Stopping ITC fraud with respect to items like steel melting scrap, which is not a consumer item rather pure industrial input for saving the bonafide manufacturing industry as well as increasing government revenue

[Pramod Kumar Rai]

1. Today Secondary Steel Manufacturers are pressurised and stressed with series of investigations even though most of them are not at fault. They are being penalized and even arrested for the wrong deeds of their scrap suppliers. Print media as well as internet is flooded with ITC (input tax credit) related fraud cases in GST regime mostly in the area of Steel sector. Professional CAs are involved in many cases in operating fake firms to fraudulently avail and pass on ITC (input tax credit) through bogus invoices without actual supplies of goods.

2. It is impossible to track revenue leakage through human surveillance and the ITC fraud cases being booked in the country are just the tip of the iceberg. Further, whatever cases are booked, most of the evasion noticed remains unpaid to the government. The cases being booked in the sector are not even 5% of the revenue leakage. Further, the extent of evasion that this sector has been witnessing is a reason for the corrupt nexus between the unscrupulous elements and tax authorities.

3. Therefore, ITC fraud cases in steel sector needs to be addressed scientifically in such a way that the root cause of ITC fraud gets eliminated, the tax collection by the government ramps up and bonafide manufacturers are not tortured at the hands of tax authorities. This article highlights the root cause of the problem, the stress faced by employment generating secondary Steel sector and has proposed a scientific solution to increase government revenue. The solution suggested will reduce pressure on investigating agencies also apart from reducing corruption in the government sector.

The basic reason for ITC fraud by traders

4. Melting scrap is generated in various household and other places where seller is not required to pay any GST. This scrap is purchased by small time Kabadi, who are all unregistered under GST. These kabadis sell the scrap to a bigger trader say X.  X, who purchases the scrap from kabadis, his turnover is definitely more than 40 lacs in a year and therefore he is exigible to GST.

5. The GST rate on this scrap is 18 %.  Now this trader X has to discharge his entire tax liability from cash ledger as there is no credit available to him. Thus this 18% tax liability fives him reason and lure to resort to fraudulent practices, where he arranges fraudulent credit to save this 18%. They are all arranging invoices from those dealers/retailers whose buyers are neither interested in credit nor a proper bill.  

6. For example, when medicines or a television or air-conditioner is sold to customer, customer is going to consume the product and therefore he is not going to claim any credit. Further for these over-the-counter purchases, consumer is not interested in proper bill. So, X gets the bill from medicine supplier, claims credit in his credit ledger and discharges his tax liability on scrap using fraudulent credit claimed on dummy purchase of medicines.  Very scrutiny of purchase and sale invoices of X itself makes it clear that some fraud is going on, because medicine and television cannot be converted into a melting scrap and that too by a trader.

7. Now these fraudsters have started doing layering also to give it a colour of genuine transaction at the level of X and downwards. They create dummy entities P and Q. Now P arranges all the fraudulent bills of medicines and issues scrap invoices to Q. P and Q just exist on paper, do not do any activity except arranging dummy purchase invoice, issuing sell invoice and filing returns. Q claims credit on the purchase of scrap invoice and issues scrap invoice to X. Thus, from a distance, just looking at Q purchase and sales invoice in isolation, no wrong can be detected. X claims credit on the dummy purchase of scrap invoice from Q and claims credit and utilises it towards his actual supply of scrap to manufacturers, which he actually procured not from Q rather from various unregistered kabadis. At times some extra layer is created between X and manufacturer also. In the process this fraudulent credit of 18% of scrap value is injected in the credit chain and thus ultimately reduces the cash revenue to that extent.

8. The uniqueness of the commodity on the one hand leads to loss of legitimate revenue and on other hand it becomes a source of rampant corruption in the tax department coupled with torture and harassment of manufacturing units for all wrong reasons.

The extent of ITC in secondary steel sector which is prone to evasion

9. On an average every secondary Steel manufacturer pays 20 to 30% of his total liability by making a debit in cash ledger and remaining by making a debit in electronic credit ledger. For secondary steel manufacturers, two-third of credit is earned through purchase of scrap and one-third through purchase of sponge iron. Thus, the primary source of credit in the electronic credit ledger is scrap supplied by traders who are all in unorganised sector. Therefore, a large chunk of government revenue is dependent on good behaviour of unscrupulous scrap traders who are mostly in unorganised sector and that is why it is prone to evasion and ITC fraud. If the source of this credit is eliminated without causing any loss to government revenue, the possibility of evasion of government taxes will automatically get reduced.

