ITC Trap: When Honest Traders Pay the Price for Someone Else's GST Default

Input Tax Credit was supposed to be the clean engine of GST. Pay tax on purchases, use the goods or services for business, and take credit. On paper, elegant. On the ground, brutal. Across India, honest traders are finding that even after paying vendors through banking channels, holding proper invoices, and recording purchases in their books, their ITC is still being denied because the supplier later turns non-compliant, vanishes, files the wrong return, or gets registration cancelled retrospectively. That is the ITC trap: the buyer pays tax once to the supplier, and then is asked to pay again to the department.

The emerging case law shows that courts are trying to strike a difficult balance. They are not giving blanket protection to every buyer. At the same time, they are increasingly refusing to let the department treat every purchaser like a conspirator merely because the supplier defaulted. Read together, the judgments show two parallel themes: first, the buyer must prove that the transaction is genuine; second, once the transaction appears genuine, ITC cannot be mechanically denied only because the supplier failed in post-sale compliance.

The sharpest warning to taxpayers comes from the Supreme Court in State of Karnataka v. Ecom Gill Coffee Trading Pvt. Ltd. Decided under the KVAT regime on 13 March 2023, the Court held that the burden of proving the correctness of the ITC claim lies on the purchasing dealer. It said that being a “bona fide purchaser” is not enough by itself. Mere invoices and cheque payments do not discharge the burden. The purchaser must establish actual physical movement of goods and the genuineness of the transaction, including details such as the seller's particulars, delivery vehicle, freight, acknowledgment of delivery, invoices, and payment trail. In other words, paper without commercial reality will not save ITC.

That judgment is often cited by the department as if it settles everything in its favour. It does not. Ecom Gill is a serious evidentiary decision, but it is not a licence for blind ITC reversal. It says the buyer must prove a real transaction; it does not say that every buyer must automatically suffer because the seller later defaults. The distinction matters. If the allegation is that the goods never moved and the invoices are accommodation entries, Ecom Gill hurts the taxpayer badly. But if the goods were actually received, paid for, recorded, and used, then a different line of GST judgments becomes relevant.

That protective line begins prominently with the Madras High Court's decision in D.Y. Beathel Enterprises v. State Tax Officer on 24 February 2021 [2021(02)LCX0204]. There, the department sought to saddle the buyers with tax liability because the sellers had not remitted tax to the Government. The Court found the enquiry fundamentally flawed because the sellers were not even properly confronted, despite the buyers insisting on it. The Court quashed the orders, directed fresh enquiry, required the sellers to be examined as witnesses, and specifically said recovery action should also be initiated against them. This is crucial: the Court recognised that if the tax has not reached the Government, liability may ultimately fall somewhere, but the department cannot lazily bypass the supplier and pounce on the purchaser first.

The Calcutta High Court strengthened that approach in Suncraft Energy Pvt. Ltd. v. Assistant Commissioner, State Tax on 2 August 2023 [2023(08)LCX0001]. The dispute arose from invoices not reflecting in the buyer's GSTR-2A for FY 2017-18. The Court noted earlier GST clarifications that GSTR-2A is only a facilitative tool and that there should be no automatic reversal of ITC merely because the seller has not paid tax. It held that the department had not conducted any real enquiry against the supplier, had ignored the buyer's invoices and bank statements, and ought first to proceed against the selling dealer. Only in exceptional situations-such as collusion, missing dealer, closed business, or lack of assets-could direct action against the buyer be justified. The Court therefore set aside the demand.

That relief gained further practical weight when the department's SLP against Suncraft was dismissed by the Supreme Court on 14 December 2023, leaving the Calcutta High Court's relief undisturbed. Even so, the real reasoning continues to be the High Court's: mismatch in GSTR-2A or 2B, by itself, cannot become a shortcut for recovery from a purchaser who has documentary proof and whose supplier has not first been seriously pursued.

