2009 (8) TMI 14 - SC - Central Excise

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

M/s. Maruti Suzuki Ltd. Versus Commissioner of Central Excise, Delhi-III

SC held that naphtha used to generate electricity qualifies as 'input' only to the extent the resulting electricity is used within the factory for ... Entitlement to CENVAT credit on naphtha used for generating electricity - a part of electricity supplied to its sister units, vendors, joint ventures - Scope of word 'input' under Rule 2(g) - Imposition of penalty - Held That:- Electricity generation is a separate and distinct activity. It is an independent activity. It has its own economics. It does not form part of the process in which 'inputs' are transformed into separate identifiable commodity, though it may stand connected to such processes. It may not have any concern with the manufacture of the finished product. However, it is an ancillary activity. It is an activity which is anterior to the process of manufacture of the final product. It is on account of the use of the above expression 'used in relation to manufacture' that such an activity of electricity generation comes within the ambit of the definition because it is integrally connected with the manufacture of the final product. Mere fact that the item is a packing material whose value is included in the assessable value of final product will not entitle the manufacturer to take credit. Oils and lubricants mentioned in the definition are required for smooth running of machines, hence they are included as they are used in relation to manufacture of the final product. The intention of the Legislature is that inputs falling in the inclusive part must have nexus with the manufacture of the final product. It may be noted from the CENVAT Credit Rules of 2004 vis-a vis CENVAT Credit Rules of 2002 that the word 'for' in the inclusive part after the words 'steam used' is substituted by the words 'used in or in relation to the manufacture of final products'. In some of the cases in batch before us the show cause notice goes right up to January 2005, hence, CENVAT Credit Rules, 2004 also apply to those cases. In short, an item would fall within the category of 'inputs' as defined only on compliance with all the three parts of the definition clause. We hold that the definition of 'input' brings within its fold, inputs used for generation of electricity or steam, provided such electricity or steam is used within the factory of production for manufacture of final products or for any other purpose. The important point to be noted is that, in the present case, excess electricity has been cleared by the assessee at the agreed rate from time to time in favour of its joint ventures, vendors etc. for a price and has also cleared such electricity in favour of the grid for distribution. To that extent, in our view, assessee was not entitled to CENVAT credit. In short, assessee is entitled to credit on the eligible inputs utilized in the generation of electricity to the extent to which they are using the produced electricity within their factory (for captive consumption). They are not entitled to CENVAT credit to the extent of the excess electricity cleared at the contractual rates in favour of joint ventures, vendors etc., which is sold at a price. We are of the view that penalty is not leviable on appellant/assessee, particularly when in large number of other cases, on account of conflict of views expressed by various Tribunals/High Court, the assessees have also succeeded. Hence, although M/s. Maruti Suzuki Ltd. (appellant) has failed in their civil appeals the Department will not impose penalty. ISSUES PRESENTED AND CONSIDERED 1. Whether CENVAT credit is admissible on duty paid on fuel (naphtha) used for generation of electricity when a portion of the electricity generated is wheeled out/supplied outside the factory to joint ventures, vendors or the grid. 2. How the term 'input' in Rule 2(g) of the CENVAT Credit Rules, 2002 (and the corresponding definition in the 2004 Rules) must be construed, in particular the interplay between (i) the specific/substantive part ('used in or in relation to the manufacture of final products whether directly or indirectly'), (ii) the inclusive illustrations (e.g., goods used as fuel; for generation of electricity or steam), and (iii) the qualifying phrase 'within the factory of production'. 3. Whether Rule 6 (obligation where dutiable and exempted goods are manufactured) applies to inputs used for generation of electricity which is not an excisable commodity, and whether the manufacturer must reverse/surrender CENVAT credit proportionate to electricity cleared outside the factory. 4. Whether penalty is leviable on the assessee for taking CENVAT credit in the circumstances of conflicting authority and repeated amendments to the Rules. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Admissibility of CENVAT credit on fuel used for captive electricity generation where some electricity is wheeled out Legal framework: Rule 2(g) defines 'input' and Rule 3 allows CENVAT credit on inputs received in the factory; Rule 4 deals with removal of inputs on which credit taken; Rule 6 restricts credit on inputs used in manufacture of exempted goods and prescribes account/quantification mechanisms. Precedent treatment: The Court relied on prior decisions applying the 'integrally connected' or 'dependence' tests (as in earlier authorities) to treat ancillary processes as part of manufacture when they are integral and captive to production. Interpretation and reasoning: Electricity generation is an independent economic activity but can be an ancillary process integrally connected to manufacture. The crucial test is whether the process and use remain integrally connected to manufacture - i.e., captive consumption for manufacturing activity. Where electricity is used within the factory for manufacture, fuel used in generation qualifies as an 'input'. Conversely, where excess electricity is sold/cleared outside the factory for a price (wheeled out to joint ventures, vendors or the grid), the nexus between generation and the manufacture is severed for that portion; such clearance is a sale and not use 'in or in relation to the manufacture ... within the factory of production'. The inclusive examples must be read with the substantive requirement of use in or in relation to manufacture and the place qualification. Ratio vs. Obiter: Ratio - CENVAT credit on inputs used to generate electricity is admissible only