Obstacles in GST Litigation

Obstacles in GST Litigation

GST litigation in India is not slowing down — it is accelerating. In the ninth year of the regime, with the GST Appellate Tribunal (GSTAT) now operational, AI-driven return scrutiny entrenched and legacy transitional-credit disputes still unresolved, taxpayers face a complex, multi-layered dispute landscape. Whether your immediate problem is an Input Tax Credit (ITC) denial notice, a classification dispute, a refund rejection or a pre-deposit that has just locked up working capital, the obstacles in 2026 are specific, recurring and — if you know what to look for — largely avoidable.

Why GST Litigation Is Structurally Different From Other Tax Disputes

Several features make GST disputes harder to manage than direct-tax assessments, and understanding them changes how you approach every notice.

Dual authority structure. India's GST is administered simultaneously by the Central Board of Indirect Taxes and Customs (CBIC) and State Tax authorities. A single cross-state transaction can attract scrutiny from both the Central GST officer and the State GST officer. Section 6(2)(b) of the CGST Act 2017 prevents one authority from proceeding on a matter already taken up by the other, but in practice this boundary is routinely blurred, and you will sometimes receive parallel SCNs (show-cause notices) for the same period from both wings.

Real-time data scrutiny. The GST system captures every outward supply in GSTR-1 and reconciles it — automatically — with the recipient's GSTR-2B. AI-driven analytics flag mismatches between GSTR-1, GSTR-3B, GSTR-2B, e-invoice data and e-way bills. A buyer who claims ITC on a purchase that the seller omitted from GSTR-1 can receive an automated demand notice within weeks, not after years as was common pre-GST.

Short and strictly enforced timelines. The limitation period for filing a reply to an SCN is typically 30 days from service, extendable by a further 30 days. Appeals to the First Appellate Authority under Section 107 of the CGST Act must be filed within 3 months of the original order (with one additional month for sufficient cause). Missing these windows can make a perfectly meritorious case non-maintainable.

Overlapping statutes. The Companies Act 2013, FEMA 1999, Customs Act 1962 and Income-tax Act 1961 all intersect with GST — particularly on related-party valuation, import of services and export refunds. A dispute that originates in GST may require evidence and arguments that cut across all of these frameworks simultaneously.

GSTAT 2026: What Has Actually Changed — and What Has Not

The GST Appellate Tribunal was operationalised following amendments to Sections 109 to 122 of the CGST Act enacted in 2023. The Principal Bench sits in New Delhi; State Benches are being constituted in phases.

What genuinely changes with GSTAT:

• Taxpayers now have a statutory second appellate forum below the High Court. Before GSTAT's constitution, anyone aggrieved by a First Appellate Authority order had to go directly to the High Court under Article 226 — expensive, slow and, critically, producing no binding precedent on questions of fact.
• Appeals to GSTAT under Section 112 must be filed within 3 months of the First Appellate Authority's order. GSTAT can condone delay by a further 3 months for sufficient cause. If both windows are missed, you must approach the High Court for condonation — adding time and cost.
• Pre-deposit at GSTAT under Section 112(8): 20% of the remaining disputed tax (that is, 20% of the 90% balance after the 10% already deposited at the First Appeal stage), subject to a maximum of Rs. 50 crore CGST + Rs. 50 crore SGST. For large enterprises disputing Rs. 200 crore-plus demands, the cap provides meaningful relief; for SMEs disputing Rs. 1-10 crore, the full percentages apply.

What has not changed: the backlog. Legacy disputes where orders were passed before GSTAT was notified are being filed before the tribunal through transitional provisions, creating immediate queue pressure on newly constituted benches. High Court stays obtained in writ petitions may need to be vacated and re-litigated before GSTAT, with fresh pre-deposit calculations at each stage.

Classification Disputes: Where the Biggest Money Gets Trapped

Classification — determining which HSN (Harmonised System of Nomenclature) code for goods or SAC (Services Accounting Code) for services applies — determines the tax rate and whether a supply is exempt, taxable at 5%, 12%, 18% or 28%. A one-rate-bracket reclassification on a product with Rs. 40 crore in annual sales can produce a demand of Rs. 3.2 to Rs. 5.2 crore plus interest and penalty.