The Calcutta High Court took the same fairness principle into another common departmental tactic: retrospective cancellation of the supplier's registration. In Sanchita Kundu & Anr. v. Assistant Commissioner of State Tax on 5 May 2022 [2022(05)LCX0012], ITC was denied because the supplier's registration had been cancelled retrospectively, covering the transaction period. The petitioners argued that the transactions were genuine, the suppliers appeared valid on the Government portal at the time, payment was made through banks, and they could not be blamed for later discoveries that the suppliers were fake unless collusion was established. The Court accepted that, without further verification, it could not be said that the buyers had failed in their statutory obligations. It set aside the orders and directed reconsideration on the basis of documents, timing of cancellation, and genuineness of purchases.

That reasoning was reaffirmed in Gargo Traders v. Joint Commissioner, Commercial Taxes on 12 June 2023 [2023(06)LCX0015]. There too, the supplier's registration had been cancelled retrospectively. The buyer showed invoice-cum-challan, e-way bill, transportation bill, and bank statements, and argued that the supplier's registration was shown as valid on the portal at the time of transaction. The Court recorded that there was no allegation of collusion, observed that without proper verification it could not be said that the buyer had failed in any statutory obligation, and held that the authorities had rejected the claim merely on retrospective cancellation without considering the taxpayer's documents. The impugned orders were set aside for fresh consideration.

The latest and perhaps most significant judicial pushback is the Gauhati High Court Division Bench decision in McLeod Russel India Ltd. v. Union of India dated 9 December 2025 [2025(12)LCX0020]. The Court dealt directly with Section 16(2)(aa), which links ITC entitlement to the supplier furnishing invoice details in GSTR-1 and those details appearing in the recipient's auto-generated statement. The Court acknowledged the anti-evasion objective behind the provision but also recognised the practical impossibility faced by genuine buyers. It observed that denial of ITC for supplier-side GSTR-1 default can be arbitrary because the buyer often has no control over that compliance. The Bench therefore read down the provision, at least until CBIC evolves a practical solution, and held that before denying ITC, a bona fide purchaser must be given an opportunity to prove its bona fides through tax invoices and other documents.

So where does this leave the trader? The answer is uncomfortable but clear. Courts are not saying, “Buyer always wins.” They are saying, “Department must distinguish between a fake claim and a genuine claim.” If the department proves that the transaction itself is bogus, Ecom Gill becomes a major hurdle. But if the buyer can show real receipt of goods or services, real payment, real business use, no collusion, and reasonable due diligence at the time of purchase, then Beathel, Suncraft, Sanchita Kundu, Gargo Traders, and McLeod Russel become powerful shields against mechanical denial.

The practical lesson is that ITC litigation is now largely an evidence war. A trader who keeps only the tax invoice is exposed. A trader who keeps the full commercial trail is in a much stronger position. Read together, these cases suggest a working litigation file should include: tax invoice, e-way bill, lorry receipt or transporter document, vehicle details, delivery acknowledgment, weighment or gate entry where relevant, stock register entry, purchase register, payment proof through banking channels, supplier GST registration status as appearing on the portal at the time of transaction, correspondence with supplier, and proof of onward sale or use in business. These are not merely accounting niceties anymore; they are survival documents.

There is also a compliance lesson for the department. These judgments repeatedly reject the temptation to convert system mismatch into adjudication. GSTR-2A or 2B is useful, but not conclusive. Retrospective cancellation is relevant, but not self-executing against the buyer. Supplier default matters, but cannot erase the buyer's rights without enquiry. And if the State wants to call a transaction fake, it must do the hard work of investigation, not rely on portal labels and assumptions.

The real tragedy of the ITC trap is that it punishes the wrong kind of risk. GST was sold as a trust-based value added system. Yet in practice, many traders are being told to underwrite the tax morality of every supplier in their chain. Courts are now pushing back against that excess, but only for taxpayers who can show clean hands and credible records. Good faith alone is no longer enough. Good faith, backed by documents, diligence, and demonstrable commercial reality-that is what survives scrutiny.

In that sense, the modern ITC battle is no longer just about Section 16. It is about proof, process, and proportionality. The strongest reading of the present case law is this: a genuine buyer should not lose lakhs merely because a supplier later defaults, disappears, or misfiles returns; but the buyer must be ready to prove, in exacting detail, that the transaction was real from day one. That is both the warning and the hope emerging from the courts.

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.