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/10/13Taxation and Corporate Laws Cenvat credit on input serv ices and goods

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1 Conventional Tax System

In any manufacturing technology, output of one manufacturer becomes input of another. Again even after

manufacture is complete, goods pass through various stages like distributor, wholesaler, semi-wholesaler and

retailer.

Conventionally, tax is charged based on selling price.

In following chart, A is selling goods to B and B selling to C. Tax rate is 10%.

DetailA B C

Purchases- 110 165

Value Added100 40 35

Sub-Total100 150 200

Add Tax 10%10 15 20

Total

110 165 200

It can be seen that B is paying tax on ` 100 on which A has already paid the tax. B is also paying tax on ` 10

which is tax paid by A.

Similarly, C is paying tax on ` 100 on which A and B have already paid the tax.

This is termed as cascading effect. This distorts the tax structure as tax burden depends on number of stages

through which goods passes.

End use exemptions cannot be given since even if exemption is granted to C in aforesaid example, the

product cannot become tax free as tax borne earlier on those goods cannot be known.

2 Tax credit System under VAT

Tax credit system is used to avoid these defects. The purchaser of goods gets Vat credit of tax paid by the

earlier seller.

Following chart indicates transaction with Vat and without Vat.


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Transaction without VAT Transaction With VAT

DetailsA B A B

Purchases- 110 - 100

Value Added100 40 100 40

Subtotal100 150 100 140

Add Tax10 15 10 14

Total

110 165 110 154

Here, B has purchased goods from A as usual, but in Vat system, he gets credit (set off) of tax paid by A.

Thus, his net purchase price becomes ` 100 only. His value addition is same as earlier i.e. ` 40. He pays tax

of ` 14 on ` 140. However, he has got credit of ` 10 (tax paid by A). Hence, effectively, he is paying tax of `

4 only (i.e. 10% of ` 40 only).

Then it does not matter through how many stages the product passes, since at every stage, tax is paid only on

value added and not on entire transaction.

Further, total tax paid on the product is ` 14 out of which ` 10 are paid by A and ` 4 by B. Thus, if exemption

is given to B, the product can be made entirely tax free (e.g. for exports or for mass consumption goods or

poor mans needs etc.)

Thus, Vat works on principle of granting credit (set off) of tax paid on input goods, input services and capital

goods.

3 Highlights of Cenvat Credit

Cenvat (Central Value Added Tax) Credit is available of excise duty paid on input goods and service taxpaid on input services and excise duty paid on capital goods.

Instant Credit i.e. Cenvat credit of excise duty paid on input goods and service tax paid on input services

is available immediately on receipt of goods or services without waiting for its consumption.

Cenvat credit of excise duty paid on capital goods is available in two financial years @ 50% each.

Destination principle, Government really gets tax only when goods are finally consumed. Hence, it is

termed as consumption based tax.

One to one co-relation not required. Entire Cenvat of all eligible input goods, input services and capital

goods can be utilised for payment of any eligible excise duty on manufactured final product or taxable output

services.


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Credit of excise duty and service tax inter-changeable

4 Input Service [Rule 2(i)]

Definition in two parts

First part used by service provider for providing output service or by manufacturer used directly or

indirectly in relation to manufacture

Definition has inclusive and exclusive clauses

5 Inclusive part of Input Service

Includes services used in relation to

Modernisation, renovation or repairs of a factory, premises of provider of output service or an office

relating to such factory or premises, advertisement or sales promotion, market research, storage upto the

place of removal, procurement of inputs (Continued)

Accounting, auditing, financing, recruitment and quality control, coaching and training, computer

networking, credit rating, share registry, security, business exhibition, legal services, inward transportation of

inputs or capital goods and outward transportation upto the place of removal.

6 Includes and In relation to

If the word include/s is used it means that the definition is not exhaustive but it is inclusive, i.e. it

expands the meaning

The expression in relation to is a very broad expression. These are words of comprehension which

might both have a direct significance as well as an indirect significance depending on the context.

Relating to is equivalent to or synonymous with as to concerning with and pertaining to.

If you are interested in case law in respect of interpretation of these terms, you may post your query on

www.taxmann.com/servicetaxqueries.aspx

7 Services in inclusive part of definition

These relate to procurement, marketing, administration, accounting, raising of finance, human resources.

All five resources i.e. M s Men, Material, Machines, Money and Minutes covered

Except services specifically excluded, all other services should get covered.

8 Ineligible Input Services

Input Services relating to setting up of original plant or office are not eligible.

Construction and works contract services for building, civil structure, laying of foundation or structuresfor capital goods except when used for construction or works contract service itself

Renting of motor vehicle for transport of passengers is not eligible as input service exceptwhere motor

vehicle is eligible as capital goods


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Services of general Insurance, servicing, repair and maintenance of motor vehicle where motor vehicle is

not eligible as capital goods

Exception Motor vehicles manufacturers of vehicles manufactured by them and insurance company of

vehicles insured by them can avail Cenvat credit of input services General Insurance, servicing, repair and

maintenance of motor vehicle

All employee benefits such as Outdoor catering, beauty treatment, health services, membership of club,life insurance, health insurance, travel benefits, LTA - used primarily for personal use or consumption of

employee are not eligible.

9 Input Service Distributor Rule 7

If an assessee has more than one manufacturing plants and/or place of provision of services, he can

transfer the Cenvat credit of input services received at Head Office, Branch Offices or Depots to factories

and places where service provided.

The HO, branches or depots have to register under Central Excise as Input Service Distributor (ISD),file returns etc.

They should issue monthly Invoice to distribute credit to factories and/or places of provision of service,

on basis of turnover of previous month/quarter

No credit where input service exclusively for exempted goods or exempted service

If only one factory or place of provision of service, then entire credit can be taken at that place by

keeping proper records, without registering as ISD.

Invoice in name of HO or branch legally permissible

10 Inputs (goods) for service provider

Only inputs (goods) used for providing taxable services eligible

Consumable eligible, but LDO, HSD and petrol not eligible

Goods used for generation of electricity or steam for captive use eligible exceptLDO, HSD and petrol

(furnace oil eligible)

11 Inputs (goods) for manufacturer

All goods used in factory by manufacturer having some relation with manufacture

Accessories and warranty spares supplied along with main final product

Power generation for captive consumption

HSD, LDO and petrol not eligible

12 Ineligible Inputs (goods)

LDO, HSD and Petrol not eligible


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Goods on which 1%/2% excise duty is paid are not eligible.

Goods (and services) used for civil construction, foundation, structure not eligible except when used for

works contract or construction but not worth taking Credit

Motor vehicles are not inputs eligible as capital goods in some cases

Any goods (and services) like food or other items for personal use or consumption of employee not

eligible

Goods having no relation with manufacture not eligible

13 Reversal of Cenvat, if inputs partially or fully written off

Cenvat credit reversal is required even if the input goods are written off fully or partially in books of

account (if they are slow moving or obsolete).

Not applicable when general provision made in books of account This is permissible as per Accounting

Standards

14 Inputs and Services in Negative List

Building for office or factory

Motor vehicle related services with few exceptions

Employee benefits.

Input services for setting up of plant or office.

15 Removal for job work of inputs by manufacturer

Inputs on which Cenvat credit is availed can be removed for job work and brought back under Cenvat

Credit Rule 4(5)(a).

Removal under Own challan

Goods should be returned after job work within 180 days. If not, Cenvat credit on inputs (which were

sent for job work) should be reversed.

Dutiability of scrap at job workers place case law that duty liability of scrap is not of Principal

Manufacturer but of job worker

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