispute under Section 16(2)(c).

The difficulty is more pronounced for periods preceding the introduction of Rule 37A, when no corresponding statutory mechanism for re-availment existed. The Court has directed the proper officer to take this absence into account when determining the consequences of the supplier's default. However, it has not created a universal alternative mechanism for restoring credit in every case where the existing statutory route does not apply.

This leaves an important question unanswered: where the supplier eventually deposits the tax, but the purchaser's case does not fall within the specific mechanism for re-availment, how is the reversed credit to be restored? The judgment identifies the difficulty and requires the relevant statutory framework to be considered, but the precise route to relief in every such situation remains open.

A judicial check and a step towards fairness

Shaurya Alloys is significant because it addresses the consequences of supplier default within the wider GST framework, including retrospective cancellation of registration, the recovery mechanism under Section 76, re-availment under Rule 37A and the invocation of Section 74 where fraud, willful misstatement or suppression is alleged against the purchaser. Most importantly, it makes clear that Section 16(2)(c) cannot be invoked mechanically, without examining the transaction and the circumstances of the supplier's default.

The judgment maintains a balance between two competing considerations: the Government's legitimate requirement that tax must reach the treasury, and the need to ensure that a purchaser is not automatically made to bear the consequences of a supplier's independent default. Yet the Court has not removed the statutory condition of actual tax payment or guaranteed that every bona fide purchaser will retain ITC. The final outcome will continue to depend on the facts, the evidence and the statutory scheme applicable to the relevant tax period.

For businesses, the message is clear: maintaining a complete documentary trail is essential, but the Department must also investigate the supplier's default and disclose the basis on which the purchaser's credit is questioned. For tax administration, a supplier's default may start an inquiry, but it cannot be the end of that inquiry.

Conclusively, Shaurya Alloys has drawn a judicial check against mechanical denial of ITC, while leaving important questions for future adjudication. The lasting test of the judgment will be whether its safeguards ensure that the genuine purchaser is not made the default bearer of another person's tax liability, without disregarding the legal requirement that ITC can be claimed only when the conditions under GST law are satisfied in future.

Author is an Advocate practicing at Punjab and Haryana High Court. Views are personal.