to the extent the electricity so generated is consumed within the factory (captive consumption) and used in or in relation to manufacture; electricity or inputs attributable to electricity cleared outside the factory for value are not eligible for credit. This is the operative holding. Conclusions: CENVAT credit on naphtha used to generate electricity is admissible pro tanto for the proportion of electricity consumed within the factory; credit must be reversed or not allowed to the extent electricity/generated output is wheeled out/sold outside the factory. Issue 2 - Construction of 'input' in Rule 2(g): interaction of specific part, inclusive part and place of use Legal framework: Rule 2(g) (2002 Rules) and the corresponding Rule 2(k)(i) (2004 Rules) define 'input' in three conceptual parts: (i) the specific/substantive limb ('all goods ... used in or in relation to the manufacture of final products whether directly or indirectly'), (ii) an inclusive illustrative limb listing categories (lubricants, goods used as fuel, for generation of electricity/steam, packing material etc.), and (iii) a qualification of place of use ('within the factory of production'). Precedent treatment: Earlier authorities recognized a broad scope for 'used in relation to manufacture' and permitted inclusion of ancillary processes where integrally connected; statutory amendments and subsequent rules reiterate the substantive requirement. Interpretation and reasoning: The definition must be read as a whole - neither limb is freestanding. The specific part establishes the essential requirement of nexus with manufacture (directly or indirectly, contained or not in the final product). The inclusive part illustrates categories of goods that, subject to the nexus requirement, may be inputs. The place-of-use qualification ('within the factory of production') further limits eligibility. The Court emphasized that the inclusive categories (e.g., fuel; generation of electricity) become relevant only if the item is used in or in relation to manufacture within the factory. Legislative change in 2004 (restating the requirement in the inclusive limb) confirms that nexus to manufacture remains crucial. Ratio vs. Obiter: Ratio - All three parts must be satisfied for eligibility: (a) the good must fall within the substantive definition (used in or in relation to manufacture), (b) if relied upon as an inclusive illustrative category it must still satisfy the substantive nexus, and (c) place-of-use within the factory is a necessary qualification. Obiter - Examples and policy remarks explaining why legislature included inclusive illustrations (to clarify doubtful categories). Conclusions: Inputs enumerated in the inclusive part are not automatically inputs; they qualify only when used in or in relation to manufacture and within the factory. Therefore, fuel used to generate electricity qualifies only to the extent the generated electricity serves manufacturing activity within the factory. Issue 3 - Applicability of Rule 6 and manner of reversal when inputs are used to produce non-excisable output (electricity) sold outside Legal framework: Rule 6(1) bars credit on inputs used in manufacture of exempted goods; Rule 6(2)/(3) prescribes separate accounts or payment mechanisms where both dutiable and exempted goods are manufactured and contains special clauses for inputs used as fuel and certain exempted categories; Rule 3(4) and Rule 4/5 address utilisation and payment where inputs are removed. Precedent treatment: Authorities interpret Rule 6 to protect CENVAT scheme from subsidy of inputs used for exempted outputs and permit apportionment where both dutiable and exempted goods are made; however electricity as such is not an excisable commodity and Rules have been interpreted in context. Interpretation and reasoning: Electricity generation, when sold outside the factory, is not 'used in or in relation to the manufacture ... within the factory'; the statutory machinery that requires payment/adjustment on removal (Rule 3(4), Rule 4) is engaged when inputs are removed as such. The special provisions in Rule 6 concerning inputs used as fuel reflect practical difficulties of segregation; nonetheless those provisions do not enlarge eligibility where the basic nexus is absent. Because electricity sold outside is a commercial sale, the portion of input attributable to that sale is not eligible for credit. Rule 6's principal purpose is distinct (apportionment where exempted goods are manufactured); it does not provide an entitlement to credit where nexus to manufacture is missing. Ratio vs. Obiter: Ratio - Rule 6 does not save/validate credit for inputs used to generate electricity that is cleared outside the factory; the obligation to deny credit for the portion sold follows from the definition of 'input' and place-of-use requirement. Obiter - Discussion of Rule 6(2)/(3) options and legislative rationale for special treatment of fuel inputs vis-à-vis account-keeping. Conclusions: The assessee must be denied CENVAT credit proportionate to the quantity of input attributable to electricity wheeled out/cleared outside the factory; Rule 6 does not entitle retention of credit for such portion. Issue 4 - Levy of penalty in circumstances of conflicting authorities and repeated amendments Legal framework: General principles of penalty under excise law and recognition of litigation/controversy where legitimate conflicting views exist among tribunals and courts; relevance of legislative amendments creating uncertainty. Precedent treatment: Courts exercise discretion on penalty where honest/conflicting legal positions have been taken by assessees and there is no deliberate attempt to defraud revenue. Interpretation and reasoning: Given frequent amendments to CENVAT Rules and divergent views in appellate fora, assessees may have reasonably taken a legal position later held incorrect. Imposition of penalty in such context - where litigation is widespread and outcomes not uniform - would be harsh and contrary to judicial approach of avoiding penal consequences where bona fide legal disputes exist. Ratio vs. Obiter: Ratio - Penalty not leviable in the present facts where substantial conflict of authority existed and similar litigants succeeded in other fora; the Court exercises discretion to withhold penalty. Obiter - Observations on litigation caused by repeated amendments. Conclusions: No penalty will be imposed on the assessee for taking the disputed CENVAT credit in the circumstances described.