Analysis of Cenvat Credit - Changes in FA 2011

Introduction:
The primary object of cenvat credit was to avoid the cascading effect and ensure that the
chain of cenvat credit continues. Cenvat credit rules were introduced [replacing Modvat]
in the year 2004, and until 2010 the assessee had to wait to find clarity in law. As the
time passed through the industry started to understand the concept of cenvat credit with
various judicial decisions bringing in the clarity in the scope and understanding the intent
of the rules. Further the decision of Bombay High Court in case of Coca-Cola India Pvt
Ltd, 2009 (242) ELT 168 and Ultra Tech Ultratech Cements, 2010 TIOL 745 HC
Mumbai, wherein it was held that services in relation to business was allowed as cenvat
credit. However the Finance Act 2011 had tinkered the cenvat credit rules, with an
objective of overcoming the said decisions while furthering confusion. Further the said
budget has kept in mind the principles of functionality test alive as laid down in case of
M/s Maruti Suzuki Ltd. - 2009-TIOL-94-SC which is a departure from the earlier
understanding of the scheme as well as the concepts of GST going forward or seamless
credit.

Cenvat Credit Rules

The Cenvat credit rules is now called the Cenvat Credit (Amendment) Rules,
2011.Earlier it was called Cenvat Credit Rules, 2004

Definition of inputs
The definition of ‘input’ contained in rule 2(k) has been revised.
For better understanding of the definition of input inclusions and exclusions which has
been tabled below

Inclusions Exclusions
All goods used in the factory by the Light diesel oil, high speed diesel oil,
manufacturer of the final product Motor spirit commonly known as petrol
Any goods including accessories cleared Any goods used for the construction of a
along with the final product and goods building or a civil structure or laying of
used for providing free warranty. foundation or making of structure for
support of capital goods.
Similarly, goods used for generation of Capital goods except when used as parts
electricity or steam for captive use also and components in manufacture of final
constitute inputs. products and also does not include the
motor vehicles.

Goods used primarily for personal use or

consumption of any employee including
food articles etc.
Goods having no relationship with
whatsoever with the manufacture of final
product.
A. Issues/Impact on the said amendments

o Employees using safety precaution uniforms, in order to protect themselves while

discharging their duty of manufacturing activity, cenvat credits on such uniforms would
be available.

o Goods such as storage racks used in stores, tables and chairs used in administrative
department/ accounts department/ sofas chairs kept at receptions/ waiting rooms shall not
be allowed as credits.

o Tools and equipments used for garden maintenance, tube lights, fans, exhaust fans
fitted either at the manufacturing area or administrative areas shall not be allowed as
input credits.

o Goods used as staff welfare measures, such as seasonal gifts to employees,

complimentary gifts to clients during new year/ Dewali/ Christmas etc shall also be
denied.

o Going the principles of Cost Accounting Standards- 4, in order to arrive at the value of
the cost of the product such manufacturer would have to factor in the above said cost in
its final price and excise duty have to be paid on such final price, when manufacturer is
denied enjoying the input credits on above said items, would certainly impact the margins
of the manufacturer, which could result in undue tax planning.

o Such demarcation would create a barrier in implementing GST.

Definition of input service

For better understanding of the definition of input services inclusions and exclusions
which has been tabled below

Inclusions Exclusions
Any service used by the provider of taxable Architect service, port service, air port
service for providing output service or service, other port services, commercial
Used by a manufacturer whether directly or or industrial construction service, works
indirectly in relation to manufacture of contract service and construction of
final product and clearance of final productresidential complex when they are used
upto the place of removal in construction of building or civil
structure or even when used for laying
foundation or making structure for
support of capital goods.
Services in relation to Services such as rent a cab service,
· Modernization or renovation or repairs of general insurance service, authorised
the premises of provider of output service service station service and supply of
or an office relating to such premises tangible goods service shall not be
· Advertisement or sales promotion available as credits, unless they are used
 · Market research by service providers who have been
· Storage up to the place of removal allowed to take Cenvat credit of duty
· Procurement of inputs paid on capital goods
· Accounting, auditing, financing,
recruitment and quality control, coaching
and training, computer networking, credit
rating, share registry and security, business
exhibition, legal service)
· Inward transportation of inputs or capital
goods and
· Outward transportation up to the place of
removal

Services such as those provided in

relation to outdoor catering, beauty
treatment, health service, cosmetic and
plastic surgery, membership of a club,
health and fitness centre, life insurance,
health insurance and travel benefit
extended to employees on vacation such
as leave or home travel concession, when
such services are used primarily for
personal use or consumption of any
employee.

