"Invoice Cancelled? Tax Still Due." - Madras HC on Why Cancelling Invoices Won't Magically Erase GST Liability

Can you escape GST liability simply by cancelling an invoice after a deal falls through? The Madras High Court's decision in Sudhan VFX v. Superintendent [2025(11)LCX0197] offers a crisp-if uncomfortable-answer: No. If you've raised an invoice and declared the corresponding outward supply in GSTR-1, the tax liability can arise even if you never receive payment. A unilateral, after-the-fact "invoice cancellation" is not a silver bullet. You must prove, with books and contemporaneous documents, that no supply ever took place or that the declared liability has been lawfully reversed within the GST framework.

This article unpacks the facts, the procedural backdrop (Rule 88C, DRC-01B and recovery), the Court's reasoning, and the practical compliance playbook taxpayers should adopt to avoid getting caught in the GSTR-1 vs. GSTR-3B mismatch net.

• The dispute: A GST recovery notice for Rs.39,60,000 of IGST for the tax period 4–5 July 2023.

• Taxpayer's stand: Invoices were raised but the contract never fructified, no consideration was received, and therefore no tax was payable. The transactions were reported in GSTR-1 but omitted in GSTR-3B. A DRC-01B intimation under Rule 88C was replied to the same day, asserting that the invoices had been cancelled and no payments were received.

• Department's stance: Liability arose because the taxpayer declared the supplies in GSTR-1; recovery under Section 79 was, therefore, justified.

• What the Court said:

○ The taxpayer's reply was incomplete and unsubstantiated.

○ Non-receipt of payment does not, by itself, extinguish liability once an invoice and outward supply have been declared.

○ If the taxpayer truly made no supply, the claim must be evidenced by annual books of account and other contemporaneous records. Unilateral invoice cancellation later is "of no avail."

○ The matter was remanded: the taxpayer must file a proper, evidence-backed reply within the time allowed; failing which, the petition stands dismissed.

Bottom line: The Court did not finally decide the tax liability. It insisted on proof-and reminded that payment is not the trigger for liability in such situations.

Under GST, the time of supply for services (Section 13) generally hinges on the earlier of:

1. the date of invoice (if issued within the prescribed time) or

2. the date of receipt of payment.

Once you issue a tax invoice declaring a taxable supply, the law typically fastens liability on that declaration, even if the money hasn't arrived. The architecture of returns reinforces this: GSTR-1 is the declaration of outward supplies, while GSTR-3B is the self-assessment and payment of that liability. If you disclose a supply in GSTR-1 but fail to pay it in GSTR-3B, you create a mismatch. The system (via Rule 88C) then nudges you to either pay or explain-and if you neither pay nor convincingly explain, recovery can follow.

In other words, non-receipt of payment is a commercial reality but not a legal excuse, absent a legally recognised reversal (e.g., credit notes) within stipulated timelines or conclusive proof that no supply ever occurred.

Rule 88C is the guardrail against under-payment when outward supplies reported in GSTR-1 exceed tax actually paid via GSTR-3B. The steps:

1. System flags difference between liability in GSTR-1 and tax paid in GSTR-3B.

2. Intimation (DRC-01B) is issued, inviting the taxpayer to pay the differential or explain the variance with reasons and evidence.

3. If you don't pay or your explanation fails, the officer may move to recovery (Section 79) or initiate proceedings under Sections 73/74, depending on the context and instructions in force.

In Sudhan VFX [2025(11)LCX0197], the taxpayer did respond but merely asserted that "invoices were cancelled" and "no payment was received." The Court found this insufficient-especially where GSTR-1 had already disclosed the outward supply. The Court stressed the need to corroborate the claim with annual books and proper evidence.

The Court's sharpest caution is this: "Unilateral invoice cancellation" after you've declared an outward supply is not a recognised GST cure-all. The law provides specific tools:

• E-invoice cancellation window: If an e-invoice (IRN) was generated, there is a narrow window to cancel that IRN. Once it closes, you can't "cancel" the invoice in the portal-you must reverse via a credit note.

• Credit notes (Section 34): Where the value of supply is reduced, or supply is not provided, or the agreement is rescinded, you may issue a credit note subject to statutory timelines. This flows through GSTR-1 (credit/debit note tables) and reduces liability for the relevant period. Outside the permitted window, you cannot reduce tax via credit notes; your only route is civil recovery from the recipient (commercially) or other remedies-not a retrospective tax deletion.

• Books of account: Your ledger trail must match the story you tell. If your books show the amount as receivable at year-end, a later "cancellation" looks suspect. If your books and audit trail reflect no accrual-because the contract genuinely failed-your defense strengthens.

Takeaway: GST demands formal reversals within time and documentary harmony. Anything else is noise.

Importantly, the High Court didn't summarily uphold the recovery. It remanded the matter, directing the department to pass a fresh order within 30 days and directing the taxpayer to file a proper, evidence-backed reply within that time-failing which, the writ would be deemed dismissed. This approach respects natural justice while signalling that bare assertions aren't enough.

Here's a structured response strategy to keep you compliant and persuasive.

• Was an IRN generated? If yes, check whether the cancellation window is still open. If open, cancel the IRN immediately. If closed, move to credit note mechanics.

• Was the supply actually rendered-wholly, partly, or not at all? Capture this in a contemporaneous note with email trails, correspondence, and internal job sheets.

• What did you declare in GSTR-1? Identify invoice numbers, dates, and amounts that hit GSTR-1.

• No supply actually made? Issue a credit note referencing the original invoice(s), citing "contract rescission/no service delivered," within statutory timelines. Report it in GSTR-1 (CDN tables) of the relevant tax period.

