Introduction:

In the recent judgment delivered in M/S Pilcon Infrastructure Pvt. Ltd. v. State of U.P. & Anr., the Allahabad High Court has once again emphasized strict compliance with statutory safeguards under Rule 86A of the U.P. Goods and Services Tax Rules, 2017, firmly holding that the power to block Input Tax Credit (ITC) can be exercised only when the authorities have “reason to believe,” and such reasons must be recorded in writing, failing which the action becomes arbitrary and contrary to the very architecture of GST. The petitioners, M/S Pilcon Infrastructure Pvt. Ltd., approached the High Court after their Input Tax Credit was blocked by the GST Network, communicated through an email dated 24.07.2025, without any written record of reasons that led the authorities to conclude that the ITC was either fraudulently obtained or ineligible.

Arguments:

The petitioner argued that GST is fundamentally dependent on maintaining the uninterrupted ITC chain, which is the backbone of value addition, neutrality of taxation, and seamless functioning of the GST system. They contended that Rule 86A empowers the authorities to block credit only when a clear and demonstrable “reason to believe” exists, which must be recorded in writing, and that a mere entry or notation in the electronic credit ledger stating that a supplier was “non-functional” is not sufficient compliance with the mandatory requirement. The petitioners submitted that ITC cannot be blocked based on suspicion, assumptions, third-party reports, or vague references that lack specificity and supporting materials.

They argued that unfounded blockage of ITC significantly disrupts business operations, hampers liquidity, and violates both the letter and spirit of GST law. They asserted that absence of written reasons also deprives the taxpayer of the ability to challenge the action effectively, thereby making the process opaque, arbitrary, and violative of principles of natural justice. They prayed for unblocking of the credit and quashing of the action taken without adhering to the statutory mandate of recording reasons. On the other side, the State contended that the authorities had sufficient material to arrive at a prima facie satisfaction that the petitioner’s supplier was not functional, and therefore the ITC availed based on such invoices was questionable. It was argued that recording reasons in the electronic credit ledger amounted to substantial compliance and that the power under Rule 86A is preventive, not punitive, allowing authorities to protect revenue by temporarily blocking ITC that appears doubtful. The State further maintained that it is not necessary to communicate detailed reasons to the taxpayer and that the authorities had valid grounds to believe that the credit claimed was not genuine considering the inputs received from their internal verification system.

Judgement:

However, the High Court rejected these submissions and observed that when a statute explicitly requires reasons to be recorded in writing, such reasons must exist in a tangible, verifiable form prior to exercising the power. The Court stated that a mere remark inserted in the electronic ledger is not a substitute for formally recorded reasons that reflect the actual formation of belief by the officer. It clarified that while reasons need not be elaborate or shared with the petitioner at the initial stage, they must be recorded in the official file, demonstrating independent application of mind. The High Court strongly emphasized that suspicion alone cannot justify blocking ITC because GST operates on a credit-flow mechanism, and unjustified disruption of ITC flow negatively affects the entire value chain and results in cascading taxation, defeating the purpose of GST. According to the Bench, blocking ITC is a serious step that impacts working capital and day-to-day business operations, and therefore cannot be exercised mechanically or casually. The Court underscored that the phrase “reason to believe” has a well-settled legal meaning and represents a higher threshold than mere doubt or suspicion. Such belief must be based on objective material and cannot arise from assumptions or unsupported claims. The Bench reiterated that the requirement of recording reasons in writing is an essential safeguard against abuse of power, ensuring transparency, accountability, and judicial review. The Court further clarified that even if the reasons are recorded ex parte, they must still be properly documented, since this ensures that the power is not exercised arbitrarily. The Bench observed that the State failed to produce any written record of reasons that existed at the time when ITC was blocked, indicating that the action was taken without proper compliance with Rule 86A. Consequently, the Court held that the blocking of credit was unsustainable in law. The judges, Justice Saumitra Dayal Singh and Justice Indrajeet Shukla, highlighted that maintaining the ITC chain is the “soul” of the GST system, and any interference with this chain must strictly follow statutory requirements. They held that Rule 86A cannot be invoked casually because doing so hampers the taxpayer’s right to carry out business and disturbs the fundamental design of GST. The Court also clarified that even if the supplier is suspected of being non-functional, authorities must still record their reasons in writing and demonstrate the basis of such findings. After analyzing the submissions and statutory provisions, the High Court concluded that the action taken by the tax authorities lacked legal foundation and violated the mandatory requirement of recording reasons. Therefore, the writ petition was allowed, and the authorities were directed to unblock the petitioner’s Input Tax Credit. The judgment serves as a significant reaffirmation of taxpayer protections under GST law and places clear limits on the discretionary power of officers, ensuring that such power must be exercised with caution, responsibility, and adherence to statutory mandates. By insisting that reasons be recorded in writing, the High Court has ensured that transparency and due process remain integral to the functioning of the GST regime, while also protecting businesses from arbitrary disruptions that can severely affect their operations. The ruling will have broader implications, sending a strong message to GST officers across the state and the country that procedural safeguards are not optional and must be followed meticulously to maintain fairness and legality in tax administration.