Supplier Defaults, Buyer Punished? Karnataka High Court Says “Chase the Supplier First” — Buyer’s Relief Survives Even After Section 16(2)(c) Is Upheld

Supplier Defaults, Buyer Punished? Karnataka High Court Says “Chase the Supplier First” — Buyer’s Relief Survives Even After Section 16(2)(c) Is Upheld

By CA Chandrasekhar Kutty, Founding Partner, Sashthi Taxlegal Advisory Services LLP

M/s Sunlog Services Private Limited vs. The Assistant Commissioner of Central Tax & Ors. — W.P. No. 21235/2026 (T-RES), High Court of Karnataka at Bengaluru, Oral Order dated 21.07.2026 (Hon’ble Mr. Justice B M Shyam Prasad)

Why This Order Matters Right Now

Just yesterday, we reported that the Hon’ble Supreme Court, by its speaking order dated 24.07.2026 in Bhandari Scrap Traders vs. Union of India (SLP(C) No. 23931/2026 and connected matters), dismissed the challenge to Section 16(2)(c) of the CGST Act, 2017 and affirmed the Gujarat High Court’s judgment in Maruti Enterprise (SCA No. 18080/2023 and group matters, decided 01.05.2026). The constitutional validity of the provision — that a buyer gets Input Tax Credit only if the supplier has actually paid the tax to the Government — now stands settled.

Many taxpayers read that development as the end of the road. It is not.

Just three days before the Supreme Court’s order, on 21.07.2026, the Karnataka High Court granted an ad interim order in favour of the buyer in Sunlog Services, staying proceedings arising out of a Section 73 adjudication where the demand was founded solely on the supplier’s failure to pay tax. The order is a timely reminder that while the vires battle is over, the enforcement battle — against whom should the Revenue proceed first — is very much alive.

The Facts in Sunlog Services

The petitioner was visited with an Adjudication Order dated 30.12.2025 under Section 73 of the CGST Act, arising from a mismatch between GSTR-2A and GSTR-3B. The story is one that hundreds of businesses will recognise:

1. The petitioner had made full payment to the supplier, including the tax component.
2. The supplier failed to file returns and did not remit the tax to the Government.
3. The supplier was facing proceedings before the National Company Law Tribunal (NCLT).
4. The Adjudicating Officer took the view that since the Department would have no effective recourse against a supplier in insolvency, it is the petitioner who must discharge the liability and then recover the amount from the defaulting supplier, subject to the NCLT proceedings.

In effect, the Department told the honest buyer: pay the tax again, and go stand in the queue before the NCLT.

The Grounds That Persuaded the Court

The learned counsel for the petitioner pressed for interference on the following grounds, each of which the Court considered while granting the interim order:

(a) Proceed against the defaulter first. The authorities could not have proceeded against the petitioner — who had admittedly made remittances to the supplier — without first initiating proceedings against the supplier, the actual defaulter.

(b) The Suncraft Energy principle. The Division Bench of the Calcutta High Court in Suncraft Energy (P.) Ltd. vs. Assistant Commissioner, State Tax [2023] 153 taxmann.com 81 (Calcutta) held that where the buyer produces tax invoices and bank statements substantiating payment of the price along with tax, action against the buyer without resorting to any action against the selling dealer has to be branded as arbitrary.

(c) The Apex Court left Suncraft undisturbed. When the Suncraft ruling was carried to the Supreme Court, the Court did not interfere, having regard to the extent of the demand.

(d) The Instakart reading down. A Co-ordinate Bench of the Karnataka High Court in Instakart Services (P.) Ltd. vs. Union of India [2026] 185 taxmann.com 308 (Karnataka) has read down Section 16(2)(c) of the CGST Act and Rule 64 to allow the benefit of ITC to a bona fide recipient where the default or lapse is that of the supplier — although that decision is presently under challenge in an intra-court appeal.

The Court also noted that in W.P. No. 13730/2026, an interim order had already been granted on the very question of whether action can be initiated against a recipient who is not in default without first initiating proceedings against the defaulting supplier.

Considering these circumstances, the Court granted the interim order as prayed for, to remain in force until further orders, with liberty to the respondents to complete pleadings and seek vacating. The matter is listed on 22.09.2026.

