ITC from Cancelled or Non-Compliant Vendors: Judicial Protection, Practical Risks & How Businesses Are Responding

Denial of Input Tax Credit (ITC) due to supplier non-compliance or cancellation of GST registration has become one of the most common GST disputes. A recent judgment of the Gauhati High Court (WP(C) No. 5725 of 2022, dated 09-12-2025) has brought much-needed balance to this issue.

While Section 16(2)(aa) links ITC to supplier reporting under Section 37 and reflection in GSTR-2B, the Court highlighted an important gap — the law only says “communicated in the prescribed manner” without clearly stating that GSTR-2B is the only possible manner. Based on this, the Court held that although GSTR-2B is the general rule, bonafide ITC cannot be denied mechanically, and recipients must be given a chance to prove genuineness in deserving cases.

What the Courts Are Consistently Saying

1. Gauhati High Court (2025)

The Court recognised revenue concerns around fake invoicing, but clearly held that:

• GSTR-2B is the rule, not an absolute bar

• In genuine cases, recipients must get an opportunity to prove ITC

• Blanket denial without examining facts violates natural justice

This ruling is particularly important as it comes after the introduction of Section 16(2)(aa).

2. Madras High Court – D.Y. Beathel Enterprises

The Madras High Court laid down a critical principle:

• If tax is not paid, recovery must first be made from the supplier

• A recipient who has paid tax to the supplier cannot be treated as a defaulter

• Direct recovery from the buyer is unsustainable

3. Calcutta High Court – Suncraft Energy Pvt Ltd

The Calcutta High Court held that:

• ITC is a substantive right, not a procedural concession

• GSTR-2B mismatch alone cannot justify ITC denial

• Authorities must verify actual transactions and documents

4. Delhi High Court – Quest Merchandising (VAT, persuasive value)

The Delhi High Court ruled that a purchaser cannot be punished for the seller’s default when transactions are genuine — a principle still relied upon under GST.

The Real Risk Area: Cancelled Vendors

Most disputes arise when:

• Supplier GST registration is cancelled retrospectively

• Recipient had no knowledge of default at the time of purchase

• Invoices and payments were valid when supply occurred

Courts have repeatedly held that subsequent or retrospective cancellation does not invalidate past genuine supplies. Automatic ITC reversal in such cases results in double taxation — once when tax is paid to the supplier, and again when ITC is reversed from the recipient.

How Companies Are Responding in Practice

Due to repeated litigation and uncertainty, businesses are no longer relying only on legal remedies. Many have changed their commercial behaviour.

Common practices now include:

• Monthly vendor follow-ups for return filing

• Withholding the GST portion of payment until GSTR-1 and GSTR-3B are filed

• Releasing GST amounts only after tax payment confirmation

• Including compliance-linked payment clauses in vendor contracts

Though not mandated by GST law, these practices have evolved as risk-mitigation tools to protect ITC and avoid future reversals, interest, and penalties.

Why This Helps in Litigation

Courts increasingly examine whether the recipient acted in good faith. Companies that can demonstrate:

• Regular compliance monitoring

• Vendor due diligence

• Documented follow-upsare far better placed to defend ITC, even when vendors default.

Practical Checklist to Safeguard ITC

Companies should maintain:

• Proof that the supplier was registered on the date of supply

• Valid GST invoices (Section 31 compliant)

• Bank proof of payment including GST

• Proof of receipt of goods/services (GRN, e-way bill, work completion proof)

• Vendor compliance records and communication

• Contract clauses linking GST payment to compliance

Key Takeaway

GSTR-2B is the rule — but not the end of the road.Courts are clearly moving towards a fair and balanced approach, where bonafide taxpayers are not punished for supplier lapses without proper examination. The Gauhati High Court judgment dated 09-12-2025 strengthens this position and reinforces an important message:

👉 Substance matters more than form, and documentation remains the strongest defence.