Fake invoicing and circular trading allegations: building the defence file
This is the allegation that carries arrest, attachment and prosecution together. The defence is documentary and it has to be built before the summons.
An allegation of fake invoicing is that an invoice was issued without an underlying supply, and that credit was availed on it. The consequences run across Section 74 for the demand, Section 122(1) for penalty including on a person who takes credit without receipt, Section 132 for prosecution, Section 69 for arrest, Section 83 for attachment and Rule 86A for blocking. The defence turns on proving the supply actually occurred, and on separating a genuine purchase from a supplier's own misconduct.
How these cases are built by the department
An investigation begins with a supplier, not with you. A supplier is found to be non existent at its registered address, or to have filed GSTR-1 without GSTR-3B, or to have issued invoices far exceeding its capacity.
The chain is then mapped from the portal. Every recipient of that supplier's invoices becomes a noticee. Statements are recorded from the supplier's proprietor or accountant, often admitting the issue of accommodation invoices.
Blocking under Rule 86A and attachment under Section 83 usually follow within days, before any quantification. Then a summons under Section 70, then a DRC-01 under Section 74 with a hundred percent penalty.
The department's case is therefore rarely about your documents at the outset. It is about the supplier. Your task is to break that inference with your own record.
The three layer defence, applied to this allegation
Existence. Purchase order, invoice with the e-invoice reference number, e-way bill, transporter document and vehicle number, toll or fastag record if available, weighbridge slip, gate entry, goods receipt note, and the quality inspection report. Records generated by third parties are the ones that persuade.
Consumption. Stock ledger movement, bill of material, production or job card records, and the outward invoice into which the material went, on which tax was paid. This is the layer that most often ends the case, because the department must then explain a fictitious purchase that produced a real, taxed sale.
Diligence. GSTIN status at the date of the transaction, the invoice in GSTR-2B, payment through banking channels with the bank statement, and correspondence with the supplier when a discrepancy surfaced. Cash payment or a circular fund flow destroys this layer entirely.
For services, replace movement with deliverables: scope, timesheets, reports, approvals, correspondence and the output that consumed the service.
Procedural defences that matter as much as the evidence
Cross examination of the supplier whose statement is relied on. A refusal is a natural justice ground of the first order, and Andaman Timber Industries is the authority.
Retraction and the value of a statement. A statement recorded during investigation is not a substitute for evidence of the supply, and where it was recorded at unreasonable hours or under coercion, the surrounding record matters. Radhika Agarwal has strengthened this line considerably.
Relied upon documents. Ask in writing for the investigation report, the supplier's enquiry file and the statements. An order that relies on material not supplied is vulnerable.
Coerced payment. A DRC-03 made during search, without determination, is now squarely challengeable and a refund can be pressed.
And the Section 74 ingredient. Even where credit is denied, the hundred percent penalty requires fraud or wilful misstatement by you, not by your supplier.
What separates a survivable file from a fatal one
Fatal: payment in cash, payment routed back to your own group, no transport record, purchase from an address you cannot describe, invoice values that do not match any production requirement, and a supplier introduced by a broker whose identity you cannot establish.
Survivable: complete third party movement records, a matched production and sales chain, banking payment, and a documented attempt to chase the supplier when the mismatch appeared.
In practice the outcome is decided by what existed before the notice. This is the one area of GST where the compliance system, and not the argument, decides the result.
Authorities relied on
The claimant must prove the genuineness of the transaction and the actual movement of goods; invoices and payments alone are insufficient.
Denial of cross examination of witnesses whose statements form the basis of the order vitiates the order.
Arrest safeguards apply to GST; grounds of arrest must be in writing and coercive recovery during search or custody is impermissible.
Provisional attachment requires tangible material and recorded reasons; the power is draconian and strictly construed.
What to do on Monday
Institute a supplier onboarding file — GSTIN status, address verification, first order documentation — and keep it dated.
Make the transport document mandatory at the goods inward stage; a receipt without it should not be booked.
Reconcile purchases to production and sales at least quarterly so that the consumption layer exists before it is needed.
Apply in writing for cross examination the moment a statement is referred to in a notice.
Never sign a blank statement and never make a search time payment without a protest letter.
This page states the general position. A reader with a specific question on their own facts may write to the GST practice at AMLEGALS.
Write to the GST practiceQuestions we are asked on this
The supplier has admitted issuing fake invoices. Are we finished?
No. His admission binds him. Against you it is a statement that must be tested, and you are entitled to cross examine him. Your own movement and consumption records are what answer it.
Can penalty be imposed on our director personally?
Section 122(1A) and Section 137 permit proceedings against persons who retain the benefit of a transaction and against officers of the company in specified circumstances. Each requires its own findings and should be resisted separately.
Should we pay to avoid arrest?
Payment does not bar prosecution and, after Radhika Agarwal, arrest cannot be used as a collection technique. Take the decision on the merits and the arithmetic, with counsel, not under pressure in a search.
Can we claim credit again if the supplier later pays?
Where credit was reversed under Rule 37A, re availment is provided for. Where it was reversed under a Section 74 demand, the position is different and depends on the terms of the order.
How far back can the department go?
Under Section 74 the extended limitation applies, and for the earlier years the Section 168A extension notifications are also in play. Build the limitation table before arguing merits.
In this cluster
- Input tax credit under GST: the complete 2026 position
- Section 16(2)(c): can your ITC be denied because the supplier did not pay tax?
- Section 16(4) time limit for claiming ITC: what survives after the amnesty
- GSTR-2A and 2B mismatch notices: how to answer without conceding
- Blocked credits under Section 17(5): the clause by clause map
- Safari Retreats: what the Supreme Court decided on ITC for construction, and what Parliament then undid
- ITC on canteen, transport, insurance and other employee benefits
- ITC reversal under Rules 42 and 43: working the formula correctly
- Rule 37: ITC reversal when you do not pay your supplier within 180 days
- Rule 37A: reversal where your supplier did not file its GSTR-3B
GST Insights is published by AMLEGALS for general information. Law stated as on 3 September 2026. Not advice on any particular set of facts; not an advertisement or a solicitation under Rule 36 of the Bar Council of India Rules. Readers with a question on their own facts may write to the GST practice of their own accord.