Blocking of Electronic Credit Ledger: Legal Challenges and Remedies Available To Tax Payers

Rule 86A of the CGST Rules empowers the Commissioner or an authorized officer (not below the rank of Assistant Commissioner) to block the use of ITC available in the ECL if he has “reasons to believe” that:

1. ITC has been fraudulently availed or is ineligible; and

2. Such credit is availed:

   • On the strength of fake invoices.

   • Without actual receipt of goods or services.

   • Where the supplier is non-existent or not conducting business from the registered place.

   • Without payment of tax to the government.

The rule allows the blocking for up to one year, after which the credit should be unblocked unless fresh grounds arise.

Grounds for disallowing debit of an amount from Electronic credit ledger

1. "reasons to believe" — Perusal of the rule makes it clear that the Commissioner, or an officer authorised by him, not below the rank of Assistant Commissioner, must have "reasons to believe" that credit of input tax available in the Electronic credit ledger is either ineligible or has been fraudulently availed by the Registered person, before disallowing the debit of amount from Electronic credit ledger of the said Registered person under Rule 86A.

The reasons for such belief must be based only on one or more of the following grounds:

1. The credit is availed by the Registered person on the invoices or Debit notes issued by a supplier, who is found to be non-existent or is found not to be conducting any business from the place declared in registration.

2. The credit is availed by the Registered person on invoices or Debit notes, without actually receiving any goods or services or both.

3. The credit is availed by the Registered person on invoices or Debit notes, the tax in respect of which has not been paid to the government.

4. The Registered person claiming the credit is found to be non-existent or is found not to be conducting any business from the place declared in registration.

5. The credit is availed by the Registered person without having any invoice or Debit note or any other valid document for it.

Absence of application of mind—  The Commissioner, or an officer authorised by him, not below the rank of Assistant Commissioner, must form an opinion for disallowing debit of an amount from Electronic credit ledger in respect of a Registered person, only after proper application of mind considering all the facts of the case, including the nature of prima facie fraudulently availed or ineligible Input tax credit and whether the same is covered under the grounds mentioned in sub-rule (1) of Rule 86A; the amount of Input tax credit involved; and whether disallowing such debit of Electronic credit ledger of a person is necessary for restricting him from utilizing/ passing on fraudulently availed or ineligible Input tax credit to protect the interests of revenue.

The power of disallowing debit from Electronic credit ledger must not be exercised in a mechanical manner— The power of disallowing debit of amount from Electronic credit ledger must not be exercised in a mechanical manner, careful examination of all the facts of the case is important to determine case(s) fit for exercising power under Rule 86A.

The remedy of disallowing debit of amount from Electronic credit ledger being, by its very nature, extraordinary, has to be resorted to with utmost circumspection and with maximum care and caution.

It contemplates an objective determination based on intelligent care and evaluation as distinguished from a purely subjective consideration of suspicion.

Allowing debit of disallowed/restricted credit under sub-rule (2) of Rule 86A

1. The Commissioner or the authorized officer, as the case may be, either on his own or based on the submissions made by the taxpayer with material evidence thereof, may examine the matter afresh and on being satisfied that the Input tax credit, initially considered to be fraudulently availed or ineligible as per conditions of sub-rule (1) of Rule 86A, is no more ineligible or wrongly availed, either partially or fully, may allow the use of the credit, so disallowed/restricted, up to the extent of eligibility, as per powers granted under sub-rule (2) of Rule 86A.

Reasons for allowing the debit of Electronic credit ledger, which had been earlier disallowed, shall be duly recorded on file in writing, before allowing such debit of Electronic credit ledger.

1. The restriction imposed as per sub-rule (1) of Rule 86A shall cease to have effect after the expiry of a period of one year from the date of imposing such restriction. In other words, upon expiry of one year from the date of restriction, the Registered person would be able to debit Input tax credit so disallowed, subject to any other action that may be taken against the Registered person.

2. As the restriction on debit of Electronic credit ledger under sub-rule (1) of Rule 86A is resorted to protect the interests of the revenue and the said action also has bearing on the working capital of the Registered person, it should be endeavored that in all such cases, the investigation and adjudication are completed at the earliest, well within the period of restriction, so that the due liability arising out of the same can be recovered from the said Taxable person and the purpose of disallowing debit from Electronic credit ledger is achieved.

Legal Challenges

1. Lack of Due Process and Natural Justice

The blocking of credit under Rule 86A is typically done without issuing a show-cause notice or providing an opportunity of being heard, violating the principles of natural justice (audi alteram partem). Courts have repeatedly emphasized that even administrative actions affecting rights must adhere to fair procedure.

2. Vague Standard – “Reasons to Believe”

The phrase “reasons to believe” is subjective and open to arbitrary interpretation. Without adequate guidelines or objective criteria, this power may be misused.

3. No Timeframe for Disposal

Although the rule limits the blockage to one year, there is no mandate for early resolution or requirement to communicate the grounds of action promptly, leading to indefinite hardship.

Remedies Available to Taxpayers

1. Writ Petition under Article 226— when no alternative remedy is effective or where the action is arbitrary, the taxpayer may directly approach the High Court under Article 226 for writ relief.

2. Representation and Review— A formal representation can be made to the jurisdictional GST officer seeking reasons and requesting unblocking, backed by documentary evidence.

3. Appeal Mechanism—If blocking leads to any adjudication or order, the taxpayer may prefer an appeal under Section 107 of the CGST Act, although this becomes effective only after an order is passed, not just for the act of blocking.

Relevant Judicial pronouncement—

1. PUNJAB AND HARYANA HIGH COURT in case of Rajnandini Metal Ltd. V/s Union of India [2022] 48 TAXLOK.COM 114 (P&H), held that Merely by recording that some investigation is going-on a drastic far-reaching action under Rule 86A of the CGST Rules cannot be sustained. There is no reason recorded by the Authority for exercising power under Rule 86A of the CGST Act, 2017 which would show independent application of mind that can constitute reasons to believe which is sine qua non for exercising power under Rule 86A of the CGST Rules.

2. GUJARAT HIGH COURT in case of Samay Alloys India Pvt. Ltd. V/s State of Gujarat [2022] 45 TAXLOK.COM 033 (Gujarat), held that If no input tax credit was available in the ledger, the blocking of electronic credit ledger under Rule 86-A of the Rules and insertion of negative balance in the ledger would be wholly without jurisdiction and illegal. There is no power of negative block for credit to be availed in future. The respondents are directed to withdraw negative block of the electronic credit ledger at the earliest.

3. ANDHRA PRADESH HIGH COURT in case of As Steel Traders (VSP) Private Limited V/s The Union of India [2021] 40 TAXLOK.COM 017 (AP), held that Restriction imposed under Rule 86A will cease to have effect after the expiry of period of one year from the date of imposing such restriction. Since that period of one year has been elapsed in instant case, this court directed the respondents to de-block the Input Tax Credit and permit the petitioners to utilize the Input Tax Credit.

4. GUJARAT HIGH COURT in case of Nipun A Bhagat V/s State of Gujarat [2021] 32 TAXLOK.COM 044 (Gujarat) (Gujarat), held that Rule 86A cannot be invoked for blocking the input tax credit available in the electronic credit ledger of the petitioner who was a Director of the private company.