Input Tax Credit (ITC): Challenges, Compliance, and the Evolving Legal Landscape

The introduction of the Goods and Services Tax (GST) in India in 2017 marked one of the most significant tax reforms in the country’s history. Designed to unify various indirect taxes and promote transparency, GST operates on the principle of seamless input tax credit (ITC). ITC is the backbone of the GST system which ensures that taxes are paid only on the value added at each stage of the supply chain. However, while ITC is meant to simplify and rationalize taxation, its implementation has raised several legal, procedural, and practical challenges for businesses.

Understanding the Concept of Input Tax Credit

Input Tax Credit allows taxpayers to claim credit for the GST paid on inputs (goods or services) that are used in the course of business. When a taxpayer purchases raw materials, capital goods, or services, they pay GST. This GST can be claimed as a credit and used to offset the GST liability on outward supplies.

For example, if a manufacturer pays ₹10,000 as GST on inputs and collects ₹15,000 as GST on sales, they need to pay only the difference of ₹5,000. This prevents cascading taxation, where tax is charged on tax, and ensures seamless flow of credit through the supply chain.

Statutory Framework Governing ITC

The legal basis for ITC lies primarily in:

• Section 16 of the CGST Act (eligibility and conditions for taking credit)

• Section 17 (apportionment of credit and blocked credits)

• Section 18 (availability of credit in special circumstances)

• Rules 36, 37, 42, 43 of the CGST Rules (documentation and computation)

Key conditions for availing ITC include:

• Possession of a tax invoice

• Receipt of goods or services

• Tax actually paid to the government by the supplier

• Filing of returns by both supplier and recipient

• Utilization only for business purposes

These conditions appear straightforward, but practical implementation has led to frequent disputes and litigation.

Restrictions and Blocked Credits

Not all GST paid on purchases is eligible for ITC. Section 17(5) lists “blocked credits,” meaning GST paid on certain items cannot be claimed. These include:

• Motor vehicles (with exceptions)

• Food, beverages, catering, and club memberships

• Works contract services for construction

• Goods or services used for personal consumption

While the intent behind blocked credits is to prevent misuse, many taxpayers argue that the restrictions increase compliance complexity and undermine GST’s goal of seamless credit.

The GSTR-2A / 2B vs. ITC Eligibility Debate

One of the most contentious issues in GST practice is the dependency on supplier compliance for availing ITC. ITC is reflected in auto-generated statements like GSTR-2A and GSTR-2B only when the supplier files GSTR-1 accurately.

This has led to several challenges:

• Buyers face denial of ITC due to supplier’s non-compliance.

• Honest taxpayers are penalized for reasons beyond their control.

• Frequent reconciliations between purchase records and 2A/2B are required, increasing compliance burden.

Courts have offered mixed views, but many judgments stress that the government should not penalize compliant buyers for default by suppliers, especially when transactions are genuine.

The Principle of “Matching” and Its Practical Issues

GST was originally designed with a system of invoice matching—credit would be allowed only when both supplier and recipient uploaded matching invoices. Although the government deferred full-scale matching due to technical challenges, the principle still influences compliance requirements.

Practical issues include:

• Frequent mismatches due to clerical errors

• Credit denial even when goods have been received

• Excessive dependence on portal-generated data

• Burden shifting onto recipients to chase suppliers for compliance

These issues highlight the need for a simpler and more taxpayer-friendly credit mechanism.

Timelines and Restrictions for Claiming ITC

ITC must be claimed within strict time limits:

• Earlier of 30th November of the following financial year or

• Filing of the annual return

Missing this deadline leads to permanent loss of credit, resulting in significant financial impact. For small and medium businesses with limited accounting resources, adhering to these timelines can be challenging.

Fraudulent ITC and Government Crackdowns

The ease of availing ITC also opened the door to fake invoice rackets—where unscrupulous entities issued invoices without actual supply to generate illegal credits. In response, the government has intensified enforcement:

• Arrests under GST laws for fraudulent ITC

• Suspension of GSTINs

• Blocking of electronic credit ledgers

• AI-driven analytics to detect suspicious patterns

While these measures curb tax evasion, they also sometimes affect genuine businesses, especially when credits are frozen pending verification.

udicial Trends and Key Judgments

Courts across India have played an active role in interpreting ITC provisions. Key judicial themes include:

• ITC is a vested right, not a concession, when all statutory conditions are met.

• Authorities cannot block credit indefinitely without initiating adjudication.

• Buyer’s ITC cannot be denied solely due to supplier fraud if the buyer acted in good faith.

• Procedural lapses should not override substantive rights.

However, conflicting judgments highlight the need for legislative clarity and uniform administration.

Emerging Trends: E-Invoicing and Digital Compliance

To streamline ITC verification, India introduced e-invoicing, which requires large businesses to generate invoices through the government portal. Benefits include:

• Reduction in fake invoices

• Automatic population of returns

• Faster reconciliation of ITC

• More reliable audit trails

As e-invoicing expands to smaller businesses, ITC-related disputes may gradually reduce, though compliance costs may rise initially.

The Road Toward a More Effective ITC System

To realize the true spirit of GST, India must simplify ITC compliance. Possible reforms include:

• Relaxing buyer dependence on supplier filing

• Simplifying rules for blocked credits

• Creating uniform nationwide audit and verification standards

• Providing real-time verification tools for taxpayers

• Enhancing education and training for small businesses

A transparent, predictable, and easy-to-comply ITC system will improve GST efficiency, reduce litigation, and support business growth.

Conclusion

Input Tax Credit is the foundation of India’s GST framework, enabling tax neutrality and ensuring smooth flow of credit across the supply chain. However, the current system faces multiple challenges, supplier non-compliance, technical complexities, restrictive provisions, and evolving regulatory interpretations. As GST matures, refining the ITC mechanism is essential for achieving its original purpose: a transparent, unified, and business-friendly taxation system.