Is This a “Contradiction” of the Supreme Court? A Careful Reading

At first blush, the Karnataka order appears to swim against the tide of the Supreme Court’s dismissal in Bhandari Scrap Traders. A closer reading shows the two operate on different planes, and understanding this distinction is the key to litigation strategy going forward:

• What the Supreme Court settled: the constitutional validity of Section 16(2)(c). The condition that the supplier must have actually paid the tax is valid, and the provision will neither be struck down nor read down. To that extent, the Instakart line of reasoning (reading down the provision) now stands on fragile ground and its intra-court appeal will have to reckon with the Supreme Court’s affirmation.
• What the Supreme Court did not decide: the manner and sequence of enforcement. Nothing in Maruti Enterprise or in the Supreme Court’s order obliges the Department to recover from the innocent buyer first, while the defaulting supplier goes untouched. On the contrary, the Gujarat High Court itself, in paragraph 87, recorded that the Act arms the Department with ample powers — Sections 73, 74, and the recovery machinery — against the selling dealer, and imported the balance struck by the European Court of Justice in Axel Kittel: credit can be denied only where the recipient knew or ought to have known of the fraud. Paragraph 90 expressly left the merits of individual cases open.

The Sunlog interim order sits comfortably within that space. It does not question the validity of Section 16(2)(c); it questions the arbitrariness of an enforcement approach that ignores the buyer’s proof of payment and lets the actual defaulter — conveniently shielded behind NCLT proceedings — escape while the honest buyer is made to pay twice.

Paragraph 88 of the Gujarat Judgment: The Silver Lining Everyone Should Read

Amid the disappointment of the vires verdict, paragraph 88 of the Gujarat High Court’s judgment deserves to be read and re-read, because it is a judicial charter for reform — now carrying the Supreme Court’s implicit endorsement:

• The Court acknowledged the “dicey situation which purchasers are facing” and called it “high time” the Government undertakes a comprehensive re-evaluation.
• It flagged a “pressing need for legislative amendments or clarifications” within the GST framework to alleviate the disproportionate financial and administrative burdens on purchasers with an honest claim of ITC.
• It asked the Government to implement a robust, technology-driven tracking mechanism enabling real-time verification of supplier payments against specific invoices, thereby insulating bona fide recipients from vendor defaults.
• Most significantly for cases like Sunlog, it directed that the Government must take “prompt and immediate steps for recovery of tax from the erring suppliers, instead of compelling the purchasers to avail themselves of alternate cumbersome remedies.”

The Adjudicating Officer’s stance in Sunlog — “you pay now, and recover from the supplier through the NCLT” — is precisely the “cumbersome remedy” approach that the Gujarat High Court deprecated. The Karnataka High Court’s interim order gives that observation practical teeth.

What Should Taxpayers Do Now? Practical Takeaways

1. Do not treat every supplier-default demand as indefensible. The vires challenge is closed; the arbitrariness-in-enforcement challenge is open. Where you hold tax invoices, e-way bills, proof of receipt of goods and bank statements evidencing payment of price plus tax, insist that the Department first demonstrate action against the defaulting supplier.
2. Build the evidentiary file under Section 155. The burden of proving eligibility is on the claimant. A complete documentation trail — invoice, GSTR-2A/2B reflection, transport documents, payment proof — remains your first line of defence and directly supports the bona fide recipient argument recognised in Axel Kittel and adopted in paragraph 87 of Maruti Enterprise.
3. Track the reversal and re-availment mechanism. Section 41(2) read with Rule 37A allows re-availment of reversed credit once the supplier pays. Where the supplier is in insolvency, quantify and preserve this claim in the CIRP process as well.
4. Strengthen your contracts. The Gujarat High Court itself suggested (paragraph 76) that purchase agreements should carry indemnity clauses obliging the supplier to make good any loss caused by his failure to remit tax. Make this a standard clause in vendor onboarding.
5. Watch these dates and matters: Sunlog Services is listed on 22.09.2026; the intra-court appeal against Instakart is pending; the SLP against the Tripura High Court’s Sahil Enterprises decision remains alive before the Supreme Court; and W.P. No. 13730/2026 (Karnataka) squarely raises the sequencing question.

Conclusion: The Provision Is Valid, But the Buyer Is Not Defenceless

The Supreme Court has shut the door on the constitutional challenge to Section 16(2)(c). The Karnataka High Court, in Sunlog Services, has kept another door open — the door of fair, non-arbitrary enforcement. Read together with paragraph 88 of Maruti Enterprise, the message to the field formations is unmistakable: recover from the defaulter first, and do not convert every supplier default into a recovery drive against the honest buyer.

For businesses, the strategy now shifts from attacking the statute to defending the facts — documentation, bona fides, and the demand that the Revenue exhaust its remedies against the real defaulter. That fight, as Sunlog shows, can still be won at the interim stage.

This article is for general information only and does not constitute professional advice. For case-specific guidance on GST litigation, please reach out to Sashthi Taxlegal Advisory Services LLP — Hosur • Bengaluru.