Analysis of Cenvat Credit - Changes in FA 2011

Introduction:

The primary object of cenvat credit was to avoid the cascading effect and ensure that the chain of cenvat credit continues. Cenvat credit rules were introduced[ replacing Modvat] in the year 2004, and until 2010 the assessee had to wait to find clarity in law. As the time passed through the industry started to understand the concept of cenvat credit with various judicial decisions bringing in the clarity in the scope and understanding the intent of the rules. Further the decision of Bombay High Court in case of Coca-Cola India Pvt Ltd, 2009 (242) ELT 168 and Ultra Tech Ultratech Cements,  2010 TIOL 745 HC Mumbai, wherein it was held that services in relation to business was allowed as cenvat credit. However the Finance Act 2011 had tinkered the cenvat credit rules, with an objective of overcoming the said decisions while furthering confusion. Further the said budget has kept in mind the principles of functionality test alive as laid down in case of M/s Maruti Suzuki Ltd. - 2009-TIOL-94-SC which is a departure from the earlier understanding of the scheme as well as the concepts of GST going forward or seamless credit.

Cenvat Credit Rules

The Cenvat credit rules is now called the Cenvat Credit (Amendment) Rules, 2011.Earlier it was called Cenvat Credit Rules, 2004

Definition of inputs

The definition of ‘input’ contained in rule 2(k) has been revised.

For better understanding of the definition of input inclusions and exclusions which has been tabled below

A.   Issues/Impact on the said amendments

o   Employees using safety precaution uniforms, in order to protect themselves while discharging their duty of manufacturing activity, cenvat credits on such uniforms would be available.

o   Goods such as storage racks used in stores, tables and chairs used in administrative department/ accounts department/ sofas chairs kept at receptions/ waiting rooms shall not be allowed as credits.

o   Tools and equipments used for garden maintenance, tube lights, fans, exhaust fans fitted either at the manufacturing area or administrative areas shall not be allowed as input credits.

o   Goods used as staff welfare measures, such as seasonal gifts to employees, complimentary gifts to clients during new year/ Dewali/ Christmas etc shall also be denied.

o   Going the principles of Cost Accounting Standards- 4, in order to arrive at the value of the cost of the product such manufacturer would have to factor in the above said cost in its final price and excise duty have to be paid on such final price, when manufacturer is denied enjoying the input credits on above said items, would certainly impact the margins of the manufacturer, which could result in undue tax planning.

o   Such demarcation would create a barrier in implementing GST.

Definition of input service

For better understanding of the definition of input services inclusions and exclusions which has been tabled below

Note : The limb “such as  activities in relation business” have been deleted in this budget.

B.   Issues on the said amendments

o   As service industry predominantly depends on skill sets/ intellect of an individual, and majority of expenses incurred by such industry is towards welfare and benefit of human resource. Denial of the benefit the of cenvat credit on services like rent- a –cab, insurance, Sodexho pass, cafeteria, air ticket booking for LTC was completely illogical. As service industry consider human resource cost as its direct cost, and such costs are considered for the purpose of discharging service tax, therefore the margins would certainly be impacted. The decision behind denial of such credits was for that the industry was enjoying double benefit in form of cenvat credit as well as income tax deduction towards the said expenses, such reasoning needs to be judicially examined when the law was completely silent on this aspect.

o   Removal of the words “Such as” and “Services used in relation to business” from the definition of input service was to counter the decision of Bombay High Court in case of Coca-Cola India Pvt Ltd, 2009 (242) ELT 168 and Ultra Tech Ultratech Cements,  2010 TIOL 745 HC Mumbai, in the aforesaid decision the honorable High court had expressed its view that "input service" is very wide and covers not only services, which are directly or indirectly used in or in relation to the manufacture of final products but also includes various services used in relation to the business Rule 3 has been amended to specify that the Cenvat credit would not be allowed on inputs on which duty has been paid under the benefit of notification no.1/2011. Keeping the principles of functionality alive as laid down in case of M/s Maruti Suzuki Ltd. - 2009-TIOL-94-SC.

4  The definition of ‘exempted goods’ has been amended and now it includes even those goods on which the option has been exercised by the manufacturer to pay the duty at concessional rate of 1% on 130 specified entries as prescribed in notification no.1/2011-CE.

4  The provisions have also been amended to specify that the Cenvat credit shall not be utilised for payment of excise duty at concessional rate of duty of 1% under notification no.1/2011. Which means the payment is mandatorily required to be paid in cash. Further the receiver shall not be eligible to avail when the goods have suffered duty at 1%. This change is effective from 1^st March 2011.

4  The definition of ‘exempted services’ has also been amended. Now the definition includes even those services in respect of which the service provider has opted for exemption on part of the value with a condition that no Cenvat credit of input or input services is available. For example, if the service provider engaged in providing the service of ‘construction of complex’ service claiming the abatement of 67% as per the service tax notification no.1/2006 without the Cenvat credit benefit and pays tax only on 33% value, then even such service would be construed as ‘exempted service’.

4  The important change in the definition has been brought in the definition of ‘exempted service’ by way of explanation in this budget. Now, the exempted service includes even ‘trading activity’. However the value would be the difference between the purchase and sale price.

