The Goods and Services Tax regime in India was introduced to create a unified indirect tax structure and replace the earlier system of multiple taxes such as VAT, excise duty and service tax. One of the central features of the GST framework is the mechanism of input tax credit, which allows businesses to set off the tax paid on inputs against the tax payable on outputs. This seamless flow of credit reduces cascading effects of taxation and provides relief to the business sector. However, as with any large-scale reform, the system has also been misused by certain elements to fraudulently claim credits without genuine business activity. To address such practices, the government brought in Rule 86A into the Central Goods and Services Tax Rules, 2017, creating a framework for blocking credit in cases of fraudulent or ineligible claims.
Introduction of Rule 86A
The Central Board of Indirect Taxes and Customs observed that several businesses were engaging in the practice of issuing invoices without actual supply of goods or services. Such fake invoicing enabled buyers to avail input tax credit without any underlying transaction, thereby causing loss of revenue to the exchequer. To deal with this menace, the government introduced Rule 86A through Notification No. 75/2019 dated 26 December 2019.
Rule 86A allows the Commissioner or an officer authorized by him to disallow the use of input tax credit available in the electronic credit ledger of a registered person. The officer must have reasons to believe, based on material evidence, that the credit has been fraudulently availed or is otherwise ineligible. This provision empowers the department to act swiftly against fraudulent claims and protect government revenue, while also ensuring that only genuine credits are utilized by taxpayers.
Objective and Scope of Rule 86A
The main purpose of Rule 86A is to prevent wrongful availment and utilization of credits. The scope of the rule is not limited to one type of fraudulent activity but extends to all instances where the availability of credit appears suspicious, unsupported by documents, or not in accordance with law. By introducing this rule, the government aimed to strike a balance between facilitating smooth business operations for compliant taxpayers and safeguarding revenue from unscrupulous activities.
The scope of Rule 86A is wide enough to cover different types of transactions, including cases where suppliers are found to be non-existent, where goods or services are never actually supplied, or where invoices are raised without payment of tax to the government. In all such circumstances, the rule allows officers to act immediately and restrict the usage of disputed credit.
Powers under Rule 86A
Rule 86A vests significant powers in the Commissioner and his authorized officers. These powers include the ability to disallow debit of the electronic credit ledger, effectively blocking the use of credits that the taxpayer has already claimed. This action can severely impact the working capital of the taxpayer, since blocked credits cannot be used to pay output tax liability, thereby forcing the business to arrange funds through other means.
However, such powers are not absolute. The rule requires that the officer must first form a reasonable belief that the credit is fraudulent or ineligible. This belief must be based on credible material evidence and not merely on suspicion. The requirement of forming a reasoned opinion acts as a safeguard against arbitrary exercise of power.
The Concept of Reasons to Believe
The phrase reasons to believe is not new to Indian tax law. It has been used in several legislations, including income tax law, and has been interpreted by courts on many occasions. In the context of Rule 86A, the phrase implies that the officer must have some objective basis for forming his belief. Mere suspicion or assumption cannot justify the blocking of credit. There must be tangible material or evidence indicating that the taxpayer has wrongly availed or fraudulently claimed input tax credit.
The insistence on reasons to believe ensures that officers do not exercise powers in a mechanical manner. It obliges them to record their reasons in writing, which can be later reviewed by higher authorities or courts if challenged. This mechanism is essential to maintain accountability and fairness in the implementation of Rule 86A.
Legal Precedents and Judicial Scrutiny
Soon after the introduction of Rule 86A, its implementation was challenged before various High Courts. One of the landmark cases was heard by the Gujarat High Court, where the validity and interpretation of the rule came under judicial scrutiny.
In the case concerning S.S. Industries, the Gujarat High Court examined the powers conferred under Rule 86A and observed that while the rule permits blocking of credit, it casts an obligation on the authority concerned to form an opinion based on reasons. The court pointed out that the rule does not provide for passing a formal order recording such reasons, which creates uncertainty and leaves room for arbitrary use of power.
