Issues Concerning Cenvat Rules 13th July, 2006

Historical perspective VAT introduced in France for the first time in 1954 Success of VAT pronounced in a unitary system Adopted by a large number of countries Major advantage – prevents cascading of taxes Transparent mechanism, enhanced tax compliance, better revenue growth, better system of record keeping In India introduced as a part of LTFP in 1986 Introduced in a truncated form as modvat – restricted up to the manufacturing stage

Presentation Structure Some industry friendly aspects of the Cenvat Rules Some restrictions on availment of cenvat credit Input goods for cenvat - understanding the definition Input goods eligibility for cenvat – some controversies Capital goods eligibility for cenvat – some cases Reversal of credit on scrap of capital goods or inputs Contd..

Presentation Structure Availability and Utilization of cenvat credit –some issues Responsibility of person taking credit - issues Some miscellaneous issues Separate Accounts Vs Common accounts Way Forward

Industry friendly and pragmatic approach of policy maker

Availment of credit on receipt of goods (not on payment) No requirement of one to one correlation Duty credit extended to service tax and then further made inter-sectoral Time for availment – within an year ( not specified) Credit available on duty paid on inputs going into intermediate goods Credit available on raw materials and components going into manufacture of capital goods Concept of ISD introduced to permit flexibility in utilization of input service credit

Restrictions on availment of credit under Cenvat Scheme

Input tax on diesel and petrol Input tax on office equipment and appliances ( allowed to service providers) Cenvat on motor vehicles ( some exceptions in case of service providers) No refund of excess cenvat ( except in case of exports) Service providers not entitled to cenvat on additional customs duty ( Section3(5) of the Customs Tariff) Utilization of cenvat under one head restricted for usage under another head ( education cess, NCCD)

Input Goods for Cenvat

All goods used in or in relation to manufacture of final goods Includes consumables like lubricating/cutting oils, greases and coolants Includes accessories of final products cleared along with the final product ( what about value …….) Includes goods used as paint, packaging material or fuel (in the factory of production) Goods used for generation of electricity or steam ( in the factory of production)

Input Goods eligibility for Cenvat Cases & controversies

Inputs to be used in the factory of prodcuction CBEC circular to this effect Vikram Cements case (SC) 2006 – allowed cenvat on explosives used in mines located away from the factory Also allowed cenvat on fuel used outside the factory so long as electricity/steam generated was used in the factory Haldia Petrochemicals ( 2005) allowed credit on Naptha sent to job worker for generation of electricity

Inputs to be used in or in relation to the manufacture of final product Duty paid on goods used in the effluent treatment plant – IFFCO (1996) SC Inputs used in relation to trial production which turn into scrap – Fertilizer Corp(1996) and later followed in Duracell case –contrary view in Warner Lambert Inputs lost in fire or pilfered before being used in or in relation to manufacture –Ashok Leyland (2004) Inputs lost in course of work in process – allowed in Asian Paints (2004)

Inputs to be used in or in relation to the manufacture of final product Value of goods written off in accounts – no need to reverse credit – BHEL case (2002) followed in Kinetic Motors (2005) Fuel used in DG sets installed in another unit ( different registration )of the same assessee by which power was supplied to both the units – Diamond Cement ( 2004) Inputs which only facilitate manufacture – lighting equipment, inputs used in R&D, Cement used in maintenance of plant and machinery - disallowed

Capital Goods eligibility for Cenvat Cases & controversies

Capital Goods Only those defined as such under Rule 2(a) Used in the factory of manufacture or for provision of services Can be sent outside for job-work a period of 180 days Used exclusively for manufacturing exempted goods or providing exempted services – not allowed Permissible on those obtained on lease/loan/hire Depreciation under I-Tax Act not to be claimed on excise portion Upto 50% in the first financial year

Case law Capital goods must be used within the factory – allowed even if partly used in factory and partly outside –India Cements (2005) Capital goods extended from factory to outside –like ropeway –allowed Manikgarh Cement (2004) Installation of Capital goods not required – not a pre-requisite for availing first 50% credit – Goyal MG Gases ( 2004) Capital goods should be used in the factory –purpose is immaterial – quality control, testing , material handling - Ghatampur Sugar (1998)

Reversal of credit on disposal of input /capital goods - used/waste /scrap

Rule 5 provides that if capital goods or inputs are cleared as such –an amount equal to the credit availed needs to be reversed In Banswara Synthetics (2005) following the Rajasthan Spinning case the Tribunal held that in absence of any provision under the cenvat rules no duty was required to be paid on scrap of capital goods To nullify the above decision Rule 5A was introduced –which requires a manufacturer to pay an amount equal to the duty leviable on transaction value when cap goods are cleared as waste/scrap

The issue still remains what about duty payable on inputs which are cleared not ‘as such’ In Arihant Solvex (2005) the issue was whether duty was liable to be paid on exempted by products which arose in the manufacture of final goods Facts : In edible oil manufacture, acid oil, de-oiled cake emerged as by-products. These were specifically exempted products as per the tariff Contention : Not intended to be manufactured but incidental or accidental to manufacture of final products Revenues contention : No distinction between final products and by products – both are classified under the tariff – amount of 8% demanded on sale price of exempted products

Reliance placed on instruction of CBEC –’ Credit admissible in respect of amount of inputs contained in any waste or by product and should not be denied if the inputs are used in intermediate of the final product and even if such intermediate is exempt from duty’ Held no duty was payable on the by-product as it was a fallout of the manufacturing of the final product In case the by-product was not exempted –it would have been liable to pay duty as per the tariff.

