Telangana High Court Invalidates Electronic Credit Ledger Blocking Under Rule 86A Without Natural Justice Compliance

Case Background

Case Name: Bhavani Oxides and others Vs State of Telangana and others
Court: Telangana High Court
Writ Petition Numbers: W.P.Nos.10390, 10425, 10459 and 12733 of 2024
Date of Order: 26/06/2024

Introduction

The Telangana High Court recently delivered a significant ruling on the exercise of power under Rule 86A of the Central Goods and Services Tax Rules, 2017 (CGST Rules, 2017), holding that blocking of an assessee's electronic credit ledger without adherence to principles of natural justice and without furnishing adequate reasons cannot survive legal scrutiny. A batch of four writ petitions raising substantially identical questions was heard and disposed of together through a common order.

The ruling carries far-reaching implications for GST enforcement practice across the country, particularly in cases where tax authorities resort to Rule 86A actions without issuing prior notice or disclosing the factual and material basis underlying the decision to block input tax credit (ITC).

Facts of the Case

The primary facts were drawn from Writ Petition No. 10390 of 2024. The petitioner in that matter is a proprietorship firm engaged in the manufacture and supply of zinc oxide, duly registered under the GST authorities of Telangana State under both the Central Goods and Service Tax Act, 2017 (CGST Act) and the Telangana State Goods and Service Tax Act, 2017 (SGST Act). The petitioner described itself as a bona fide purchaser of inputs from multiple suppliers and maintained proper tax invoices, e-way bills, and weighment slips in compliance with applicable provisions.

On 14.03.2024, the State Tax Officer purported to exercise power under Rule 86A of the CGST Rules, 2017 and blocked the petitioner's electronic credit ledger. The stated ground in the blocking order was: "Registration of supplier has been cancelled." No show cause notice was issued prior to this action. No supplier-specific details — such as the name of the supplier, the date of cancellation of registration, or any supporting material evidence — were disclosed to the petitioner. As a consequence, the electronic credit ledger reflected a closing balance of zero, effectively paralysing the petitioner's business operations.

The remaining three writ petitions raised similar grievances. In W.P.No.10390 of 2024, proceedings under Section 74 of the CGST Act had already been initiated and were still pending at the time the Rule 86A blocking action was taken. In the other three matters — W.P.Nos.10425, 10459 and 12733 of 2024 — the electronic credit ledgers were blocked directly without any notice having been issued under Section 74.

Arguments on Behalf of the Petitioners

Counsel appearing for the petitioners advanced several overlapping grounds:

  1. Violation of natural justice: The action of blocking the electronic credit ledger was taken without issuing a show cause notice, rendering it arbitrary and contrary to the principles of natural justice.

  2. Pending Section 74 proceedings: In W.P.No.10390 of 2024, since a notice under Section 74 of the CGST Act had already been issued to the petitioner and one of its suppliers, the Department ought to have followed that statutory procedure and awaited its outcome rather than simultaneously invoking Rule 86A.

  3. Departmental circular acknowledgment: Reliance was placed on Circular No. CBEC-20/16/05/2021-GST/1552 dated 02.11.2021 issued by the Central Board of Indirect Taxes and Customs (CBIC), GST Policy Wing. The circular itself recognised that the power under Rule 86A is extraordinary in nature and must not be exercised mechanically. It mandated application of mind, objective determination, and existence of material evidence before the power is invoked.

  4. Absence of requisite details in the order: The blocking orders did not contain the name of the supplier whose registration was cancelled, the date of such cancellation, or any other particulars forming the foundation for the "reasons to believe" required under Rule 86A.

  5. Excess of statutory scope: In W.P.No.12733 of 2024, it was contended that the language of Rule 86A permits blocking only of an amount equivalent to the credit fraudulently availed or found ineligible, not the entire credit balance. The action in that matter went beyond what the rule authorises.

  6. Judicial precedents: The petitioners relied upon:

    • M/s. Laxmi Fine Chem v. Assistant Commissioner, 2024 (5) TMI 509
    • M/s. Sri Krishna Enterprises v. The Superintendent of Central Tax, 2023 (11) TMI 957
    • Samay Alloys India Pvt. Ltd. v. State of Gujarat, 2022 (2) TMI 843

Revenue's Counterarguments

The Special Government Pleader appearing for the State Tax authorities resisted the writ petitions on the following grounds:

  • Rule 86A is constitutionality-unchallenged and must be read as it stands. Since the rule is completely silent on the requirement of following natural justice, the blocking action cannot be condemned solely on that basis.