CHANAKYA NATIONAL LAW UNIVERSITY, PATNA

TAXATION LAW

Project on:-

CENVAT – PROBLEMS AND PERSPECTIVES

Submitted To: Mr. G.P. Pandey

Submitted By: ABHISHEK KUMAR

Roll No. : 502

Semester : VIII, 4th Year.

ACKNOWLEDGEMENT

The present project on the “CENVAT – Problems and Perspectives” has been able to get its

final shape with the support and help of people from various quarters. My sincere thanks go to all

the members without whom the study could not have come to its present state. I am proud to

acknowledge gratitude to the individuals during my study and without whom the study may not

be completed. I have taken this opportunity to thank those who genuinely helped me.

With immense pleasure, I express my deepest sense of gratitude to Mr. G.P. Pandey, Faculty for

Taxation Law, Chanakya National Law University for helping me in my project. I am also

thankful to the whole Chanakya National Law University family that provided me all the

material I required for the project. Not to forget thanking to my parents without the co-operation

of which completion of this project would not had been possible.

I have made every effort to acknowledge credits, but I apologies in advance for any omission

that may have inadvertently taken place.

Last but not least I would like to thank Almighty whose blessing helped me to complete the

project.

RESEARCH METHODOLOGY

Method of Research:

The researcher has adopted a purely doctrinal method of research. The researcher has made extensive

use of the library at the Chanakya National Law University and also the internet sources.

Aims and Objectives:

The aim of the project is to present an overview of the terms “CENVAT – Problems and Perspectives s”

through different cases, writings and articles

Sources of Data:

The following secondary sources of data have been used in the project-

1. Cases

2. Books

3. Websites

Method of Writing:

The method of writing followed in the course of this research paper is primarily analytical.

CONTENTS

ACKNOWLEDGEMENT

RESEARCH METHODOLOGY

CHAPTERISATION

INTRODUCTION……………………………………………….

CENVAT – PROVISIONS AND PROBLEMS………………….

CENVAT – A FRESH PERSPECTIVE………………………….

CONCLUSION

BIBLIOGRAPHY

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INTRODUCTION

The Government of India has amended the definitions of Input and Input Service as defined

under Rules 2 (k) and 2(l) respectively of the Cenvat Credit Rules, 2004 vide Notification No.

3/2011-CE(NT) dated 1st March,2006. The following article deals with the history of the

CENVAT credit, the recent amendments and their impact.

HISTORY

Excise Duty in India traces its history back to 1889 when the Salt, Abkari and Customs

departments were together. With the passage of time, new Acts came into effect. However, one

shortcoming persisted – Cascading of taxes commonly known as Double Taxation. It is a

situation wherein, taxes are paid on taxes already paid. To remove this limitation, the

Government of India introduced the concept of providing credit of taxes on goods used in

manufacture. The Government materialised the concept by bringing Proforma Credit Scheme

wherein, credit was provided for taxes paid on goods used as input in manufacture.

This ensured that taxes paid on inputs were given credit and thus, no taxes were levied on such

input taxes. However, this scheme suffered from a deficiency as it allowed credit of only those

inputs which were used in manufacture of finished goods falling under the same tariff entry.

Since the benefit of Proforma Credit Scheme was very limited and did not completely tackle the

main concern i.e. the double taxation problem, the Government of India introduced Modified

Value Addition Tax Scheme (MODVAT Scheme) in 1986. The original MODVAT Scheme did

not provide for credit of taxes paid on Capital Goods however, it was later amended to provide

such credit of taxes on Capital Goods also. As far as tax credit on Inputs was concerned, Rule 57

of the MODVAT Scheme was much wider as compared to Proforma Credit Scheme. However,

the MODVAT Scheme had its own limitations as it was theoretically sound but had difficulties

in its practical application. The Scheme had burdensome compliance procedures and formalities

and thus, was not Assessee friendly.

With a view to eradicate the problems encountered so far, the Government of India introduced

The CENVAT Scheme 2002, which was later replaced by the CENVAT Scheme 2004. The

CENVAT Scheme is Assessee friendly and allows the Assessee on his own, to avail credit of

taxes paid on Inputs, Input Services and Capital Goods used in manufacture, without

intimating/declaring to the Department every time it is availed, provided he could prove that

such Inputs, Input Services and Capital Goods were used in manufacture. This reduced the

burden of compliance on the Assessee resulting in cost and time saving.

CENVAT – PROVISIONS AND PROBLEMS

THERE are a number of assessees who are engaged in provision of taxable services as well as

sale of traded goods or are engaged in the manufacture of dutiable goods as well as sale of traded

goods. In case of such assessees, there would be input services specifically pertaining to traded

goods as well common input services that are used both for duitable goods/taxable services and

for traded goods.

