Sukumar Mukhopadhyay: Budget tips for simplifying Cenvat

The new Cenvat rules continue to be restrictive and the rigid definitions adopted make the rules complicated and will lead to a lot of litigation in the future.

Judging by the number of crucial issues on Modvat (Modified VAT) and Cenvat (Central VAT) which are travelling all the way to the Supreme Court, one can imagine how many cases are actually being adjudicated and appealed against at the level of juniors, commissioners and tribunals. Even fundamental issues such as whether Modvat is the same as Cenvat or not have been subject of contradictory decisions by the Supreme Court itself. Now the Supreme Court has settled the issue in the case of Vikram Cement vs Commissioner of Central Excise, Indore, 2006 (194) ELT 3(SC), holding that Modvat is the same as Cenvat. The SC, in this judgement, has also broadened the scope of Modvat (Cenvat) by interpreting the entitlement to input tax credit not only in cases where the inputs have been used "within" the factory of production but even outside if "ultimately" they were used within. Explosives are used for the manufacture of an intermediate product, namely limestone, which is finally used for the manufacture of cement. Since the rules of Modvat, and now Cenvat, allow strictly only inputs which are used in relation to manufacture "within" the factory of production, the input duty paid on these explosives was not allowed credit.

The Supreme Court has ruled that even inputs used in the manufacture of an intermediate product, which is then used in the manufacture of the final product, is entitled to Modvat credit. While this judgement was given for the old rules, the new Cenvat Rules of 2004 have continued to be almost equally stringent, though slightly more liberal. They are not clearly worded to accommodate the type of situation discussed in the Supreme Court judgement. After this judgement discussed above, the first item of reform in respect of Cenvat should be to amend the Cenvat rules to include the expression "in or for final use in the factory". This will implement the interpretation of the Supreme Court in letter and spirit.

Another reform, which is a must in respect of Cenvat is to simply abolish the distinction between capital goods and input. Since the initial Modvat scheme in 1986 did not include capital goods, this distinction was relevant. But it is no longer relevant after the 1994-5 Budget when this scheme was extended to capital goods. After that, nearly a dozen budgets have been passed and the suggestion has been offered half a dozen times that the distinction between capital goods and input should be abolished. It is high time this recommendation is implemented. An omnibus rule should be that input tax credit will be allowed to all excisable goods excepting those in a negative list which includes items like petrol, car, office furniture, etc. where the government does not want to allow input tax credit. This was recommended by the Partho Shome Committee on page 15 of its report, 2001, and by the Kelkar Committee, 2002, on page 8 of its report.

One more issue is that input tax credit is now allowed in respect of capital goods "used" in the factory of manufacture, but in the case of input it is allowed for those "used in or in relation to manufacture". This distinction is unreasonable and also fraught with the possibility of inviting litigations. Manufacture is a highly litigated subject and even now the flow of judgements by the Supreme Court on manufacture is torrential. The concept still continues to be enigmatic. Once we introduce the concept of manufacture in Cenvat, we also invite this enigma. If input credit can be allowed for capital goods if they are used in the factory, why cannot the same be allowed for input also? Why introduce the further concept of "manufacture" for input, which is absent in the case of capital goods? The Partho Shome Committee also recommended on page 15 that the only expression that should be used is "used in the factory of the manufacturer". In this Budget, this suggestion should be implemented.

The next improvement that deserves attention relates to expressions such as "in the factory of manufacturer", "within the factory of production" etc. Distinction has been made between "in" and "within" and between "manufacture" and "production". Such distinctions are well known recipe for litigation. In fact, there are very many Supreme Court judgements in respect of the distinction between production and manufacture. These distinctions should be immediately abolished and the only expression that should be used is "in the factory of manufacture".

The inter-changeability in respect of input tax credit for goods and for services should be made more general and all pervasive. At present, there are so many conditions laid down in the Cenvat Rules due to the restrictive situation prevailing in the system that the rules themselves have become highly complicated.

It is understandable that the Cenvat procedure itself cannot be more simple to operate than the whole tax structure itself. Today, the tax structure of Central Excise is extremely complicated because of numerous duties and exemptions. Eligibility of Cenvat is for twelve taxes, namely: (i) Basic excise duty in the First Schedule, (ii) Excise duty in the Second Schedule, (iii) Additional duties of Excise under Textiles and Textile Articles Act (iv) Additional excise duty under Goods of Special Importance Act (v) National Calamity Contingent duty (vi) Education Cess, (vii) Additional Duty (Countervailing Duty) under Section 3 of Customs Tariff Act (viii) Additional Duty under sub-section (5) of Section 3 of the Customs Tariff Act (ix) Additional Duty of Excise leviable under Section 157 of the Finance Act, 2003 (x) Service tax (xi) Education cess on service tax and (xii) Additional Duty of Excise leviable under Section 85 of the Finance Act, 2005. Unless a conscious effort is made to reduce the number of these additional duties and cesses, any attempt to only simplify Cenvat procedure is doomed to failure.

In the context of such a complicated Cenvat system, it will be most unreal to assume that tax-payers will not make genuine mistakes. So a liberal interpretation must be given while deciding cases of violation in respect of Cenvat. While there are several judicial pronouncements to that effect, a clear-cut circular by the Ministry of Finance is necessary announcing that all cases of genuine mistake in regard to Cenvat procedure must be dealt with liberally.