Input Tax Credit under GST: Law, Limitations, Litigation & the Real Business Impact

When GST was introduced in 2017, one promise stood above all — seamless flow of credit. Businesses were told that the cascading burden of “tax on tax” would finally disappear. The mechanism that would make this possible was Input Tax Credit (ITC).

Nearly a decade later, ITC remains the backbone of GST but also its most litigated and controversial feature.

For many businesses today, ITC is no longer just a benefit. It has become a compliance battlefield.

Why ITC Is the Core of GST

GST is designed as a value-added tax. That means tax should apply only to the value added at each stage of the supply chain.

Without ITC, every transaction would accumulate tax on the full value repeatedly increasing costs and distorting pricing.

ITC ensures that:

1. Tax paid on purchases can be adjusted against tax payable on sales
2. Businesses do not bear tax as a cost
3. Supply chains remain neutral
4. Final consumers alone bear the tax burden

In practical terms, ITC directly affects:

1. Working capital
2. Cash flow cycles
3. Profit margins
4. Competitive pricing

If ITC is blocked, delayed, or denied liquidity suffers immediately.

The Legal Framework: Where ITC Comes From

The right to claim ITC flows from Section 16 of the CGST Act, 2017. However, it is not an unconditional right.

To claim ITC, a taxpayer must satisfy four core conditions:

1.     Possession of a valid tax invoice

2.     Actual receipt of goods or services

3.     Tax must have been paid to the Government

4.     The recipient must file the prescribed return

On paper, these conditions appear reasonable. But in practice, each one becomes a potential point of dispute.

For example:

1. What if goods are received in instalments?
2. What if the supplier files the invoice but fails to deposit tax?
3. What if there is a minor mismatch in return data?

These grey areas have triggered thousands of disputes.

The Time Barrier: Section 16(4)

One of the most rigid aspects of GST is the time limit for availing ITC.

If credit is not claimed within the prescribed deadline, it lapses permanently — even if:

1. The tax was genuinely paid
2. The goods were genuinely received
3. The transaction was fully legitimate

This provision has raised serious concerns. Businesses argue that a procedural delay should not permanently extinguish substantive credit, especially when tax has already reached the government.

The debate essentially becomes:

Should GST prioritise procedural discipline over economic neutrality?

Blocked Credits: The Return of Cascading?

Section 17(5) introduces what are popularly known as “blocked credits.”

ITC is denied on certain goods and services such as:

1. Motor vehicles (with exceptions)
2. Food and beverages
3. Club memberships
4. Works contract services for construction of immovable property

The intention behind these restrictions is revenue protection. However, from a business perspective, blocked credits increase cost.

Consider this:

If a company constructs an office building and cannot claim ITC on construction services, that tax becomes part of the project cost. This reintroduces cascading something GST was meant to eliminate.

The policy tension is clear:

Revenue security vs. seamless credit.

The Supplier Default Problem: A Major Controversy

Perhaps the most debated issue under GST is denial of ITC due to supplier non-compliance.

Imagine this situation:

1. You purchase goods
2. You pay the supplier including GST
3. You receive proper invoice
4. You use goods in business

Later, the department denies your ITC because the supplier did not deposit tax.

The question becomes:

Should the buyer be punished for the seller’s default?

Courts across India have increasingly examined this issue. Many High Courts have observed that if the recipient has acted in good faith and fulfilled all statutory conditions within their control, denial of ITC may be unjust.

This issue strikes at the heart of commercial practicality.

ITC: A Vested Right or a Conditional Concession?

The nature of ITC has been debated since the pre-GST era.

In earlier tax regimes, courts had recognised that once credit is validly earned, it becomes a vested right.

However, judicial decisions have also described ITC as a concession meaning it exists only within statutory boundaries.

Under GST, courts are attempting to strike a balance:

1. ITC is subject to statutory conditions
2. But authorities cannot deny it arbitrarily
3. Administrative action must remain reasonable

The emerging principle appears to be this:

ITC may be conditional, but it is not discretionary.

Natural Justice and Administrative Fairness

Another area where courts have intervened is procedural fairness.

ITC has been denied in several cases through:

1. Automated notices
2. Cryptic orders
3. Lack of personal hearing
4. Non-speaking assessment orders

Judiciary has consistently emphasized that even in a technology-driven tax regime, principles of natural justice cannot be ignored.

Efficiency cannot replace fairness.

Constitutional Perspective: Article 14

Restrictions and denial of ITC have also been examined under Article 14 of the Constitution (equality before law).

If two similarly placed taxpayers are treated differently due to system glitches or supplier default, constitutional concerns arise.

Courts have cautioned that tax administration must remain:

1. Non-arbitrary
2. Proportionate
3. Transparent

GST cannot become a system where genuine businesses bear disproportionate compliance risk.

Impact on MSMEs: The Silent Struggle

Large corporations may have compliance teams and technological systems to manage reconciliation. Small and medium enterprises often do not.

For MSMEs:

1. ITC blockage means working capital freeze
2. Delayed refunds mean borrowing costs
3. Supplier non-compliance creates financial exposure
4. Complex reconciliation increases administrative burden

Ironically, a tax reform aimed at ease of doing business sometimes increases compliance stress for smaller players.

The Way Forward: Reforming the ITC Ecosystem

If GST is to mature into a stable value-added tax system, ITC reforms are essential.

Possible improvements include:

1. Simplifying return architecture
2. Limiting buyer liability for supplier default
3. Rationalising blocked credits
4. Providing clearer legislative drafting
5. Strengthening technological reliability

A predictable ITC framework builds confidence. Uncertainty fuels litigation.