The High Court emphasized that the government must issue proper guidelines to ensure that Rule 86A is not used as a tool of harassment against taxpayers. It stressed the need for transparency and accountability in the exercise of these powers, so that genuine businesses are not adversely affected.
Concerns Raised by Stakeholders
Since its introduction, Rule 86A has been a subject of intense debate among professionals, businesses, and legal experts. The major concerns revolve around the possibility of misuse and its impact on working capital. Blocking of credit means that even though the taxpayer may have complied with all requirements, he cannot utilize his credit balance for discharging output liability until the restriction is lifted.
Businesses argue that such action, if taken without adequate justification, can cripple operations by creating sudden cash flow issues. Moreover, since the rule does not initially require issuance of a speaking order to the taxpayer, it leaves them in the dark regarding the reasons behind the blocking of their credit. This lack of transparency was one of the primary issues highlighted before the judiciary.
Another concern relates to the duration of restriction. Rule 86A allows blocking of credit for a period of up to one year. While the restriction automatically ceases after one year, businesses argue that even a few months of blocked credit can have devastating effects on operations, especially for small and medium enterprises.
The Balancing Act Between Revenue Protection and Taxpayer Rights
The government faces a delicate balancing act in this context. On one hand, there is an undeniable need to protect revenue from fraudulent activities such as fake invoicing. These practices not only cause loss to the exchequer but also distort competition by giving unfair advantage to dishonest taxpayers. On the other hand, excessive or arbitrary use of powers under Rule 86A can undermine the confidence of genuine taxpayers, discourage compliance, and adversely affect business operations.
The challenge lies in creating a framework that allows swift action against fraudulent claims without compromising the rights of legitimate taxpayers. Judicial scrutiny and stakeholder feedback have highlighted the importance of checks and balances, as well as the need for clear guidelines that prevent arbitrary actions by tax authorities.
Evolution Towards Guidelines
Recognizing the issues raised by the courts and stakeholders, the Central Board of Indirect Taxes and Customs later issued detailed guidelines for the exercise of powers under Rule 86A. These guidelines sought to provide clarity on the grounds for blocking credit, the competent authorities who can invoke such powers, and the procedure to be followed.
By issuing guidelines, the Board aimed to bring in greater accountability and transparency, while ensuring that officers act strictly within the framework of law. These instructions also attempted to standardize the exercise of discretion, thereby reducing the scope for arbitrary decisions.
Transition to Further Discussion
The discussion so far highlights the legal foundation and background of Rule 86A, including its introduction, objectives, scope, powers, judicial scrutiny, and the concerns raised by taxpayers. We will examine in detail the guidelines issued by the CBIC for implementing this rule, covering the specific grounds for blocking credit, the authority structure, and the prescribed procedure for invoking these powers.
CBIC Guidelines on Blocking of Credit under Rule 86A
The implementation of Rule 86A of the Central Goods and Services Tax Rules marked a significant step in tackling the misuse of input tax credit. However, the introduction of such a provision also led to apprehensions about possible misuse, arbitrary actions, and lack of clarity in application.
In response to judicial observations and stakeholder concerns, the Central Board of Indirect Taxes and Customs issued detailed guidelines through Circular No. 04/2021. These guidelines provide a structured approach for officers to exercise powers under Rule 86A, clearly defining the grounds, authorities, and procedure to ensure fair application of the law.
Purpose of CBIC Guidelines
The primary purpose of the CBIC guidelines is to bring clarity, consistency, and accountability in the exercise of powers granted under Rule 86A. Without a uniform approach, the provision could have been applied differently by officers across jurisdictions, leading to inconsistency and potential harassment of taxpayers.
By laying down specific conditions and procedural requirements, the Board aimed to strike a balance between protecting revenue and safeguarding taxpayer rights.
