Kwality Metals vs The State Of Karnataka on 2 April, 2024

1. Outcome

The High Court of Karnataka (Dharwad Bench) allowed all the writ appeals. It set aside the common order of the learned Single Judge and quashed the impugned orders issued by the Assistant Commissioner of Commercial Taxes that blocked the Electronic Credit Ledgers (ECLs) of the appellants under Rule 86A of the CGST Rules, 2017.

2. Core Issue

The core issues before the High Court were:
* Whether the revenue authorities were justified in blocking the Electronic Credit Ledgers (ECLs) of the taxpayers by invoking Rule 86A of the CGST Rules, 2017, without providing a pre-decisional hearing.
* Whether the "reasons to believe" recorded by the revenue authorities for blocking the ECLs satisfied the mandatory requirements of Rule 86A, particularly when based on a "borrowed satisfaction" from another officer's report.

3. Key Facts

• The appellants (including Kwality Metals, K-9-Enterprises, K-9-Industries) are GST-registered dealers involved in the business of Lead, lead scrap, etc.
• They had availed Input Tax Credit (ITC) on purchases from other GST-registered dealers, and this ITC was available in their Electronic Credit Ledgers (ECLs).
• The Assistant Commissioner of Commercial Taxes (respondents) blocked the appellants' ECLs on June 27, 2023, by invoking Rule 86A of the Central Goods and Services Tax Rules, 2017.
• The blocking action was primarily based on a "Field visit report by the Asst. State Tax Officer, Vasco-D-Gama, (Goa)", which indicated that some of the appellants' suppliers were non-existent or not conducting business from their registered places.
• The appellants challenged these blocking orders by filing writ petitions, arguing that the action was taken without a proper hearing and lacked valid grounds.
• The learned Single Judge dismissed the writ petitions, upholding the revenue's action, which led the appellants to file these intra-court appeals.

4. Arguments (Taxpayer vs Revenue)

Taxpayer (Appellants / Amicus Curiae):
* Natural Justice: A pre-decisional hearing is mandatory before blocking the ECL, as it entails serious civil consequences. A post-decisional hearing is not an adequate substitute, except in exceptional, urgent circumstances, which were absent here.
* Rule 86A Application: The power under Rule 86A is drastic and draconian, requiring strict compliance with all conditions, including an independent formation of "reasons to believe."
* Borrowed Satisfaction: The blocking orders were based solely on a "borrowed satisfaction" from another officer's field report (Goa) and not on an independent application of mind or inquiry by the concerned officer.
* Onus of Proof: The onus was on the revenue to demonstrate that the appellants had deliberately availed fraudulent or ineligible ITC, which was not established.
* Bona Fide Purchaser: A bona fide purchaser (appellant) should not be denied ITC due to a supplier's default or alleged wrongdoing without verifying the genuineness of the transaction at the time of purchase.
* Impact of Blocking: Blocking ECL defeats the principles of Value Added Tax (VAT), leads to a cascading effect, and causes irreparable injury and hardship, as ITC is a valuable right.
* CBEC Circular: The procedure for blocking ECL, as explained in CBEC Circular No. CBEC-20/16/05/2021-GST/1552 dated 02.11.2021, mandates proper application of mind, objective determination, and recording of reasons, which was violated.
* No Urgency: Unlike bank accounts, ITC cannot be immediately encashed; thus, there was no emergency to bypass a pre-decisional hearing.
* Alternative Remedies: Since notices under Sections 73/74 for assessment have been issued, the recovery proceedings can continue, making the drastic step of blocking ITC unnecessary without prior hearing.
* Appellants' Standing: Appellants are established businesses and not "flight risk" or "fly-by-night operators."

Revenue (Respondents):
* Supported the impugned order of the learned Single Judge.
* Contended that the action was justified and there was no merit in the appeals.
* (Implicitly) Argued that the "reasons to believe" were sufficient and that a pre-decisional hearing was not necessary or that a post-decisional hearing (as directed by the Single Judge) was adequate.