In 1986 modified value added tax i.e. modvat was introduced by the central government which

enabled the manufacturers to avail credit of excise duty paid on the input used in or in relation to

manufacture of end product .

Modvat scheme was renamed as central value added tax scheme i.e. cenvat scheme in the year

2000. Under this scheme duty paid on input stage is offset against duty payable at the final stage.

Scheme designed to reduce the cascading effect of indirect taxes on final products.

How Tax Credit System works.

VAT is based on Tax Credit System where the duty paid on input stage is offset against duty

payable at final stage .In conventional tax system , tax is calculated with reference to selling

price of the product .

However modern production technology requires variety of inputs and multiple processing in

manufacture of goods.

Thus for manufacture of a product , output of one manufacturer becomes input for other

manufacturer, who carries out further processing and sells it to third manufacturer.The process

continues till final product is manufactured.

In multiple processing manufacture, a tax based on selling price of a product will result in

taxation at many stages, as raw material passes from one stage to another till the manufacture of

final product.

As stages of production and sale continues , each subsequent purchaser has to pay tax again and

again on the inputs which has already been subjected to tax.This is called cascading effect.

VAT eliminates the cascading effect of tax by Tax Credit System.Under TCS , credit is provided

at each stage of tax paid at earlier stage.

Assuming that rate of Tax is 10%. In conventional system if the cost price a product

manufactured by A is Rs. 100 and that product is purchased by manufacturer B as input for

further processing.

Then along with tax, purchase price of B will be Rs. 110.

If B does a value addition Rs. 40 on that input , then selling price of that product will be Rs.

165. (Rs. 110+40=150 + 10% Tax= 165.

If C purchases the product from B as input for further processing , does a value addition of Rs.

35, then the selling price of that product will be Rs. 220 ( 165+35 =200+10% Tax= 220)

Under Tax Credit system.

Assuming rate of Tax is 10%

If the cost price a product manufactured by A is Rs. 100 and that product is purchased by

manufacturer B as input for further processing.

Then along with tax, purchase price of B will be Rs. 110.

However B will get a credit of duty already paid i.e Rs. 10 , he will not consider this amount in

his cost .

B does a value addition Rs. 40 on that input , then selling price of that product will be Rs. 154.

(Rs. 100+40=140 + 10% Tax(Rs.14)= 154).

Though B will mark the invoice price as Rs. 154 , he will pay a tax of only Rs. 4 (14-10) as B

has got a credit of Rs. 10 on account of 10% tax already paid on that product by earlier

manufacturer

C purchases the product from B as input for further processing , does a value addition of Rs. 60,

then the selling price of that product will be Rs. 206( 140+60=200+10% Tax= 220-14=206)

Here C will not consider Rs. 14 as his cost as he is getting a credit of Rs. 14 , which is the

amount of tax paid by the earlier manufacturer.

C will only pay Rs. 6 as tax i.e. 10% of value addition of Rs. 60 done by him.

If C sells his product to D for further processing ,Then purchase price of D will be Rs. 220.

However D will get a credit of duty already paid i.e Rs. 20 , so he will not consider this amount

in his cost .

If D does a value addition of Rs. 50 on that input the selling price of D will be Rs. 275( 200+

50=250 + 10% Tax= 275)

However D will pay only Rs. 5 as duty (10% of Rs. 50) as he has got a credit of Rs. 20 i.e.

amount of tax paid by earlier manufacturer.

Advantages of Tax Credit System.

Under TCS and VAT , exports can be made tax free which allows goods manufactured in India

to compete with goods manufactured in other countries on price front.

As the exporters are allowed CENVAT credit , inputs for manufacture of export products comes

totally duty free which helps in keeping the prices low and competitive.

Taxation can be target specific as VAT allows differential taxation of goods and services.

It is a self regulating system where value chain is unbroken and each user of input has a interest

in keeping the system working. Tax enforcement is strengthened as TCS provides audit trail

through different stages of production and trade.

It acts as a self policing mechanism as every stakeholder has a monetary interest involved i.e.

getting the tax credit. If someone wants to evade tax, he will not get the benefit of tax credit and

there is no incentive for evading taxes.

Moreover his products will also not find market as users of inputs will not buy something which

does not give them tax credit.

The question that arises in such cases is whether the assessee is entitled to take credit in respect

of input services that are specifically pertaining to traded goods as well as common input

services that are used both for dutiable goods/taxable services and for traded goods?

