Exempted by-product no longer gives relief

Of late, official circles have expressed a lot of concern over alleged mis-utilisation of the CENVAT credit by certain manufacturing industries. One possible reason for the spurt in availment of credit, as quoted by the authorities, is the integration of service tax in the chain, which allows input service tax credit along with excise.

A recent ruling by the Customs, Central Excise and Service Tax Appellate Tribunal has come in handy for the government, which is trying to curb excesses in CENVAT availment. If the same is justifiable is another question. Simply put, the tribunal has said that exempted by-products will no longer get an exemption when CENVAT credit is availed on inputs.

The earlier position was that as it is difficult to determine and distinguish the input tax that go into exempted and taxable final products, the manufacturer will discharge the tax liability by paying duty on 8% of the value of the exempted finished product. The rule was introduced on the premise that there should be rationalised norm in this regard as when common inputs go into both exempt and taxable final products, the differentiation is difficult.


Interestingly, the Tribunal���s larger Bench decision also goes on to hold that this view is applicable where the exempted final product result out of the intended manufacturing process or an unintended by-product. The ruling can have adverse implications for a cross section of the manufacturing industry, considering that many processes bring out both exempt and taxable by-products.

To put things in perspective, when a manufacturer of dutiable and exempt goods uses common inputs in the manufacture of such goods and takes credit on such inputs, the Cenvat Credit Rules, 2004 (CENVAT Rules) envisage payment of an amount at a specified percentage of sale price of such exempted goods. Similar provisions existed in Rule 57CC of the erstwhile Central Excise Rules, 1944 (relating to Modvat Credit) with regard to the usage of the common inputs in the manufacture of dutiable and exempt products.

The payment has been a subject of extensive litigation between the assessees and the Central Excise authorities and continues to be contentious. One of the issues arising out of this rule is the applicability of the provisions where one of the products to emerge from manufacturing is an exempted by-product. The matter was referred to the larger Bench of the Customs, Excise and Service Tax Appellate Tribunal in the case of Rallies India as there were two streams of views on the interpretation of the provisions by different preceding decisions of the Tribunal. In order to understand the rationale on which this decision has been given by the larger Bench, it would be necessary to understand the facts in the decision.

In the case, the appellants are engaged in the manufacture of gelatin. For this purpose, they use raw materials ��� animal bones and hydrochloric acid (HCL). They avail benefit of modvat credit in respect of HCL. The animal bones are treated with HCL to form water soluble compound. This material (phosphoryl liquor/mother liquor) is removed from the process undertaken by the appellant.

The other material in the process is further processed to manufacture Gelatin. Mother liquor, being hazardous chemical waste, is processed by the appellant with lime to form dye-calcium phosphate to manufacture phosphoryl, which attracts nil duty.The credit availed by the appellant on HCL was being used by them for discharge of duty leviable on Gelatin. The contentious issue brought out by the Revenue authorities in this case was that to the extent HCL was being used for manufacture of gelatin as also for manufacture of phosphoryl (exempted product), the appellants are liable to reverse an amount of 8% of the value of the goods.

The appellants relied on various earlier decisions, where it was held that there is no requirement to pay 8% of the selling price of the exempted by-products under the erstwhile Rule 57CC. The department relied on certain other decisions given by the Tribunal which held the opposite view. The appellants had relied on Rule 57D of the erstwhile Central Excise Rules, which deal with credit on the inputs used in the manufacture of by-products.

The larger Bench has specifically commented that the use of the expression ���By-Product��� in Rule 57D has to be examined and interpreted in the context of the rule, which refers to by-products along with waste, refuse, etc. It was held that the provisions of Rule 57D have to be applied in cases where the waste, scrap and by-products are not at all excisable. Reliance on the said provision in the case of payment of 8% of the price on the sale of by-products which are excisable but exempted is not warranted.

The larger Bench took note of the SC decision in the appellant���s case in the context of Sales Tax, where they have explained the entire process of manufacture and the emergence of various products at different levels. The facts suggest that the use of the HCL is not required for the manufacture of gelatin, but is required only for the extraction of inorganic part of the bones to convert the same to phosphoryl.

This clearly shows that the emergence of phosphoryl cannot be regarded as an unwanted product emerging in the process but arising only out of the intended manufacturing process. The larger Bench also took note of another SC judgment on the case of Commissioner of Sales Tax Vs BPCL, wherein it was observed that where a subsidiary product is turned out regularly and continuously in the course of a manufacturing and is also sold regularly, an intention can be attributed to the manufacturer to manufacture and sell not merely the main items but also the subsidiary products.

Hence, the present manufacture of phosphoryl is also to be regarded as manufacture of intended products. Based on above, it was concluded that as long as the excisable products emerging out of common inputs are cleared from the assessee���s factory are both dutiable and enjoy exemption or attract nil rate of duty, the provisions of Rule 57CC will come into play. Interestingly, the larger Bench decision also goes on to hold that this view is applicable where the exempted final product result out of the intended manufacturing process or an unintended by-product.

Hence, this judgment puts at rest the controversy in terms of the applicability of the provisions of erstwhile Rule 57CC (or the present Rule 6 of CENVAT Rules) to the byproducts.

(The authors are with PwC)