Rule 86A and the Protection of Taxpayers’ Rights in ITC Blocking

The present article examines a recent judgment by the Delhi High Court, which has given critical clarity with respect to the interpretation and applicability of Rule 86A of the Central Goods and Services Tax (CGST) Rules, 2017. The primary question of law considered was whether, in the absence of any fraudulent or ineligible credit in the Electronic Credit Ledger (ECL) on the date of issuance of the blocking order, the revenue could block the debit of input tax credit (ITC) from the ECL of a taxpayer pertaining to earlier periods.

While Rule 86A is a preventive provision to check the misuse of ITC and ensure better compliance under the GST regime, its reach and the discretion provided therein have been under judicial scrutiny in a continuing process, considering the apprehension of overreach and procedural fairness and the eventual hardship to the genuine taxpayers.

Understanding the Purpose and Scope of Rule 86A

Rule 86A was brought in to curb the abuse of the facility of ITC, which is an important component of the mechanism for ensuring tax neutrality and thereby facilitating seamless availability of credit. This provision gives powers to GST authorities to restrict the use of ITC in the ECL of a taxpayer if there are reasonable grounds to believe that such credit has been claimed wrongly.

ITC is blocked under this rule when:

• ·        The credit is fraudulently availed or is ineligible because of non-existent supplies or fictitious documentation.
• ·        It is based on invoices issued without the actual receipt of goods or services.
• ·        The transaction contravenes the provisions of the CGST Act or Rules.

The overriding purpose of Rule 86A is to protect the revenue of the government as well as to deter tax evasion without compromising procedural fairness and safeguards that prevent arbitrary action against compliant taxpayers.

Arguments Presented

Thus, in this case, the Revenue authorities and the taxpayers advanced conflicting interpretations of Rule 86A(1) of the CGST Rules.

The Revenue contended that Rule 86A(1) enables the department to block the debit of an amount equivalent to the ITC that was fraudulently claimed or ineligible, even if such credit has already been utilized in previous tax periods. According to its opinion, the intent of the rule is to avoid undue enrichment and protect government revenue, irrespective of when such fraudulent credit was utilized. The Revenue emphasized that the words “amount equivalent to such credit” are to be construed independently of the words “credit of input tax available in the electronic credit ledger.” The Revenue placed reliance on the earlier High Court decisions and a CBIC circular to support the widest amplitude of the provision.

On the other hand, the taxpayers contended that Rule 86A(1) can be invoked only when the ITC is actually available in the ECL at the time the order is passed. They further contend that once the credit has been utilized, there is no existing balance to be blocked, and therefore, the authorities cannot apply the said rule retrospectively. The taxpayers relied on the literal interpretation of the statutory language and the overall legislative framework of the CGST Act and Rules, submitting that Revenue’s approach would extend the rule beyond its intended scope and violate the principle of certainty in taxation.

Court’s Analysis and Findings

The Delhi High Court went into an in-depth analysis to bring out the real meaning and intention of Rule 86A(1). To begin with, the Court underlined that the opening clause of that provision specifies the preconditions for using it, namely, there should be a balance of input tax credit available in the Electronic Credit Ledger of the taxpayer at the time the blocking order is issued, and the Commissioner or an officer authorized must have legitimate cause to believe that such credit has either been fraudulently availed or is ineligible.

According to the interpretation of the words of the rule, the Court held that the phrase “credit of input tax available in the electronic credit ledger” means credit available at present in the ledger and not the amounts that have been consumed during previous periods. In effect, it thereby rejected Revenue's contention that the words “amount equivalent to such credit” could be divorced from the stipulation that ITC should be available in the ledger.

The Bench also examined the judicial precedents and CBIC circular relied upon by the Revenue and observed that none of those support such a retrospective or extended interpretation of the rule. Conversely, the Court held that the literal interpretation of Rule 86A(1)-in that it applies only to the ITC available to the assesse at present-met both the legislative intent and administrative direction.

While assessing the legislative framework, the Court explained that Rule 86A(1) is a preventive provision, which is supposed to restrict, for temporary periods, the utilization of ITC in cases where fraudulent claims are perceived. It does not grant recovery powers, which must be exercised through the statutory mechanisms under Sections 73 and 74 of the CGST Act. Hence, any determination of tax liability or its recovery has to be made in accordance with due process under the said sections, providing the taxpayer with procedural fairness.