Section 37 of the Central Excise Act, 1944 and Section 94 of the Finance Act, 1994 provides

powers to the Central Government to make rules to provide for credit of duty or service tax

paid/deemed to have paid on the goods used in, or in relation to manufacture of excisable goods

or provision of taxable services. In exercise of these powers, the Central Government has made

Cenvat Credit Rules, 2004.

Rule 3 of the Cenvat Credit rules provide that a manufacturer of final product or provider of

taxable service shall be allowed to take credit (Cenvat credit) in respect of any input

service received by the manufacturer of final product or by provider of output service.

Rule 2(1) defines ‘input service' to mean any service:-

 i) used by a provider of taxable service for providing an output service; or

 ii) used by the manufacturer, whether directly or indirectly, in or in relation to the manufacture

of final products and clearance of final products, upto the place of removal,

and includes services used in relation to setting up, modernization, renovation or repairs of a

factory, premises of provider of output service or an office relating to such factory or premises,

advertisement or sales promotion, market research, storage upto the place of

removal, procurement of inputs, activities relating to business, such as accounting, auditing,

financing, recruitment and quality control, coaching and training, computer networking, credit

rating, share registry, and security,  inward transportation of inputs or capital goods and outward

transportation upto the place of removal;

Above definition makes it clear that input service would mean only those services which are

used by a provider of taxable service for providing output service or used by a manufacturer in or

in relation to manufacture. Hence any services exclusively used for traded goods would not get

covered under the definition of input service and cenvat credit would not be available for the

same.

Rule 6 provides the mechanism for availment of cenvat credit by a manufacturer of dutiable and

exempted goods and providers of taxable and exempted services. Let's try to see to analyse and

see whether traded goods can be considered as exempted goods or exempted services.

Rule 2(d) defines “exempted goods” as excisable goods which are exempt from the whole of

the duty of excise leviable thereon, and includes goods which are chargeable to “NIL” rate of

duty.

In order to get classified as “exempted goods”, the goods should be first excisable goods i.e.

excise duty should be leviable on the same and then there should be an exemption from payment

of excise duty or it should be chargeable at NIL rate of duty. Obviously excise duty is not

leviable on the traded goods and hence traded goods would not fall under the category of

“exempted goods”.

Rule 2(e) defines “exempted services” as taxable services which are exempt from whole of the

service tax leviable thereon, and includes services on which no service tax us leviable under

section 66 of the Finance Act.

Bare reading of the above definition shows that the definition is wide and even covers all the

services on which service tax is not leviable. However trading activity on which VAT/CST is

charged cannot be called service and therefore cannot be considered as an exempted service also.

Hence on the perusal of above definitions, it is clear that traded goods would neither fall under

the category of dutiable /exempted goods or taxable/exempt services and hence Rule 6 would not

apply in determining the eligibility of cenvat credit in respect of common input services used in

providing dutiable goods/taxable services and traded goods.

Hon'ble CESTAT in the case of M/s. ABB Ltd. and Others vs. Commissioner of Central

Excise and Service Tax, Bangalore (2009-TIOL-830-CESTAT-BANG-LB) has held that the

words “activities relating to business” in the inclusive part of the definition of input service is a

term of wide import and credit would be available in respect of all input services related to the

business activities. Hence based on this, one view can be taken that cenvat credit in respect of

common input services used in providing dutiable goods/taxable services and traded goods,

would be available by treating them as services related to business activities.

However such an interpretation would not be fair on account of the following reasons:

 i) Services referred to in the inclusive definition of the input services under Rule 2(1) are

required to be used in or in relation to the manufacture of final product of provision of taxable

services and inclusive definition only suggest that some services which may seemingly not

appear to be used in relation to the manufacture of final product would nevertheless deemed to

be so used [Prima facie view in the case of Colgate Palmolive (I) Ltd. Vs. Commissioner of

Central Excise Mumbai (2007-TIOL-485-CESTAT-MUM).

 ii) In case assessee undertakes an activity, which cannot be called service or cannot be called

manufacture, that activity goes out of the scope/purview of the Excise Act as well as Finance Act

and hence to interpret that service tax credit will be allowed in respect of common input services

utilized for providing one activity covered under the Act and another outside the ambit of the Act

would not be fair;

iii) Even on the grounds of equity, in case an assessee undertakes 100% of this business activity

as trading, he would not be entitled to credit of any input services. Hence merely because the

assessee also provides dutiable goods/taxable services, in addition to trading activity, he should

not be entitled to full credit of service tax credit in respect of common inputs without the express

authority of law.

