GST: Tax paid, credit denied

The denial of input tax credit creates serious financial strain, especially for smaller businesses
| Photo Credit:
DHARMAPADA BEHERA

Imagine a business that purchases goods worth ₹10 lakh, paying ₹1.8 lakh as goods and services tax (GST) to the supplier. The expectation is simple — this ₹1.8 lakh should be claimable as input tax credit (ITC), allowing the business to reduce its own tax liability. But what if, due to a clerical oversight by the supplier — say, a missed invoice entry in an online return — the ITC is denied? The purchaser is then forced to pay ₹1.8 lakhs again, effectively being taxed twice for the same transaction. This is not an isolated glitch, but a structural flaw in the GST regime that continues to burden taxpayers.

At the heart of the GST lies the concept of ITC — a mechanism that prevents cascading taxes by ensuring GST is levied only on the value added at each stage of production and distribution. Without this credit chain, GST would lose its economic neutrality and operate more like a multi-layered consumption tax, inflating costs and distorting competitiveness. However, the current system tightly couples ITC entitlement to an automated reconciliation process involving 3 returns: the supplier’s GSTR-1 (outward supplies return filed by the supplier), the purchaser’s auto-generated GSTR-2A, and the final tax payment and ITC claim in GSTR-3B.

The process becomes problematic when a supplier fails to report an invoice or commits a minor error in GSTR-1. In such cases, the purchaser’s GSTR-2A reflects an incomplete picture, and their ITC claim — despite having paid the tax — is denied. The Supreme Court of India recently weighed in on this issue, asking why should businesses suffer for errors they did not commit, often discovered only after denial of credit?

The Timeline Trap

The statutory framework compounds this problem. Under Sections 37 and 39 of the Central GST Act, 2017, suppliers must file GSTR-1 (outward supplies), while purchasers must file GSTR-3B (summary return for payment and ITC claim). Both filings are subject to a strict rectification deadline — November 30 following the end of the relevant financial year. However, purchasers often become aware of mismatches only during reconciliation, typically done much later in the year. By then, the statutory window to rectify any discrepancy — whether their own or their supplier’s — has often already closed.

The result is that taxpayers are penalised for lapses over which they had no control and no real-time visibility. This elevates form over substance and undermines the intent of GST as a tax on value addition, not on clerical compliance.

Divergent Rulings

The judiciary has responded to this issue with markedly different philosophies. On one end, the Telangana High Court in Yokohama India (P) Ltd. v. State of Telangana (2022) and the Punjab and Haryana High Court in Bar Code of India v. Union of India (2024) adopted a formalistic stance, holding that ITC cannot be availed unless the credit appears in GSTR-2A. These rulings elevate procedural compliance to a determinative threshold, disregarding whether the tax was actually paid to the exchequer.

On the other hand, the Odisha High Court in Shiva Jyoti Construction (2023) held that rectification should be permitted even after the statutory deadline, so long as there is no revenue loss. It correctly frames the issue — not as one of tax evasion — but of ensuring rightful credit for tax already remitted to the exchequer.

Echoing this sentiment, the Bombay High Court in Star Engineers (I) (2023) emphasised that laws must be interpreted in light of economic realities and legislative intent. It observed that bona fide, inadvertent errors in GST filings should not lead to credit denial, particularly when the government has already received the tax. Its invocation of the principle of “freeplay in the joints” underscores the need for flexibility within the tax regime to accommodate genuine mistakes, rather than penalising good faith compliance.

Similar views have been endorsed by the Karnataka and Jharkhand High Courts, reinforcing the point that the tax framework should support — rather than sabotage — honest businesses. Denying ITC due to procedural lapses, when the tax itself has been paid, not only causes double taxation but also undermines the promise of seamless credit flow — the foundation of GST. As such, the Supreme Court’s intervention, casting doubt on the rigid reasoning in Yokohama and Bar Code of India, could mark a turning point.

The Balancing Act

The case for allowing rectification is not about bending the rules — it is about applying common sense. At the heart of it lies a basic question: Should tax law serve fairness or get stuck in paperwork? A fair tax system should not punish people for mistakes that they did not make or could not have known about. Yet under GST, taxpayers often lose out on ITC just because their suppliers made small clerical errors in filing returns. This ignores how businesses actually work, where small slip-ups are bound to happen.

Even from an etymological point of view, tax was never meant to be a penalty. The word ‘tax’ comes from the Latin taxare — meaning to assess or value — not to confiscate. As Adam Smith, in The Wealth of Nations, writing centuries before enterprise resource software, laid down that a good tax must be fair, certain, and convenient. Denying credit for honest mistakes made by someone else fails on all three counts.

But this is not just a matter of fairness. The denial of ITC creates serious financial strain, especially for smaller businesses. It increases tax costs, locks up working capital, and discourages companies from working with newer or smaller suppliers who might be more prone to filing mistakes. This hits Micro, Small and Medium Enterprises (MSMEs) the hardest — businesses that contribute around 30-40 per cent of India’s GDP and exports. They often operate on tight margins and cannot afford to be hit with surprise tax liabilities. Over time, these narrows supply chains, reduces market competition, and weakens economic resilience.

Some argue that allowing correction might lead to more fraud. But this concern is overstated. Fraud can and should be tackled through proper audits and enforcement. The real issue here is not fraud — it is that the GST system and its portal is too inflexible. The Supreme Court has rightly pointed out that software limitations should not decide tax rights. If the technology cannot handle reasonable corrections, the solution is to upgrade the system and not to deny taxpayers their legitimate dues.

Towards a functional regime

The Supreme Court’s intervention may well be the turning point towards a more rational, fair, and economically sound GST framework. If GST — designed to tax value addition, not mistakes — is to truly support economic progress, it cannot become a tool for quiet overreach. After all, when legitimate credit is blocked for technical lapses, the result is not better compliance, but inflated revenue at the taxpayer’s expense. As the late Justice Benjamin Cardozo (US Supreme Court) put it, “The law, like the traveler, must be ready for the morrow. It must have a principle of growth.” This should guide GST’s evolution towards substance over form, and fairness over formality.

The writer is an advocate before the Delhi High Court

Published on April 8, 2025