Grounds for Blocking of Credit
The guidelines specify that the power to block input tax credit can be exercised only in certain defined situations. These grounds are based on tangible circumstances that indicate fraudulent or ineligible credit. The officer must have reasons to believe, supported by material evidence, that credit has been wrongly availed in any of the following situations:
Credit on Invoices from Non-Existent Suppliers
One of the most common methods of fraudulent credit involves availing ITC on invoices issued by suppliers who do not exist or who do not conduct business from the registered premises. Such suppliers often issue invoices without actual supply of goods or services, enabling buyers to claim credit without any genuine transaction. The guidelines recognize this as a strong ground for invoking Rule 86A.
Credit Without Receipt of Goods or Services
Another circumstance where credit can be blocked is when the registered person avails ITC without actually receiving goods or services. The fundamental principle of GST is that credit is available only when goods or services are received and used in the course of business. If investigation reveals that no actual supply has taken place, officers are empowered to restrict the use of such credit.
Credit on Invoices Where Tax Has Not Been Paid to Government
In situations where credit is claimed on invoices but the tax reflected in such invoices has not been deposited with the government by the supplier, the credit is treated as ineligible. The guidelines identify such cases as a valid reason for blocking ITC. This ensures that credit flows only from genuine tax-paid transactions.
Credit Claimed by Non-Existent Taxpayer
If the taxpayer himself is found to be non-existent or not conducting business from the declared premises, any credit availed by him can be blocked. This provision deals with cases where fraudulent registrations are obtained only for the purpose of claiming and passing on fake credits.
Credit Without Valid Documentation
Credit availed without possession of valid invoices, debit notes, or other prescribed documents is also treated as ineligible. Documentation is a key requirement for availing ITC, and absence of such documents indicates potential misuse.
These defined grounds provide clarity to both taxpayers and officers, ensuring that the extraordinary power to block credits is exercised only in genuine cases of fraud or ineligibility.
Authority to Block Credit
The guidelines also define the authority structure for exercising powers under Rule 86A. The Commissioner or Principal Commissioner is responsible for authorizing officers, and the level of officer permitted to exercise the power depends on the monetary value of the disputed credit.
Monetary Limits for Authorization
- Where the amount of ineligible or fraudulently availed credit does not exceed one crore rupees, the power to block credit can be exercised by a Deputy Commissioner or Assistant Commissioner.
- For cases involving amounts above one crore but up to five crore rupees, the authority lies with an Additional Commissioner or Joint Commissioner.
- In cases exceeding five crore rupees, the Principal Commissioner or Commissioner alone is empowered to invoke Rule 86A.
By prescribing these monetary thresholds, the guidelines ensure that the power to block credit of significant amounts rests with senior officers, thereby reducing the risk of arbitrary or hasty decisions.
Role of Audit Commissionerate
If during an audit conducted under Section 65 or 66 of the CGST Act it is discovered that credit has been fraudulently availed or is ineligible, the Audit Commissionerate is required to refer the matter to the jurisdictional Commissioner. This ensures proper coordination between audit findings and enforcement action under Rule 86A.
Procedure for Blocking of Credit
The guidelines lay down a step-by-step procedure for officers to follow before blocking ITC. These steps are designed to ensure that decisions are evidence-based and that officers record reasons in writing to maintain accountability.
Formation of Belief
Before blocking credit, the Commissioner or authorized officer must have reasons to believe that ITC has been fraudulently availed or is ineligible. This belief must be based on material evidence and not on mere suspicion. For example, documentary evidence of non-existent suppliers, statements recorded during investigation, or discrepancies in records may constitute valid grounds for forming such a belief.
Recording of Reasons
The guidelines emphasize that reasons must be recorded in writing on file before any action is taken. This requirement creates a record that can be reviewed later, ensuring transparency and enabling higher authorities or courts to examine the justification if the action is challenged.
Limiting the Blocked Amount
The amount blocked must not exceed the extent of credit believed to be fraudulent or ineligible. Officers are not permitted to block the entire credit ledger if only a portion of the ITC is disputed. This restriction prevents excessive hardship to taxpayers and ensures proportionality in the exercise of power.