Hon'ble CESTAT in the case of M/s. Orion Appliances Ltd. vs. CST, Ahmedabad[2010-TIOL-

752-CESTAT-AHM], while dealing with this issue has held as under:

i) Trading activity is nothing but purchase and sales and is covered under sales tax law; it cannot

be called a service and hence cannot be considered as an exempted service also.

ii) Since trading activity is not an exempted service, it is not correct to apply Rule 6 of the

Cenvat credit rules as well as Rule 3 of the Service tax credit Rules.

iii) In cases where an assessee is undertaking activity which cannot be called a service or

manufacture, that activity goes out of the purview of both Central Excise Act as well as Finance

Act, 1994.

iv) An assessee would not be eligible to take input service tax credit on an output which is

neither a service nor excisable goods.

v) There are no provisions in the law to cover situations where an assessee is providing a taxable

service and is undertaking another activity which is neither a service nor manufacture.

vi) In such a situation, the only correct legal position appears to be that it is for the appellant to

choose and segregate the quantum of input service attributable to trading activity and exclude the

same from the records maintained for availment of credit.

vii) Naturally this cannot be done in advance since it may not be possible to forecast what would

be the quantum of trading activity and other activity which is liable to excise duty/service tax.

The only obvious legally correct solution would be to be to ensure that once in a quarter or once

in a six months, the quantum of input service tax credit attributed to trading activities according

to standard accounting principles is deducted and the balance only availed for the purpose of

payment of service tax of output service.

viii) There are several decisions of various High Courts and also of the Tribunal wherein a view

has been taken that subsequent reversal of credit amounts to non availment of credit.

Further while appreciating that the decision reached by the Hon'ble CESTAT was not as

proposed in the show cause notice or in the appeal, the bench also stated that the procedure

adopted by the department was also not correct and at the same time, as per the law the assessee

is not eligible for service tax paid on input service attributable to trading activity and hence the

only solution that can be thought of has been discussed above.

The above judgement really deserves kudos because the Hon'ble CESTAT has preferred a very

well reasoned and fair judgement on an issue, which has wide ramifications to majority of the

assessees across the country as well as for the department. Also it needs to be appreciated that

the members of the bench have also prescribed the way and the periodicity for reversal of credit,

taking into consideration practical difficulties faced for working out the same.

This issue has been discussed and litigated over a period of time since the introduction of Cenvat

credit in respect of service tax. It's high time that CBEC realizes the need for providing a

clarification on this issue so as to ensure that the litigation on the same is put to rest.

Maruti Suzuki Ltd. vs CCE (2009) 9 SCC193

Facts.

Appellant Maruti Suzuki Ltd. is engaged in thebusiness of manufacturing motor vehicles .

These motor vehicles are cleared on payment of duty. Assessee claimed CENVAT credit on

"input" in accordance with CENVAT Credit Rules. Assessee has installed three turbines in their

factory for generation of electricity using naphtha as fuel to run the gas turbines and are

availing CENVAT Credit on naphtha used for generation of electricity in gas turbines.

Assessee also uses diesel generating set 3 for generation of electricity with the use of diesel for

which they had not availed any credit.

In their factory, assessee has a common distribution point for electricity generated in turbines as

well as DG set and the entire electricity which is generated in the turbines and DG set(s), placed

in the factory, is distributed through common distribution point.

During the disputed period assessee cleared a part of electricity generated in the factory to its

joint ventures, vendors etc.Revenue claimed Tax on the portion of electricity which was wheeled

out to vendors, joint venture companies.

Contention of the appellant

So long as naphtha is used as fuel for generation of electricity, appellant is entitled to take credit

of duty paid on it and there is no need to reverse proportionate credit to the extent of power

wheeled out to joint ventures, vendors etc.

Rule which define "input", is in two parts.

The first part is the specific part followed by the inclusive part.

In the inclusive part several items stood included such as lubricating oils, greases, cutting oils,

coolants, accessories, goods used as paint, or as packing material, or as fuel, or for generation of

electricity or steam used for manufacture of final products or for any other purpose, within the

factory of production.

Since the appellant had used naphtha as fuel for generation of electricity, hence, the said item fell

within the inclusive part of the definition.

Therefore so long as naphtha received in the appellant's factory was used as fuel, the same stood

covered by the definition of "input" irrespective of the fact that some portion of electricity

generated by use of naphtha stood cleared outside the factory.

It was further contended that once naphtha came to be used in generation of electricity which

was partly used for captive consumption and partly in other units of the appellant it was not open

to the Department to deny credit on the ground that part of the electricity was cleared outside the

factory to the joint ventures, vendors etc.

There is no condition attached to it. Hence, it was not open to the Revenue to deny credit on the

ground that part of the electricity stood cleared outside the factory to its joint ventures, vendors

etc.