Court’s Analysis and Final Decision

The Delhi High Court emphatically held that Rule 86A(1) cannot be invoked in cases where there is no input tax credit (ITC) available in the taxpayer's Electronic Credit Ledger (ECL) at the time of the order. It clarified that, even assuming the authorities were of the opinion that the taxpayer had earlier availed or utilised ITC fraudulently, no past transactions would justify the invoking of Rule 86A(1).

Interpreting the phrase “amount equivalent to such credit”, the Court explained that this applies only to the ITC presently available in the ECL which the Commissioner or authorized officer has reasons to believe is fraudulently availed or ineligible. It does not extend to ITC which have already been used for tax payments or refunded in earlier periods.

Thereafter, the court quashed the impugned orders passed by the taxing authorities and held that blocking of ITC beyond the amount available as of now in the ECL was illegal and without jurisdiction. The judgment reinforces that Rule 86A(1) is preventive, not punitive, and its application must remain strictly within the bounds of the statute.

Rule 86A and ITC Blocking: Key Questions Answered

1. What is Rule 86A of the CGST Rules, 2017?

Rule 86A empowers GST authorities to restrict the use of Input Tax Credit (ITC) in a taxpayer’s Electronic Credit Ledger (ECL) if there is reason to believe that such credit has been fraudulently availed or is ineligible. The rule is a preventive measure aimed at curbing fake invoicing and ITC misuse under the GST regime.

2. Why was Rule 86A introduced?

It was introduced to prevent the misuse of ITC, which is essential for ensuring tax neutrality and seamless credit flow in the GST system. The rule helps safeguard government revenue by allowing temporary blocking of credits obtained through:

• Fake or non-existent suppliers

• Invoices without actual goods or services

• Transactions violating GST laws or rules

3. What was the key legal issue before the Delhi High Court?

The main question was whether tax authorities can block ITC under Rule 86A for past periods, even if no credit is currently available in the taxpayer’s ECL on the date of the blocking order.

4. What did the Revenue Department argue?

The Revenue contended that Rule 86A(1) gives them authority to block an amount equivalent to the fraudulently availed ITC, even if that credit has already been utilized in previous tax periods. They claimed that the phrase “amount equivalent to such credit” allows retrospective blocking to prevent undue enrichment.

5. What was the taxpayers’ argument?

Taxpayers argued that Rule 86A(1) can only be used when ITC is actually available in the ECL at the time the order is passed. Once the credit has been utilized, it cannot be blocked retrospectively. They relied on the plain wording of the rule and emphasized the need for certainty and procedural fairness in taxation.

6. How did the Delhi High Court interpret Rule 86A(1)?

The Court analyzed the language of Rule 86A(1) and concluded that:

• The rule applies only to ITC currently available in the ECL.

• The phrase “credit of input tax available in the electronic credit ledger” refers to existing and unutilized credit.

• The expression “amount equivalent to such credit” cannot be separated from this condition.

7. Did the Court accept the Revenue’s interpretation?

No. The Delhi High Court rejected the Revenue’s argument that ITC blocking can apply to past utilized credits. The Court found that such an interpretation goes beyond the intent of Rule 86A and lacks support from the statutory text, case law, or CBIC circulars.

8. What distinction did the Court make regarding Rule 86A’s purpose?

The Court clarified that Rule 86A is preventive, not punitive. It only allows temporary restriction on the use of ITC suspected to be fraudulent. It does not authorize recovery of tax dues. Recovery must follow the proper adjudication process under Sections 73 and 74 of the CGST Act.

9. What was the final judgment of the Delhi High Court?

The Court held that Rule 86A(1) cannot be invoked when no ITC exists in the taxpayer’s ECL at the time of the order. Any attempt to block ITC beyond the amount currently available is illegal and without jurisdiction. The Court therefore quashed the blocking orders passed by the tax authorities.

10. What is the significance of this ruling for taxpayers?

This judgment is a major relief for genuine taxpayers. It ensures that:

• ITC blocking cannot be applied retrospectively.

• Procedural fairness and statutory limits must be respected.

• Rule 86A will remain a temporary preventive tool, not a mechanism for recovery or penalty.