2025 (5) TMI 547 - HC - GST

Blocking of Electronic Credit Ledger (ECL) under Rule 86A of the Central Goods and Services Tax Rules 2017 (CGST Rules) - absence of a pre-decisional hearing and independent reasons recorded by the authority - principles of natural justice - HELD THAT - In K-9-Enterprises 2024 (10) TMI 491 - KARNATAKA HIGH COURT the issues were answered in favour of the petitioner-assessee by holding that The aforesaid facts and circumstances are sufficient to come to the unmistakable conclusion that in the absence of valid nor sufficient material which constituted reasons to believe which was available with respondents the mandatory requirements/pre-requisites/ingredients/parameters contained in Rule 86A had not been fulfilled/satisfied by the respondents-revenue who were clearly not entitled to place reliance upon borrowed satisfaction of another officer and pass the impugned orders illegally and arbitrarily blocking the ECL of the appellant by invoking Rule 86A which is not only contrary to law but also the material on record and consequently the impugned orders deserve to be quashed. In the instant case since no pre-decisional hearing are provided/granted by the respondents before passing the impugned order coupled with the fact that the impugned order invoking Section 86A blocking of the Electronic credit ledger of the petition does not contain independent or cogent reasons to believe/accept by placing reliance upon reports of enforcement authority which is impermissible in law since the same is on borrowed satisfaction as held by Division Bench the impugned order deserves to be quashed. It is also pertinent to note that the impugned order except stating that the registered person/ supplier found to be a bill trader and involved in issuance/availment in fake invoices and the business premises is not existing no other reasons are forthcoming in the impugned order. The concerned respondents are directed to unblock the Electronic credit ledger of the petitioner immediately upon the receipt of copy of this order so as to enable the petitioner to file returns forthwith - Petition allowed.

Summary

The core legal questions considered by the Court in this matter include:

1. Whether the impugned order blocking the Electronic Credit Ledger (ECL) under Rule 86A of the Central Goods and Services Tax Rules, 2017 (CGST Rules) was legally valid, particularly in the absence of a pre-decisional hearing and independent reasons recorded by the authority.

2. Whether the provisions of Rule 86A are reasonable, non-arbitrary, and constitutionally valid, especially with respect to Articles 14 and 19(1)(g) of the Constitution of India.

3. The extent and nature of the satisfaction or "reasons to believe" required under Rule 86A before blocking the ECL, including the necessity of independent application of mind by the competent authority rather than reliance on borrowed satisfaction from other officers.

4. The procedural safeguards and requirements that must be fulfilled before exercising the power under Rule 86A, including the necessity of recording cogent reasons in writing and providing an opportunity for hearing.

5. The applicability of principles of proportionality, reasoned decision-making, and the doctrine of legitimate expectation in the context of blocking input tax credits.

6. The legal parameters governing provisional attachment of property under analogous provisions, including the necessity of forming an opinion based on tangible material to protect government revenue, as elaborated in precedents dealing with similar draconian powers.

Issue-wise Detailed Analysis:

Issue 1: Validity of the Impugned Order Blocking the Electronic Credit Ledger under Rule 86A

The relevant legal framework is Rule 86A of the CGST Rules, 2017, which empowers the Commissioner or an authorized officer to block the debit of amount from the electronic credit ledger if there are "reasons to believe" that the input tax credit (ITC) was fraudulently availed or is ineligible. The rule mandates that such reasons must be recorded in writing and must be based on cogent material. The CBEC Circular dated 02.11.2021 further clarifies that the power must be exercised with utmost circumspection and after proper application of mind, considering all facts and circumstances.

The Court relied heavily on the Division Bench judgment in K-9-Enterprises, which held that the power under Rule 86A is drastic and draconian, necessitating strict compliance with procedural safeguards. The Court emphasized that the "reasons to believe" must arise from an independent inquiry and cannot be based on borrowed satisfaction from other officers or mere suspicion.

In the instant case, the impugned order blocked the petitioner's ECL solely on the basis of a field visit report by an Assistant State Tax Officer from Goa, without any independent application of mind or pre-decisional hearing. The order was cryptic, vague, and failed to record cogent reasons or explain why blocking was necessary. The Court found that this violated the mandatory requirements of Rule 86A and the principles of natural justice.

The Court applied the law to the facts by noting that the petitioner was not given an opportunity to be heard before the order was passed, and the authority did not independently verify the genuineness of the transactions or the supplier's status at the relevant time of credit availing. The mere fact that the supplier was found to be non-existent at a later date was insufficient to justify blocking the credit already availed.

Competing arguments by the respondents, who contended that the order was justified and supported by material, were rejected on the ground that reliance on borrowed satisfaction without independent analysis is impermissible. The Court concluded that the impugned order was illegal, arbitrary, and deserved to be quashed.

