CENVAT Credit and Capital Goods

Vikas Nanda

The term capital goods as defined in the Section 2(a) of the CENVAT Credit Rules, 2004
is not an inclusive definition. The Honble Supreme Court has further held that any
exercise to treat an item as capital goods by adopting any interpretative process will be
futile. An item can be treated as capital goods under CENVAT Credit Rules only if it
satisfies that the goods fell under one of the specified chapters or headings of the Tariff or
it is a spare part, component or accessory or that it falls under one of the specified items.

The term Capital goods has been assigned different meanings in different fiscal
statutes. An object may be treated as a capital asset under the Income Tax Act but not
as capital goods under the Central Excise Act at the same time. So what Shakespeare
believed, Whats in a name? A rose by any other name would smell as sweet, does not
hold goods for fiscal statues. The term Capital goods is primarily associated with Excise
only. A finished product produced or manufactured by an Industry may eventually
become the raw material or input for another product manufactured by another
Industry. This is where the concept of availment of CENVAT credit, broadly, comes into
picture. Where any goods on which duty had been paid at the time of removal thereof is
brought to any factory for being re-made, refined, re-conditioned or for any other reason
and the process to which the goods are subjected to amount to manufacture, the
Assessee is entitled to CENVAT credit of the duty paid. Section 3 of the CENVAT Credit
Rules, 2004 provides for various duties, taxes, cesses etc. the payment of which entitles
the manufacturer to avail credit. The credit, so taken, can be used to pay a duty of
excise on the final product, service tax on an output service etc. The credit can also be
utilised for payment of an amount equal to CENVAT credit taken on Capital goods but
only if such capital goods are removed as capital goods only.

Capital Goods?
There appears to be a lack of uniformity amongst various State and Central Acts in
terms of defining Capital goods. According to Section 2 (a) of the CENVAT Credit Rules,
2004, capital goods means all goods falling under Chapter 82, Chapter 84, Chapter 85,
Chapter 90 (Heading No. 68.02 and Sub-heading No. 6801.10) of the First Schedule to
the Excise Tariff Act, pollution control equipment; components, spares and accessories
of the goods specified above, moulds and dies, jigs and fixtures, refractoriness and
refractory materials, tubes and pipes and fittings thereof; and storage tank used in the
factory of the manufacturer of the final products, but does not include any equipment
or appliance used in an office; or storage tank used for providing output service, And,
motor vehicle registered in the name of provider of output service for providing taxable
service as specified in various Sub-clauses (f), (n), (o), (zr), (zzp), (zzt) and (zzw) of Clause
(105) of Section 65 of the Finance Act.

