Fictitious Firms, Fake Invoicing & Fraudulent ITC under GST: Modus Operandi, Legal Exposure and Enforcement Framework

Fictitious firms under GST: Busting the Racket

 Introduction

Nearing half a decade since its inception, this flawed yet functional indirect tax, GST, has become a matter of the moment in the world of tax professionals. Introduced with the aim to bring a positive change in the economy, it has a long way to go keeping in mind the current state of affairs.

The poor implementation of GST has created a big hurdle for the new and migrated taxpayers in adapting the new system and on the other side as well, the Govt. is also struggling to clear the mess by way of easing the compliances through measures like QRMP scheme, waiving late fees on returns in certain cases etc. For a tax which has subsumed almost every other indirect tax in the country, one may argue that the occurrence of problems during the initial implementation stages is only natural, but even the troublemakers are not leaving any stone unturned to monetize this situation by indulging in illegal practices. From issuing fake invoices by creating fictitious firms to clandestine removal of goods, there is no offence under GST which hasn’t already hit the papers.

The most well engineered fraud which is being committed by the miscreants is the fraudulent availment and transfer of ITC by way of creating fictitious firms, the cases of which have almost reached the ceiling by now. This type of fraud is very hard to trace as it doesn’t result in any mismatch in any periodical returns furnished under GST and the consideration of every fraudulent transaction involved, flows through proper banking channel.

This article aims to enable the professionals to play their role in stopping such kind of activity by making them aware of the methodology adopted by the miscreants in committing this fraud.

Methodology adopted to commit fraud

Out of various ways to commit fraud by way of creating fictitious firms, we have discussed the most commonly used structure, which mainly involves the following:

        I.            Issue of fake invoices in the name of fictitious firms:

The cycle of this fraud starts from the dealers who are engaged in the B2C supplies and serve the end consumers. These dealers get their inward supplies from wholesalers/distributors of big companies after payment of GST. The recipients of these dealers generally pay in cash and as the ITC is not claimed by the final customers of these dealers, most of these customers do not demand the bill for their purchases. These dealers issue fake invoices in the name of the fictitious firms to transfer the ITC to them (invoices for the goods which have already been bought by the end consumers).

The people running the racket of fictitious firms register these firms on GST portal on the basis of Aadhaar, PAN etc. of unknown persons. Although no actual goods are delivered to the fictitious firms, the payment for the goods mentioned in invoices is made by the fictitious firms to the dealer through proper banking channel e.g., RTGS, and in return these firms receive the cash from the dealer.

By way of the above arrangement, it is clear that the fictitious firms are in a position to receive fake invoices (with ITC) by making payment through proper banking channel e.g., RTGS (and receiving cash against it).

     II.            Issue of these fake invoices by fictitious firms to other buyers:

After receiving the fake invoices from the B2C dealers, these fictitious firms raise invoices of outwards supplies in the name of other companies who want to avail fraudulent ITC. These fictitious firms charge commission from these companies which are shown as recipients of these fictitious firms. The fictitious firms settle their own output liability with the ITC on the purchased bills from B2C dealers. The payment for the goods indicated in the invoice is made by these recipient companies by way of proper banking channel (e.g., RTGS) and to settle the transaction, they receive cash from the fictitious firms (which was originally received from B2C dealers). The fake recipients of these fictitious firms are those companies which buy their genuine supplies in black i.e., without bill (in kaccha). These companies (recipients of fictitious firms) enjoy the benefit of converting their inwards supplies (without bill) in genuine supplies (with bill) by way of these fake invoices.

To calculate the benefit resulting from this arrangement, B2C dealers get the commission from fictitious firms and get their cash deposited in bank, fictitious firms charge commission from their fake recipients and pay commission to B2C dealers (the difference being the return) and the recipients of fictitious firms, get the invoices in support of the goods (originally purchased without bill) and fraudulently claim the ITC.

There is no actual supply of goods or services in the above discussed arrangement. In order to present the whole cycle as genuine in case of any inspection by authorities, the payment against the bills is only made through proper banking channels as discussed. Moreover, this arrangement doesn’t result in any mismatch in GST returns. Apart from the B2C suppliers, other sellers whose customers generally pay in cash e.g., few jewellery dealers are also involved in such kind of rackets.

Legal Provisions attracted

The above arrangement of creating fictitious firms and availing fraudulent ITC attracts various provisions given under the GST legislation.

The law specifically prohibits[1] the entitlement of input tax credit on any goods or services or both unless he has received them. Further, activities like the issue of invoice or bill without supply of goods or services, furnishing any false information with regard to registration particulars, utilizing ITC without actual receipt of goods or services or both are covered under offences and penalties[2] given under the GST, for which penalty specified is Rs. 10000 or amount equivalent to tax evaded. This penalty is also imposed on the person at whose instance the above transaction is conducted.

Along with the penalty, the imposition of fine along with imprisonment has also been provided[3] for, the amount of fine and the term of imprisonment depends on the amount of tax evaded.

Comments

Even if the cases of fake invoice rackets are on the rise, it would be fallacious to put the entire blame on the GST because even in the pre-GST era, these rackets were in operation. However, the only difference was that the area or operation and amount of tax evasion by the perpetrators was at smaller scale, reason being the different VAT Acts for different states and the lower rate of VAT compared to GST. The opportunists might have taken the advantage of poor technological infrastructure, easy registration under GST, loopholes in generation of E-way bills, but the department, nevertheless, has been counteractive in its approach to tackle the situation by devising SOPs for verification of risky taxpayers, training the GST officers, making provision for e-invoicing.

Regardless of the fraudsters finding ways to ride the gravy train by using illegitimate means, we professionals should play our part in taking down any such rackets we come across, by reporting the same to the appropriate authorities.

Your input can be a step forward in making GST, reach its potential.

Disclaimer: The purpose of the article is to enlighten the readers with the fraud mechanism so they can play their role in reporting these rackets. Under no circumstances, the author would be held liable in any way for damages arising from the use of this article.

The author can be reached at vaibhav@rvachartered.com

Vaibhav Rai

Chartered Accountant