Karnataka High Court Clarifies Rule 86A Cannot Be Invoked Against Supplier for Alleged Wrongful ITC Availment by Customer

Background: The petitioner challenged a show-cause notice issued under Rule 86A of the Central Goods and Service Tax (CGST) / Karnataka Goods and Service Tax (KGST) Rules, 2017, which blocked Input Tax Credit (ITC) in the petitioner’s Electronic Credit Ledger. The notice alleged that the petitioner had supplied goods to M/s. Million Lights by passing on fraudulent ITC without actual supply of goods, and sought to treat such transactions as irregular.

Arguments: The petitioner contended that Rule 86A could only be invoked where the petitioner itself had wrongfully availed ITC, not where the allegation was that the petitioner’s customer had availed ITC illegally. The petitioner further argued that output tax had been paid on the transactions in question, and thus the power under Rule 86A was not applicable. The respondent, representing the tax department, submitted that investigations were ongoing regarding the customer’s wrongful availment of ITC and pointed to admissions allegedly made by the petitioner’s partner regarding issuance of invoices without actual supply of goods.

Court’s Reasoning: The Court undertook a detailed analysis of Rule 86A, which empowers the Commissioner or an authorized officer to restrict the use of ITC in the electronic credit ledger if it has been fraudulently availed or is otherwise ineligible. The Court emphasized that the rule applies only in specific circumstances, such as when ITC is availed on the basis of documents from non-existent suppliers, without receipt of goods or services, or where the tax charged has not been paid to the government. The Court found that the allegations in the present case related solely to the customer (M/s. Million Lights) allegedly availing ITC on the basis of invoices issued by the petitioner without actual supply of goods. There was no allegation that the petitioner itself had fraudulently availed ITC or was not conducting business from its registered place.

The Court clarified that while Rule 86A may be invoked against the customer who allegedly availed ITC fraudulently, it cannot be pressed into service against the supplier (the petitioner) in the absence of allegations that the supplier itself availed ineligible ITC. The jurisdiction under Rule 86A is limited to preventing utilization of credit by the person who has fraudulently availed or is ineligible for such credit, and not for penalizing suppliers for the actions of their customers.

Decision: The Karnataka High Court held that the show-cause notice issued to the petitioner under Rule 86A was without jurisdiction and therefore set it aside. The Court directed that the petitioner’s blocked Electronic Credit Ledger be unblocked forthwith. It was clarified that the observations were limited to the present proceedings and all other contentions of the Department were kept open. The writ petition was accordingly disposed of.