The current 18% GST on scrap is leading to loss of revenue to Government and choking secondary Steel manufacturing industry

10. Today because liability to pay is casted on supplier, who are all in unorganised sector and who are resorting to various fraudulent practices and running away creating a lot of trouble for manufacturing units. Secondary Steel manufacturing units are under tremendous pressure. When the investigating teams visit, they do not look at the problem in a holistic way and for them the ineligible credit has been injected into the credit Chain and it has reached to manufacturing unit and therefore they are resorting to all investigation tactics such as search, summon and arrest and coercing manufacturing units to pay the tax which is never due from them. This is killing the vibrant secondary Steel manufacturing industry.

11. The business entities all over India are perturbed with high handedness of GST authorities with respect to investigation termed as “fake ITC”. The officers are not differentiating between wrong doer and honest tax payer and in the process arm-twisting the business entity which has got permanent establishment and who creates employment in the country. The investigations being done under constant threat of arrest with abusive procedures is killing the golden goose which pays the tax and creates employment and is retarding the economy.

The Core Issue to be addressed

12. The Core issue at hand is
    1. Blatant violation of ITC by traders of scrap mostly in the unorganised sector and resultant loss of govt revenue because fraudulently availed credit enters in the credit chain.
    2. The stress being faced by manufacturing units, who are actually eligible for credit as they have actually received the goods along with invoice and supplier has filed GSTR 1 and GSTR 3B. Manufacturers have also discharged output tax liability on manufactured goods corresponding to inputs received. Their output supply is not disputed by department. Since traders run away and manufacturers with fixed establishment cannot run away, revenue authorities are chasing manufacturers and trying to penalise them for the malpractices of traders. This is killing manufacturing sector which creates huge employment.

13. A large number of investigations are being carried out by DGGI and Preventive teams. Manufacturing units who have got fixed establishments are being pressurized to pay the credit involved using DRC-03, even though there is no fault on their part. The investigating agencies are using threat of arrest and threat of attaching properties including freezing of bank accounts in case of refusal to pay.

The solution for stopping ITC fraud by traders

14. The due amount of 18%, which is required to be paid in cash by trader X in above example gets evaded. All the parties such as P, Q and X, who are involved in this fraud share the evaded tax among themselves.  Thus, the root cause of this fraud is a high tax level which is 18%.  If the melting scrap being supplied by traders is exempted from GST, this fraudulent activity will stop as there is no tax to be evaded and thus nothing is available for sharing.  

15. If government exempts the melting scrap supplied by traders from GST, then there will be no loss to government at all, because the melting scrap is not an item of consumption by an individual, rather an industrial input and thus whatever tax is genuinely paid on scrap is eligible for credit. It should be noted that any tax which is paid, where the recipient claims credit, there is no tax collection by government in real sense. Government collects tax in real sense if and only if GST is paid and no credit is claimed by buyer. Therefore, exempting melting scrap will actually lead to higher cash tax payment by manufacturing units and thus even if we assume zero ITC fraud today, the overall collection of government will remain unchanged even after exempting scrap supplied by traders.

Exempting melting scrap supplied by traders from GST will actually increase govt revenue

16. Once GST is exempted on melting scrap, there is nothing remains to be shareable amongst the various scrupulous traders and therefore the ITC fraud will cease to exist. Today whatever fraudulent ITC is being injected by traders, to that extent it actually reduces the cash collection of government. Once injection of fraudulent credit in the system is stopped, the government revenue will increase.

Scrap generated by manufacturing units

17. Scrap is also generated at the end of various manufacturing units such as auto component manufacturers. This scrap also enters into the melting chain. It may be argued that if this scrap is exempted, it will break the credit chain on the part of manufacturing units who generate scrap. They may face other difficulties such as reversal of credit attributable to exempt scrap. To take care of this scenario, GST on melting scrap for a manufacturer/generator supplier may not be exempted, but for traders supplier it should be exempted.  If steel manufacturer buys the scrap directly from a manufacturing unit, since both the entities have got fixed establishment, one can pay GST and other can claim credit thereof without any difficulty. Whatever purchase is done by Steel manufacturing units from traders, there will be no GST available for credit.