It was further submitted that under Rule 6(1) , when input was used in the manufacture of

exempted goods, Cenvat credit is not admissible.

However, Rule 6(1) was not attracted to the facts of the present cases as naphtha was "used as

fuel" in generation of electricity which is not an excisable item.

Since electricity was neither exempted nor chargeable to `nil' rate of duty, Rule 6(1) was not

applicable in the case of naphtha used in the generation of electricity or steam and, therefore, the

appellant was entitled to avail full credit on naphtha as the restriction under Rule 6(1) was not

applicable.

Therefore, wheeling out a part of electricity generated in the factory of the appellant to its joint

ventures or vendors could not have deprived the appellant of the credit of duty paid on naphtha

used as fuel in their factory.

Contention of Revenue.

Basic idea of CENVAT credit is that it is admissible so long as the inputs are used in or in

relation to the manufacture of final products, whether directly or indirectly and, therefore, the

CENVAT scheme was not designed to grant windfall benefits by way of credit to inputs not used

ultimately in or in relation to manufacture of the final products but are used in or in relation to

the production of electricity .

Definition of the word "input" was required to be read as a whole and not in a disjunctive

manner

Specific part of Rule 2(k ) covers all inputs as long as they were used in or in relation to the

manufacture of final product(s), directly or indirectly.

Since the appellant has used naphtha in the generation of electricity, part of which has been

consumed outside the factory or production; that the said input has not been used as fuel per se

but it has been used for the specific purpose of generation of electricity consumed outside the

factory of production and consequently the said naphtha would not fall within the definition of

“input”under Rule 2(k)

Reasoning of the Court.

Definition of the word "input" can be divided into three parts, namely:

(i) specific part

(ii) inclusive part

(iii) place of use

(i) specific part,

the word "input" is defined to mean all goods, except light diesel oil, high speed diesel oil and

petrol, used in or in relation to the manufacture of final products whether directly or indirectly

and whether contained in the final product or not.

The crucial requirement, therefore, is that all goods "used in or in relation to the manufacture" of

final products qualify as "input". This presupposes that the element of "manufacture" must be

present.

In the case of J.K. Cotton Spinning and Weaving Mills Co. Ltd. v. S.T.O. 1965 (16) STC 563

SC it was held that the expression "in the manufacture of goods" should normally encompass

the entire process carried on by the dealer of converting raw material into finished goods.

It was further held that where any particular process (generation of electricity) is so integrally

connected with the ultimate production of goods, that, but for such process, manufacture of

goods would be inexpedient, then goods required in such process would fall within the

expression "in the manufacture of goods".

In the case of Union Carbide India Ltd. v. Collector of Central Excise, 1996 (86) ELT 613 , a

Bench of CEGAT observed that a wide impact of the expression "used in relation to

manufacture" must be allowed its natural play. Inputs (raw materials) used in the entire process

of conversion into finished products or any other process (like electricity generation) which is

integrally connected with the ultimate production of final product has to fall within the above

expression. It was observed that the purpose was to widen the scope, ambit and content of

"inputs". Electricity generation is an independent activity. It does not form part of the process in

which "inputs" are transformed into separate identifiable commodity, though it may stand

connected to such processes.

It may not have any concern with the manufacture of the finished product. However, electricity

generation is an ancillary activity. It is an activity which is anterior to the process of

manufacture of the final product

In CCE v. Ballarpur Industries Ltd. (1989) 4 SCC 566

Difference between the expression "used in the manufacture" and "used as input (raw material)"

was highlighted. It was held that undoubtedly the said two expressions are distinct and separate,

but, when an ancillary process (like electricity generation) aids the making of an end product,

then, the ancillary process gets integrally connected to the end product.

The Court applied what is called as "the dependence test". In the definition of "input" the

expression "used in or in relation to the manufacture of final product" is not a standalone item. It

has to be read in entirety and when so read it reads as "used in or in relation to the manufacture

of final product whether directly or indirectly and whether contained in the final product or not".

These words "whether directly or indirectly" and "whether contained in the final product or not"

indicates the intention of the legislature. What the legislature intends to say is that even if the use

of input (like electricity) in the manufacturing process is not direct but indirect still such an item

would stand covered by the definition of "input". It has been clarified by the definition of

"input" that the following considerations will not be relevant:

(a) use of input in the manufacturing process be it direct or indirect;

(b) even if the input is not contained in the final product, it would still be covered by the

definition.

These considerations have been made irrelevant by the use of the expression "goods used in or in

relation to the manufacture of final product". Moreover, the said expression, viz, "used in or in

relation to the manufacture of the final product" in the specific/substantive part of the definition

is so wide that it would cover innumerable items as "input" To avoid such contingency the

Legislature has incorporated the inclusive part after the substantive part qualified by the place of

use. The intention of the Legislature is that inputs falling in the inclusive part must have nexus

with the manufacture of the final product.

