2009 (8) TMI 14 - SC - Central Excise

CENVAT credit on naphtha allowed only for captive power use; no penalty due to interpretation conflicts

SC held that naphtha used to generate electricity qualifies as 'input' only to the extent the resulting electricity is used within the factory for ... Definition of 'input' under Rule 2(g) - used in or in relation to the manufacture of final products - input used as fuel - input used for generation of electricity or steam - within the factory of production - CENVAT credit admissibility - obligation under Rule 6 (dutiable and exempted goods)Definition of 'input' under Rule 2(g) - used in or in relation to the manufacture of final products - input used as fuel - input used for generation of electricity or steam - within the factory of production - Scope and construction of the definition of 'input' in Rule 2(g) of the CENVAT Credit Rules, 2002 - HELD THAT: - The definition in Rule 2(g) is to be read in three parts: (i) the specific/substantive part requiring goods to be 'used in or in relation to the manufacture of final products' (directly or indirectly), (ii) the inclusive illustrations (lubricants, packing, fuel, generation of electricity/steam, etc.) and (iii) the place of use qualification 'within the factory of production'. All three parts must be satisfied for a good to qualify as an 'input'. The inclusive items are not standalone grants of entitlement; they become relevant only if the item has the requisite nexus or functional utility with the manufacture of the final product and is used within the factory. The 2004 amendments merely restate and reinforce the same crucial requirement that inclusive items must be used in or in relation to manufacture of final products and within the factory. [Paras 10, 15, 16, 17, 18]Definition of 'input' requires satisfaction of the specific part, the inclusive part and the place-of-use requirement; inclusive examples do not by themselves confer input status unless used in or in relation to manufacture within the factory.CENVAT credit admissibility - input used for generation of electricity or steam - within the factory of production - used in or in relation to the manufacture of final products - Entitlement to CENVAT credit on duty paid on fuel (naphtha) used to generate electricity when part of the electricity is wheeled out/sold outside the factory - HELD THAT: - Applying the 'process and use' and 'dependence' tests, electricity generation qualifies as part of manufacture when it is a captive arrangement and the electricity produced is used within the factory for manufacturing activity; in that situation inputs used in generation (such as naphtha) qualify as inputs for CENVAT credit. However, where excess electricity generated is cleared outside the factory to joint ventures, vendors or to the grid for a price, the nexus between the generation process and the manufacturing use is broken. Electricity so sold or wheeled out for consideration is not 'used in or in relation to the manufacture of final product within the factory' and therefore the inputs attributable to that portion are not eligible for CENVAT credit. The Court applied prior authorities and held that only the portion of input consumption corresponding to captive consumption within the factory qualifies; the portion corresponding to electricity cleared outside at contractual rates does not. [Paras 13, 19, 20]Credit on inputs used to generate electricity is admissible only to the extent electricity is used within the factory (captive consumption); inputs attributable to electricity wheeled out/sold outside the factory are not eligible for CENVAT credit.CENVAT credit admissibility - obligation under Rule 6 (dutiable and exempted goods) - Levy of penalty on the assessee for taking CENVAT credit in the disputed circumstances - HELD THAT: - Having concluded that entitlement to credit is limited to the portion of electricity used within the factory, the Court noted the prevalence of conflicting decisions and repeated amendments to the Rules which had generated substantial litigation. In view of the conflict of views in earlier authorities and the legislative changes, the Court exercised its discretion to withhold imposition of penalty on the assessee despite dismissal of the appeals on merits. [Paras 21]Penalty shall not be imposed on the assessee.Final Conclusion: The appeals are dismissed on merits: CENVAT credit on inputs used to generate electricity (naphtha) is permissible only to the extent the electricity is consumed within the factory for manufacture (captive use); inputs attributable to electricity wheeled out or sold outside the factory are not eligible for credit. No penalty shall be imposed on the appellant. Issues: (i) Whether CENVAT credit is admissible on inputs (fuel) used to generate electricity when a portion of the generated electricity is wheeled out/sold outside the factory to joint ventures, vendors or the grid.Analysis: The statutory definition of 'input' contains (i) a specific part requiring goods to be 'used in or in relation to the manufacture of final products whether directly or indirectly', (ii) an inclusive part listing categories (for example goods used as fuel or for generation of electricity or steam) and (iii) a place-of-use qualification requiring such use 'within the factory of production.' All three parts must be satisfied for goods to qualify as eligible inputs. Ancillary activities such as captive electricity generation qualify as part of manufacture only when the process and the use are integrally connected and the electricity is used within the factory for manufacture. Where excess electricity is wheeled out or cleared for a price to third parties (including joint ventures, vendors or the grid), the process-and-use nexus is severed and the place-of-use requirement is not satisfied. Rules concerning CENVAT credit entitlement and reversal (including Rule 3 and Rule 6) operate accordingly, and amendments in the 2004 Rules reiterate the requirement that generation/use be in relation to manufacture within the factory.Conclusion: CENVAT credit on inputs used to generate electricity is admissible only to the extent the produced electricity is used within the factory for manufacture (captive consumption). To the extent excess electricity is wheeled out or sold outside the factory, credit is not admissible and proportionate credit must be reversed.