Substantive use of inputs controls set-off, while a specific bar on notified motor spirits overrides general relief provisions.

For set-off purposes, coal used in sponge iron manufacture was treated according to its substantive role in the process: where non-coking coal functioned as a reductant in the rotary kiln and its heat-generation was only incidental, it was characterised as raw material rather than fuel, supporting full set-off. By contrast, HSD oil, being a notified motor spirit, attracted the specific embargo under the relevant rule, so set-off was unavailable despite the general set-off provisions. The governing principle is that the true function of an input controls its tax treatment, and a specific prohibition on set-off for notified motor spirits prevails over general entitlement rules.

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Issues: (i) Whether coal used in the manufacture of sponge iron was liable to be treated as fuel so as to restrict set-off to 50%, or whether it was used as raw material so as to entitle the dealer to 100% set-off under the relevant rules; (ii) Whether set-off on purchase of HSD oil, being motor spirit notified under section 41(4), was admissible under Rule 52(1)(a) in view of the embargo contained in Rule 54(b).

Issue (i): Whether coal used in the manufacture of sponge iron was liable to be treated as fuel so as to restrict set-off to 50%, or whether it was used as raw material so as to entitle the dealer to 100% set-off under the relevant rules.

Analysis: The report relied upon in the assessment showed that non-coking coal was mixed with iron ore in the rotary kiln, where it functioned as a reductant and enabled the reduction of iron ore into sponge iron. Although heat was generated in the process and the coal indirectly contributed to the heat requirement, the essential role of the coal in the manufacturing process was as a raw material and not as fuel. Mere generation of heat did not change the character of the coal for purposes of set-off. The view taken by the assessing authority and appellate authority was based on a misreading of the report.

Conclusion: The coal was held to be used as raw material and the dealer was entitled to 100% set-off. This issue was decided in favour of the assessee.

Issue (ii): Whether set-off on purchase of HSD oil, being motor spirit notified under section 41(4), was admissible under Rule 52(1)(a) in view of the embargo contained in Rule 54(b).

Analysis: Rule 54(b) created a specific prohibition against grant of set-off in respect of purchases of motor spirits notified under section 41(4), except in the situations expressly mentioned in that rule. Since HSD oil fell within the category of motor spirit and was used as fuel, the claim for set-off could not be sustained under Rule 52 or Rule 53. The Tribunal's grant of set-off ignored the overriding effect of Rule 54(b).

Conclusion: Set-off on HSD oil was held to be inadmissible. This issue was decided in favour of the Revenue.

Final Conclusion: The common judgment of the Tribunal was sustained on the coal issue and set aside on the HSD oil issue, resulting in a mixed outcome with no order as to costs.

Ratio Decidendi: For set-off purposes, the true character of a material in the manufacturing process must be determined by its substantive function, and a specific statutory embargo on set-off for notified motor spirits prevails over general set-off provisions.

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