Communication through GST Portal
Once credit is blocked, the taxpayer is informed through the GST portal. The communication includes details of the officer who has imposed the restriction, ensuring that the taxpayer knows the source of the decision and can make representations accordingly.
Practical Illustrations
The CBIC guidelines become clearer when viewed through practical examples.
For instance, if a company avails ITC on invoices received from a supplier who is later found to have no place of business at the registered address, the officer can restrict such credit under Rule 86A. Similarly, if a trader avails credit on inputs without ever receiving the goods, the ledger can be blocked to prevent further misuse.
Another situation could involve a manufacturer claiming credit on invoices where the supplier has not deposited the tax collected into the government treasury. In such a case, the credit is not supported by actual tax payment, making it ineligible.
These examples demonstrate how the guidelines provide a framework for officers to deal with real-life situations of fraudulent or wrongful availment of credit.
Checks Against Arbitrary Use
The guidelines are not just about empowering officers; they also incorporate checks to protect taxpayers from arbitrary decisions. By insisting on recording reasons in writing, limiting the blocked amount, and assigning authority based on monetary limits, the Board has created multiple safeguards.
These safeguards aim to ensure that power is exercised judiciously and proportionately, while giving taxpayers the ability to seek review or relief if their credits are blocked unfairly.
Significance of the Guidelines
The issuance of these guidelines represents an important step in harmonizing the application of Rule 86A across the country. They create uniformity in practice, reduce the scope for misuse, and provide clarity to taxpayers about the circumstances under which their credits can be blocked. At the same time, they reinforce the government’s commitment to tackling fraudulent practices such as fake invoicing, thereby protecting the integrity of the GST system.
Rule 86A and Blocking of Credit: Practical Implications and Challenges
Rule 86A of the CGST Rules has introduced a powerful mechanism to restrict the misuse of input tax credit through fraudulent transactions. While the CBIC guidelines have provided a framework for exercising this power, the practical application has raised several questions, challenges, and debates among businesses, tax professionals, and the judiciary. We explore the real-world implications of Rule 86A, its challenges, and the broader impact on industry practices.
Practical Implications for Taxpayers
Increased Scrutiny of Suppliers
One of the immediate implications of Rule 86A is that taxpayers are now more cautious in dealing with their suppliers. Since input tax credit can be blocked if the supplier is found to be non-existent or not paying taxes to the government, businesses are increasingly conducting due diligence before entering into transactions. Verification of GST registration details, compliance records, and business premises has become part of vendor selection processes.
Need for Robust Documentation
The guidelines make it clear that credit without valid documentation can be blocked. This has forced taxpayers to maintain robust documentation for every transaction, including invoices, debit notes, e-way bills, and delivery proofs. Many organizations have adopted digital record-keeping systems to ensure that documents are readily available in case of scrutiny.
Financial Impact of Blocked Credit
When ITC is blocked under Rule 86A, taxpayers are unable to use it for offsetting output tax liability. This increases their cash outflow, as they must pay taxes in cash despite having credit balances in their ledger. For small and medium enterprises, the sudden blocking of credit can create liquidity issues, affecting day-to-day operations.
Increased Litigation
The discretionary nature of Rule 86A has led to increased litigation. Taxpayers often challenge the blocking of credit on grounds of insufficient evidence, lack of opportunity to be heard, or disproportionate action. Courts have been called upon to interpret the rule and determine whether authorities have acted within the boundaries of law and fairness.
Challenges in Implementation
Subjective Nature of “Reasons to Believe”
One of the major challenges is the subjective interpretation of the phrase “reasons to believe.” While the guidelines require officers to record reasons in writing, the sufficiency of those reasons remains open to challenge. Different officers may interpret similar facts differently, leading to inconsistency.
Delay in Unblocking of Credit
Although the rule provides that restrictions automatically lapse after one year, taxpayers often face delays in unblocking credit even when they provide evidence of genuine transactions. This results in unnecessary financial hardship and forces businesses to approach courts for relief.
