The indirect tax department that had arrested many promoters for circular trading and escaping goods and services tax may have to rethink its strategy after the Mumbai High Court granted bail to many of them.

The arrests came after the indirect tax department issued notices in February this year and raided premises of several companies for allegedly inflating turnover through fake invoices to shell companies.

People close to the development said that several promoters then approached the criminal bench of the Bombay High Court which granted them bail and sought an explanation from the department. Bail was granted to different people in the past few weeks.

Some industry observers suspect that circular trading may be used to inflate turnover or for bringing in black money to system. Tax experts, however, pointed out that this doesn’t necessarily mean tax evasion and that some genuine businesses are facing trouble on this count.

“We have argued that the entire issue is based on the department’s assumption that the supply of goods should result in movement of goods,” said Abhishek A Rastogi, partner at law firm Khaitan & Co, who represented some promoters in their bail pleas. “The legal principle of revenue neutrality comes into play. In case there is no loss of revenue, the proceedings cannot be non-bailable and cognisable.”

Legal experts said the taxman had upped the ante by arresting promoters in the last few months.

“The GST officers have suo moto converted enquiries into criminal cases by arresting the promoters, which was seldom done under the earlier tax framework,” said Sujay N Kantawala, a high court advocate.

DEPT’S POWER TO ARREST MAY BE CHALLENGED
“This is clearly premature as determination of actual tax liability exercise is not carried out prior to arrest. This amounts to clear contempt of binding judgements,” he said.

ET had first reported on March 6 that indirect tax officials had started arresting promoters

following raids and suspecting circular trade.

People close to the development said some sectors tend to get involved in circular trading but it doesn’t necessarily mean there is tax evasion.

A person familiar with the development cited the example of a Mumbai company that is into trading of plastic goods. The said company sold goods to a company based in Pune, which sold the same goods to another company based in Bengaluru. Now, the third company sold the goods to the first, the Mumbai-based firm. All this while, the goods were kept safe at a godown in Mumbai and GST credits were paid on every lap of transaction. The series of sales helped the firms inflate turnover and avail larger valuations and loans, the person said.

POWER TO ARREST
Meanwhile, a battery of lawyers are looking at challenging a particular section of the GST law that gives arresting powers to the taxman, people in the know said. A separate petition in this regard could be filed in the coming weeks, they said.

The indirect tax department started issuing notices to several companies in the past few weeks, seeking evidence of all the purchase and sale transactions including the invoices. The department suspects that several companies are merely buying fake bills that help them claim input tax credit and actual buying and selling of goods is not taking place.

Input tax credit is a mechanism whereby a company can set off the GST paid by them on purchases against future tax liabilities. Industry trackers said that in many cases the promoters of such companies had landed in jail.