Advocate practicing in various Courts (Supreme Court of India, High Court & subordinate Courts) and
Tribunals in the field of Real estate, Civil And Arbitration Laws, Company Matters, Foreign Exchange,
Excise And Customs Matters
Income tax defines Capital asset to mean property of any kind held by an Assessee,
whether or not connected with his business or profession, but does not include(i) Any
stock-in-trade, consumable stores or raw materials held for the purposes of his
business or profession, (ii) Personal effects, that is to say, movable property (including
wearing apparel and furniture, but excluding jewellery held for personal use by the
Assessee or any member of his family dependent on him, (iii) Agricultural land in India
with certain specified exceptions. The definition under the Excise Act is an exhaustive
definition where as the definition under the Income Tax Act is a wider definition only
specifying certain exceptions to the general norm. In Vikram Cement v. Commissioner of
Central Excise, Indore
1
(2005) 7 SCC 74, the Honble Supreme Court of India held that
Rule 2(b) of CENVAT Credit Rules gives a specific definition of the term capital goods.
It is not an inclusive definition with the result that any exercise to treat an item as
capital goods by adopting any interpretative process will be futile. An item can be
treated as capital goods under CENVAT Credit Rules only if it satisfies that the goods
fell under one of the specified chapters or headings of the Tariff or it is a spare part,
component or accessory or that it falls under one of the specified items. Further, the
said goods must be used in the factory of the manufacturer of the final product.
Recently, in fact, in the month of July 2010 itself, the Honble Supreme Court of India
dealt with a dispute between the Assessee and the Revenue on the classification of
certain items as capital goods (CCE, Jaipur v. M/s Rajasthan Spinning & Weaving Mills
Ltd. MANU/SC/0465/2010). In this case, the Assessee, engaged in the manufacture of
yarn, availed MODVAT credit on capital goods in respect of steel plates and M.S.
Channels used for erection of chimney for the diesel generating set. The Assistant
Commissioner was of the view that since steel plates and M.S. Channels were not used
as input in the manufacture of final product, these could not be covered under any of
the chapter headings in the Table under Rule 57Q, and MODVAT credit on the said
items was inadmissible. The Apex Court affirmed the user test laid down in
Commissioner of Central Excise, Coimbatore & Ors. v. Jawahar Mills Ltd. & Ors. and
approved that capital goods can be machines, machinery, plant, equipment, apparatus,
tools or appliances if any of these goods is used for producing or processing of any
goods or for bringing about any change in the substance for the manufacture of final
product. The Court further held that on applying the user test on the facts in hand,
there was no hesitation in holding that the steel plates and M.S. Channels, used in the
fabrication of chimney would fall within the ambit of capital goods as contemplated in
Rule 57Q. It is not the case of the Revenue that both these items are not required to be
used in the fabrication of chimney, which is an integral part of the diesel generating set,
particularly when the Pollution Control laws make it mandatory that all plants which
emit effluents should be so equipped with apparatus which can reduce or get rid of the
effluent gases. Therefore, any equipment used for the said purpose has to be treated as
an accessory in terms of Serial No. 5 of the goods described in Column (2) of the Table
below Rule 57Q. The Courts have to be given credit for the development of various
Doctrines and Tests to enable the authorities and the Assesses to arrive at the true and
correct interpretation of the legislative intent. In a similar case, though not relevant for
the purposes of CENVAT credit but equally important for understanding the application
of such kinds of tests and doctrines, the Supreme Court delved upon the Doctrine of
Merger. The issue involved in the case was pertaining to adjudication of different
appeals, one filed by Revenue and the other by Assessee but both arising from a
common Order (CCE, Delhi v. M/s Pearl Drinks Ltd.). The Appeal filed by Revenue and
Assessee involved different aspect of the common Order. The Apex Court observed that
the doctrine of merger has its origin in common law. It has its application not only in
the realm of judicial Orders but also in the realm of estates. In its application, two
Orders passed by judicial and quasi-judicial Courts and authorities it implies that the
Order passed by a lower authority would lose its finality and efficacy in favour of an
Order passed by a higher authority before whom correctness of such an Order may
have been assailed in appeal or revision. The doctrine applies regardless whether the
higher Court or authority affirms or modifies the Order passed by the Lower Court or
Authority.
Availability and conditions for availing CENVAT Credit
CENVAT credit is available for the specified duties paid on any input or capital goods
received in the factory for manufacture of final product or any input service received by
a manufacturing unit. In production of a finished goods, besides the raw material,
various kinds of services may at times be also availed by the various taxes paid on such
kind of services availed can also be utilised as CENVAT credit. This is where the terms
inputs and input services become of great use. This is perhaps also the area which