Availability and Utilization of Cenvat

Full credit of duty paid is available as credit irrespective of whether it is less or more or paid under protest – Sterlite Industries (2004) Credit required to be reversed if final goods exempted subsequently –Albert David (2003) Credit can be availed on the certified B/E if receipt of goods and duty payment is ascertained – Vikrant Tyres (2004) Proviso to Rule 9(2) provides discretion to the AC/DC to allow credit –can condone defects or minor procedural lapses

Utilization of credit for- - duty on final product manufactured - payment of ‘amount’ on inputs/capital goods removed as such/removal of goods for repairs/ 10% payment on exempted goods/capital goods not returned within 180 days Full credit of duty on inputs/capital goods obtained from fiscal concession areas Restrictions of credit on marble slabs/ pan masala/goods procured from EOUs CVD available as credit even if paid thru DEPB Fiscal concession area units allowed to avail credit on inputs/capital goods –but avail it only in respect of exempted goods

Responsibility of person taking cenvat credit

Rule 9(3) imposes the duty of taking reasonable steps that credit of duty taken has been paid Rule 15(1) provides penalty for not taking reasonable steps Rule 9(5) puts the burden of proof of admissibility of credit on the person taking the credit Reasonable steps – Need to ascertain the identity and address of the manufacturer or supplier - Personal knowledge - Certificate from a person whose writing/signature is known or from Range Supdt of the supplier User –manufacturer not liable if manufacturer-supplier does not pay duty. Credit cannot be denied so long as transaction was bonafide – Prachi Polyproducts ( 2005)

Miscellaneous Issues relating to cenvat credit on inputs/input services

Credit of service tax on advances Credit is available on services received in the factory of the manufacturer of excisable goods or premises of provider of output taxable services Section 67 – Value of service tax : services provided or to be provided Rule 6 of Service tax Rules – Service tax to be paid on payment received towards value of taxable services Service tax payable on advance payments However in case of advance payments service is neither received nor used Can credit be availed by the service receiver of service tax paid in advance to the service provider Clarification required as to the point of time credit can be claimed by the service recipient

Credit of service tax on outward transportation Rule 2(l) define input service ( for manufacturers) as “all taxable services used whether directly or indirectly, in or in relation to – - manufacture of final products; and - clearance of final products from the place of removal” Inclusive part of the definition provides that input service includes ‘outward transportation up to the place of removal’ Departmental circular provides that cenvat credit shall not be available of service tax paid on outward transportation from the place of removal Can a circular provide contrary to the rule …..

Credit on input service used in manufacture of excisable goods/taxable services Rule 3(2) provides cenvat credit of duties paid on inputs lying in stock on the date the goods become excisable goods Cenvat credit also needs to be extended on service tax paid on input services used in or in relation to the manufacture of such excisable goods lying in stock /provision of taxable services which ceases to be an exempted service The modality for extending such credit on input services can be worked out on basis of balance sheet figures for the previous year

Eligibility to avail credit on inputs sent directly to the job-worker Rule 4(5) provides for availment of input credit on inputs sent to job –worker for further processing or manufacture Rule does not provide for credit of duty paid on such inputs if sent directly to the job-worker (without first bringing them into the factory of the manufacturer of final goods) In case of Yeshwant Process works (2004) it was held that cenvat credit cannot be denied for sending inputs directly to job -worker

Separate Account or Common account of inputs/input services

Utilizing Cenvat Credit - Conditions Case – 1 Where both - exempted as well as dutiable goods are manufactured; or exempted as well as taxable services are rendered. and separate accounts are maintained for receipt consumption, inventory. Cenvat Credit is allowed only on inputs / input services utilized for manufacture of dutiable goods or for rendering taxable services.

Utilizing Cenvat Credit - Conditions Case – 2 (When separate accounts are not maintained) Service Provider: Cenvat Credit on input services to be utilized only upto 20% of amount of Service Tax payable on taxable output services. 100% credit allowed on services covered under Rule 6(5) Manufacturer : Rule 6(3)(b)- For utilizing credit, manufacturer to pay 10% of the total price

Separate Account Vs Common Account To be examined on case to case basis. Key considerations: For Output Service Provider - If, majority of input services fall under Rule 6(5) of Cenvat Rules, 20% cap shall have minimal tax impact; Whether quantum of Service Tax on input service is lower than 20% cap on output Service Tax liability. For manufacturer of excisable goods - Maintenance of separate accounts should be beneficial.

Way Forward

Cenvat credit needs more simplicity of operation Need to de-link with the concept of used in or in relation to manufacture What comes in the factory - avail credit of duty paid –pay duty on what goes out Eventually expected to merge with the utopian ‘GST’; Corporate(s) must comprehensively evaluate their operations, agreements with vendors and continuously analyze their business structure to optimize cenvat credit Any analysis must keep in mind VAT and service tax implications

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