FAKE INPUT TAX CREDIT (ITC) UNDER GST – DETAILED LEGAL ANALYSIS

Under GST law, Input Tax Credit (ITC) is a statutory benefit, not an absolute right. Fake ITC arises when credit is:

• Availed without actual supply of goods or services, or
• Availed based on invoices issued by fake / non-existent suppliers, or
• Availed with intent to evade tax, even if documents appear valid.

Fake ITC is considered tax evasion by design, often involving multiple layers of shell entities.

---

Section-wise Legal Provisions

---

A. Section 16 – Conditions for Availment of ITC

ITC can be availed only if all conditions are cumulatively satisfied:

1. Possession of a valid tax invoice
2. Actual receipt of goods/services
3. Tax charged has been actually paid to the Government
4. Recipient has filed returns
5. ITC reflects in GSTR-2B

📌 Failure of any one condition makes ITC ineligible

---

B. Section 16(2)(c) – Supplier’s Tax Payment

This provision is heavily litigated.

• Department’s stand: If supplier has not paid tax → ITC is fake
• Judicial view: Recipient cannot be punished for supplier’s default if bona fide is proved

Courts insist on:

• Proof of collusion
• Knowledge of fraud
• Lack of due diligence

---

C. Section 17 – Blocked Credits

Fake ITC cases often involve:

• ITC on personal consumption
• ITC on goods not used in business
• Ineligible capital goods

---

Recovery Provisions

---

A. Section 73 – Non-fraud Cases

Applicable when:

• No fraud
• No wilful misstatement
• No suppression

Consequences:

• Tax + Interest (Section 50)
• Penalty up to 10% of tax or ₹10,000

---

B. Section 74 – Fraud / Suppression

Invoked in fake ITC cases by default.

Key elements:

• Fraud
• Wilful misstatement
• Intent to evade tax

Consequences:

• Tax + Interest
• 100% penalty
• Extended limitation period (5 years)

📌 Burden of proving fraud lies on the department

---

Penal Provisions – Section 122

Penalty imposed if a person:

• Issues fake invoice
• Avails ITC without receipt of goods
• Utilises fake ITC

Penalty:

₹10,000 or amount of tax involved – whichever is higher

Both supplier and recipient can be penalised.

---

Prosecution & Arrest – Sections 69 & 132

---

A. Nature of Offence

Fake ITC is classified as:

• Cognizable
• Non-bailable (above ₹5 crore)

---

B. Quantum-based Punishment

📌 Arrest should be last resort, not routine

---

C. Supreme Court & HC View

• Arrest cannot be mechanical
• Reasons must be recorded
• Arrest before adjudication requires extraordinary circumstances
• Bail is the rule, jail is the exception

---

Procedural Powers of Department

---

A. Rule 86A – Blocking of ITC

Electronic Credit Ledger can be blocked if:

• ITC fraud suspected
• Invoice without supply
• Supplier non-existent

Limitations:

• Max blocking period: 1 year
• Reasons must be recorded in writing

Courts have struck down arbitrary blocking.

---

B. Section 67 – Search & Seizure

Allowed if:

• Reasons to believe
• Tax evasion involved

Illegality arises when:

• No authorization
• Fishing enquiries

---

Investigation Methodology Used by Department

• Supplier chain analysis
• Bank account trail
• IP address & common login analysis
• Transport verification
• Stock & consumption ratio
• Statement under Section 70

📌 Statement alone cannot sustain demand unless corroborated

---

Judicial Precedents – Key Principles

Courts have repeatedly held:

✔️ ITC cannot be denied merely because supplier is bogus
✔️ Burden to prove fake ITC lies on department
✔️ Recipient’s due diligence is relevant
✔️ Mens rea must be established for prosecution
✔️ Portal-only SCN service is insufficient (Sec 169)

---

Defence Strategy in Fake ITC Cases

Documentary Evidence

• Purchase invoices
• E-way bills
• Lorry receipts
• Weighment slips
• Stock register
• Production records

Financial Trail

• Payment through bank
• No cash dealings

Legal Grounds

• No collusion
• Supplier active at time of transaction
• Violation of natural justice
• Rule 86A misuse
• Invalid SCN service

---

Preventive Compliance Measures

• Supplier verification before onboarding
• Monthly GSTR-2B reconciliation
• Avoid paper-only suppliers
• Maintain transport evidence
• Periodic vendor audit

---

Important Practical Distinction ⚠️

---

Conclusion

Fake ITC is treated as one of the gravest GST offences, but every ITC dispute is not fake ITC. Courts have consistently protected genuine taxpayers and discouraged arbitrary arrests and coercive recovery.