Inclusive part of the definition covers:

(a) Lubricating oils, greases, cutting oils and coolants;

(b) Accessories;

(c) Paints;

(d) Packing materials;

(e) Input used as fuel;

(f) Input used for generation of steam or electricity.

The consideration such as input being used as packing material, input used as fuel, input used for

generation of electricity or steam, input used as an accessory and input used as paint are per se

also not relevant.

All these considerations become relevant only when they are read with the expression "used in or

in relation to the manufacture of final product" in the substantive/specific part of the definition.

The expression "used in or in relation to the manufacture" have many shades and would cover

various situations based on the purpose for which the input is used. However, the specified input

would become eligible for credit only when used in or in relation to the manufacture of final

product. Therefore, none of the categories in the inclusive part of the definition would constitute

relevant consideration per se. They become relevant only when the above crucial requirement of

being "used in or in relation to the manufacture" stands complied with. Therefore the definition

should be read in its entirety.

The definition is in three parts, namely, specific part, inclusive part and place of use. All the

three parts are required to be satisfied before an input becomes an eligible input. Whether an

assessee would be entitled to claim CENVAT credit in cases where it sells electricity outside the

factory to the joint ventures, vendors or gives it to the grid for distribution?

The test laid down by SC in the case of CCE v. Rajasthan State Chemical Works 1991 (55)

ELT 444 (SC) is whether the process and the use are integrally connected.

Applying the said test, it was held that :

- when the electricity generation is a captive arrangement and the requirement is for carrying out

the manufacturing activity, the electricity generation also forms part of the manufacturing

activity and the "input" used in that electricity generation is an "input used in the manufacture"

of final product.

However, to the extent the excess electricity is cleared to the grid for distribution or to the joint

ventures, vendors, and that too for a price (sale) the "process and the use test" fails. In such a

case, the nexus between the process and the use gets disconnected. In such a case, it cannot be

said that electricity generated is "used in or in relation to the manufacture of final product, within

the factory".

Therefore, to the extent of the clearance of excess electricity outside the factory to the joint

ventures, vendors, grid etc. would not be admissible for CENVAT credit as such wheeled out

electricity, cleared for a price, would not fall within the definition of "input“.

CENVAT – A FRESH PERSPECTIVE

Amendments

With a view to further widen the scope of Inputs under CENVAT Scheme, the Government of

India in Budget 2011, amended the definition of ‘Input’ as defined under Rule 2 (k) of the

Cenvat Credit Rules, 2004 vide Notification No. 3/2011-CE (NT) dated 1st March,2011. The

following is a comparison between the definition of Input prior to its amendment and post

amendment.

Input Rule 2(k) PRE-AMENDEDMENT

“Input” means -

all goods, except light diesel oil, high speed diesel oil and motor spirit, commonly known as

petrol, used in or in relation to the manufacture of final product whether directly or indirectly and

whether contained in the final product or not and includes lubricating oils, greases, cutting oils,

coolants, accessories of final products cleared alongwith final product, goods used as paints, or

as packing material, or as fuel, or for generation of electricity or steam used in or in relation to

manufacture of final products or for any other purpose, within factory of production;

all goods, except light diesel oil, high speed diesel oil and motor spirit, commonly known as

petrol and motor vehicles used for providing output service;

Explanation 1.- The light diesel oil, high speed diesel oil and motor spirit, commonly known as

petrol, shall not be treated as an input for any purpose whatsoever.

Explanation 2.- Input includes goods used in manufacture of capital goods which are further used

in the factory of the manufacturer; but shall not include cement, angles, channels, Centrally

Twisted Deform bar (CTD) or Thermo Mechanically Treated bar (TMT) and other items for

construction of factory shed, building or laying of foundation or making structure for support of

capital goods.

Input Rule 2(k) POST-AMENDEDMENT

“Input” means -

all goods used in the factory by the manufacturer of the final product;

or any goods including accessories, cleared along with final product, the value of which is

included in the value of the final product and goods used for providing free warranty for final

products; or

all goods used for generation of electricity or steam for captive use; or

all goods used for providing output any service;

but excludes-

light diesel oil, high speed diesel oil, or motor spirit, commonly known as

petrol;

any goods used for-

construction of a building or a civil structure or a part thereof; or

laying of foundation or making of structure for specified in Sub-clauses (zn), (zzl), (zzm), (zzq),

(zzzh) and (zzzza) of Clause (105) of Section 65 of the Finance Act;

capital goods except when used as parts or components in the manufacture of a final product;

motor vehicles;

any goods, such as food items, goods used in a guesthouse, residential colony, club or a

recreation facility and clinical establishment, when such goods are used primarily for personal

use or consumption of any employee; and

any goods which have no relation whatsoever with the manufacture of a final product.

