Reversal of wrongly taken Cenvat credit can satisfy a conditional exemption, but interest and penalty may still survive.

Full reversal of wrongly taken Cenvat credit after detection was treated as non-availment for purposes of the conditional exemption under Notification No. 1/2006-ST, so the service tax demand was set aside. The credit had been disclosed in ST-3 returns and the breach appeared inadvertent rather than deliberate, supporting the exemption claim. However, reversal only after wrongful availment did not erase liability for the period during which the credit remained utilised, so interest remained payable up to the date of reversal. Penalty was also sustained because the exemption condition had been breached, resulting in only partial relief.

---

---

Issues: (i) Whether reversal of the entire Cenvat credit after detection and before final adjudication entitled the assessee to the benefit of the conditional exemption under Notification No. 1/2006-ST. (ii) Whether interest and penalty remained payable despite reversal of credit.

Issue (i): Whether reversal of the entire Cenvat credit after detection and before final adjudication entitled the assessee to the benefit of the conditional exemption under Notification No. 1/2006-ST.

Analysis: The assessee had disclosed the availment and utilisation of Cenvat credit in ST-3 returns, and the demand arose only on scrutiny of those returns. The credit was subsequently reversed in full. In such circumstances, the availment was treated as an inadvertent error rather than a deliberate breach. Reversal of the wrongly taken credit was treated as having the effect of non-availment of credit, so the condition attached to the exemption notification stood satisfied.

Conclusion: The assessee was held entitled to the benefit of the exemption notification, and the demand of service tax was set aside.

Issue (ii): Whether interest and penalty remained payable despite reversal of credit.

Analysis: Although the credit was reversed, it was reversed only after being taken and remained available for a period during which the assessee was required to pay interest for the period of wrongful availment till reversal. The breach of the notification condition also justified imposition of penalty.

Conclusion: Interest for the period of availment till reversal and penalty were held payable.

Final Conclusion: The appeal succeeded only to the extent of setting aside the service tax demand, while the liability to interest for the intervening period and penalty was sustained, resulting in a partial allowance of the appeal.

Ratio Decidendi: Where a conditional exemption is linked to non-availment of credit, full reversal of the wrongly taken credit can amount to non-availment for the purpose of the exemption, but such reversal does not by itself extinguish liability to interest for the period of wrongful availment or to penalty where the condition has been breached.

---