OCTOBER 19, 2024

By Suja Ananthakrishnan, Advocate

RULE 86A of the Central Goods and Services Tax Rules, 2017 empowers the Commissioner or any officer authorized by the Commissioner, not below the rank of an Assistant Commissioner, to block any taxpayer from debiting the electronic credit ledger for a limited period of time when the Commissioner or any other authorized officer has reason to believe that the ITC has been availed fraudulently.

The power to block ITC under Rule 86A can be exercised by the authorized officer for the following reasons:

1. When the supplier is non-existent or the supplier of the goods or services is not conducting the business from the registered place.

2. When there is non-receipt of goods or services or both.

3. When the ITC has been availed on documents on which the tax has not been paid to the Government.

4. When the recipient is non-existent or the recipient is not conducting the business from the registered place.

5. When the recipient is not in possession of the documents (under Rule 36) for availing ITC.

Rule 86A(3) specifies that the blocking of ITC cannot exceed a period of 1 year.

As said, blocking of the ITC was a previously unheard-of power in the field of indirect taxes and there had initially been doubts cast on whether such powers could be exercised and whether the same was violative of Sections 16 and 17 of the CGST Act, 2017.

However, the Hon'ble Gujarat High Court in S.S. Industries v. Union of India, 2020-TIOL-2228-HC-AHM-GST has upheld the DGGSTI's power to block the taxpayer's ITC in the electronic credit ledger under Rule 86A of the CGST Rules, 2017. The Hon'ble Gujarat High Court in this case has observed that 'there is something which the Revenue has noticed and, therefore, are looking into the same before taking any final call as regards the claim of the Writ Applicants to avail the ITC'. Based on this reasoning, the Hon'ble Gujarat High Court has categorically held that the powers under Rule 86A can be invoked during the pendency of the inquiry or investigation. The Hon'ble Gujarat High Court also held that availment of ITC and its utilization are two different stages, and there is no vested right of the taxpayer before taking credit.

Thus, the authority can block the ITC of the assessee if he has reasons to believe that the ITC has been fraudulently availed.

The expression 'reason to believe' in Rule 86A casts a strict obligation on the authorized authority to form an opinion regarding the blocking of the ITC, based on the facts of the case. The Hon'ble Karnataka High Court in K-9 Enterprises 2024-TIOL-1739-HC-KAR-GST has held that the 'reasons to believe' have to be strictly complied by the authorized authority. The Hon'ble Karnataka High Court in this case also emphasized that the pre-decisional hearings prior to blocking of Electronic Credit Ledger are mandatory. The decision in K-9 Enterprises was followed by a Single Member Bench of the Hon'ble Karnataka High Court in M/s. Lead Factory v. Assistant Commissioner of Commercial Taxes, 2024-TIOL-1697-HC-KAR-GST. Further in the M/s. Lead Factory case, it was also observed that the order blocking the Electronic Credit Ledger under Rule 86A did not contain any cogent 'reasons to believe' and for both the reasons the Hon'ble Karnataka High Court quashed the order blocking the ITC.

The CBIC has issued CBEC-20/16/05/2021-GST/1552 dated 2.11.2021 to provide guidelines with regard to exercise of Rule 86A. The guidelines in the circular can be summed up as below:

1. The power under Rule 86A should not be used in a mechanical manner.

2. Disallowing the debit should be used as an extraordinary remedy.

3. Reasons for blocking the credit should be based on material evidence.

The 'guidelines' issued by the CBIC were interpreted by the Hon'ble Madras High Court in TVL J.M. Traders v. Deputy Commissioner (ST) [W. P. No. 1387 of 2024]. The Hon'ble High Court held that Rule 86A does not stipulate that a prior notice has to be given to the taxpayer. However, because of the nature of the power exercised, the reasons for exercising the power under Rule 86A have to be communicated to the taxpayer contemporaneously. In this particular case, since apart from mentioning the name of the supplier in the Electronic Credit Ledger, no reasons were provided by the authorities, the Hon'ble Madras High Court held that the taxpayer was entitled to unblocking of ITC that had been blocked under Rule 86A.

Section 86A(3) provides that blocking of ITC is permissible for a maximum period of one year.

In this context, reference may be made to the following cases:

1. Barmecha TexFab Pvt Ltd v. Commissioner, Government of Gujarat, 2022-TIOL-136-HC-AHM-GST,

2. Advent India PE Advisors Pvt Ltd v. The Union of India and Others, 2021-TIOL-2268-HC-MUM-GST

In the afore-mentioned cases, it was held that the electronic credit ledger can be blocked for the duration of one year under Rule 86A, and once the one year had lapsed, the ledger should automatically get unblocked.