Note : The limb “such as activities in relation business” have been deleted in this
budget.

B. Issues on the said amendments

o As service industry predominantly depends on skill sets/ intellect of an individual, and

majority of expenses incurred by such industry is towards welfare and benefit of human
resource. Denial of the benefit the of cenvat credit on services like rent- a –cab,
insurance, Sodexho pass, cafeteria, air ticket booking for LTC was completely illogical.
As service industry consider human resource cost as its direct cost, and such costs are
considered for the purpose of discharging service tax, therefore the margins would
certainly be impacted. The decision behind denial of such credits was for that the industry
was enjoying double benefit in form of cenvat credit as well as income tax deduction
towards the said expenses, such reasoning needs to be judicially examined when the law
was completely silent on this aspect.

o Removal of the words “Such as” and “Services used in relation to business” from the
definition of input service was to counter the decision of Bombay High Court in case of
Coca-Cola India Pvt Ltd, 2009 (242) ELT 168 and Ultra Tech Ultratech Cements, 2010
TIOL 745 HC Mumbai, in the aforesaid decision the honorable High court had expressed
its view that "input service" is very wide and covers not only services, which are directly
or indirectly used in or in relation to the manufacture of final products but also includes
various services used in relation to the business Rule 3 has been amended to specify that
the Cenvat credit would not be allowed on inputs on which duty has been paid under the
benefit of notification no.1/2011. Keeping the principles of functionality alive as laid
down in case of M/s Maruti Suzuki Ltd. - 2009-TIOL-94-SC.

4 The definition of ‘exempted goods’ has been amended and now it includes even those
goods on which the option has been exercised by the manufacturer to pay the duty at
concessional rate of 1% on 130 specified entries as prescribed in notification no.1/2011-
CE.

4 The provisions have also been amended to specify that the Cenvat credit shall not be
utilised for payment of excise duty at concessional rate of duty of 1% under notification
no.1/2011. Which means the payment is mandatorily required to be paid in cash. Further
the receiver shall not be eligible to avail when the goods have suffered duty at 1%. This
change is effective from 1st March 2011.

4 The definition of ‘exempted services’ has also been amended. Now the definition
includes even those services in respect of which the service provider has opted for
exemption on part of the value with a condition that no Cenvat credit of input or input
services is available. For example, if the service provider engaged in providing the
service of ‘construction of complex’ service claiming the abatement of 67% as per the
service tax notification no.1/2006 without the Cenvat credit benefit and pays tax only on
33% value, then even such service would be construed as ‘exempted service’.

4 The important change in the definition has been brought in the definition of ‘exempted
service’ by way of explanation in this budget. Now, the exempted service includes even
‘trading activity’. However the value would be the difference between the purchase and
sale price.

4 Earlier the definition of manufacturer or producer relating to jewellery included only a

person doing Job work in relation to articles of jewellery, however the same is amended
to include a person who is liable to pay duty on removal of goods which are mentioned in
the chapter 61(Articles of apparel and clothing accessories, knitted or crocheted, chapter
62(Articles of apparel and clothing accessories, not knitted or crocheted), Other made up
textile articles, sets, worn clothing and worn textile articles, rags.

4 Issues on the said amendments

o The said manufacturer/service provider would have to follow Rule 6 of Cenvat Credit
Rules, in order to restrict the credit with respect to credits pertaining to input and input
services with respect to such exempted goods/ exempted service.

o Rise in administrative cost in maintaining separate books for input used in

manufacture of taxable goods and exempted goods. (however no separate books could be
maintained with respect to common input services, wherein the formula with
proportionate credits needs to be adopted in arriving at the value of eligible input service
credits

o Accountant needs to be trained, in identification of eligible input or input service

credits.

C. Earlier Cenvat credit was available on 100% of additional duty on all excisable
leviable under section 3 of Customs tariff Act, but now the credit is restricted to an extent
of 85% of the additional customs duty paid on ships, boats, and other floating structures
for breaking up.

