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 manufacture or other purposes (captive consumption). CENVAT credit is not admissible on that proportion of naphtha attributable to electricity sold or supplied to sister units, vendors, joint ventures, or the grid for a price. The assessee was therefore entitled to proportionate credit limited to internal use. However, considering divergent decisions of various HC and tribunals and the prevailing interpretational conflict, SC ruled that no penalty would be leviable on the assessee despite disallowance of part of the credit.

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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.

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