Circular for Input Service Distributor: Ate, drank absolutely nothing, and broke the glass worth twelve cents

[Pradeep Jain]

INTRODUCTION:

There may be more than one factory registered under Central Excise and running under the same management. In order to facilitate the management, single head office is being set up for incurring expenses, availing services, easy disbursements and communication purpose. Normally, the invoices of services are being received in the name and address of the head office. Department does not allow the Cenvat credit of such input services as the invoices bear the address of head office despite fact that the same are consumed at different units of that head office. Also, sometimes common expense is being incurred by the head office which benefits all the units of that management like advertisement expenses. In such cases, besides the technical lapses like non- mention of the address of factory, there is dispute about the quantum of credit attributable to each factory. In order to overcome these problems, the concept of input service distributor has been introduced in the Cenvat Credit Rules, 2004. In such cases, the head office receives the input services in its name and further distributes the same to the factories running under its management after getting itself registered as input service distributor. The manner of distribution of credit has been laid down in the rule 7 of the Cenvat Credit Rules, 2004 which had undergone amendment in the month of February. By virtue of the said amendment, some confusion was there in the manner of interpretation which has been clarified by issuing a circular in this budget. The amendment, confusion and clarification have been discussed here in this piece of articulation.

Situation upto 28.2.2014:-

The manner of distribution of input service credit has been explained in the rule 7(d) of the Cenvat Credit Rules, 2004. The relevant portion in issue effective upto 28.2.2014 read as follows:-

“credit of service tax attributable to service used in more than one unit shall be distributed pro rata on the basis of the turnover during the relevant period of the concerned unit to the sum total of the turnover of all the units to which the service relates during the same period.”

Explanation1.- For the purpose of this rule “unit” includes the premises of the provider of output service and the premises of manufacturer including the factory, whether registered or otherwise.

Explanation2.- For the purpose of this rule, the total turnover shall be determined in the same manner as determined in rule 5 “Total Turnover” means sum total of the value of –

(a) All excisable goods cleared during the relevant period including exempted goods, dutiable goods and excisable goods exported;

(b) Export turnover of services determined in terms of clause (D) of sub-rule (1) above and the value of all other services, during the relevant period; and

(c) All inputs removed as such under sub-rule (5) of rule 3 against an invoice, during the period for which the claim is filed.”

Explanation3. - (a)The relevant period shall be the month previous to the month during which the CENVAT credit is distributed.

(b) In case if any of its unit pays tax or duty on quarterly basis as provided in rule 6 of Service Tax Rules, 1994 or rule 8 of Central Excise Rules, 2002 then the relevant period shall be the quarter previous to the quarter during which the CENVAT credit is distributed.

(c) In case of an assessee who does not have any total turnover in the said period, the input service distributor shall distribute any credit only after the end of such relevant period wherein the total turnover of its units is available.

The effect of this provision was that if the service was used in more than one unit, it was distributed on pro rata basis of sales to total sales of all the units to which the service related. In other words, if any input service was being used in the unit 1 and 2 out of total four units, it was distributed in these two units based upon total turnover of these two units only. The situation can be explained with the help of following example:-

Suppose an Input service distributor (ISD) has four units. The turnover of the four units and credit available for distribution may be assumed as follows:-

	Amount (in Rs.)
Unit A	20 crores
Unit B	30 crores
Unit C	10 crores
Unit D	5 crores
Total credit distributable	15000

Suppose the above input service was consumed in unit A and B only, so according to above provision, the credit was to be distributed as follows:-

Unit A’s share: Turnover of unit A/ Total turnover of unit A andB * Cenvat Credit

= 20/50 * 15000

= ₹ 6000/-

Unit B’s share = 30/50 * 15000

= ₹ 9000/-.