D. Rule 3 (5) has also been amended to further include that the reversal of credit/
payment of duty would not be required on inputs when they are removed under free
warranty. For this purpose, free warranty means ‘warranty’ provided by the
manufacturer, the value of which is included in the price of the final product and is not
charged separately from the customer.

E. Rule 3(5B) is also amended and now the rule requires that the Cenvat credit availed
to be paid back even if the Cenvat availed inputs or capital goods are partially written off.
Earlier it was required only when the goods are fully written off. This change is effective
from 1st March 2011. 6/2006

F. Rule 4 is amended to state that the Cenvat credit would be allowed even on capital
goods which is received outside the factory and used for generation of electricity for
captive used in factory. Earlier Cenvat Credit is available only on capital goods which
are used in the factory

G. The Rule 4 (7) is amended to state that when any payment made towards the input
service is returned then the manufacturer or service provider who has taken the credit on
such input service shall pay proportionate amount to the cenvat availed in respect of such
amount returned. This payment can be by utilizing the Cenvat credit or otherwise.

Major change in Rule 6

H. The provisions of Rule 6 before amendment had not considered many of the vital
aspects prevalent in the industry, the application of rule 6 was very limited in as much as
it had not considered the trading activity. Further value with respect to compositional
scheme with respect to the abated portion is also brought into the preview of Rule 6.
Further goods falling within the preview of notification 1/2011, wherein the assessee
avails the benefit of paying duty at the rate of 1%, would also be considered as exempted
goods and no credit shall be allowed on the same.

I. Rule 6 of the Cenvat credit Rules 2004 has undergone major change. The heading of
the rule itself has been changed as ‘Obligation of a manufacturer or producer of final
products and a provider of taxable service’. Earlier the heading was ‘Obligation of
manufacturer of dutiable and exempted goods and provider of taxable and exempted
services.

J. This very change in the title of the rule will have serious implication as the argument
of non applicability of the rule 6, when the manufacturer manufacturing dutiable goods
also provides services which are not liable to service tax. The converse of which also
holds good.

K. In other words the assessee is curtailed to take the benefit of input/ input services,
when the manufacturer was providing exempt services and service provider providing
exempted goods.

L. Further previously with trading not being considered either as exempted goods or
exempted services, the benefit of input services which were commonly used for trading
activity was possible, now with the change in definition of exempted service to include
trading and also with the omission of the words “Activities in relation to business”, such
arguments would not stand in the law.

M. Sub Rule 1 has also been changed to state that the Cenvat credit benefit would not be
allowed on inputs or input services which are used in or in relation to manufacture of
exempted goods or for provision of exempted service. Earlier the rule has the wordings
that the credit would not be allowed on ‘input or input service which is used in the
manufacture of exempted goods or for provision of exempted service’. Due to this
change, now the assesse is prevented from taking the contention of availing full credit on
input or input service in relation to manufacture of exempted goods or provision of
exempted goods.

N. The sub rule 2 now provides for maintenance of separate records in more detailed
manner in respect of receipt, consumption an inventory of inputs and the receipt and use
of input services used:

i) in or in relation to manufacture of exempted goods;

ii) in or in relation to the manufacture of dutiable final products excluding exempted

goods;

iii) for the provision of exempted services;

iv) for the provision of output services excluding exempted services.

O. Earlier sub rule 3 required that the provider of output service providing exempted
service to pay 6% on the value of exempted service and avail the Cenvat credit fully
(unless any input/input service is exclusively used for exempted service). Now this rate
of 6% has been reduced to 5%. The rate of 5% is applicable on exempted value in case of
taxable services which are partially taxable. For example, if only 33% of construction
service is taxable then 5% should be paid on 67% value. This type of restriction would be
cumbersome and may not be complied.

P. In Sub rule 3 in addition to option of paying 5% amount on exempted goods/exempted

services or claiming the Cenvat credit proportionately as provided in Rule 6 (3A), a new
option has been provided. The new third option would be to maintain separate accounts
for the receipt, consumption and inventory of inputs as provided in the new rule and pay
an amount as determined under sub-rule (3A) in respect of only input services.

Q. In addition to the above changes, a new explanation has been added to state that the
payment of amount of 5% as discussed above would be deemed to be Cenvat credit not
taken for the purpose of an exemption wherein exemption is granted on condition that no
Cenvat credit of inputs and input services shall be taken.