• Partial supply? Consider a partial credit note for the unapplied portion; adjust valuation and tax accordingly.

• E-invoice already beyond cancellation window? Credit note is your lawful reversal-not a portal "delete."

• Revenue recognition: Ensure the general ledger reflects no accrual where no supply was delivered. If revenue was initially accrued, reverse with proper narration and board-approved documentation where necessary.

• Receivables ledger: Close out the customer receivable with the credit note (and any write-offs if commercially relevant).

• Working papers: Maintain a reconciliation pack tying invoices, credit notes, return disclosures (GSTR-1, GSTR-3B), and trial balance movements.

When Rule 88C intimation arrives:

• Attach documentary proof: Cancelled IRN acknowledgment or credit note details; emails evidencing contract failure; work completion certificates (or lack thereof); POs and termination notices; any refund of advances if taken.

• Reconciliation statement: A table mapping each invoice in GSTR-1 to its credit note (or IRN-cancellation) with dates and amounts; show the net effect in GSTR-3B.

• Books-to-return bridge: A one-pager showing how trial balance mirrors the reversal.

• Affidavit or management declaration (where appropriate): Close the narrative gaps.

• Sales governance: Don't raise tax invoices until contract conditions precedent are met (e.g., client sign-off, delivery milestones).

• Provisional documentation: Where business pressure compels early paperwork, consider issuing a proforma invoice or work order acknowledgement rather than a tax invoice.

• Return discipline: Align GSTR-1 and GSTR-3B; perform pre-filing checks for mismatches, especially around month-end rushes.

• Credit note timeliness: Calendarize deadlines and automate reminders; late reversals are often worthless for tax reduction.

The Court's insistence on annual books as an anchor is a reminder: adjudication often turns on quality of evidence. The following bundle usually persuades:

• Board/management note recording contract non-fructification;

• Email/letter trail with the customer confirming cancellation or non-performance;

• Job/production logs showing no service delivery or a halted project;

• IRN cancellation acknowledgement (if within window) or credit notes duly reported;

• Ledger extracts showing revenue reversal and closure of receivable;

• GSTR-1 and GSTR-3B reconciliation demonstrating the tax effect of reversal.

Without this, a post-facto "invoice cancelled" line in a DRC-01B reply looks like a convenient assertion rather than a verifiable fact.

Service contracts frequently evolve-scope shifts, deliveries slip, and clients back out. In that world, the Sudhan VFX order teaches four big lessons:

1. The moment you put an invoice into the tax system, you take on a presumption of supply. Rebutting that presumption needs timely statutory reversals and coherent accounting.

2. Cash is not king for time of supply. GST liability isn't deferred merely because you haven't been paid.

3. The portal is not your accountant. Deleting or "cancelling" entries outside prescribed workflows does not make tax exposure disappear.

4. Process beats firefighting. Good sales controls and return discipline will save months of litigation grief.

Q1. If no service was actually delivered, do I still owe GST merely because I issued an invoice?

Yes, unless you reverse it correctly. If an invoice entered the system, the time of supply likely triggered. You must cancel the IRN within the allowable window or issue a credit note (within statutory timelines) and ensure your books and returns reflect the reversal. Mere "cancellation" after the fact, without these steps, won't shield you.

Q2. Can I just show that I never received money and get relief?

No. Non-receipt of consideration is not, by itself, a ground to nullify tax once supply is declared. You need to prove no supply (with records) or lawfully reverse the earlier declaration.

Q3. What if I miss the credit-note deadline?

Then you generally cannot reduce output tax through the return flow. Your remedy may be commercial (renegotiate/collect) or civil, but the tax return mechanism won't allow a late reduction.

Q4. How detailed must a DRC-01B reply be?

Very. Attach documentary proof, provide a line-by-line reconciliation, and align it to ledger movements and returns. A bare assertion will almost certainly invite recovery.

The Madras High Court here acted at the admission stage and chose a process-oriented remedy: remand with a direction to decide afresh within 30 days and a clear warning-file a proper, evidence-backed reply or face dismissal. The Court's observations on liability and the insufficiency of unilateral invoice cancellation are persuasive and practical. While not a final adjudication on merits, they will likely influence how assessing officers and appellate authorities treat GSTR-1/3B mismatches where taxpayers claim that no supply occurred.

• Before invoicing: Confirm milestone completion; prefer proforma for tentative stages.

• If a deal collapses post-invoice:

○ Cancel IRN within the allowed window, or

○ Issue a credit note promptly and report it correctly.

• Monthly close: Reconcile GSTR-1 vs. GSTR-3B; pre-empt Rule 88C triggers.

• When DRC-01B arrives: Respond with evidence, reconciliations, and books-to-return bridges.

• Year-end: Ensure the trial balance does not carry receivables for supplies you claim never happened.

• Documentation: Maintain email trails, SOWs, termination notices, job logs, management notes.

Sudhan VFX v. Superintendent [2025(11)LCX0197] is a timely reminder that, in GST, form must follow law-not convenience. Once a supply is declared in GSTR-1, the liability presumption attaches. To unwind it, you need timely statutory reversals (IRN cancellation or credit notes) and consistent accounting evidence. Unilateral, late-stage "invoice cancellation" is not a compliant cure.

If your contract genuinely fell apart, the law provides a path to cleanse the tax trail-but you must walk it properly, on time, and with proof in hand.

Disclaimer: The information given in this article is solely for purpose of understanding the law. It is completely based on the interpretation of the author and cannot be constituted as a legal advise, the author of this article and Lawcrux team is not responsible for any legal issues if arises on the basis of the interpretation given above.