draws huge amounts of Court litigation. The terms inputs and input services are
defined in the rules in the following words; input means(i) 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 products whether directly or indirectly and
whether contained in the final product or not and includes lubricating oils, greases,
cutting oils, coolants, accessories of the final products cleared along with the final
product, goods used as paint, 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 the factory of production; (ii) all goods, except light diesel oil, high
speed diesel oil, motor spirit, commonly known as petrol and motor vehicles, used for
providing any output service; And 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 up to the place of removal. There is however, a
restriction as to the place of use of the inputs. Rule 4(1) of the CENVAT Credit Rules
provides that CENVAT credit on inputs can be taken on receipt of the inputs in the
factory of the manufacturer or in the premises provider of output services. In
Commissioner of Central Excise, Jaipur v. J.K. Udaipur Udyog Ltd.
2
(2004) 7 SCC 344,
the Honble Supreme Court while dealing with the issue of use of explosives by cement
manufacturers in mining areas held that the expression used for manufacture of final
products or for any other purpose, within the factory of production in the definition of
input is important and it clearly indicates that in order to satisfy the requirement of
this sub-rule, the article or goods must be used within the factory of production. If the
article is not used within the factory of production, it will not be input. Further, a
mine from where the raw material is extracted and is situate at some distance, but no
manufacturing process is carried on, cannot qualify to be a factory.
A CENVAT Credit in respect of capital goods are allowed to a manufacturer and provider
of output service even if the capital goods are acquired by him on lease, hire purchase
or a loan agreement. The credit can further be availed even if the Capital goods are sent
to a job worker for further processing etc of the inputs. The only condition being that
such goods should be received back in the factory within 180 days of them being sent to
the job worker. If the goods are not received in the factory premises within 180 days,
the manufacturer is to debit the CENVAT credit accordingly. He can though re-avail the
credit when the inputs are received back in the factory. CENVAT credit rules further
regulate the amount and manner of availing the credit. Restrictions are placed on the
amount of credits that can be taken at various times. A CENVAT credit in respect of
capital goods received in a given financial year can be taken only for an amount not
exceeding 50 per cent, of the duty paid on such capital goods in the same financial year.
The balance of CENVAT credit can be taken only in subsequent financial years provided
the goods are in possession of the manufacturer or the service provider.
Every product has a life span. A capital goods, such as a machinery used in
manufacturing of a product, may eventually loose its utility or may even destroyed on
account of unforeseen circumstances such as a fire hazard or any other such
eventuality. What happens to the CENVAT credit availed on such occasions? Should
there be a total reversal of CENVAT credit taken initially or should there be a
proportionate deduction based upon the value of the machinery. Rule 3(5) of the
CENVAT Credit Rules provides that when capital goods, on which CENVAT credit has
been taken, are removed as such from the factory, or premises of the provider of output
service, the manufacturer of the final products or provider of output service, as the case
may be, is liable pay an amount equal to the credit availed in respect of such inputs or
capital goods. By an amendment brought about in the said rule (which took effect from
13
th
November, 2007) a proviso was inserted. This proviso takes care of the above
mentioned queries. As per the inserted proviso if the capital goods, on which CENVAT
Credit has been taken, are removed after being used, the manufacturer or provider of
output service shall pay an amount equal to the CENVAT Credit taken on the said
capital goods reduced by 2.5 per cent for each quarter of a year or part thereof from the
date of taking the CENVAT Credit. So, it is now clear that a proportionate deduction on
account of use of the machinery is permissible in the original credit taken. Why, did it
take so long to identify this bottleneck, still remains a mystery though? The other
question, as to destruction of the capital goods in an accident etc. has also been delved
upon by Courts. A common principle that has emerged in such cases is that when a
capital goods/machinery is lost or turned into a scrap owing to an accident etc., it
looses its original identity as capital goods. It implies that the destroyed goods is not
being sold in the form as it existed prior to its destruction thereby, entitling the
manufacturer to pay an amount lesser than the CENVAT credit taken at the time of
procuring the said goods. This aspect has also been taken care of by amendment by
way of an insertion. It is now provided that if the capital goods are cleared as waste and
scrap, the manufacturer is liable to pay an amount equal to the duty leviable on the
transaction value, i.e. the value at which the transaction of sale of the scrap is taking
place.



1
Ed.: MANU/SC/0510/2005; 2005 (102) ECC 121; 2005 (187) ELT 145(SC); JT 2005 (7) SC 637.
2
Ed.: MANU/SC/0714/2004; 2004(96) ECC 73; 2004 (171) ELT 289 (SC); JT 2004 (7) SC 152; 2004 (3)
SCALE 6.