R. Taxable services specified in sub clauses zx (insurance business) and zzzzf (insurance
relating to unit linked plan) of section 65(105) of the finance Act, shall pay for every
month an amount equal to 20% of the Cenvat credit availed on inputs and input services
in that month. Earlier this provision was not there.

S. As even trading activity would be considered as ‘exempted service’ as per the

amendments, the value of trading activity should also be considered for availment of
credit proportionately. The value of such trading would be difference between the sale
price and the purchase price of the goods trade.

T. A major hit in this FA has been the omission of rule 6 (5). Earlier as per this rule, on
as many as 16 common services such as security services, banking or financial services
etc. the assessee could have claimed the credit of service tax paid to the extent of 100%
even if they are partially used for taxable activity. Now, even these services would be
subject to proportionate formula as specified in Rule 6 (3A).

U. A new rule 6 (6A) has been introduced with effect from 1st March 2011 to state that
the provisions of Rule 6 shall not be applicable in case of taxable services provided,
without payment of service tax to SEZ unit or developers for their authorized operations.
However the services which are exempted from payment of taxes vide exemption
notification are considered as exempted services and consequently the benefit of cenvat
credit attributable on such portion is restricted.

For the purpose of Rule 6 of cenvat credit Rules, exempted means the following

Actvity Status Treatment

Trading activity Exempted service Difference between the
purchase price and sale
price needs to be
considered
Goods attracting 1% rate of Exempted Goods Turnover of such 1%
 duty as specified in rated goods to be
notification 1/2011 considered
Payment of tax on taxable Exempted Service The value in respect of
services, with a condition services covered by a
that benefit of credit is not composition scheme will
available be tax amount divided by
the rate of service tax
applicable under section
66 read with any general
exemption. As the
prevalent rate is 10% the
value shall be ten times
the amount of service
paid or payable.

V. In rule 9(7) of the Cenvat Credit Rules under first proviso, a manufacturer availing
exemption notification based on value or quantity of clearances in a financial year, he
shall file a quarterly return in the form specified, by notification, by the Board within ten
days after the close of the quarter to which the return relates. (previously the same was to
be filed within twenty days after the close of the quarter to which the return relates)

Rule 6 of Cenvat Credit illustration

The following is the illustrative example for working under Rule 6 of cenvat Credit Rules

1. ABC Ltd is a Company engaged in manufacturing excisable goods, from the

following information, ascertain the duty liability of the company for the
month of April 2011?

Sales for April Cenvat Credit Cenvat Credit Rate of Duty

2011 input balance input Service
balance
10,00,000/- 1,00,000 20,000 10%

Sol. Since the company is only engaged in manufacturing excisable goods therefore the
company would not fall within the preview of Rule 6 of Cenvat Credit Rules 2004.

Therefore the liability of the Company for the month of April 2011 is as follows

Duty Liability for the Month 10,00,000*10% 1,00,000/-

of April 2011
Less : Cenvat Credit
Inputs 1,00,000/-
Input Service 20,000/-
Total Cenvat Credit availed (1,20,000)/-
Duty paid in cash / (Closing (20,000)
 balance of Cenvat Credit)

2. From the question No.1 ascertain the tax liability of ABC Ltd , if ABC
Ltd is also engaged in manufacturing exempted goods, the value of
exempted goods for the month of April 2011 is Rs. 2,00,000/-?
Further total value of exempted goods for the previous year was
24,00,000/- and total value of taxable goods for the previous year
was 95,00,000?

Sol. In the present case the company is engaged in manufacturing of dutiable goods and
exempted goods, therefore the company has the following options

Option 1

Maintain separate accounts for receipt, consumption and inventory of inputs/ input
services used in manufacture of dutiable goods and exempted goods.

In case the Company opts to maintain separate inventory records with respect to
manufacture of dutiable goods and exempted goods, then ABC Ltd shall avail cenvat
credit attributable only to manufacture of dutiable goods.