Alternative to outright exemption of melting scrap supplied by traders

18. If melting scrap supplied by traders cannot be exempted and government wants that whoever is dealing with scrap should be part of the government data system and for that reason it cannot be exempted. Then we suggest that the tax rate on melting scrap be reduced to 0.5%. When the tax rate is low, then the probability of fraudulent injection of ITC gets reduced as sharable amount becomes so low that it will be no more lucrative.

19. If it can be neither exempted, nor tax rate can be reduced to a token level of 0.5%, then Manufacturing units are also ready to discharge GST on their scrap purchase on reverse charge basis. In that scenario they themselves shall be paying 18% tax in cash on scrap purchase and claiming credit thereof.

The tax collected by investigating agencies from manufacturing units  who have actually received the goods, will be ultimately refunded to them after settlement of litigation because under the law they are eligible for credit

20. Under the current regime whatever ITC fraud cases are being booked, traders are primarily not paying any amount and whatever amount is being recovered from manufacturing units, under the law the amount cannot be retained by government. The manufacturing units will automatically get refund after conclusion of litigation.  Therefore, ultimately government is going to lose revenue if it continues with 18% GST rate on melting scrap supplied by traders. Precisely for this reason the current practice of charging 18% GST on melting scrap supplied by traders needs to be abolished.

21. Let us understand the issue with a typical case of credit where manufacturing unit has received the goods along with invoice and supplier has filed GSTR-1 and GSTR 3B.

1. A Pune based dealer received invoices from Hyderabad based dealer without the goods mentioned on the invoice. Department calls it a case of “goodless invoice”. Pune dealer claims the credit based on the invoices issued by the Hyderabad dealer. So, this is a case of claim of credit without receiving goods. The nature of transaction itself suggests that Pune dealer is in connivance with Hyderabad dealer.
2. Pune dealer also receives scraps without invoice from a number of other dealers. Some of these scrap suppliers have a turnover of less than 40 lakhs per annum and some have a turnover of more than 40 lakhs per annum. Irrespective of the turnover, supplier must raise invoice because invoice is a document to track the turnover.
3. Pune dealer supplies scrap so received to a Nagpur manufacturer on cover of invoice supported by E-way bill. Since there is actual supply, there is actual movement of goods which can be verified from a number of records including FASTTAG/toll records etc.
4. Hyderabad dealer as well as Pune dealer have filed GSTR-1 and GSTR-3B with respect to their supplies as per books of account maintained by them.”

22. Eligibility and conditions of claiming ITC is given under section 16 of the CGST/SGST Act, 2017 read with Rule 36 and 37 of CGST/SGST Rules, 2017. Some more restrictions and details of ineligible credit are given in section 17, more precisely in section 17(5) read with Rule 38, 42 and 43.

23. Under section 16/17, a registered person is eligible to claim credit of taxes charged on goods and services actually received by him and which are used or intended to be used in the furtherance of his business, where output supply is a taxable supply or a zero-rated supply like exports.

24. It should be noted that claim of credit under Chapter V of the act is an independent event under section 16 for every registered person compared to payment of tax by that person on his output supply under Chapter X of the Act under Section 49 read with Section 39. Under section 16(2), there is a requirement of possession of tax invoice issued by the supplier and actual receipt of the goods and services. Under section 16(2)(c), there is also a requirement that the tax charged on the invoice is actually paid either in cash or through utilization of ITC by the supplier.

25. There is also a requirement for the person who is claiming credit that he shall file a return under section 39, because the expression used under Section 16(2)(d) is "he". However, a conjoint reading of section 16 with section 39 read with Rule 60 and 61, one can make out that this filing of return refers to filing of GSTR-1 by the supplier and GSTR-3B by supplier under which tax is paid. Tax is actually paid by debiting the amount from cash and/or credit ledger under Section 49 of the act by actually filing the return GSTR 3B under Section 39.