The most contested classification battlegrounds in FY 2026-27:

• IT and software services: Is a particular supply "development of software" (SAC 998313, 18%) or a supply of "packaged software" on a physical medium (goods with GST on MRP)? Does a SaaS subscription attract IGST as an import of service by the Indian recipient — and if so, who pays: the Indian company through the reverse charge mechanism, or the foreign vendor?
• Pharmaceutical intermediates vs. APIs vs. formulations: Rate differentials between raw materials (12-18%), active pharmaceutical ingredients — APIs — (12%) and finished formulations (5% or 12%) create legitimate Inverted Duty Structure (IDS) refund opportunities. They also invite reclassification notices when the department disputes whether what you call an "intermediate" is actually a taxable formulation.
• Works contracts in construction: Section 17(5)(c) of the CGST Act blocks ITC on construction of immovable property. Disputes arise constantly on whether a "fit-out," "retrofitting" or "plant installation" contract qualifies as a works contract attracting this block.
• Food and beverages: The boundary between "restaurant services" (5%, no ITC), "outdoor catering" (5%, no ITC in most cases) and "supply of food by a canteen/mess operator" (different rate structures, ITC eligibility contested) has produced some of the most fact-intensive litigation in the GST era.

Practical step before responding: Pull the applicable HSN or SAC, the rate notification (Notification No. 1/2017-Central Tax (Rate) for goods; Notification No. 11/2017-Central Tax (Rate) for services), any CBIC circular and relevant Advance Authority Ruling (AAR) or Appellate AAR (AAAR) orders in your jurisdiction. Build your classification matrix before drafting the SCN reply — not during tribunal proceedings, when changing your position looks opportunistic.

ITC Denial Under Section 16: The Most Litigated Provision in GST

Section 16 of the CGST Act sets four cumulative conditions for ITC eligibility. Two of these generate the bulk of 2026 litigation:

Section 16(2)(aa) — inserted by the Finance Act 2021, effective 1 January 2022 — makes ITC available only if the credit appears in the recipient's GSTR-2B for the relevant period. This creates hard dependency on the supplier's filing discipline. If your vendor files GSTR-1 late or omits an invoice, your GSTR-2B credit disappears — and any ITC claimed in GSTR-3B that is not in GSTR-2B is disallowed, attracting demand plus 18% interest under Section 50.

Section 16(2)(c): ITC is available only if the supplier has actually paid the tax. This provision has been upheld as constitutional by some High Courts and challenged in others. The Supreme Court has not, as of mid-2026, delivered a final binding ruling. Until it does, taxpayers must maintain documentary proof that vendor payments — including tax — were made, and must take a cautious position unless they have specific favourable precedent binding in their jurisdiction.

Section 16(4) — the hardest cut-off in GST: ITC for FY 2026-27 must be claimed by the earlier of: (a) 30 November 2027, or (b) the date of filing GSTR-9 (annual return) for FY 2026-27. Credits discovered after that date are forfeited permanently — no rectification mechanism exists. Run a full ITC audit for FY 2026-27 before October 2027 to ensure nothing is missed.

Worked Example: An ITC Denial Demand and Its Appeal Journey

Scenario: A mid-size packaging manufacturer in FY 2024-25 claimed ITC of Rs. 80 lakh from four vendors. One vendor — accounting for Rs. 35 lakh of that ITC — subsequently defaulted on GSTR-3B filings for four months and did not remit the corresponding tax. The GST officer issues an SCN under Section 74 of the CGST Act (alleging suppression), demanding:

The company disputes the demand. It files an appeal before the GST Commissioner (Appeals) under Section 107.

Pre-deposit at First Appeal: 10% of disputed tax only = 10% × Rs. 35 lakh = Rs. 3.5 lakh in cash. Note that pre-deposit is computed on the tax component alone, not on interest or penalty.

The First Appellate Authority confirms the demand. The company files an appeal before GSTAT under Section 112.

Pre-deposit at GSTAT: 20% of remaining disputed tax = 20% × Rs. 31.5 lakh (Rs. 35 lakh less Rs. 3.5 lakh already paid) = Rs. 6.3 lakh in cash.

Total cash locked before a single GSTAT hearing: Rs. 9.8 lakh. At a working capital cost of 12% per annum and an 18-month wait for the first substantive GSTAT hearing, the carrying cost is approximately Rs. 1.76 lakh — real money, on top of counsel fees, that accrues even if the company ultimately wins.