Inventory records of inputs and input services used in manufacturing of dutiable goods
and exempted goods is as follows

Particulars Inputs/ input service to be Inputs /input service to be

used in manufacture of used in manufacture of
dutiable goods exempted goods
Inputs 70,000 30,000
Input Service 15,000 5,000
Total Inputs 95,000 35,000

· The manufacturer shall avail cenvat credit only to an extent of Rs. 95,000/-

Liability of the Company for the month of April 2011 is as follows

Duty Liability for the Month 10,00,000*10 1,00,000/-

of April 2011 %
Less: Cenvat Credit
As per the above table U/R (95,000)
6(2)
Balance Payable in Cash 5000/-

Option 2
If the Company opts not to maintain separate inventory records, shall follow any of the
following options

i. Pay an amount equal to 5% of value of exempted goods and exempted

service or
ii. Pay an amount as determined under sub- Rule 3(A) or
iii. Maintain separate accounts for receipts, consumption and inventory of inputs
only as provided in option 1 (Rs 70,000)

Liability of the company for the month of April 2011 under option 2(i) is as follows

Duty Liability for the Month 10,00,000*10 1,00,000/-

of April 2011 %
Inputs 1,00,000/-
Input Service 20,000/-
Total Cenvat Credit availed 1,20,000/-
Less : Reversal of Cenvat (10,000)
Credit on 5% of Value of
Exempted goods
(2,00,000*5%)
Eligible Credit 1,10,000
Duty paid in cash / (Closing (10,000)
balance of Cenvat Credit)

Liability of the company for the month of April 2011 under option 2(ii) under Rule
6(3)(ii) is as follows
When the Company decides to follow Sub-Rule 3A of Rule 6 of Cenvat Credit Rules, the
following procedures and conditions namely needs to be complied with

i. Intimate in writing to the Superintendent of Central Excise giving the

following particulars

a. Name address and registration No of manufacturer of goods or provider of output

service

b. Date from which this option is proposed to be exercised

c. Description of dutiable goods or taxable service

d. Description of exempted goods or taxable service

e. Cenvat credit of inputs and input services lying in balance as on date of exercising
this option.

ABC, Ltd shall determine and pay provisionally for every month as follows
 Total Cenvat Credit for the 1,00,000 (30% of credits
month on inputs attributes to exempted goods)
Input Service 20,000/-
Total Cenvat Credit availed 1,20,000/-
Less: Reversal of cenvat Credit (4033)
on proportionate basis for input
service on provisional basis
(24,00,000*20,000)/1,19,00,000

Input credit attributable to (30,000)

exempted goods

Eligible credit on provisional 85,967

basis
Duty Liability for the Month of 10,00,000*10% 1,00,000/-
April 2011
Eligible credit on provisional 85,967
basis
Duty paid in cash / (Closing 14,033
balance of Cenvat Credit)

The Company after computing and discharge its duty liability on provisional basis. At the
completion of the financial year, the company shall re-compute its duty liability after
considering the actual figures for the year, and re-determine its duty liability. After such
re- computation of duty in case of any short payment of duty, the company shall pay the
amount of differential taxes within 30th June of the succeeding year, else interest would
be payable at the rate of 24% PA

ABC, Ltd actual clearance for the year 2011-12 was Rs. 1,05,00,000/- towards dutiable
goods and exempted clearance was 28,00,000/-

a) Total input service for the month 20,000

of April 2011
b) Credit availed provisionally 15967
c) Actual credit to have been availed 15790
on the basis of re-computation made
at the end of the year
(20,000*28,00,000)/13,300,000 =
4210/-
20,000-4210=
d) Excess availed credit (b-c) 177
In case the excess availed credit is
reversed back within 30th June, no
interest shall be payable in case, such
reversal is done after 30th june, interest
 at the rate 24% PA

Note: This kind of exercise needs to be done for every month in order to ascertain
the actual credit.

For the purpose of Rule 6 of cenvat credit Rules, exempted means the following

Activity Status Treatment

Trading activity Exempted service Difference between the purchase
price and sale price needs to be
considered
Goods attracting 1% rate Exempted Goods Turnover of such 1% rated
of duty as specified in goods to be considered
notification 1/2011
Payment of tax on taxable Exempted Service The value in respect of services
services, with a condition covered by a composition
that benefit of credit is not scheme will be tax amount
available divided by the rate of service tax
applicable under section 66 read
with any general exemption. As
the prevalent rate is 10% the
value shall be ten times the
amount of service paid or
payable.