Cenvat credit on inputs for exempt goods is recoverable, but penalty is not automatic on the facts.

Cenvat credit on inputs used to manufacture wholly exempt final products was held not allowable, even if the credit was originally taken when the product was dutiable, because the governing rules expressly barred credit for inputs used in exempted goods and permitted recovery of wrongly availed credit. The demand for reversal was treated as within limitation since the notice was issued within one year of such utilisation. Penalty was not imposed, as the facts did not justify it. The substantive recovery was sustained, while the penalty was set aside.

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Issues: (i) Whether Cenvat credit already taken on inputs was liable to be reversed when the finished product subsequently became wholly exempt from duty. (ii) Whether the demand was barred by limitation and whether penalty was imposable.

Issue (i): Whether Cenvat credit already taken on inputs was liable to be reversed when the finished product subsequently became wholly exempt from duty.

Analysis: The credit had been taken when the final product was dutiable, but the inputs in question were later used in the manufacture of goods that had become wholly exempt from duty. On a harmonious reading of the Cenvat scheme, the credit mechanism operates only where the final product bears excise duty, and the specific provision excluding credit on inputs used in exempted goods applied. The earlier decisions relied upon by the assessee were held inapplicable because the governing rules now contained an express bar and a recovery mechanism for wrongly utilised credit.

Conclusion: The credit was not allowable in respect of inputs used for the manufacture of wholly exempted goods, and recovery of such credit was justified, in favour of Revenue.

Issue (ii): Whether the demand was barred by limitation and whether penalty was imposable.

Analysis: The recovery related to the utilisation of inputs in the manufacture of exempted goods, and the notice was issued within one year of such utilisation. The Tribunal therefore treated the demand as within time. However, in the facts and circumstances, it found no basis for imposition of penalty.

Conclusion: The demand was within limitation, but penalty was not imposable, partly in favour of the assessee.

Final Conclusion: The substantive demand for reversal and recovery of Cenvat credit was sustained, while the penalty was set aside, resulting in a partial success for both sides.

Ratio Decidendi: Where inputs are used in the manufacture of wholly exempted final products, Cenvat credit attributable to such inputs is not allowable and may be recovered under the governing rules, even if the credit was originally taken when the final product was dutiable; penalty, however, is not automatic and depends on the facts of the case.

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