However, if the turnover of any unit was not available during the period, the credit was to be distributed only after end of such relevant period when the turnover of that unit was available. But what if the unit was under establishment stage and turnover was not available for couple of months or even a year? In our view, the lacuna was there in the explanations to this rule, however, there was no problem with the sub-rule (d) which laid down correct manner of distribution of credit to the units which actually consumed the input service. But, the amendment was carried out in the main body of sub-rule (d) which is the reason of all the post amendment problems which are discussed herein.

The amendment: situation after 28.2.2014:-

The amendment was carried out in the main body of sub-rule (d) of rule 7 of Cenvat Credit Rules, 2004 vide notification no. 05/2014-CE (N.T.) dated 24.2.2014, effective from 1.3.2014. This notification substituted the above referred provision as follows:-

‘credit of service tax attributable to service used by more than one unit shall be distributed pro rata on the basis of the turnover of such units during the relevant period to the total turnover of all its units, which are operational in the current year, during the said relevant period’

The amended provision had created the confusion amongst assessees as the Revenue officials were interpreting this provision in a way that in the case an input service is used by more than one unit, its credit will be distributed amongst such units (which actually used the input service) however, the denominator for distribution shall remain the “total turnover of all of its units”. This interpretation taken by department can be explained with the help of following example:-

The situation can be explained with the help of following example:-

Suppose an Input service distributor (ISD) has four units. The turnover of the four units and credit available for distribution may be assumed as follows:-

	Amount (in Rs.)
Unit A	20 crores
Unit B	30 crores
Unit C	10 crores
Unit D	5 crores
Total credit distributable	15000

Suppose the input service to which the above referred credit was attributable was utilized only by unit A and B. According to amended provision, the credit is to be distributed as follows:-

Unit A’s share = Turnover of A/ Total Turnover (A+B+C+D)*Cenvat Credit

= 20/65*15000

= ₹ 4615/-

Unit B’s share = 30/65*15000

= ₹ 6923/-

Thus, by virtue of amended provision, total credit distributed between the two units A and B was ₹ 11538/- only and credit of ₹ 3462/- was lapsed. This lacuna was the root of problem, so it was represented to the Government to bring suitable clarification in this regard.

Clarification given vide Budget, 2014:-

Now, while announcing the budget, clarification has been issued by Board to clarify the amended rule 7(d) of the Cenvat Credit Rules, 2004. This clarification has been issued vide Circular no. 178/4/2014-ST dated 11.7.2014. In this circular, it has been clarified that in case the input service has been utilized in more than one unit, the credit will be distributed in all the units (despite fact that the service was used only in two / three units out of total four units working under ISD). This clarification has been explained in the circular at para 4 which reads as follows:-

“4. An Input Service Distributor (ISD) has a total of 4 units namely ‘A’, “B’, ‘C’ and ‘D’, which are operational in the current year. The credit of input service pertaining to more than one unit shall be distributed as follows:-

Distribution to A =	X	x	Z
	Y

X = Turnover of unit ‘A’ during the relevant period

Y = Total turnover of all its unit i.e. ‘A’+’B’+’C’+’D’ during the relevant period

Z = Total credit of service tax attributable to services used by more than one unit.

Similarly the credit shall be distributed to the other units ‘B’, ‘C’ and ‘D’.

Illustration:

An ISD has a common input service credit of ₹ 12000 pertaining to more than one unit. The ISD has 4 units namely ‘A’, ‘B’, ‘C’ and ‘D’ which are operational in the current year.

 

Unit	Turnover in the previous year (in Rs.)
A (Manufacturing excisable goods)	25, 00,000
B (Manufacturing excisable and exempted goods)	30, 00,000
C (providing exclusively exempted service)	15,00,000
D (providing taxable and exempted service)	30, 00,000
Total	1, 00, 00,000

 

The common input service relates to units ‘A’, ‘B’ and ‘C’, the distribution will be as under:

(i) Distribution to ‘A’ = 12000 * 2500000/10000000 = 3000

(ii) Distribution to ‘B’ = 12000 * 3000000/10000000 = 3600

(iii) Distribution to ‘C’ = 12000 * 1500000/10000000 = 1800

(iv) Distribution to ‘D’ = 12000 * 3000000/10000000 = 3600

The distribution for the purpose of rule 7(d), will be done in this ratio in all cases, Irrespective of whether such common input services were used in all the units or in some of the units.”