4  Earlier the definition of manufacturer or producer relating to jewellery included only a person doing  Job work in relation to  articles of  jewellery, however the same is amended to include a person who is liable to pay duty on removal of goods which are mentioned in the chapter 61(Articles of apparel and clothing accessories, knitted or crocheted, chapter 62(Articles of apparel and clothing accessories, not knitted or crocheted), Other made up textile articles, sets, worn clothing and worn textile articles, rags.

4  Issues on the said amendments

o   The said manufacturer/service provider would have to follow Rule 6 of Cenvat Credit Rules, in order to restrict the credit with respect to credits pertaining to input and input services with respect to such exempted goods/ exempted service.

o   Rise in administrative cost in maintaining separate books for input used in manufacture of taxable goods and exempted goods. (however no separate books could be maintained with respect to common input services, wherein the formula with proportionate credits needs to be adopted in arriving at the value of eligible input service credits

o   Accountant needs to be trained, in identification of eligible input or input service credits.

C.   Earlier Cenvat credit was available on 100% of additional duty on all excisable leviable under section 3 of Customs tariff Act, but now the credit is restricted to an extent of 85% of the additional customs duty paid on ships, boats, and other floating structures for breaking up.

D.  Rule 3 (5) has also been amended to further include that the reversal of credit/ payment of duty would not be required on inputs when they are removed under free warranty. For this purpose, free warranty means ‘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.

E.   Rule 3(5B) is also amended and now the rule requires that the Cenvat credit availed to be paid back even if the Cenvat availed inputs or capital goods are partially written off. Earlier it was required only when the goods are fully written off. This change is effective from 1^st March 2011. 6/2006

F.   Rule 4 is amended to state that the Cenvat credit would be allowed even on capital goods which is received outside the factory and used for generation of electricity for captive used in factory. Earlier  Cenvat Credit is available only on capital goods which are used in the factory

G.  The Rule 4 (7) is amended to state that when any payment made towards the input service is returned then the manufacturer or service provider who has taken the credit on such input service shall pay proportionate amount to the cenvat availed in respect of such amount returned. This payment can be by utilizing the Cenvat credit or otherwise.

Major change in Rule 6

H.  The provisions of Rule 6 before amendment had not considered many of the vital aspects prevalent in the industry, the application of rule 6 was very limited in as much as it had not considered the trading activity. Further value with respect to compositional scheme with respect to the abated portion is also brought into the preview of Rule 6. Further goods falling within the preview of notification 1/2011, wherein the assessee avails the benefit of paying duty at the rate of 1%, would also be considered as exempted goods and no credit shall be allowed on the same.

I.  Rule 6 of the Cenvat credit Rules 2004 has undergone major change. The heading of the rule itself has been changed as ‘Obligation of a manufacturer or producer of final products and a provider of taxable service’. Earlier the heading was ‘Obligation of manufacturer of dutiable and exempted goods and provider of taxable and exempted services. 

J.   This very change in the title of the rule will have serious implication as the argument of non applicability of the rule 6, when the manufacturer manufacturing dutiable goods also provides services which are not liable to service tax. The converse of which also holds good.

K.   In other words the assessee is curtailed to take the benefit of input/ input services, when the manufacturer was providing exempt services and service provider providing exempted goods.

L.   Further previously with trading not being considered either as exempted goods or exempted services, the benefit of input services which were commonly used for trading activity was possible, now with the change in definition of exempted service to include trading and also with the omission of the words “Activities in relation to business”, such arguments would not stand in the law.

M.  Sub Rule 1 has also been changed to state that the Cenvat credit benefit would not be allowed on inputs or input services which are used in or in relation to manufacture of exempted goods or for provision of exempted service. Earlier the rule has the wordings that the credit would not be allowed on ‘input or input service which is used in the manufacture of exempted goods or for provision of exempted service’. Due to this change, now the assesse is prevented from taking the contention of availing full credit on input or input service in relation to manufacture of exempted goods or provision of exempted goods.

N.  The sub rule 2 now provides for maintenance of separate records in more detailed manner in respect of receipt, consumption an inventory of inputs and the receipt and use of input services used:

i) in or in relation to manufacture of exempted goods;

ii) in or in relation to the manufacture of dutiable final products excluding exempted goods;

iii) for the provision of exempted services;

iv) for the provision of output services excluding exempted services.

O.  Earlier sub rule 3 required that the provider of output service providing exempted service to pay 6% on the value of exempted service and avail the Cenvat credit fully (unless any input/input service is exclusively used for exempted service). Now this rate of 6% has been reduced to 5%. The rate of 5% is applicable on exempted value in case of taxable services which are partially taxable. For example, if only 33% of construction service is taxable then 5% should be paid on 67% value. This type of restriction would be cumbersome and may not be complied.

P.  In Sub rule 3 in addition to option of paying 5% amount on exempted goods/exempted services or claiming the Cenvat credit proportionately as provided in Rule 6 (3A), a new option has been provided. The new third option would be to maintain separate accounts for the receipt, consumption and inventory of inputs as provided in the new rule and pay an amount as determined under sub-rule (3A) in respect of only input services.   