Issue 2: Reasonableness and Constitutional Validity of Rule 86A

The petitioner challenged Rule 86A as being unreasonable, arbitrary, and violative of Articles 14 (equality before law) and 19(1)(g) (right to practice any profession or carry on any occupation, trade or business) of the Constitution.

The Court, while not expressly striking down the rule, underscored the necessity for strict adherence to procedural safeguards and reasoned decision-making to ensure that the exercise of power under Rule 86A does not become arbitrary or discriminatory. The Court's reasoning implicitly affirms that the rule, if applied in a mechanical or non-transparent manner, would violate constitutional guarantees.

The Court's emphasis on the doctrine of proportionality and the requirement of an objective basis for "reasons to believe" serves to protect the taxpayer's rights under Article 14 and 19(1)(g) by preventing arbitrary deprivation of the valuable right to avail ITC.

Issue 3: Requirements of "Reasons to Believe" and Independent Application of Mind

The Court elaborated on the meaning and scope of "reasons to believe" under Rule 86A, drawing from the CBEC Circular and judicial precedents. It held that the authority must form an opinion based on tangible, cogent material and not on mere suspicion or information received from other officers. The satisfaction must be the authority's own, arrived at after careful examination of all facts.

The Court criticized the impugned order for being based on "borrowed satisfaction" from a field visit report without any independent inquiry or verification. It held that such reliance violates the statutory mandate and principles of administrative law, which require that a delegated power be exercised by the designated authority personally and not mechanically.

This reasoning aligns with the principle that administrative action must be reasoned and based on evidence, ensuring fairness and transparency.

Issue 4: Procedural Safeguards and Pre-decisional Hearing

The Court underscored that the power to block ECL under Rule 86A is extraordinary and draconian, affecting the taxpayer's ability to discharge tax liabilities. Consequently, the taxpayer must be afforded a pre-decisional hearing to present their case and rebut allegations before such power is exercised.

The absence of such hearing in the impugned order was a critical flaw that vitiated the order. The Court relied on the Division Bench's precedent, which held that denial of such hearing violates principles of natural justice and renders the order unsustainable.

The Court also noted that the impugned order failed to record any reasons or findings justifying the blocking, further compounding the procedural infirmity.

Issue 5: Doctrine of Proportionality and Legitimate Expectation

The Court applied the doctrine of proportionality to assess the necessity and reasonableness of blocking the ECL. It emphasized that the power must be exercised only when necessary to protect revenue and not merely for expediency or convenience.

The Court found that the impugned order lacked a proximate or live nexus between the need for blocking and the protection of revenue. Mere apprehension of loss or suspicion without tangible material is insufficient.

The Court also highlighted the petitioner's legitimate expectation to avail ITC, a valuable right, and that arbitrary blocking without due process violates this expectation and causes irreparable injury.

Issue 6: Analogous Principles Governing Provisional Attachment of Property

The Court drew parallels with the law relating to provisional attachment of property under Section 83 of the CGST Act and similar provisions in other statutes. It reiterated the settled principle that such draconian powers require formation of a valid opinion based on tangible material and necessity to protect government revenue.

The Court cited authoritative precedents which held that the opinion must not be an unguided subjective discretion but must bear a live nexus to protecting revenue, and that the power must be exercised with strict adherence to statutory conditions.

Applying these principles, the Court found the impugned order lacking any recorded opinion or tangible material to justify provisional blocking of the ECL. The order was therefore ultra vires and liable to be quashed.

Significant Holdings:

"The power of disallowing debit of amount from electronic credit ledger must not be exercised in a mechanical manner and careful examination of all the facts of the case is important to determine cases 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."

"When a thing is directed to be done in a particular manner, it must be done in that manner or not at all is the well-established principle of administrative law."

"The formation of the opinion must bear a proximate and live nexus to the purpose of protecting the interest of the government revenue. Necessity postulates that the interest of the Revenue can be protected only by a provisional attachment without which the interest of the Revenue would stand defeated."

"The impugned orders are bald, vague, cryptic, laconic, unreasoned and non-speaking and deserve to be set aside."

"The respondents-revenue committed a grave and serious error/illegality/infirmity in passing the impugned orders blocking the Electronic Credit Ledgers of the Appellants by invoking Rule 86A of the CGST Rules."

The Court ultimately quashed the impugned order dated 26.03.2025 blocking the petitioner's Electronic Credit Ledger and directed immediate unblocking to enable filing of returns. The respondents were granted liberty to proceed afresh in accordance with law, including issuance of fresh notices and allowing the petitioner to submit documents and contest proceedings. The petitioner was directed to appear before the authority on a specified date, with the caveat that failure to appear would revive the quashed order automatically.