Need for modifications in CENVAT Credit scheme

[Hardik Shah]

CENVAT Credit scheme was introduced with an objective to offer offset of the taxes paid on procurement against the output taxes however it has been observed that the credit eligibility was always been a subject matter of litigation on various grounds. CENVAT Credit Rules have not been amended as swiftly as required to keep the pace with the changing requirement of trade and industry and also on account of removal of anomalies & for simplification purposes. However, within the limited amendments so made, the scope of interpretation creped-in which became the cause of litigations. In the present article, we wish to provide our views on the topics which we believe require amendment or suitable clarification for achieving the basic objective of reduction in the cascading effect of taxes by virtue of allowance of tax credits on the goods and services used for the manufacture of goods and provision of services.

One of the areas which require amendment appears to be the definition of the term ‘capital goods’. The scope of the term ‘capital goods’, at present is restrictive and covers only those goods which are featuring in the specified Chapters of Excise Tariff and few identified motor vehicles. In the present day, the meaning of the term capital goods in business parlance has increased multi-folds to cover a lot of other goods which was probably not envisaged when the definition was drafted a decade ago. This was done to avoid litigation on whether certain goods were capital goods or not in view of the large amount of litigation on the subject; however time has now come to revisit the same in the light of present business requirements and technological advances. In view of this, it is suggested that the scope of coverage of ‘capital goods’ should be extended to cover majority of goods considering the innovation and technology enabled businesses. In addition, considering the present economic scenario and the need for encouragement to manufacturing sector, it is suggested to provide the benefit of credit on capital goods in the first year of purchase only as against the principle of availment in installments.

With respect to the definition of input service, there is an apparent distinction between the eligibility of credit to a manufacturer and service provider. Manufacturer can avail the credit of those services which even contributes indirectly to the manufacturing activities however the same is not true for service providers as the legislation requires nexus to be proved for taking credit. For example, professional service providers obtain indemnity insurance services for safeguarding their business against any claim raised by the clients in case of any negligence on the part of providers. Though the services have no direct nexus with output services, they are essential and vital for running their business effectively and efficiently. However, in absence of direct nexus with output services, authorities may disallow the claim of CENVAT Credit of service tax paid on the insurance services. Accordingly, it is suggested to expand the scope of eligibility of credit to service providers so as to bring them at par with manufacturers. In furtherance, with the deletion of the word ‘setting-up’ from the inclusive portion of the definition of input service, authorities have got the avenue to challenge the claim of offset on credits relating to establishment of factory or office. In this regard, it would be advisable to reinstate the said terminology since the ambit for claiming eligibility already falls within the main part of the definition of input service in the case of manufacturer and hence, this results into unnecessary pilling of litigation.

Vide Notification No. 1/2014 (N.T.) dated January 8, 2014, as a welcome measure to clear the ambiguity, an explanation was inserted to allow the utilization of CENVAT credit in the following situations:

1. Input or capital goods removed as such or
2. Input or capital goods removed after usage or
3. Input or capital goods written off from the books of account.

Rule 3(4) of CENVAT Credit Rules lays down the principles for which credit can be utilised. The allowance of usage of CENVAT Credit in respect of (i) capital goods when removed after use and (ii) inputs or capital goods when written off from the books of accounts; have not been specified in the aforementioned provision. Accordingly, to avoid any unnecessary litigation, it is suggested to suitably incorporate the entries of referred notification for the purview of utilization of CENVAT Credit.

With the introduction of taxation based on negative list of service, the principles to determine an export transaction have undergone a substantial change. In addition, Rule 6(8) provides the principles for treating an export transaction as exempt for the purpose of CENVAT Credit. The specified rule is reproduced for easy reference:

For the purpose of this rule, a service provided or agreed to be provided shall not be an exempted service when:-

(a) the service satisfies the conditions specified under rule 6A of the Service Tax Rules, 1994 and the payment for the service is to be received in convertible foreign currency; and

(b) such payment has not been received for a period of six months or such extended period as maybe allowed from time-to-time by the Reserve Bank of India, from the date of provision.

The drafting of the specified provision seems to be confusing as the provision contains the condition of ‘not’ and the ingredients of the principles to be fulfilled have also been framed with the condition of ‘not’. Normally, a sentence containing two negative phrases linked to each other may be construed as positive. In the presentation made available by the Finance Ministry in July 2013, the intention behind this provision was made clear that the payment if received within the period permissible by the Reserve Bank of India then the service would be construed as Export of Service, otherwise the service would be treated as exempt service. Considering the intention, it appears that there is a need for simplification of drafting of the legislation.

Supreme Court decision in the case of Union of India Vs. Ind-Swift Laboratories Limited (2011 (2) TMI 6 - Supreme Court) has held that the provision relating to charge of interest in the case of wrongful availment of credit specifies the condition of availment or utilization and hence, assessee would be liable to pay interest even if the credit was availed but not utilized. Pursuant to the Supreme Court decision, an amendment was made in the provision for charge of interest only to the cases where the wrongful credit was availed and utilized. However, it is interesting to note that similar amendment has not been carried forward in the provisions relating to levy of penalty. In view of this, as per the present set of Rules, if credit has been wrongfully availed by an assessee then he is exposed to the risk of penalty though he is not liable to pay interest at the time of reversal. Hence, it is recommended to amend the provisions of levy of penalty in synchronization with the provision of charge of interest.

We understand that the preparations for the introduction of Goods and Service Tax (‘GST’) are at an advance stage wherein the intention of the legislation would be to bring seamless transfer of credits or to provide complete credit chain. In view of the foregoing, if suitable amendments or clarifications are carried out, transition to GST can be smoother in comparison to the present set of Rules imbibing various unanswered questions.

With inputs from Devisha Tayal.