CENVAT credit on unusable scrap from manufacturing process need not be reversed when rejected forgings are not cleared as inputs as such.

Where rough steel forgings were machined and ground to meet supply specifications, the process constituted manufacture and the rejected pieces arising from cracks, blow holes and undersize were treated as unusable waste and scrap, not as inputs removed as such. On that basis, reversal of CENVAT credit was not required and the demand for differential duty did not survive. Since the substantive demand failed, the penalty was also unsustainable.

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Issues: Whether the appellants were liable to reverse CENVAT credit and pay differential duty on rough steel forgings cleared as scrap after machining and grinding, and whether the penalty was sustainable.

Analysis: The inputs received were subjected to machining and grinding to bring them to the required specifications for supply to the Railways, and the process resulted in rejection of some forgings on account of cracks, blow holes and undersize. Such process was held to amount to manufacture, and the rejected material was treated as unusable waste and scrap rather than inputs removed as such. On that basis, the appellant was entitled to retain the credit taken on the inputs, and the demand of differential duty did not survive. Once the demand failed, the penalty also could not be sustained.

Conclusion: The demand for reversal of credit and the penalty were set aside; the appeal was allowed in favour of the assessee.

Ratio Decidendi: Where inputs are subjected to a manufacturing process and the resulting unusable material is cleared as waste and scrap, it is not a clearance of inputs as such, and CENVAT credit need not be reversed merely because the original material was rejected during manufacture.

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