Final Thoughts

Input Tax Credit is not a peripheral feature of GST, it is its structural foundation.

When ITC flows smoothly, GST functions efficiently.
When ITC is blocked, disputed, or delayed, the entire tax system feels the strain.

Judicial intervention has played a crucial role in safeguarding fairness and preventing excessive rigidity. However, long-term stability requires legislative clarity and administrative balance.

GST was envisioned as a modern, transparent, and business-friendly tax regime. For that vision to fully materialize, ITC must operate as an enabling mechanism, not as a recurring compliance obstacle.

FQA

Q1. What is the fundamental objective of Input Tax Credit under GST?

Answer:
The fundamental objective of ITC is to eliminate the cascading effect of taxation by ensuring that tax is levied only on the value added at each stage of the supply chain. It allows businesses to set off tax paid on purchases against tax payable on outward supplies, thereby preventing “tax on tax.”

Q2. Why is ITC considered the backbone of GST?

Answer:
GST is designed as a value-added tax system. Without ITC, GST would lose its core design and become a multi-point tax burden. ITC ensures supply chain neutrality, protects profit margins, maintains competitive pricing, and prevents working capital blockage. When ITC is disrupted, the entire GST structure weakens.

Q3. What are the statutory conditions for claiming ITC under Section 16 of the CGST Act?

Answer:
To claim ITC, a taxpayer must:

1.     Possess a valid tax invoice

2.     Actually receive goods or services

3.     Ensure that tax has been paid to the Government

4.     File the prescribed return

Failure to satisfy any of these conditions can lead to denial of credit.

Q4. Why is Section 16(4) considered controversial?

Answer:
Section 16(4) imposes a strict time limit for availing ITC. If credit is not claimed within the prescribed deadline, it permanently lapses—even if the transaction is genuine and tax has been paid. Businesses argue that procedural delay should not extinguish substantive rights, especially when revenue has already been collected.

Q5. What are “blocked credits” under Section 17(5)?

Answer:
Blocked credits are specific goods and services on which ITC is not allowed, such as:

1. Motor vehicles (subject to exceptions)
2. Food and beverages
3. Club memberships
4. Works contract services for construction of immovable property

These restrictions aim at revenue protection but often reintroduce cascading.

Q6. How do blocked credits reintroduce cascading?

Answer:
When ITC on certain inputs (like construction services) is denied, the tax paid becomes part of the cost of the asset. That cost is then embedded into future pricing, effectively creating a “tax on tax” situation — something GST was meant to eliminate.

Q7. What is the supplier default issue under GST?

Answer:
The supplier default issue arises when a buyer claims ITC after paying GST to the supplier, but the supplier fails to deposit that tax with the government. Authorities sometimes deny ITC to the buyer on this ground, raising the question of whether a purchaser should suffer for a seller’s non-compliance.

Q8. Why is denial of ITC due to supplier default legally debated?

Answer:
The debate centers around fairness and control. The buyer has no control over whether the supplier deposits tax. If the buyer has acted in good faith and complied with all statutory requirements, denying ITC may violate principles of reasonableness and proportionality.

Q9. Is ITC a vested right or a conditional concession?

Answer:
ITC is considered a statutory right subject to conditions. It is not an absolute constitutional right. However, once conditions are fulfilled, authorities cannot deny it arbitrarily. Courts are increasingly holding that while ITC is conditional, it is not discretionary.

Q10. How do principles of natural justice apply to ITC disputes?

Answer:
Even in a technology-driven GST regime, authorities must:

1. Issue proper show cause notices
2. Provide opportunity of hearing
3. Pass reasoned (speaking) orders

Automated or cryptic orders denying ITC violate procedural fairness and can be set aside by courts.

Q11. How does Article 14 of the Constitution relate to ITC disputes?

Answer:
Article 14 guarantees equality before law and protection against arbitrariness. If similarly placed taxpayers are treated differently due to system glitches or supplier defaults, constitutional concerns arise. Courts examine whether denial of ITC is arbitrary, disproportionate, or unreasonable.

Q12. Why are MSMEs particularly vulnerable in ITC disputes?

Answer:
MSMEs often lack sophisticated compliance systems. ITC blockage affects their working capital directly. Delays in refunds increase borrowing costs. Supplier non-compliance exposes them to financial risk, making GST compliance disproportionately burdensome for smaller entities.

Q13. How does ITC impact working capital?

Answer:
If ITC is denied or delayed, businesses must pay output tax in cash instead of adjusting input credit. This locks liquidity and disrupts cash flow cycles, directly affecting operational stability.

Q14. What policy tension exists within the ITC framework?

Answer:
The central tension is between:

1. Revenue protection and fraud prevention
   versus
2. Seamless credit flow and economic neutrality

Excessive restrictions protect revenue but undermine GST’s value-added design.

Q15. What reforms can strengthen the ITC ecosystem?

Answer:

Possible reforms include:

1. Simplifying return architecture
2. Limiting buyer liability for supplier default
3. Rationalizing blocked credits
4. Improving drafting clarity
5. Enhancing technological reliability

A stable ITC framework reduces litigation and builds business confidence.

Q16. Why is ITC considered more than just an accounting adjustment?

Answer:
ITC directly affects liquidity, pricing, investment decisions, and financial planning. It determines whether tax becomes a pass-through mechanism or a business cost. Hence, it is central to commercial viability.

Q17. What is the broader judicial trend in ITC litigation?

Answer:
Courts are not dismantling statutory conditions but are ensuring:

1. Administrative fairness
2. Non-arbitrary decision-making
3. Proportionality in enforcement
4. Protection of bona fide taxpayers

The judicial approach aims at balancing compliance with fairness.