26. Registered Central Excise dealer cannot be compared with Registered GST dealer
    1. It should be noted that registered dealers under GST have a different status as compared to registered dealers under Central Excise regime. A Registered Dealer under Central Excise regime was neither claiming any credit nor he was chargeable to duty nor he was assessed to duty. During the Central Excise regime, tax was paid only by the manufacturer and not by any dealer. Once the tax was paid by the manufacturer, for the purposes of credit, the tax shown on the invoice and the goods on which tax was paid was inseparable, until credit is again claimed by another manufacturer. The credit was claimed again by the manufacturer and not by the registered dealer.
    2. Therefore, when goods were routed from one manufacturer to another manufacturer through a single registered dealer called "First Stage dealer" or 2 registered dealers called "1^st and 2^nd stage dealers" respectively, goods and the tax shown by the originating manufacturer was moving in one box (as if credit and physical goods were glued to each other) and there was no option of un-boxing it by the dealer. In Central Excise regime, the dealer was simply forwarding the credit and while selling the goods, he also used to mention as to from which manufacturer goods have come and how much tax has been paid by the manufacturer.
    3. If goods valued at ₹ 100/- attracting 16% central excise duty was purchased by dealer where ₹ 16/- has been paid as tax by the manufacturer, now if the dealer sells the same goods for say ₹ 500/-, he is not assessed to 16 % tax on ₹ 500/-. He simply charges a price of ₹ 500/- where central excise credit of ₹ 16/- alone is passed on.
    4. When, the Central Excise dealer receives identical goods from two different sources, he has no option to swap the credit while selling goods down the line, because for Central Excise dealer the tax paid by the manufacturer cannot be jettisoned from the goods at Central Excise dealer level.

27. As far as a dealer in GST regime is concerned, the situation has changed completely. First of all, he claims credit on his receipt of goods and services. Once the credit is claimed, credit enters in Electronic Credit Ledger maintained under Section 49 and credit is jettisoned from the goods and it can be used in respect of any kind of output supply. When he supplies any goods, he is then assessed to tax which he is required to pay by 20th of the next month. For him, claim of credit on his input supplies under Section 16 and payment of tax on his output supplies under Section 49 are two independent events.

28. Tax is paid by a dealer either by making a debit in Electronic Credit Ledger or by making a debit in Electronic Cash ledger under Section 49 of the act. GSTR-3B return under Section 39 cannot be filed by him until he discharges his tax liabilities on his output supplies shown in return. Today GSTR-3B is a summary return i.e., it does not capture transaction wise details. However, suppliers are also required to file GSTR-1 under Section 37, which is a transaction wise return capturing registration number of supplier as well as recipient, description and HSN code of the commodity, place of supply, etc. Recipient get their GSTR-2A populated based on the GSTR-1 filed by the supplier. Through GSTN Portal, recipient can also see whether his supplier has filed GSTR-3B or not. Once GSTR-1 is filed and recipient sees that the invoice on which he has taken credit is getting populated under GSTR-2A and for the corresponding month, supplier has also filed GSTR-3B meaning thereby that the supplier has paid the tax as provided under Section 49; the credit on the part of the recipient becomes absolute specially in cases where recipient has paid full consideration along with tax to the supplier.

29. The manufacturer recipients of goods and services does not know as to how the supplier is going to pay the tax shown on the invoice. Whether supplier will pay the tax by making debit in Cash Ledger or Credit Ledger or combination of the two. The mode of payment of tax by supplier is neither shown on the invoice nor it is possible for recipient to know it. At a date subsequent to supply, tax is to be paid by supplier and recipient can only ascertain whether GSTR-1 is filed or not and GSTR-3B is filed or not by the supplier. Law does not give any power at the hands of the recipient to audit the books of account of the supplier or to know as to how the credit is being taken by the supplier and how he is discharging his tax liability. This is not practicable also.

Eligibility of Credit for Nagpur party

30. Now coming back to the facts given in the opening paragraphs, as far as Nagpur buyer is concerned, since he has received goods along with invoice for which he has made payment along with taxes to supplier and he has ensured that the concerned invoices are incorporated in the GSTR-1 filed by the supplier getting populated in the GSTR-2A and supplier has paid the tax under Section 49 by filing GSTR-3B, the credit claimed by the Nagpur manufacturer is absolute. The mode of payment of tax is mentioned under Section 49 as per which tax stands paid.

31. There is no negligence or absence of due diligence at the end of Nagpur party. One can attribute wrong doing on the part of Nagpur party if and only if the Nagpur party was in connivance with Pune and Hyderabad parties for getting the credit. But if he is not in connivance, neither there is any civil nor any criminal liability on the part of Nagpur party.

32. Since there is no civil liability on the part of Nagpur party their property or bank accounts should not be attached under Section 83 of the act at all.