5. Court’s Reasoning

The High Court meticulously addressed the two main points of consideration:

• On Pre-Decisional Hearing and Natural Justice:

  • The Court held that even though Rule 86A does not explicitly provide for it, the principles of natural justice, specifically the right to a pre-decisional hearing (audi alteram partem), must be read into the provision.
  • Blocking the Electronic Credit Ledger (ECL) entails "serious civil consequences" for a taxpayer, thereby necessitating adherence to natural justice.
  • The Court emphasized that a post-decisional hearing is generally not a substitute for a pre-decisional hearing, especially when such severe consequences are involved, citing Supreme Court precedents.
  • It noted that the process of utilizing ITC is not instantaneous like withdrawing cash from a bank, implying that immediate blocking without a hearing was not warranted by emergency, as the revenue could monitor.
  • The Court found the Single Judge erred in concluding that a pre-decisional hearing was not required.

• On "Reasons to Believe" under Rule 86A:

  • The Court reiterated that Rule 86A confers a "drastic and draconian" power, requiring a stringent and objective application of mind by the authorized officer.
  • The "reasons to believe" must be based on the officer's own independent inquiry and objective material, not merely on a "borrowed satisfaction" or communication from another officer (e.g., the Goa field visit report).
  • The revenue failed to verify the genuineness of the transactions and placed the burden on the recipient for the alleged default of the supplier.
  • Mechanical exercise of power, without careful examination of all facts, including the nature of the alleged fraudulent ITC and the necessity to protect revenue, is impermissible.
  • The Court pointed out that a mere closure of a supplier's business in a later year (e.g., 2020-21) cannot automatically be a basis to deny ITC for transactions that might have been genuine in earlier years (e.g., 2017-18).
  • Reference was made to the CBIC Circular dated 02.11.2021, which emphasizes that the power under Rule 86A must be exercised with "utmost circumspection and with maximum care and caution" and necessitates an "objective determination based on intelligent care and evaluation."
  • The impugned blocking orders were found to be "bald, vague, cryptic, laconic, unreasoned and non-speaking," failing to meet the legal requirements.
  • The Court also relied on its own earlier judgment in Xiaomi Technology India(P) Ltd, Vs DCIT and the Supreme Court's decision in Radha Krishan Industries (related to provisional attachment under GST), which underlined the draconian nature of such powers and the necessity of "tangible material" and "proportionality" for forming an opinion to protect revenue interests.
  • The Court concluded that the mandatory prerequisites of Rule 86A were not fulfilled, and the Single Judge erred in finding otherwise.

6. Statutory References

• Central Goods and Services Tax Rules, 2017:
  • Rule 86A (Conditions of use of amount available in electronic credit ledger)
  • Rule 36 (Documents for availing ITC)
• Central Goods and Services Tax Act, 2017:
  • Section 49 (Payment of tax and other amounts)
  • Section 73 (Determination of tax not paid or short paid where fraud is not involved)
  • Section 74 (Determination of tax not paid or short paid where fraud is involved)
  • Section 107 (Appeals)
• Constitution of India:
  • Article 14
• CBIC Circular No. CBEC-20/16/05/2021-GST/1552 dated 02.11.2021
• Other Acts (referred in cited precedents):
  • Indian Penal Code, 1860 (Sections 193, 196, 228)
  • Code of Criminal Procedure, 1973 (Section 195)
  • Income Tax Act (Chapter XX-C, Section 269UD, 142(2A), 142(2D), 44AB, 153A, 281, 281B)
  • Banking Regulation Act, 1949 (Section 45)
  • Bombay Municipal Corporation Act, 1888 (Section 314)
  • Gujarat Value Added Tax Act, 2003 (Section 45)
  • Hpgst Act (Section 74, Section 83)
  • Constitution (122nd Amendment) Bill, 2016 (Statement of Objects and Reasons)
  • CGST Act (Statement of Objects and Reasons appended to the Bill)

7. Precedents Cited

The Court cited numerous judgments, including:

1. C.B. Gautham Vs. Union of India - 1992 (65) taxman 440 (SC) (on reading natural justice into statutes).
2. Sara India (Firm) Vs. Commissioner of Income Tax - 2008(226)ELT 22(SC) (on civil consequences and pre-decisional hearing).
3. K.I. Shephard & Ors. v. Union of India & Ors. - JT 1987 (3) 600 / (1987) 4 SCC 431 (on post-decisional hearing not being a substitute).
4. H.L. Trehan Vs. Union of India - (1989) 1 SCC 764 (reiterating post-decisional hearing not being a substitute).
5. Samay Alloys India (P) Ltd., vs. State of Gujarat - (2022) SCC OnLine Guj 2595 (explaining Electronic Credit Ledger and ITC utilization).
6. Xiaomi Technology India(P) Ltd, Vs DCIT - 2022(145) taxman.com 501 (Kar) (on provisional attachment, draconian power, reasons to believe).
7. Radha Krishan Industries Vs. The State of Himachal Pradesh - 2021 SCC OnLine SC 334 (on provisional attachment, draconian power, reasons to believe, proportionality).
8. Vishwanath Realtor v. State of Gujarat - 2015 SCC OnLine Guj 6564 (on provisional attachment and objective satisfaction).
9. Auto and General Engineering Citizen Society Vs State of Andhra Pradesh - AIR 1988 AP 266
10. State Bank of Patiala Vs. S.K. Sharma - (1996) 3 SCC 364
11. Canara Bank Vs. Devasis Das - (2003) 4 SCC 557
12. Dee Vee Project Ltd Vs. Government of Maharashtra - 2022(135) taxman.com 189(Bom)
13. Calcutta Discount co Ltd. Vs. ITO - 1961(41) ITR 191(SC)
14. Century Metal Recycling Ltd vs. Union of India - 2019(367) ELT 3 (SC)
15. CIT Vs. Kelvinator of India Limited - (2010) 2 SCC 723
16. New Nalbandh trader Vs. State of Gujarat - 2022 (66) GSTL 334 (Guj)
17. Rajanandini Metal LTD Vs. Union of India - 2022(64) GSTL 301(P&H)
18. Parity Infotech Solutions (P) Ltd Vs Govt of National Capital Territory of Delhi - 2023(151) taxman.com 349(Del)
19. Bright State Plastic Industries vs Addl. Commr of Sales Tax (Appeal) - 2022(57) GSTL 226 (Ori)
20. Arhaan Ferrous and Non-Ferrous Solutions (P) Ltd, vs Deputy Assistant Commissioner-1 (ST) - 2023(9) Centax 171(AP)
21. State of Maharashtra vs Suresh Trading Company - (1997) 11 SCC 378
22. On Quest Merchandising India Pvt.Ltd, vs. Government of NCT of Delhi - (2018) 10 GSTL 182(Del)
23. Sanchita Kundu vs. Asst. Commissioner of State Tax - 2022(63) GSTL 413 (Cal)
24. LGW Industries Ltd vs Union of India [WPA No.23512/2019(Cal)]
25. Vodafone International Holdings BV vs Union of India - (2012) 6 SCC 613
26. Commissioner of Central Excise Vs. Kay Kay Industries - (2013) 295 ELT 177
27. M/s.DY Beathel Enterprises Vs State Tax Officer - 2022(58) GSTL 269 (Mad)
28. Suncraft Energy Pvt Ltd vs.AC - State Tax - 2023(9) Centax 48 (Cal)
29. Collector of Central Excise vs. Dai Inchi Karkaria Ltd -1999(112) ELT 353 (SC)
30. Eicher Motors vs Union of India - 1999 (106) ELT 3 (SC)
31. A. K. Kraipak v. Union of India
32. ITO v. Madnani Engineering Works Ltd
33. Swadeshi Cotton Mills Co. Ltd. v. Union of India
34. State of Orissa v. Dr. Miss Binapani Dei
35. Canara Bank v. V. K. Awasthy
36. Union of India v. J. N. Sinha
37. Mohinder Singh Gill v. Chief Election Commissioner
38. Olga Tellis v. Bombay Municipal Corporation
39. Union of India v. Col. J. N. Sinha
40. Rajesh Kumar
41. Indian Minerals Case