In order to understand the current scenario and to have a holistic view of reversal of CENVAT credit under Rule 6 of CCR, 2004 (‘CCR’), one will have to look into the provisions of CENVAT credit reversal from the hindsight and evolution of such reversal since 2004.
The CENVAT Credit Rules, 2002 was replaced by CENVAT Credit Rules, 2004 allowing the cross utilisation of the CENVAT credit for goods and services and marking a major step towards integrating the tax on goods and services in the year 2004.
Glimpse of provision of Rule 6(3A) of CCR (Since 2004 for convenience)
September 10, 2004 – 28 February 2007
Option I: Maintain separate accounts
The assessees (Manufacturers and Service providers) had an outright option of maintaining separate accounts for receipt, consumption and inventory of input and input service consumed for dutiable and exempted goods and providing taxable and exempt services; take CENVAT credit only on input or input service intended for use in the manufacture of dutiable goods or in providing output service on which service tax was payable.
Option II: Not to maintain separate accounts
While Rule 6(2) of CCR brought no distinction between the manufacturers and service providers in terms of CENVAT reversal, Rule 6(3) of CCR drifted them apart.
The manufacturers of exempted goods viz. electricity, fertilizers, newspaper, textile, naptha, furnace oil, ethyl alcohol who cleared their goods under specified tariff heading were under the obligation to pay CENVAT credit ‘attributable to inputs and input services used in, or in relation to, the manufacture of such exempted final products’. (Rule 6(3)(a) of CCR)
Hence, under Rule 6(3)(a), the manufacturers construed the reversal of CENVAT credit to be on proportionate basis and allocated the CENVAT credit of inputs and input services shared in the manufacturing of dutiable and exempted final products.
Rest of the manufacturers (other than aforementioned) were under the obligation to pay an amount equivalent to 10% of the assessable value of the exempted goods. (Rule 6(3)(b) of CCR)
The service providers providing taxable as well as exempted service were under the subtle obligation which restrained them from utilising the CENVAT credit in entirety for payment of service tax liability i.e. utilization of 20% CENVAT credit pool (upper utilization cap) and paying 80% of the service tax liability in cash. The remaining CENVAT credit, however, could be carried forward and used for the subsequent period in a similar manner. (Rule 6(3)(c) of CCR)
The spectrum of the proportionate reversal (Rule 6(3)(a) of CCR) was extended from time to time to include more exempted goods. In 2005, obligation for proportionate reversal was extended to the manufacturers of Kerosene and Liquefied Petroleum Gas.
March 1, 2007 – February 28, 2008 (First time when proportionate reversal has been introduced to general insurance sector only)
It was in the year 2007 when an option exclusively for the General Insurance service provider [Section 65(105)(d) of the Finance Act, 1994] was introduced in respect of reversal of CENVAT credit attributable to exempted services. As per then Rule 6(3)(d) of CCR, the general insurance service providers were under the obligation to determine the amount of CENVAT credit attributable to exempted services based on the formula prescribed under the sub-rule (mentioned below) and pay the same before due date.
(A/B) multiplied by C where;
A denoted total value of exempted services provided during the preceding financial year;
B denoted total value of taxable and exempted services provided during the preceding financial year; and
C denoted total CENVAT credit of inputs and input services taken during the month.
It is our understanding that general insurance services were providing taxable as well as exempted insurance schemes and did not wish to maintain separate input/input services credit accounts. Further, the majority of turnover of the general insurance service provider was then exempt from payment of service tax and the option of utilising the only 20% of the CENVAT credit was hurting. Hence a relief in form of Rule 6(3)(d) of CCR was granted to general insurance sector.
Since March 1, 2008(Proportionate reversal has been extended to all industry with the same formula as applicable to general insurance companies earlier)
In 2008, Rule 6(3) of CCR was revamped vide Notification No. 10/2008 dated 1 March 2008 and the provisions of Rule 6(3) of CCR were brought at par for the manufacturers and service providers. The option of paying an amount equivalent to the CENVAT credit attributable to inputs and input services used in, or in relation to, the manufacture of exempted goods or for provision of exempted services was extended to all assessees.
