Any use of discretionary power exercised for an unauthorized purpose amounts to malice in law – HC

Rule 86A provides vide powers to the Commissioner or an officer authorized by him to impose restrictions on ITC available in the electronic credit ledger (ECL), in a case where there were reasons to believe that the ITC was fraudulently availed or was ineligible.

The Commissioner had the authority to utilize the power under Rule 86A in the following cases:

non-existent supplier/recipient or not conducting business from its registered place
the tax has not been deposited with Government
issuance of invoice without supply, and
recipient not in possession of invoice/debit note

The said Rule also specifies that on account of the said restriction, the ITC would not be allowed to be used to discharge the output GST liability or claim refund of any unutilized amount for a period of 1 year.

Let us refer to the case of S.S. Industries v. UOI – 2020 Gujarat HC, where it was held that the power under Rule 86A should neither be used as a tool to harass the assessee nor should it be used in a manner which may have an irreversible detrimental effect on the business of the assessee.

Facts of the Case:

The writ applicant was a partnership firm, engaged in the business of manufacture of goods like the TMT Bars etc.
The Joint Director, Directorate General of Goods and Services Tax was conducting the investigation against the writ applicant.
While paying the GST on the goods manufactured, applicant was availing the ITC on the input transactions upon receiving the tax paid inputs and tax invoices.
The writ applicant received tax paid inputs from 36 registered dealers.
The writ applicant received the tax invoices from its suppliers and the transactions of inputs received and the ITC availed have been recorded in the electronic credit ledger maintained by the writ applicant.
The Directorate General of GST Intelligence received information that some registered dealers were supplying only the tax invoices to the various manufacturers of steel products located across the Country, and in the course of such inquiry against such registered dealers/supplies, it was revealed that the writ applicant herein had also received inputs from them involving the ITC to the tune of Rs. 2.40 Crore.
In such circumstances, the Investigating Agency thought fit to initiate an inquiry against the writ applicant.
It was the case of the Department that the inquiry revealed that the concerned suppliers of inputs, referred to above, had issued only the tax invoices without supplying any tax paid inputs and the transactions of these input suppliers/registered dealers were only on paper and, therefore, the ITC availed by all the buyers including the writ applicant herein on such tax invoices of these input suppliers was inadmissible.
The writ applicant was pressurized, as alleged, to deposit an amount of Rs.25 Lakh in cash by uploading the Form DRC-03.
Over and above the same, the ITC of Rs. 84,34,547 was blocked by the Jaipur based agency under Rule 86A of the CGST Rules.
As the Revenue Authorities declined to refund the amount of Rs. 25 Lakh deposited by the writ applicant in cash as well as declined to unblock the ITC in the credit ledger of the writ applicant of Rs. 84,34,547, the writ applicant appealed before the High Court (HC).

Observations of HC on right of the assessee to avail the benefit of the ITC.

Rule 86A undoubtedly conferred drastic powers upon the proper officers if they had reason to believe that the activities or invoices were suspicious.
“Reason to believe” must have a rational connection with or relevant bearing on the formation of the belief.
It was a subjective term and could be interpreted differently by different individuals.
It appeared that the Rule 86A did not even contemplate for issue of any show-cause notice or intimation notice.
In such circumstances, the person affected may be taken by surprise when he would go to the portal to pay taxes and find that his ITC was not usable.
The proviso to Rule 86A specifically states that a manufacturer cannot take credit after 6 months from the date of issue of any of the documents specified in the first proviso to the said sub-rule.
The same applies to those cases where a manufacturer is seeking to take the credit after the introduction of the Rule and to cases where the manufacturer is seeking to do so after a period of six months from the date when the manufacturer received the inputs.
This rule does not operate retrospectively in the sense it does not cancel the credit nor does it in any manner affect the rights of those persons who already took the credit before coming into force of the Rule in question.
It operates prospectively in regard to those manufacturers who seek to take credit after the coming into force of this Rule.
Therefore, in HC’s opinion, the Rule in question only restricted a right of a manufacturer to take the credit beyond the stipulated period of six months under the Rule.

Observations of HC on the power conferred upon the Revenue under Rule 86A

According to the applicant, the power conferred upon the Revenue under Rule 86A is to be exercised with due care and caution, and that too, based on cogent materials and not on mere suspicion.
Rule 86A talks about “reason to believe” which was necessary to be formed for the purpose of blocking the input tax credit in cases of inquiry or investigation into fraudulent transactions.
Any opinion of the authority to be formed was not subject to objective test.
The language left no room for the relevance of an official examination as to the sufficiency of the ground on which the authority may act in forming its opinion.
But, at the same time, there must be material, based on which alone the authority could form its opinion that it has become necessary to block the ITC pending an inquiry or investigation into the fraudulent transactions of fake/bogus invoices.
The existence of relevant material was a pre-condition to the formation of the opinion.
The opinion to be formed by the Commissioner or by the delegated authority could not be on imaginary ground, wishful thinking, howsoever laudable that may be.
Such a course was impermissible in law.
But the expression “circumstances suggesting” cannot support the construction that even the existence of circumstances was a matter of subjective opinion.
That expression points out that there must exist circumstances from which the Authority forms an opinion that they are suggestive of the crucial matters set out in the three subclauses.
It was hard to contemplate that the legislature could have left to the subjective process both the formation of opinion and also the existence of circumstances on which it was to be founded.
It was also not reasonable to say that the clause permitted the Authority to say that it had formed the opinion on circumstances which in its opinion existed and which in its opinion suggested an intent to defraud or a fraudulent or unlawful purpose.
In the absence of any cogent or credible material, if the subjective satisfaction was arrived at by the authority concerned for the purpose of blocking the ITC in exercise of power under Rule 86A of the Rules, then such action would definitely amount to malice in law.
Malice, in its legal sense, meant such malice as may be assumed from the doing of a wrongful act intentionally but also without just cause or excuse or for want of reasonable or probable cause.
Any use of discretionary power exercised for an unauthorized purpose amounted to malice in law. It is immaterial whether the authority acted in good faith or bad faith.
HC stated that it could not be said that the inquiry or investigation initiated as regards the fake/bogus invoices for the purpose of ITC was mala fide or based on absolutely no materials.
It could be said that prima facie, there was something which the Revenue had noticed and, therefore, were looking into the same before taking any final call as regards the claim of the writ applicants to avail the ITC.
Even, otherwise, Rule 86A provided that on expiry of the period of one year, the restriction shall cease to have effect from the date of imposition of such restriction.

Observations of HC on whether Rule 86A contemplate any passing of a specific order with an obligation to communicate the same to the affected person

Rule 86A casts an obligation upon the authority concerned to form an opinion but is silent with regard to passing of any specific order assigning prima facie reasons for invoking Rule 86A.
To this extent, the Government needs to look into the matter and issue appropriate guidelines and also lay down some procedure to be followed for the exercise of power under Rule 86A of the Rules.
In the case on hand, the inquiry, so far, had revealed a prima facie case for the respondents to exercise the power under Rule 86A of the Rules.
Although, no specific order was passed and communicated to the writ applicants in this regard, yet in the facts of the present case, it could not be said that exercise of power under Rule 86A for the purpose of blocking the ITC was mala fide or without any application of mind.

In the overall view of the matter, HC was convinced that they should not interfere at this stage, more particularly, when the investigation was in progress. The respondents made themselves clear in the reply affidavit filed in both the matters that at the end of the investigation if they decided to issue a show-cause notice under Section 74 of the Act, then all the materials relied upon by the Department shall be disclosed to the writ applicants.

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