The analysis of above para from the circular makes it ample clear that now even if any service is being used in two units out of total three or more units, the credit will be distributed amongst all the units irrespective of the fact that the service was actually used in two units only.

Implications of Clarification:-

The implications of this clarification are explained as follows:-

• The Circular has some strange drawings. It seeks to allow the distribution of credit to all the units in case the input service is being used by more than one unit. Suppose, an ISD has seven factories (namely 1, 2, 3, etc.) and the input service is being used for only two factories (say 1 and 2 which are manufacturing only dutiable goods). Even in this case, the credit will be distributed to all the seven units.
• In the above example, say out of seven factories, the factory no. 3 and 4 are manufacturing both dutiable and exempted final products and factory no. 5 and 6 are exclusively manufacturing the exempted goods. According to this clarification, under the above given situation, the credit will be distributed to factory no. 5 and 6 also which are in fact not allowed to take and utilize the credit so distributed by ISD. In such a case, situation is worse as the input service was never utilized by these two factories, still the credit is being distributed to them and these are not allowed to utilize the credit. Thus, the assessee will lose certain amount of Cenvat credit despite fact that the input services were entirely used in manufacture of dutiable goods.
• Further, some part of credit will also be distributed to factory no. 3 and 4 which are manufacturing both dutiable and exempted goods. In such a case, though these units will be allowed to take the Cenvat Credit distributed by ISD, it will be subject to provisions of rule 6(3) of the Cenvat Credit Rules, 2004. Thus, a major part of the credit availed will get reversed. Recalling the fact that this credit which is now reversed at factory no. 3 and 4 pertains to input service which was actually utilized at factory no. 1 and 2 in manufacture of 100% dutiable goods. Here also, the assessee suffers loss of certain amount of Cenvat Credit.
• It is worth noting here that in order to avoid complicacies of rule 6 of the Cenvat Credit Rules, 2004; some manufacturers/service providers set up separate premise for manufacturing exempted goods or for providing exempted service. This clarification will complicate the situations for these manufacturers or service providers which have more than two premises (out of which one or more is providing exempted service or manufacturing exempted goods) as the ISD will be required to distribute credit to all the premises, resulting into loss of Cenvat Credit as explained in the forgoing paras.
• It is worth noting here that the definition of input service itself says that to be an input service, the service should be USED by the manufacturer or provider of output service. In the instant case, the credit will be distributed by ISD in certain cases even if the said service was not ‘used’ by the manufacturer or service provider. This service will not be an “input service” for such manufacturers or service providers; so now, will the department allow such credit distributed by the ISD?

Before winding:-

The clarification issued by Board seems to be suffering from certain lacunas. Also, the circular saying that the credit will be distributed in all the units despite the fact that the service was consumed in only two units; is against the very basic provision of Cenvat Credit Rules, 2004. Since it will not be an input service, its credit will ultimately be denied in the unit where it was not actually USED. Resultantly, the situation will be same as it was before the issue of this Circular. So, in our view, issuing this circular is a sheer waste of time. Remember the famous saying... "Ate, drank absolutely nothing, and broke the glass worth twelve cents”...

Discussions to this article

[Naveed S]

Very informative and very well explained article.

However, I personally feel that there cannot be denial of input service credit that are distributed and on which credit availed by units that do not USE such inputs for their manufacture or for providing output service. The reason being that such input service credit is distributed as per rule 7 (d) wherein no such condition has been stipulated and also due to the fact that the main head office and management is common and same.

However, the point surely is debatable and need clarification from the department.