Modernising India’s GST Input Tax Credit Framework: Lessons from Canada for Enhanced Efficiency and Fairness

The author is Dev Arora, a Second Year Student from Rajiv Gandhi National University of Law, Punjab.

---

Introduction

The Goods and Services Tax (hereinafter GST) was introduced by the 122nd Constitutional Amendment Bill, 2014, to provide an integrated indirect tax structure for the country. India was subjected to an elaborate system of indirect taxes by virtue of multiple State and Central levies, which were regarded as hidden costs in the process of trade and industry. So the amendment seeks to simplify the system by providing for a comprehensive, destination-based tax system in India.

Unlike all previous tax systems, GST is imposed on the final product, as well as on input goods and services used in production and distribution. In this context, there was a risk of double taxation. To counter such a risk, the GST mechanism ensures that there is an Input Tax Credit (hereinafter ITC), whereby businesses may offset taxes already paid on inputs from their output tax liabilities.

However, the challenges of assimilation and realisation of the ITC mechanism in India still exist. The article, therefore, examines the ITC mechanism, its major shortcomings, draws a comparison with the Canadian GST model, and suggests changes for improvement.

Understanding the ITC mechanism in India

The ITC mechanism under GST is a feature that allows a registered person to claim credit for the tax paid on goods or services purchased and that can be set off against their output tax liability. The main objective is to lessen tax incidence at many points, which will avoid the cascading effect of taxation and therefore lessen the total tax load on the person, and uphold tax neutrality.

Under Section 41 of the Central Goods and Services Act, 2017 (hereinafter CGST Act), a registered person is entitled to avail credit of eligible input tax as per self-assessment made in the return furnished under Section 39.

Further, Section 16 of the CGST Act and Rule 36 of the CGST Rules, 2017, elaborate on the eligibility conditions to avail ITC. According to the said provision, ITC is available to goods and services, which are used or intended to be used in the course or furtherance of business, having a valid tax invoice, debit note, or any other statutory document evidencing payment of tax by the person registered. The recipient must have received the goods or services, and the tax must have been paid to the Government exchequer by the supplier.

Key Challenges in the Indian ITC Framework

While the GST law has been amended multiple times since its introduction in 2017, the regime governing ITC remains one of the most disputed and litigated topics under GST.

In particular, Section 16(2)(c) of the CGST Act mandates that ITC can be claimed only if the corresponding tax has been paid by the supplier to the government. This shift in compliance is mostly outside the control of the recipient. As a consequence, recipients, especially small enterprises, are in an extremely vulnerable position, even if they have engaged in legitimate transactions and fully paid the supplier (including the tax). The implications of being denied, subject to reversal of, or otherwise being denied credit for ITC result in liabilities under Section 50, double taxation based on repayment of tax, and possible penalties under Section 122.

In this context, the CBIC circular dated 27 December 2022 seeks to guide officers in handling mismatches between GSTR-1 and GSTR-3B in ITC claims. However, it provides limited relief, as it fails to offer remedies when suppliers are untraceable or have absconded, permits excessive documentation demands that may lead to administrative harassment, and lacks a statutory refund mechanism for denied ITC despite full payment by the recipient.

Various High Courts have dealt with the constitutionality of Section 16(2)(c) in the past. The Kerala High Court in its recent decision in Muhammed Abdul Saini v. State Tax Officer rejected the challenge to Section 16(2)(c), relying on the precedent set in Nahasshukoor v. Assistant Commissioner. The Court justified the provision as advancing a legitimate state purpose, in protecting its revenue and making sure the GST framework is legitimate. Similarly, in Tirupati Balaji Traders v. Union of India, the HC ruled that ITC could not be allowed if the supplier did not remit tax payable to the government.

However, this particular aspect and its subsequent application are really significant questions that have to be asked about its fairness, proportionality and the effective and legitimate administration of tax. The current legislative framework punishes tax-compliant recipients for acts of supplier default and arguably undermines the significance of tax fairness whilst achieving operational objectives to facilitate the seamless ease of doing business.

