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:
- Possession of a valid tax invoice
- Actual receipt of goods/services
- Tax charged has been actually paid to the Government
- Recipient has filed returns
- 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
| ITC Amount | Imprisonment |
|---|---|
| ₹1–2 crore | Up to 1 year |
| ₹2–5 crore | Up to 3 years |
| Above ₹5 crore | Up to 5 years |
📌 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 ⚠️
| Situation | Legal Outcome |
|---|---|
| Fake invoice + no goods | Fake ITC (fraud) |
| Goods received, supplier defaulted | ITC generally allowed |
| Clerical mismatch | Rectifiable |
| Circular trading | Serious offence |
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.