2025 (5) TMI 550 - HC - GST

Blocking the petitioner s 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 to believe - Violation of 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 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 he has been found non-existent or not to be conducting any business from any places for which registration has been obtained no other reasons are forthcoming in the impugned order. On this ground also the impugned order dated 03.09.2024 deserves to the quashed. Conclusion - 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 deserves to be quashed. Impugned order dated 03.09.2024 at Annexure-B is hereby quashed - petition allowed.

Summary

The core legal questions considered in this judgment are:

1. Whether the impugned order blocking the petitioner's Electronic Credit Ledger (ECL) under Rule 86A of the Central Goods and Services Tax Rules, 2017 (CGST Rules) is legally valid, particularly in the absence of a pre-decisional hearing and independent reasons to believe.

2. Whether Rule 86A of the CGST Rules is ultra vires the Constitution, specifically regarding violations of Article 19(1)(g) (right to practice any profession or to carry on any occupation, trade or business) and Article 300A (protection of property).

3. Whether the impugned order complies with the procedural and substantive safeguards mandated by law, including the requirement of formation of an independent opinion based on tangible material before blocking the ECL.

4. Whether the exercise of power under Rule 86A is arbitrary, unreasonable, discriminatory, or violative of principles of natural justice and administrative law.

5. Whether the respondents can rely on "borrowed satisfaction" or reports from other officers without independent application of mind in passing orders under Rule 86A.

6. The applicability of the doctrine of proportionality and the necessity of the formation of opinion for provisional attachment or blocking of credit under relevant tax statutes.

Issue-wise Detailed Analysis:

Issue 1: Validity of the impugned order blocking the Electronic Credit Ledger under Rule 86A

The relevant legal framework includes Rule 86A of the CGST Rules, 2017, which empowers the Commissioner or an authorized officer to block the electronic credit ledger if there are "reasons to believe" that input tax credit (ITC) has been fraudulently availed or is ineligible. The rule mandates that such reasons must be recorded in writing and based on cogent material.

Precedent from the Division Bench in K-9-Enterprises Vs. State of Karnataka clarified that the power under Rule 86A is "drastic and draconian" and must be exercised with utmost circumspection. The Court emphasized two pre-requisites: (i) the authority must have tangible material to form "reasons to believe" and (ii) these reasons must be recorded in writing after proper application of mind.

The Court held that the impugned order lacked a pre-decisional hearing and did not contain independent or cogent reasons. It relied solely on a field visit report by an officer from another jurisdiction (Goa), amounting to "borrowed satisfaction," which is impermissible. The Court reasoned that the satisfaction must arise from an independent inquiry by the authority passing the order, not from mere reliance on reports or investigations by others.

The Court noted that the impugned order was "bald, vague, cryptic, laconic, unreasoned and non-speaking," failing to meet the legal requirements. It further observed that the closure of the supplier's business after the transaction period cannot justify denial of credit, as the genuineness of the transaction at the time of credit availing was not examined.

In application, the Court quashed the impugned order for failure to comply with mandatory procedural safeguards and lack of independent reasons to believe.

Issue 2: Constitutional validity of Rule 86A

The petitioner challenged Rule 86A as ultra vires the Constitution, alleging it was unreasonable, arbitrary, discriminatory, and violated Article 19(1)(g) and Article 300A.

The Court, relying on the principles of administrative law and the precedents set forth, implicitly held that Rule 86A is constitutionally valid provided it is applied strictly in accordance with the statutory requirements. The rule's exercise must not be arbitrary or mechanical but must be based on objective material and reasoned satisfaction.

The Court's insistence on strict compliance with procedural safeguards and the requirement of independent satisfaction serves as a constitutional check against arbitrariness and violation of fundamental rights.

Issue 3: Requirement of pre-decisional hearing and independent application of mind

The Court underscored the necessity of affording a pre-decisional hearing before passing an order blocking the ECL. This is a fundamental principle of natural justice, ensuring that the affected party has an opportunity to present its case.

Precedent from the Division Bench in K-9-Enterprises confirmed that the absence of such hearing renders the order liable to be quashed. The Court also emphasized that the authority must apply its own mind and not act on the "borrowed satisfaction" of other officers.

The impugned order failed on both counts: no hearing was provided, and the order was based on reports from other officers without independent evaluation.

Issue 4: Application of the doctrine of proportionality and necessity of formation of opinion

The Court relied on authoritative decisions interpreting similar provisions under the CGST Act and other tax statutes, including the doctrine of proportionality as enunciated in Radha Krishan Industries and Vishwanath Realtor cases.

The doctrine mandates that the power to block credit or provisionally attach property must be exercised only when necessary to protect government revenue, and there must be a proximate and live nexus between the action and the intended purpose.

The Court noted that mere apprehension of huge tax demands or reliance on past conduct without tangible material is insufficient. The formation of opinion must be based on objective facts and tangible material, not on mere suspicion or expediency.

In the instant case, the impugned order failed to demonstrate necessity or proportionality, lacking any finding that the petitioner was a "fly by night operator," habitual defaulter, or likely to defeat revenue recovery.

Issue 5: Reliance on "borrowed satisfaction" and mechanical exercise of power

The Court condemned the practice of passing orders based on "borrowed satisfaction" from other officers or investigation reports without independent evaluation. It held that the authority empowered under Rule 86A must independently form an opinion based on material evidence before exercising such drastic power.

The impugned order was quashed on this ground as well, as it was based solely on communication from an officer who conducted a field visit elsewhere, without any independent inquiry or application of mind by the authority issuing the order.

Issue 6: Procedural safeguards and consequences of non-compliance

The Court reiterated that the power under Rule 86A is "extraordinary" and must be exercised with "utmost circumspection and with maximum care and caution." The absence of cogent reasons, failure to record reasons in writing, and lack of pre-decisional hearing render the order illegal and arbitrary.

The Court directed immediate unblocking of the petitioner's ECL and allowed the petitioner liberty to contest any fresh notice issued in accordance with law. It also clarified that failure to comply with the directions would revive the petition automatically.

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 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."

"The satisfaction must be reached on the basis of some objective material available before the authority and cannot be made on the flights of ones fancies or whims or caprices."

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

"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 doctrine of proportionality mandates the existence of a proximate or live link between the need for the attachment and the purpose which it is intended to secure. Mere apprehension that huge tax demands are likely to be raised is not sufficient."

"The impugned order discloses that the same has been passed mechanically and is based on borrowed satisfaction and does not meet the test of formation of an opinion of the Assessing Officer."

The Court's final determination was to quash the impugned order dated 03.09.2024 blocking the petitioner's Electronic Credit Ledger under Rule 86A for failure to comply with mandatory procedural safeguards, absence of independent reasons to believe, reliance on borrowed satisfaction, and lack of proportionality and necessity. The respondents were directed to unblock the ECL immediately and were granted liberty to proceed afresh in accordance with law, ensuring adherence to the principles laid down.