Explanation .- For the purpose of this clause, “free warranty” means a warranty provided by the

manufacturer, the value of which is included in the price of the final product and is not charged

separately from the customer.

From a plain reading of the amended definition, it can be observed that the scope of Input has

been widened. The new definition enables the manufacturer to avail credit of taxes paid on all

goods used in the factory of production except the ones specified in the negative list. The words

“used in or in relation to the manufacture of final products ,whether directly or indirectly and

whether contained in the final product or not” have been removed, thus implying that credit of

taxes on all inputs used in the factory shall be admissible. However, to check the misuse of this

broadened scope, the amended definition states that “any goods which have no relation

whatsoever with the manufacture of a final product”, thus ensuring that tax credit of Input not

used in manufacture is not extended.

Further, the Government of India has also amended the definition of ‘Input Service’ defined

under Rule 2(I) of the Cenvat Credit Rules, 2004 vide Notification No. 3/2011-CE (NT) dated

1st March,2011. The following comparison between the original definition and the amended

definition will help clear the picture.

Input Service Rule 2 (l) PRE –AMENDEDMENT

"Input service" means any service,-(i)used by a provider of taxable service for providing an

output service; or(ii)used by the manufacturer, whether directly or indirectly, in or in relation to

the manufacture of final products and clearance of final products upto the place of removal,and

includes services used in relation to setting up, modernisation, renovation or repairs of a factory,

premises of provider of output service or an office relating to such factory or premises,

advertisement or sales promotion, market research, storage upto the place of removal,

procurement of inputs, activities relating to business, such as accounting, auditing, financing,

recruitment and quality control, coaching and training, computer networking, credit rating, share

registry, and security, inward transportation of inputs or capital goods and outward transportation

upto the place of removal;

Input Service Rule 2 (l) POST-AMENDEDMENT

"Input service" means any service,-(i)used by a provider of taxable service for providing an

output service; or(ii)used by the manufacturer, whether directly or indirectly, in or in relation to

the manufacture of final products and clearance of final products upto the place of removal,and

includes services used in relation to setting up, modernisation, renovation or repairs of a factory,

premises of provider of output service or an office relating to such factory or premises,

advertisement or sales promotion, market research, storage upto the place of removal,

procurement of inputs, ,accounting, auditing, financing, recruitment and quality control,

coaching and training, computer networking, credit rating, share registry, and security, inward

transportation of inputs or capital goods and outward transportation upto the place of removal;

but excludes services -(A) specified in Sub-clauses (p), (zn), (zzl), (zzm), (zzq), (zzzh) and

(zzzza) of Clause (105) of Section 65 of the Finance Act (hereinafter referred as specified

services), in so far as they are used for- (a) construction of a building or a civil structure or a part

thereof; or(b) laying of foundation or making of structures for support of capital goods,except for

the provision of one or more of the specified services; or(B) specified in Sub-clauses (d), (o),

(zo) and (zzzzi) of Clause (105) of Section 65 of the Finance Act, in so far they may relate in a

motor vehicle except when used for the provision of taxable services for which the credit on

motor vehicle is available as capital goods; or(C) such as those provided in relation to outdoor

catering, beauty treatment, health services, cosmetic and plastic surgery, membership of a club,

health and fitness centre, life insurance, health insurance and travel benefits extended to

employees on vacation such as Leave or Home Travel Concession, when such services are used

primarily for personal use or consumption of any employee.

In the amended definition, the words “activities relating to business, such as” have been removed

thus, narrowing the scope of Input Service. This would imply that the credit is admissible only

on services used in relation of manufacture or provision of output service.

It is noteworthy that both manufacture and provision of output service are a part of business;

thus, both manufacture and provision of output service per se are narrower in scope than

business. This would also curtail the credit available as the scope of Input Service has narrowed.

Further, an exclusion clause has been added which specifically excludes services used for

personal consumption of the employees.

However, such changes would also minimise superfluous litigation and save a lot of time and

resources of the Courts as the changes have made the definition more certain.

Analysis and Impact

1. Reduction in frivolous litigations

One of the main objectives of bringing about the above amendments is to reduce litigation. The

same is also expressed in Circular No. F.No. 334/3/2011-TRU, dated 28th February,2011 issued

by the Tax Research Unit (TRU), Ministry of Finance as ‘Describe the scope of eligible inputs

and input services more clearly so as to minimise disputes in their interpretations’. This would

ensure reduction in litigations and disputes.