Impact on Genuine Businesses
There have been instances where genuine taxpayers suffered due to actions taken against their suppliers. Even though the buyer may have complied with all requirements, if the supplier fails to pay tax or is found to be non-existent, the buyer’s credit gets blocked. This raises concerns about fairness and the need for greater protection for bona fide taxpayers.
Limited Awareness Among Businesses
Many businesses, especially smaller ones, are not fully aware of the implications of Rule 86A. They may not have the resources to verify every supplier thoroughly, which puts them at risk of losing credit if the supplier defaults. Lack of awareness about preventive steps further increases vulnerability.
Judicial Interpretations
Requirement of Proper Justification
In several cases, courts have held that blocking credit under Rule 86A requires proper justification and evidence. The Gujarat High Court in the case of S.S. Industries observed that the authority must form an opinion but should not misuse the power as a tool of harassment. Courts have emphasized that such powers must be exercised cautiously, with adherence to principles of natural justice.
Temporary Nature of Restriction
Judicial forums have also highlighted that blocking of ITC under Rule 86A is a temporary measure and cannot be equated with permanent denial of credit. If, after investigation, the credit is found to be genuine, it must be restored. This interpretation reinforces the principle that taxpayers should not be deprived of genuine credit indefinitely.
Protection Against Arbitrary Action
Courts have reminded authorities that while protecting revenue is important, actions must not be arbitrary or disproportionate. Blocking of credit should be restricted only to the amount suspected to be fraudulent or ineligible, and reasons must be clearly documented. Judicial scrutiny has thus acted as an important safeguard for taxpayers.
Industry Perspectives
Compliance Burden on Businesses
Industry representatives have expressed concerns about the additional compliance burden resulting from Rule 86A. Businesses must now spend more resources on verifying suppliers, maintaining documentation, and handling disputes related to blocked credit. While this improves overall discipline, it also increases operational costs.
Trust Deficit Between Buyers and Suppliers
The possibility of credit being blocked due to supplier defaults has created a trust deficit in the supply chain. Buyers are increasingly cautious and may avoid dealing with smaller or new suppliers due to fear of future disputes. This affects business opportunities, especially for startups and small enterprises.
Role of Technology in Reducing Risks
To cope with the risks, many businesses are adopting technology-driven solutions such as vendor compliance checks, automated reconciliation of invoices with GST returns, and data analytics to flag suspicious transactions. These tools help reduce exposure to fraudulent practices and provide additional assurance to both buyers and authorities.
Administrative Challenges
Balancing Revenue Protection with Ease of Doing Business
For tax authorities, the key challenge is to balance the need to protect revenue with the government’s commitment to ease of doing business. Overzealous blocking of ITC can discourage compliance and create a negative perception about the tax regime. The guidelines attempt to strike this balance, but practical implementation remains complex.
Training of Officers
The effective application of Rule 86A requires officers to be adequately trained in identifying fraudulent transactions, evaluating evidence, and exercising discretion fairly. Without proper training, there is a risk of inconsistent decisions and potential misuse of powers.
Monitoring and Review Mechanisms
Another challenge is ensuring regular monitoring and review of cases where credit has been blocked. Without timely review, restrictions may continue unnecessarily, causing financial distress to taxpayers. Establishing systematic review mechanisms is therefore essential.
Comparative Perspectives
International Practices on Input Credit Control
Many countries with value-added tax systems have mechanisms to prevent fraudulent credit claims. For example, in the European Union, tax authorities closely monitor cross-border transactions to prevent carousel fraud. In some jurisdictions, credits are provisionally allowed but subject to verification before final approval. Comparing these practices shows that while blocking credit is not unique to India, the extent of discretionary power under Rule 86A is relatively high.
Lessons for India
India can learn from international practices by adopting more technology-driven monitoring systems rather than relying heavily on manual discretion. Automated matching of invoices, real-time alerts, and centralized risk assessment models can reduce the need for subjective blocking of credit.