The lesson: an Rs. 82-lakh dispute is simultaneously a Rs. 9.8-lakh current cash event on the day you file the GSTAT appeal. Model this before the order lands, not after.

Refund Litigation: How Exporters and IDS Claimants Get Trapped

Section 54 of the CGST Act governs refunds. Two categories account for the majority of litigation:

Export refunds (Section 54(1), Rule 89): Exporters may either pay IGST on exported goods and claim a cash refund, or export under a Letter of Undertaking (LUT) and claim a refund of accumulated input credit. Refund applications must be filed within 2 years from the relevant date — for exports, the date of export, not the invoice date. There is no provision to extend this deadline.

Common rejection grounds include: mismatch between shipping bill data on the ICEGATE portal and entries in GSTR-1; LUT not filed or filed after goods were exported; GSTR-3B not filed for all months in the refund period.

IDS refunds (Section 54(3)(ii)): These arise where input tax rates exceed output rates — common in pharmaceuticals, agro-processing and certain chemicals. The refund formula under Rule 89(4) is:

> Maximum Refund = (Net ITC × Turnover of inverted-rated supply) ÷ Adjusted Total Turnover

Worked numbers: A chemical company has Rs. 60 lakh of Net ITC for FY 2026-27. Inverted-rated supply turnover is Rs. 4 crore; Adjusted Total Turnover is Rs. 9 crore. Maximum IDS refund = Rs. 60 lakh × (4 ÷ 9) = Rs. 26.67 lakh. If the department disputes the composition of "Net ITC" by adding back reversals you have classified differently, the refundable amount drops — and a fresh appeal under Section 107 lies.

Portal discipline matters here: Refund applications filed on the GST portal are reviewed by the jurisdictional officer, who may issue a deficiency memo under Rule 90(3) within 15 days. If you do not respond within the prescribed window, the application is treated as rejected and must be refiled from scratch — resetting your position in the queue and, critically, consuming more of your 2-year limitation window.

Pre-Deposit Requirements: Quantify the Drain Before You File

For SMEs — where disputes typically range from Rs. 50 lakh to Rs. 10 crore — the statutory caps rarely apply. The full 10% and 20% are payable, and they are payable in cash, not by way of adjustment from the electronic credit ledger.

When you receive an assessment order, the first calculation your finance head should run is: "If we appeal this all the way to GSTAT, what is the total cash I need in my bank account on the day I file?" That number — not the disputed demand — is the immediate treasury problem.

Building an SCN Reply That Holds Up Through Three Appellate Layers

The SCN reply is not a formality. Courts and tribunals have consistently held that grounds not raised at the reply stage cannot be raised subsequently. A weak reply creates gaps that are almost impossible to plug before GSTAT.

A well-structured reply must contain:

1. Factual background: A clean timeline of the transaction, the parties, the amounts and the filings involved. Attach GSTR-1 extracts, GSTR-3B extracts, e-invoices, e-way bills, books-of-account entries and payment proof — every document you reference must be physically attached, not "available on request."
2. Numbered grounds of defence: One numbered paragraph per allegation in the SCN. Do not leave any allegation unanswered — silence in an SCN reply is treated as an admission by most adjudicating officers.
3. Legal submissions: Cite the exact provision (section number, rule number), the CBIC circular or FAQ that supports your position, and attach copies of binding precedent from the Supreme Court or the jurisdictional High Court.
4. Relief sought: State precisely whether you are seeking full discharge of the demand, partial discharge or waiver of penalty only.
5. Personal hearing request: Always request a personal hearing under Section 75(4) of the CGST Act. An order passed without granting a hearing after a written request is procedurally vulnerable at the First Appellate stage.

The most common and most avoidable mistake is submitting a one-page reply saying "we have complied with all GST provisions and deny all allegations." This reply produces a one-page adverse adjudication order — which then becomes the starting point for three rounds of expensive appellate proceedings.

Pitfalls to Avoid in GST Litigation

1. Missing the reply deadline. A 30-day window moves fast across a busy finance calendar. Maintain a register of all live SCNs with deadlines and designate a responsible owner for each.

