Chapter X diversion of EOU duty-free goods attracted recipient liability, customs-based duty computation, and sustained penalties.

Duty-free inputs procured by a hundred per cent export-oriented undertaking under Chapter X remained recoverable from the recipient unit when they were clandestinely diverted into the domestic market, because the recipient was responsible for receipt, storage and utilisation and was liable where the goods were not duly accounted for under rule 196. The proviso to section 3(1) of the Central Excise Act applied to goods produced by an EOU and allowed for sale in India, so duty was to be computed by reference to the customs duties on like imported goods. Penalties on the company and participating individuals were sustained for deliberate diversion and forgery, with only one supplier director's penalty reduced on account of a limited role.

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Issues: (i) whether duty on duty-free inputs procured by a hundred per cent export-oriented undertaking and clandestinely diverted to the local market was recoverable from the recipient unit under the special exemption and Chapter X procedure; (ii) whether the proviso to section 3(1) of the Central Excise Act, 1944 applied for computing the duty on such clearances; and (iii) whether penalties imposed on the company, its managing director, employees, brokers and a supplier unit were sustainable, and in one case required reduction.

Issue (i): whether duty on duty-free inputs procured by a hundred per cent export-oriented undertaking and clandestinely diverted to the local market was recoverable from the recipient unit under the special exemption and Chapter X procedure.

Analysis: The duty-free goods were obtained under Notification No. 1/95-Central Excise through CT-3 procedure for use in the recipient unit, but were in fact diverted and sold in the market. The relevant Chapter X framework placed responsibility on the user industry to account for receipt, storage and utilisation of the goods, and rule 196 made the recipient liable where the goods were not duly accounted for as used for the stated purpose. The forged re-warehousing endorsements were attributable to the recipient unit, and the supplier units were not shown to have knowledge of the forgery. The claimed invalidity of the re-warehousing certificates therefore did not absolve the recipient unit.

Conclusion: Duty liability was upheld against the recipient unit and rejected as against the supplier EOUs.

Issue (ii): whether the proviso to section 3(1) of the Central Excise Act, 1944 applied for computing the duty on such clearances.

Analysis: The goods were supplied from one EOU to another EOU located in India under the statutory exemption route and were treated as deemed export supplies under the policy framework. The proviso to section 3(1) covered excisable goods produced by a hundred per cent export-oriented undertaking and allowed to be sold in India, and the duty was therefore to be computed by reference to the customs duties that would have been leviable on like imported goods. The authorities cited for a contrary computation were distinguished on facts.

Conclusion: The proviso to section 3(1) applied and duty was correctly computed under that proviso.

Issue (iii): whether penalties imposed on the company, its managing director, employees, brokers and a supplier unit were sustainable, and in one case required reduction.

Analysis: The diversion scheme was found to be deliberate and actively facilitated by the managing director, employees and brokers, including forgery of CT-3 and AR-3A documents and handling of payments. The plea that Chapter X was self-contained and excluded penalty was rejected because the excise rules as a whole, including the penalty provisions, continued to apply. The objection that the show cause notice cited rule 173Q rather than rule 209 and did not specify the sub-clause was also rejected because the provisions were treated as pari materia and the nature of the violation was clear. Penalties under rule 209A were upheld for the persons found to have knowingly participated or abetted the diversion. As regards the supplier director, culpability was found but the quantum was reduced in view of the limited role and absence of proof of additional benefit.

Conclusion: The penalties were sustained in substance, with only the penalty on one supplier director reduced to Rs. 50,000.

Final Conclusion: The appeals failed on the core issues of duty liability, valuation basis and penal liability, and the impugned orders were substantially sustained, subject only to a reduction in one penalty.

Ratio Decidendi: Where duty-free goods procured under Chapter X are clandestinely diverted and the user unit itself is responsible for forged re-warehousing documentation, the recipient unit remains liable for duty under rule 196 and the penalty provisions of the excise rules continue to apply.

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