Modvat credit on inputs sold after non-manufacturing processing remains recoverable, while penalty needs an independent basis.

Modvat credit is not retained where duty-paid inputs are only cut into pieces, a process not amounting to manufacture, and are then sold without being used in or in relation to manufacture of the final product. In that situation, under the proviso to Rule 57F(1), duty on removal cannot be less than the credit already allowed under Rule 57A, so credit equivalent duty remains payable, subject to adjustment of duty already paid. Penalty does not follow automatically from the duty demand and requires an independent factual basis; on these facts, the record did not justify penal action.

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Issues: (i) Whether Modvat credit was admissible when the inputs, after being cut into pieces, were sold without being used in the manufacture of the final product; (ii) Whether penalty was imposable in the facts of the case.

Issue (i): Whether Modvat credit was admissible when the inputs, after being cut into pieces, were sold without being used in the manufacture of the final product.

Analysis: The inputs were HDPE/PP fabrics and the final product was HDPE/PP sacks. The only process carried out was cutting the rolls into pieces of required sizes, which did not amount to manufacture. The pieces were then sold instead of being used in the manufacture of sacks. On these facts, the inputs were not used in or in relation to manufacture, and under the proviso to Rule 57F(1) of the Central Excise Rules the duty payable on removal could not be less than the credit already allowed under Rule 57A of the Central Excise Rules.

Conclusion: Modvat credit was not retained as such on removal of the inputs, and duty equivalent to the credit was payable, in favour of Revenue.

Issue (ii): Whether penalty was imposable in the facts of the case.

Analysis: The conduct involved only the cutting of fabrics and sale of the cut pieces, without any finding of dishonest conduct or violation warranting penal action. In these circumstances, the demand for duty and the question of penalty stood on different footing, and the record did not justify imposition of penalty.

Conclusion: Penalty was not imposable, in favour of the assessee.

Final Conclusion: The duty demand to the extent of the Modvat credit was sustained, subject to adjustment of any duty already paid, while the penalty was set aside.

Ratio Decidendi: Where inputs taken on Modvat credit are not used in manufacture and are instead sold after only a process not amounting to manufacture, the duty on their removal cannot be less than the credit allowed; penalty requires an independent basis and cannot follow mechanically.

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