2. Claiming ITC beyond GSTR-2B without a reconciliation file. Any credit not appearing in GSTR-2B must be supported by GSTR-2A reconciliation, vendor follow-up correspondence and documentary evidence before it is claimed in GSTR-3B. Claiming first and reconciling later is the most reliable way to generate a Section 73 or 74 demand.

3. Letting Section 16(4) cut-offs slip. Complete your ITC audit for FY 2026-27 before October 2027. Credits discovered after 30 November 2027 are permanently forfeited.

4. Not provisioning for the pre-deposit cash requirement. Many businesses are blindsided by the liquidity requirement when an assessment order arrives. If a dispute is material, model the Section 107 and Section 112 pre-deposits as contingent cash requirements from the date the SCN is served.

5. Forum shopping through writ petitions without exhausting the appellate remedy. High Courts routinely dismiss writs filed without first exhausting the statutory appeals route, unless the impugned order is jurisdictionally void. Filing a writ that gets dismissed on this ground wastes months and creates adverse observations on record.

6. Treating GSTR-9C reconciliation loosely. GSTR-9C is self-certified since FY 2020-21. A material discrepancy between GSTR-9C and the audited accounts is an open invitation for scrutiny under Section 61 or a demand under Section 73. Reconcile before certification, not after.

7. Using advance rulings for disputes that are already under scrutiny. The AAR jurisdiction does not extend to questions already pending before a court or authority. Applying for an advance ruling under Section 97 on a matter that is simultaneously the subject of an SCN is a ground for rejection of the AAR application.

Provisioning and Disclosure for Disputed GST Positions

Every material GST dispute must be assessed under Ind AS 37 (Provisions, Contingent Liabilities and Contingent Assets) — or AS 29 for entities not applying Ind AS — at every balance-sheet date.

• Probable obligation (more likely than not that an outflow will occur): Provide in the books. The provision should reflect the best estimate of the outflow, including likely interest at 18% per annum and penalty at the applicable percentage.
• Possible obligation (not probable but not remote): Disclose as a contingent liability in the notes to the financial statements. State the nature of the dispute, total amount at stake (broken into tax, interest and penalty), and the current stage of proceedings.
• Remote obligation: No disclosure required, but document your reasoning in a dated internal memo.

For each material dispute, maintain a written assessment — typically signed off by your tax counsel — classifying the obligation as probable, possible or remote and giving the basis. This is the document your statutory auditor will rely on during the Ind AS 37 review. In any M&A or fundraising process, it is also the document that prevents a disproportionate tax-tail haircut on your enterprise valuation.

Building a GST Litigation Tracker: The Minimum Viable System

Whether you run a five-person finance function or a 50-person indirect-tax team, every business with live GST disputes needs a tracker with at minimum these columns:

Review this tracker formally at every board or audit-committee meeting where tax is on the agenda. Surprises in GST litigation — a bank attachment order, a recovery notice, an adverse GSTAT ruling — almost always trace back to a tracker that was not maintained or a deadline that was not calendared.

Key Takeaways

• GSTAT is operational — but comes with a price. The 20% pre-deposit under Section 112(8) is a real, current cash outflow. Model it at the time of the assessment order, not the GSTAT filing date.
• Sections 16(2)(aa) and 16(2)(c) are the most litigated ITC provisions. Run monthly GSTR-2B reconciliation. Do a full ITC audit for FY 2026-27 before October 2027 — credits missed after 30 November 2027 are gone permanently under Section 16(4).
• Classification disputes are high-value and often preventable. A pre-filing HSN/SAC review is far cheaper than tribunal-level litigation. For recurring, high-value classification questions, use an Advance Ruling under Section 97 to create a defensible on-record position.
• The SCN reply is the foundation of all subsequent litigation. Address every allegation. Cite every provision. Attach every document. Always invoke your right to a personal hearing under Section 75(4).
• Refund claims have a hard 2-year limitation. Do not allow export or IDS refund applications to age. Respond promptly to Rule 90(3) deficiency memos — a missed response forces you to refile, consuming your limitation window.
• Provision correctly under Ind AS 37. A probable GST obligation must be provided for in the books, not treated as remote to manage ratios. Auditors, investors and acquirers will see through a thin contingent-liability note on a material, multi-year dispute.
• A maintained litigation tracker is not optional. Missed deadlines, unprovisioned demands and uncoordinated multi-forum disputes are management failures, not legal ones. The tracker is the governance tool that prevents them.