The final issue with regard to Rule 86A is (a) blocking of credit and (b) creating negative liability.

Under Rule 86A, the Commissioner or the other authorized authority can block the taxpayer's electronic credit ledger by these two methods:

1. Blocking the input ITC available in the electronic credit ledger and

2. By blocking the anticipated ITC, which has to be availed in the electronic credit ledger.

The preceding paragraphs make it amply clear that the first question, i.e., blocking of input ITC available in the electronic credit ledger can be carried out by the authorized officer for a maximum period of one year, when the authorized officer has reason to believe that the ITC has been availed fraudulently.

The issue is with regard to the second question viz. Can future credits be set off or blocked under Rule 86A?

Reference may be made to the words in Rule 86A: '….may, for reasons to be recorded in writing, not allow debit of an amount equivalent to such credit in electronic credit ledger for discharge of any liability under section 49 or for claim of any refund of any unutilised amount.'

Sections 49(4) and (5) refer to the amount available in the electronic credit ledger. 'This amount available' can only mean the amount already existing in the Electronic Credit Ledger. In case of future dues, the amount is not available in the Electronic Credit Ledger at the time that the authorized officer blocks such credit.

Therefore, this act of blocking future dues (Negative blocking) is clearly beyond the purview of Rule 86A.

The Hon'ble Gujarat High Court in Samay Alloys India Pvt Ltd, 2022-TIOL-246-HC-AHM-GST on the same issue ruled in favour of the taxpayer. In this case, the Hon'ble Gujarat High Court held that 'The Rule 86A empowers the proper officer to disallow debit from the electronic credit ledger for an amount equivalent to the amount claimed to have been fraudulently availed. Accordingly, the rule provides for restriction on an amount and not on the very credit which is fraudulently availed. Accordingly, the rule can be invoked even when the credit fraudulently availed is utilised.' Thus, the Hon'ble Gujarat High Court had held that the department has no power to negatively block the credit to be availed in the future, and the Hon'ble Court has even observed that the blocking of the credit under Rule 86A and insertion of the negative balance when no ITC is available is without jurisdiction and illegal.

The Hon'ble Telangana High Court in Laxmi Fine Chem in W.P. No. 5256 of 2024 dated 18.3.2024 has followed the reasoning of the Hon'ble Gujarat High Court and held that the authorities do not have the power to block the credit that the taxpayer could avail in the future because Rule 86A allows blocking of ITC up to the amount available in the taxpayer's credit ledger.

In the Best Crop Science Pvt Ltd, 2024-TIOL-1625-HC-Del-GST, the Hon'ble Delhi High Court held that there was no ambiguity in Rule 86A and its literal reading would not lead to any absurdity. In this case, the petitioner had challenged the blocking of the Electronic Credit ledger beyond the available balance. One of the contentions raised by the Revenue in this case was that Rule 86A was meant to prevent fraudulent availment of ITC and, therefore, this Rule empowered the authorized officer to block the ITC irrespective of whether or not this amount was available in the Electronic Credit Ledger. However, the Hon'ble Delhi High Court negated this contention of the Revenue.

Further, the Hon'ble High Court categorically disagreed with the High Court decisions in Basanta Kumar Shaw [Calcutta] and R.M. Dairy Products LLP [Allahabad], by observing [paragraph 62] - "We are, respectfully, unable to concur with the aforesaid interpretation for the reason that it is not in conformity with the opening line of Rule 86A(1) of the Rules. The words "credit of input tax available in the electronic credit ledger" plainly refers to the credit which is at the given point of time available in the taxpayer's ECL. If the same had already been utilized in payment of tax, penalties or other dues or has been refunded, the same would not be available in the ECL."

Similarly, in the case of PMW Metal and Alloys Pvt Ltd, 2024-TIOL-1716-HC-AHM-GST, the Hon'ble Gujarat High Court followed its earlier decision in the Samay Alloys case. Further in this case, the assessee received an email notifying about the credit blocking without any prior notice, except the reason that 'credit claimed without receipt of goods/services'. The petition was allowed directing the Revenue to withdraw the negative blocking of the Electronic Credit Ledger promptly.

It is requested that the CBIC revises its advisory Circular dated 2.11.2021 (supra) by incorporating the recent judicial pronouncements so that it becomes an all-encompassing one.

[The views expressed are strictly personal.]