It is our understanding that, in order to bring uniformity in practices of attributing the CENVAT credit formula/mechanism had to be prescribed in the legislation and hence Rule 6(3A) of CCR was introduced. However, it was surprising that the formula/mechanism introduced in 2007 for attributing the CENVAT credit to exempted insurance schemes which was applicable to insurance sector was exactly replicated in Rule 6(3A) of CCR.
Other way round, the formula/mechanism which was once applicable to general insurance service provider was then extended to all manufacturers and service providers without any modifications. It is worth giving a thought that the mechanics which holds good for a specific service provider (considering the nature of business i.e. general insurance company) need not necessarily hold good for other service providers and manufacturers.
The application of formula/mechanism under Rule 6(3A) of CCR attributes total value of CENVAT credit to exempted services or exempted goods even when the inputs or input services have no relation whatsoever (referring ‘P’ of Rule 6(3A) of CCR). As a result, the new mechanism had turned out to be ‘a blessing in disguise’ where inputs or input services which had no relation whatsoever with the exempted activities bear the burden of the reversal.
Latest litigation under Rule 6(3) of CCR – Thyssenkrupp Industries (I) Pvt Ltd
The Hon’ble Mumbai CESTAT – 2014-TIOL-1825-CESTAT-MUM observed that formula prescribed under Rule 6(3A) of CCR requires reversal of CENVAT credit proportionate to ‘Total CENVAT credit’ and not to the extent of ‘Common CENVAT credit’ as “P” denotes the total CENVAT credit taken on input services during the financial year. It was further held, since the word ‘common services’ is not present in the provision of Rule 6(3) of CCR, the same cannot be introduced in the said provision while interpreting the law for the purpose of reversal of CENVAT credit.
The proportionate reversal of CENVAT credit attributable to exempted goods was practiced even under the Modvat Rules and in absence of formula, assesses were at their liberty to reverse the CENVAT credit attributable to exempted goods through application of simple mathematics.
However, with the extension of the formula/mechanism, introduced in 2007 for general insurance sector, to all assesses in 2008 vide Rule 6(3A) of CCR, the intention of reversing the CENVAT credit attributable to exempted activities seems to have been dissolved.
The formula/mechanism prescribed under Rule 6(3A) of CCR apportions total CENVAT credit to exempted services or exempted goods whereas it was intended that only the CENVAT credit which is in common and used with dutiable/taxable and exempted activities should be apportioned. Due to the presence of word ‘total’, the formula leads to attributing total CENVAT credit to exempted services or exempted goods even when the inputs or input services exclusively used for dutiable/taxable activity have no relation whatsoever with the exempted activities. The provisions and judicial precedents seem to have permitted the authorities to demand higher reversal from the assessees which is causing undue hardship. Let’s hope this budget amends the formula prescribed under Rule 6 of CCR for proportionate reversal.
Possible scenario under GST
The intention to restrict the benefit of CENVAT credit on the exempted services or exempted goods will continue in GST as well. The underlying principle of disallowing CENVAT credit where the tax is not paid on the output won’t undergo change.
Therefore we firmly believe that reversal of GST credit would still be very much in existence under GST regime. However, under the dual GST regime, assesses would be under dual obligations to reverse State GST as well as Central GST.
Regarding the option for reversal under Rule 6(3) of CCR, apart from the option of maintaining separate set of accounts for the receipt and consumption, percentage reversal method and proportionate reversal method would be prevalent as well.
A passing reference on the question whether trading will still be construed as exempted services under GST?
Since trading activity was carried out by manufacturers who availed CENVAT credit, but Centre could not levy tax on such activities and hence, it was imperative to restrict the CENVAT credit on such activities.
However under the GST regime, where the entire supply chain would be taxed by Centre as well as State, it’s hard to imagine a scenario where the trading activity would then be contemplated as exempted service (and would not attract reversal).