Q.  In addition to the above changes, a new explanation has been added to state that the payment of amount of 5% as discussed above would be deemed to be Cenvat credit not taken for the purpose of an exemption wherein exemption is granted on condition that no Cenvat credit of inputs and input services shall be taken.

R.  Taxable services specified in sub clauses zx (insurance business) and zzzzf (insurance relating to unit linked plan) of section 65(105) of the finance Act, shall pay for every month an amount equal to 20% of the Cenvat credit availed on inputs and input services in that month. Earlier this provision was not there.

S.   As even trading activity would be considered as ‘exempted service’ as per the amendments, the value of trading activity should also be considered for availment of credit proportionately. The value of such trading would be difference between the sale price and the purchase price of the goods trade.

T.   A major hit in this FA has been the omission of rule 6 (5). Earlier as per this rule, on as many as 16 common services such as security services, banking or financial services etc. the assessee could have claimed the credit of service tax paid to the extent of 100% even if they are partially used for taxable activity. Now, even these services would be subject to proportionate formula as specified in Rule 6 (3A).

U.  A new rule 6 (6A) has been introduced with effect from 1^st March 2011 to state that the provisions of Rule 6 shall not be applicable in case of taxable services provided, without payment of service tax to SEZ unit or developers for their authorized operations. However the services which are exempted from payment of taxes vide exemption notification are considered as exempted services and consequently the benefit of cenvat credit attributable on such portion is restricted. 

For the purpose of Rule 6 of cenvat credit Rules, exempted means the following

V.   In rule 9(7) of the Cenvat Credit Rules under first proviso, a manufacturer availing exemption notification based on value or quantity of clearances in a financial year, he shall file a quarterly return in the form specified, by notification, by the Board within ten days after the close of the quarter to which the return relates. (previously the same was to be filed within twenty days after the close of the quarter to which the return relates)            

Rule 6 of Cenvat Credit illustration

The following is the illustrative example for working under Rule 6 of cenvat Credit Rules

1. ABC Ltd is a Company engaged in manufacturing excisable goods, from the following information, ascertain the duty liability  of the company for the month of April 2011?

Sol.   Since the company is only engaged in manufacturing excisable goods therefore the company would not fall within the preview of Rule 6 of Cenvat Credit Rules 2004.

Therefore the liability of the Company for the month of April 2011 is as follows

2. From the question No.1 ascertain the tax liability of ABC Ltd , if ABC Ltd is also engaged in manufacturing exempted goods, the value of exempted goods for the month of April 2011 is Rs 2,00,000/-? Further total value of exempted goods for the previous year was 24,00,000/- and total value of taxable goods for the previous year was 95,00,000?

Sol. In the present case the company is engaged in manufacturing of dutiable  goods and exempted goods, therefore the company has the following options

Option 1

Maintain separate accounts for receipt, consumption and inventory of inputs/ input services used in manufacture of dutiable goods and exempted goods.

In case the Company opts to maintain separate inventory records with respect to manufacture of dutiable goods and exempted goods, then ABC Ltd shall avail cenvat credit attributable only to manufacture of dutiable goods.

Inventory records of inputs and input services used in manufacturing of dutiable goods and exempted goods is as follows

· The manufacturer shall avail cenvat credit only to an extent of Rs 95,000/-

Liability of the Company for the month of April 2011 is as follows

Option 2

If the Company opts not to maintain separate inventory records, shall follow any of the following options

1. Pay an amount equal to 5% of value of exempted goods and exempted service or
2. Pay an amount as determined under sub- Rule 3(A) or
3. Maintain separate accounts for receipts, consumption and inventory of inputs  only as provided in  option 1 (Rs 70,000)

Liability of the company for the month of April 2011 under option 2(i) is as follows

Liability of the company for the month of April 2011 under option 2(ii) under Rule 6(3)(ii) is as follows

When the Company decides to follow Sub-Rule 3A of Rule 6 of Cenvat Credit Rules, the following procedures and conditions namely needs to be complied with

                     i.        Intimate in writing to the Superintendent of Central Excise giving the following particulars

a.    Name address and registration No of manufacturer of goods or provider of output service

b.   Date from which this option is proposed to be exercised

c.    Description of dutiable goods or taxable service

d.   Description of exempted goods or taxable service

e.    Cenvat credit of inputs and input services lying in balance as on date of exercising this option.

ABC, Ltd shall determine and pay provisionally for every month as follows

The Company after computing and discharge its duty liability on provisional basis. At the completion of the financial year, the company shall re-compute its duty liability after considering the actual figures for the year, and re-determine its duty liability. After such re- computation of duty in case of any short payment of duty, the company shall pay the amount of differential taxes within 30^th June of the succeeding year, else interest would be payable at the rate of 24% PA

ABC, Ltd actual clearance for the year 2011-12 was  Rs 1,05,00,000/- towards dutiable goods and  exempted clearance was 28,00,000/-

Note: This kind of exercise needs to be done for every month in order to ascertain the actual credit.

For the purpose of Rule 6 of cenvat credit Rules, exempted means the following

  By Madhukar.N. Hiregange, FCA