2. Paving way for GST

The Indian Economy is preparing itself for an important change in the indirect taxation system

with the introduction of GST. GST shall merge various Centre and State indirect taxes into a

single tax regime. GST shall also minimise exemptions and would be levied on all transactions

whether involving goods or services. Thus, the tax net would increase manifold with introduction

of GST. Further, the said changes have broadened the scope of Inputs and included more inputs.

Thus, a wider scope of Inputs would ensure that there is no breakage in the credit chain and all

Input taxes paid are allowed as credit.

3. Wider Scope of Input

The definition of Input has been widened to cover all inputs used in factory, whether used in

manufacture or not. The amended definition of Input is similar to the definition of Capital Goods

under Rule 2(a).

Both the definitions stipulate the condition for availment of credit as usage of the said capital

good or input in the factory. The same view is also expressed in Para 7.1 (a) wherein it is stated

“The definition of “Input” contained in Rule 2(k) has been revised. The requirement that goods

should be used in or in relation to the manufacture of final products, whether directly or

indirectly and whether contained in the final product or not has been removed.

Henceforth, all goods used in the factory by the manufacturer of the final product, except those

specified in the negative list and goods having no relationship whatsoever with the manufacture

of final product, would qualify for treatment of inputs.” However, to prevent the misuse of this

provision, an exclusion clause has also been added which states “but excludes any goods which

have no relation whatsoever with the manufacture of a final product”. Thus, tax on Inputs used in

factory having even the slightest relation with manufacture of finished goods shall be admissible

as credit.

4. Increased burden on Service Provider

The Service Providers may now have to face increased financial burden. The credit of taxes paid

on input services used for the personal consumption of employees has been excluded. Further,

the scope of Input Service has been reduced. Service industry is a human resource driven

industry wherein, employees are the backbone of delivering quality service to customers. In

order to retain and motivate talent, the service industry arranged various personal services for the

employees and availed tax credit of Service Tax paid on such services. However, with

introduction of the above amendment, credit of Service Tax paid on such services would not be

available. This could lead to breakage of credit chain and increased financial burden on the

Service Provider.

CONCLUSION

Excise Duty and Service Tax are taxes levied on manufacture and service respectively. In the

process of such manufacture or provision of service, the Manufacturer or Service Provider uses

numerous inputs both in form of goods and services. The goods used in manufacture had been

classified into Inputs and Capital Goods. However, till now there were goods which didn’t fall

under any of the two categories i.e. Inputs or Capital Goods thus, leading to emergence of a third

category of goods. This third category of goods refers to those goods which were used in

manufacture but were, not covered under statutory definition of Input and Capital Goods under

CENVATt and thus, no benefit of CENVAT was available on them. It must be stated here that

the fact that certain goods are out of the ambit of Cenvat Scheme would have no impact on the

Excise paid on their manufacture. In other words, these goods had been loaded with the burden

of output duty without the facility of any corresponding credit available to the buyer or

Manufacturer as these did not qualify as Inputs or Capital Goods as per the statutory definition.

This led to the breaking of credit chain and thus, a cascading effect, whose ultimate sufferer was

the final consumer, who was already reeling under high inflation. Thus, by widening the

definition of Input, the Government has eliminated this purported third category which has been

discussed above. The same is also reflected in Circular No. 943/4/2011-CX., dated 29th

April,2004 issued by Tax Research Unit (TRU), Ministry of Finance wherein it states-“Goods

such as furniture and stationary used in an office within the factory are goods used in the factory

and are used in relation to the manufacturing business and hence the credit of same is allowed.”

Thus, a combined reading of the amended definition with the said circular would entitle

admissibility of CENVAT credit on Furniture, Stationery and many other items of similar nature

which were hitherto neither covered under Capital Goods definition nor Input definition.

The Government of India has also made parallel changes in the definition of Input Service while

limiting the scope of credit. The Government has narrowed the scope by removing the words

‘relating to business activities such as’ and adding an exclusion clause that credit of taxes paid on

services for personal use by the employees would not be admissible. This would drastically

reduce the scope of credit of taxes on Input Service. Thus, only services of the kind mentioned in

the definition and those which have a direct nexus with manufacture or output service would

qualify as Input Service for CENVAT purposes.

This may lead to an increased financial burden on the Service Provider. However, the other side

of the coin is that the definition of Input Service has been made more certain. This shall go a

long way in reducing the earlier ambiguity, resulting in lesser litigation & disputes, thereby

saving precious time and resources for both the Government & Service Provider.