Cenvat credit follows later dutiable classification, with the demand and main penalty set aside after reclassification.

Cenvat credit on inputs used in covered spandex yarn manufacture could not be denied once the final product was later re-classified as dutiable, even though the credit had been taken when the product was treated as exempt. The earlier reversal of the credit before the show cause notice supported restoration of the re-credit. The demand relating to credit utilisation was therefore unsustainable, and the penalty under Section 11AC was set aside. Penalty was, however, retained in modified form under the excise rules for improper credit utilisation.

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Issues: (i) Whether the appellant was entitled to Cenvat credit on inputs used in the manufacture of covered spandex yarn after the final product was re-classified as dutiable. (ii) Whether the demand of Rs. 90,663 and the penalties imposed were sustainable.

Issue (i): Whether the appellant was entitled to Cenvat credit on inputs used in the manufacture of covered spandex yarn after the final product was re-classified as dutiable.

Analysis: The inputs were originally used when the final product was treated as exempted. The Department later issued proceedings re-classifying the product and confirming duty, thereby changing the duty status of the final product. Once the product was held dutiable, the credit on inputs used in its manufacture could not be denied merely because it had initially been availed during the period when the product was treated as exempt. The earlier reversal of the entire credit before the show cause notice also supported restoration of credit.

Conclusion: The appellant was entitled to re-credit of the Cenvat credit already reversed.

Issue (ii): Whether the demand of Rs. 90,663 and the penalties imposed were sustainable.

Analysis: The amount of Rs. 90,663 represented credit utilization made before the final product was held dutiable on re-classification, but the larger credit had already been reversed and the duty position subsequently changed. In these circumstances, the demand of Rs. 90,663 was not sustainable. As regards penalty, the penalty under Section 11AC was not justified, but penalty was warranted for the improper utilization of credit under Rule 25.

Conclusion: The demand of Rs. 90,663 and the penalty under Section 11AC were set aside, while penalty under Rule 25 was upheld with modification.

Final Conclusion: The appeal succeeded to the extent of restoring the reversed credit and deleting the demand and main statutory penalty, but the appellant remained liable to a reduced penalty under the applicable excise rules.

Ratio Decidendi: When the Department itself later re-classifies a final product as dutiable, Cenvat credit on inputs used in its manufacture cannot be denied on the footing that the product was earlier treated as exempt, and penalties must be confined to the extent of any surviving ineligible utilization.

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