Modvat credit on fuel used to generate captively consumed steam remains available despite the intermediate product's exempt status.

Modvat credit was admissible on furnace oil, low sulphur heavy stock and light diesel oil used as fuel to generate steam for captive consumption in manufacture of the final products. The fact that steam was an intermediate product and exempt did not defeat credit, because the inputs were used in the manufacturing stream and Rule 57D protected credit in such circumstances. The penalty imposed under the Central Excise Rules also failed, as it rested entirely on the unsustainable denial of credit and no independent basis remained to sustain it.

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Issues: (i) Whether Modvat credit was admissible on furnace oil, low sulphur heavy stock and light diesel oil used as fuel to generate steam, where the steam was an intermediate product captively consumed in the manufacture of the declared final products; (ii) whether the penalty imposed under the Central Excise Rules could survive if the denial of Modvat credit was unsustainable.

Issue (i): Whether Modvat credit was admissible on furnace oil, low sulphur heavy stock and light diesel oil used as fuel to generate steam, where the steam was an intermediate product captively consumed in the manufacture of the declared final products.

Analysis: The inputs were used in the course of manufacture and the steam generated from them was not an end in itself but an intermediate product used within the factory in the line of manufacture of the final products. The amendment bringing inputs used as fuel within the Modvat scheme, together with Rule 57D(2), protected credit where an intermediate product emerged in the manufacturing stream, even if that intermediate product was exempt. The denial based on the exempt nature of steam was therefore unsustainable.

Conclusion: Modvat credit was admissible and the disallowance of credit was incorrect.

Issue (ii): Whether the penalty imposed under the Central Excise Rules could survive if the denial of Modvat credit was unsustainable.

Analysis: The penalty was founded on the same disallowance of credit. Once the credit demand failed in law, the foundation for penalty disappeared. No independent basis for sustaining the penalty remained.

Conclusion: The penalty could not be sustained.

Final Conclusion: The order denying Modvat credit and imposing penalty was set aside, and the assessee succeeded in full.

Ratio Decidendi: Inputs used as fuel for generating an intermediate product captively consumed in the manufacture of final products remain eligible for Modvat credit, and exemption of the intermediate product does not by itself defeat the credit where Rule 57D applies.

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