Understanding Input Tax Credit (ITC) and the Issue of Fake Invoicing under GST

[Pallavi Prakash]

The Goods and Services Tax (GST) was introduced with the promise of seamless credit for both goods and services throughout the supply chain, with a few exceptions. One of the core components of the GST system is Input Tax Credit (ITC), which refers to the GST paid by a registered taxpayer on the purchase of goods and services for business purposes. ITC is considered a crucial element of the GST regime because, without it, there would be a cascading effect of taxes, leading to increased costs for businesses.

The Problem of Fake Invoicing

In the context of GST, fake invoicing refers to the creation of invoices with the sole intention of claiming ITC or other GST benefits without actually conducting any real transactions. This fraudulent activity is a significant violation of GST laws and can lead to severe penalties for those involved.

Importantly, the penalties for fake invoicing do not only apply to the person or entity issuing the fake invoice. Even if a business unknowingly uses such an invoice, they could be held liable. At the conclusion of investigations, authorities may issue a Show Cause Notice (SCN) or initiate other punitive actions. This makes it critical for businesses to ensure that all invoices are genuine and compliant with the law.

Landmark Judgments on ITC and Fake Invoicing

• Engineering Tools Corporation vs. Assistant Commissioner (2024 (2) TMI 855 - MADRAS HIGH COURT)[1]

The Engineering Tools Corporation case marked an important moment in taxation law by emphasizing the need for a detailed examination of evidence before rejecting an ITC claim. This case highlighted the rights of taxpayers and ensured fairness in tax assessments. The ruling clarifies that ITC cannot be denied merely because a supplier's GST registration has been retrospectively canceled. This case underscores that tax authorities must conduct thorough investigations before rejecting ITC claims.

• M/S LGW Industries Limited & Ors vs. Union of India & Ors (2021 (12) TMI 834 - CALCUTTA HIGH COURT)[2]

In this case, the Calcutta High Court ruled that a buyer or recipient of goods and services cannot be penalized if they have fulfilled all legal obligations and were unaware of their supplier's non-compliance with GST regulations. The court held that ITC cannot be denied solely based on the cancellation of a supplier’s GST registration, provided the transaction was genuine. This ruling has set a precedent, advising businesses to perform comprehensive verification of suppliers before entering into transactions. It also emphasizes the importance of maintaining proper documentation to substantiate the validity of ITC claims.

Comparing European and Indian Approaches to Input Tax Credit

When comparing the treatment of ITC in Europe and India, there are some clear differences:

European Court of Justice (ECJ): In Europe, the ECJ has provided a clear entitlement to input tax deduction. Once ITC is validly claimed, it is generally protected and upheld.

Indian Courts: In India, the legal position is less straightforward. While Indian courts recognize the validity of ITC, they do not treat it as an absolute right. The Supreme Court of India, in the case of State of Karnataka vs. M.K. Agro Tech Pvt. Ltd. (2017), emphasized that the scope of ITC is determined by legislation and not by judicial interpretation. Although courts like the Madras High Court and Calcutta High Court have upheld the rights of taxpayers in specific cases, the protection of ITC in India is not as robust as in the European framework.

Way Forward: Recommendations to Combat Fake Invoicing

To address the issue of fake invoicing and safeguard the ITC framework under GST, the following measures are essential:

• Strengthen Legal Framework: There is a need for more stringent laws to prevent and penalize fake invoicing practices.
• Improve Detection Mechanisms: Authorities should enhance methods to identify fake invoicing early in the transaction process.
• Educate Buyers: Businesses should be educated about their rights concerning invoices received from suppliers and the process of claiming ITC. Buyers should be encouraged to verify the compliance status of their suppliers.
• Encourage Best Practices: Companies should adopt best practices in maintaining documentation and verifying the validity of transactions to avoid complications with ITC claims.

Conclusion

Input Tax Credit remains a vital element of the GST system, but the problem of fake invoicing threatens its effectiveness. Recent court rulings have underscored the need for fairness in tax assessments, ensuring that taxpayers are not penalized without a thorough investigation. Going forward, a more robust legal framework, combined with increased awareness and preventive measures, can help protect the integrity of the ITC mechanism in India.
 

[1] Writ Petition No. 3505 of 2024 And W.M.P. Nos. 3758 & 3759 of 2024

[2] WPA 23512 of 2019