Investment in mutual funds: scope of exempted service expanded by Explanation 3, applied prospectively and credit reversal requires proof of inputs used

Amendment inserting Explanation 3 expanded the scope of "exempted service" under the CENVAT Credit Rules to include activities not previously regarded as services, thereby restricting CENVAT credit availment; this expansion should operate prospectively from 01.04.2016. Investment of idle funds in mutual funds is not a service under the statutory definition unless a person performs an activity for another for consideration, so mere deployment of surplus funds does not constitute a service. For periods after 01.04.2016, revenue must establish that inputs or input services were actually used for the investment activity before invoking the Rule 6 CENVAT credit reversal mechanism.

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Issues: (i) Whether investment in mutual funds by the assessee amounts to trading/exempted service attracting reversal under Rule 6 of the CENVAT Credit Rules, 2004; and (ii) whether Explanation 3 inserted to Rule 6 by Notification No.13/2016-C.E.(N.T.) is to be given retrospective or prospective effect.

Analysis: The Tribunal examined the nature of mutual fund transactions and distinguished them from stock exchange trading, noting NAV-based pricing, creation/extinguishment of units by the mutual fund, absence of buyer-seller matching, and lack of transfer of underlying securities or market-driven price discovery. It held that the activity of investing idle funds in mutual funds does not satisfy the conditions of trading or provision of a "service" by the investor under Section 65B(44), and therefore does not fall within the pre-amendment scope of exempted services under Rule 2(e). The Tribunal further analysed Notification No.13/2016-C.E.(N.T.) which inserted Explanation 3 to Rule 6, observing the notification contained no retrospective clause and introduced a new restriction; hence it is not a declaratory or curative amendment and should operate prospectively from 01.04.2016. For the post-amendment period, the Tribunal noted Revenue failed to prove that inputs or input services were used for the alleged exempted activity; the assessee consistently stated no input services were used for investment activity and no documentary evidence was produced by Revenue to the contrary.

Conclusion: The investment in mutual funds by the assessee is not trading or an exempted service for the periods prior to 01.04.2016 and demands for those periods are unsustainable. The Explanation 3 inserted by Notification No.13/2016-C.E.(N.T.) is to be applied prospectively from 01.04.2016. For the period from 01.04.2016 onwards, Revenue failed to establish use of inputs or input services for the alleged exempted activity; consequently the impugned demands for that period are also unsustainable. The impugned order is set aside and the appeals are allowed in favour of the assessee.

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