Comparison of India and Canada’s ITC framework

Canada's GST system provides an interesting comparative perspective regarding the structural deficiencies of its ITC system in India. A significant distinguishing characteristic is that the right to claim ITCs does not depend on whether the supplier has remitted the tax to the government. Rather, if the recipient has received a proper tax invoice and the transaction is established and connected to a commercial activity, the recipient has the right to claim the credit. The obligation of compliance is imposed on the tax administration, in this case, the Canada Revenue Agency, not the taxpayer. This system of trust encourages confidence in the tax system, which incentivises the formalisation of economic activity and does not punish compliant recipients for the defaults of others.

In Canada, Input Tax Credits (ITC) can be claimed on line 106 of the GST/HST Return. To qualify for the ITC, the claimant has to be a registered taxpayer at the GST tax point, have to be using the input commercially, have to have adequate documentation in place, and have to deliver the Return within the required timeframes. Primarily, what would be included in the documentation required are the details of the supplier, date of invoice, the amount paid, and the amount of tax charged. Partial documentation is also permissible for cases involving employee reimbursements, computerised records, and contracts for purchases. This promotes compliance and an efficient administration of returns.

However, In India, ITC is viewed as a conditional concession subject to strict compliance with the rules and regulations, and is contingent on the supplier’s tax compliance as defined in Section 16 of the CGST Act, which makes the Indian ITC regime very complex and adversarial with good faith taxpayers with a valid claim tormented by credit disallowances from defaults of their suppliers even though they complied for their part.

Reforming opportunities in India’s ITC framework

Although many technological changes and procedural improvements have been implemented since the GST's introduction, the landscape of ITC access remains amongst the most legally challenged and administratively cumbersome areas of GST operation in India. Given this, there is merit in considering how Canada's much more trust-based and business-friendly GST could potentially act as a model for a complete systemic overhaul that could reduce compliance burdens, litigation, and improve economic efficiency.

The first reform India should undertake, in my view, would be to disconnect ITC entitlement from the compliance status of the seller. The GST entitlement should be based on the compliance of the recipient and the established documentation that the purchaser has the appropriate documentation and proof of commercial use. If implemented, this would refocus the law in India to reflect the Canadian model. This type of reform not only relieves pressure on compliant businesses but could also bolster more trust in the GST model.

Also, the Indian GST system could allow for situations of lesser documentation requirements in particular, low-risk situations. The Canadian model allows for such relaxations if the business is using a computerised accounting system. Given that India now has a strong e-invoicing system with over 2,396 crore e-invoices posted, it might be conducive for India to have these types of documentation relaxations as well.

The introduction of the Invoice Management System to India is a major movement towards better ITC management by facilitating real-time, bi-directional invoice reconciliation between the supplier and recipient. While the Invoice Management System improves timely transaction visibility and allows recipients to accept, reject, or mark invoices as a pending status, the overall performance is only as good as the regulation protects it on paper and is thus overshadowed by insufficient ability to enforce legal consequences, low awareness of the system among tax professionals and lack of formal re-pairing processes. Resolving these intractabilities for businesses to realise inspection equity will require business managers investing in employee training, upgrading business IT systems and developing processes for invoice viewing and dispute settlement.

Conclusion

India’s GST regime has been highly effective in consolidating the nation’s tax structure and progressing economic formalisation. However, the interaction and complexities of the ITC framework continue to be a significant pain point for many small and medium-sized enterprises. The risk of losing credits cannot just be attributed to the supplier's compliance failures.

When the buyer's ability to claim ITC is dependent upon the supplier meeting their compliance obligations, the purchaser takes on a risk that is beyond their control, and this is an undue risk. The Canadian GST model, which allows ITCs to be claimed based on valid records and the authenticity of a transaction, does not put the onus of compliance on the recipient purchaser. In which case, the purchaser’s entitlement is built on the tax authorities’ burden to enforce compliance on the vendor. Shifting responsibility away from the purchaser onto the tax authority means the compliance burden for eligible purchasers is removed.

This change would restore a sense of better efficiency and value to the indirect tax compliance process, and effective allocation of resources for compliance and enforcement. It would also help India rationalise the operational aspects of the ITC system, reduce litigation, and enhance taxpayer confidence in the fiscal integrity of the indirect tax regime.