Way Forward for Businesses
Strengthening Supplier Onboarding Processes
Businesses must strengthen their supplier onboarding processes to minimize risk. This includes verifying GST registration details, checking compliance history, and conducting periodic reviews. Establishing clear contractual clauses requiring suppliers to remain compliant with tax laws can also provide additional protection.
Investing in Compliance Technology
Adopting compliance technology is no longer optional but essential. Automated reconciliation of purchase invoices with supplier filings, data validation tools, and digital record-keeping can significantly reduce the risk of disputes under Rule 86A.
Engaging with Tax Professionals
Regular engagement with tax professionals and consultants can help businesses navigate the complexities of Rule 86A. Professional advice can assist in structuring transactions, maintaining documentation, and handling disputes effectively.
Future Outlook of Rule 86A
Evolution of Guidelines
The CBIC guidelines issued in 2021 were the first step in providing clarity on Rule 86A. However, as the tax system evolves and more cases arise, further refinements and clarifications may be introduced. Future guidelines may focus on additional safeguards for genuine taxpayers and improved mechanisms for faster review of blocked credits.
Integration with Data Analytics
The future of credit monitoring is likely to be driven by data analytics and artificial intelligence. By analyzing patterns of transactions, authorities can identify high-risk suppliers and buyers more accurately, reducing the need for discretionary blocking of credit. This approach would provide a more objective and transparent system.
Judicial Oversight
As more cases reach courts, judicial oversight will continue to shape the practical application of Rule 86A. Courts are likely to insist on strict adherence to procedural safeguards and may direct further refinements in the guidelines to protect taxpayer rights.
Conclusion
The introduction of Rule 86A into the CGST Rules marked a decisive step by the Government to strengthen the GST framework against fraudulent availment of input tax credit. With the surge of fake invoicing and manipulation of credits, the need for a mechanism that empowered tax authorities to protect revenue was undeniable. Rule 86A fills this gap by giving Commissioners and authorized officers the power to block ITC in cases where there are reasons to believe that the credit is ineligible or fraudulently availed.
Over the course of this discussion, several key aspects of this provision emerged. On one hand, Rule 86A has proven to be an essential safeguard for the GST system, ensuring that dishonest taxpayers cannot take undue advantage of the credit mechanism. It upholds the integrity of the indirect tax system by restricting ITC misuse and protecting genuine revenue inflows. On the other hand, the extraordinary nature of the power, if exercised arbitrarily, poses risks to bona fide taxpayers who may face hardship due to supplier defaults or administrative overreach.
Judicial perspectives, particularly those of High Courts, have emphasized that while the rule is valid, its application must be tempered with fairness, transparency, and due process. The CBIC guidelines issued in 2021 attempted to address this balance by laying down grounds for invoking the provision, defining competent authorities based on monetary thresholds, and mandating that reasons for blocking ITC be properly recorded in writing. These measures are aimed at ensuring that the power is exercised responsibly and only in deserving cases.
Yet, challenges remain. Subjectivity in determining “reasons to believe,” delays in unblocking ITC, and the financial strain caused to genuine businesses highlight the need for continuous refinement of the process. At the same time, businesses have been compelled to strengthen compliance practices, adopt technological solutions for monitoring supplier behavior, and realign contractual obligations to mitigate risks. For the administration, the road ahead lies in leveraging data analytics, training officers, and standardizing procedures to reduce discretion and improve accountability.
Looking forward, the successful implementation of Rule 86A depends on striking the right balance between protecting revenue and safeguarding taxpayer rights. Fraudulent credits must be curbed with firm action, but without creating an environment of uncertainty for compliant taxpayers. As the GST system matures, it is expected that this provision will evolve with further clarifications, judicial oversight, and technological integration, ensuring that it continues to serve its true purpose.
Ultimately, Rule 86A reflects the broader challenge of tax administration in a modern economy: how to combat evasion while fostering a climate of trust and compliance. If implemented with fairness and supported by robust technology and procedural safeguards, it can strengthen the GST framework, protect government revenue, and maintain the confidence of honest businesses achieving the very balance that the law envisions.