33. GST law does not say that buyer of goods will not be eligible for credit in case the supplier has claimed credit on some goods which he has not received. The precise issue is whether the person claiming the credit has received goods shown on invoice or not.

34. As already explained, under the GST law claim of credit and payment of tax are two different phenomena. Unlike Central excise regime, Credit is not stuck to goods under GST regime.
    1. For example, a Thane based dealer starts business in January 2020 and buys medicines worth ₹ 10 crores on which he claims credit of ₹ 1.8 crores in the month of January 2020. He also buys iron scrap worth ₹ 9 crores from unregistered small traders on which no credit is earned.
    2. In the month of January 2020, he sells scraps at a value of ₹ 10 crores with a GST liability of ₹ 1.8 crores. He does not make any sell of medicines in January 2020.
    3. He can discharge his entire tax liability of ₹ 1.8 crore on his output supply i.e. supply of scraps, by utilising the ₹ 1.8 crore credit lying in his electronic credit ledger which he earned on purchase of medicines. The credit earned on medicine purchase can be used for discharging tax liability on scraps and the scrap buyer can claim the credit thereof simply because claim of credit and payment of tax are two different phenomena under the GST laws.
    4. Once the credit is claimed and enters into the Credit ledger, it is as good as cash and the fact that credit was earned on medicine becomes irrelevant.

35. If someone claims wrong credit, the recourse is under section 73 and 74 to demand it along with interest and penalty. Therefore, the demand which is due from Pune dealer who has claimed credit without receipt of goods cannot be shifted to another person under GST law. It is trite of the law that the wrongdoer has to make the losses good and it is not somebody else.

36. The tax stands paid by Pune dealer simply because he has filed GSTR-3B by making debit in his cash or credit ledger.

1. If tax payment by Pune dealer is not recognised, then where is the loss to government, because Pune trader has debited the amount in credit ledger which he claimed earlier and thus wrong stands corrected. 
2. If tax payment by Pune dealer is not recognised, then he has made a supply on which he has not discharged the tax and thus government should demand tax on output supply of Pune trader from Pune trader and not from anybody else.  Govt does not question the tax payment on output supply of Pune trader and that is why it does not demand tax on output supply.
3. Govt accepts that Pune trader has paid his output tax liability by using a looted credit, that is why it disputes the claim of credit by Pune trader.

37. If the cash entered into the cash ledger is obtained by fraud or the credit entered into the credit ledger is obtained by fraud, yet it cannot be said that no tax is paid on the output supplies. If the tax is paid by earning the credit through fraudulent means, then the Pune dealer who has earned such credit through fraudulent means alone needs to be prosecuted and alone be made responsible for making good the losses to the Government.

38. Let us say that Pune trader claimed wrong credit in September 2019 and used it for supplies made in the month of September 2019. For argument sake if it is assumed that department will treat the goods supplied by the Pune dealer as non-duty paid goods because the credit through which tax was paid, was never available to the Pune dealer, then by the same logic the Nagpur party also used the credit claimed from Pune supplies and discharged his duty liabilities for supplies made to a Delhi dealer in say October 2019 and thus, Delhi supply of Nagpur party shall also be treated as non-duty paid supply and the credit can be sought to be denied to the Delhi dealer also and thus, this chain will never stop.

39. If a person claims credit without receipt of goods, the evasion of tax happens just once and for that Government cannot acquire a right to collect equivalent tax from each of the persons involved in the chain. This kind of interpretation cannot be sustained in the eyes of law. Denying credit of everybody in the chain is not only arbitrary rather ultra vires the CGST/SGST Act and the Constitution of India. The only reasonable interpretation is to deny the credit by way of action under section 73 and 74 against the person who has claimed the credit without receipt of goods.

40. Above analysis equally applies for credit of IGST because by virtue of section 20 of IGST Act, 2017, credit related provisions under CGST Act has been made applicable for IGST also.

Suggestion for GST Council

41. In view of what is stated above, it is suggested that to increase govt revenue, to stop blatant violation of ITC by traders of scrap and resultant loss of govt revenue and to save secondary steel manufacturing industry,
    1. The steel melting scrap supplied by traders be exempted from GST.
    2. In the alternative, if melting scrap supplied by traders cannot be exempted then GST on meeting scrap be reduced to 0.5%.