Rule 14 of CENVAT Credit Rules – A Pandora’s box of litigation

The CENVAT Credit Rules, 2004 (‘CCR’) have evolved as a scheme over a period of ten years. Through Rule 14 of CCR, the scheme provided for recovery of wrongly availed CENVAT Credit. As introduced, Rule 14 of CCR provided that where CENVAT credit is wrongly availed or utilized or has been erroneously refunded, the same shall be recoverable along with interest. For legitimizing recovery under Rule 14, the legislature borrowed Section 11A & Section 11AB of Central Excise Act 1944 (‘the Act’). Thus, all recovery proceedings prescribed for recovery of excise duty equally applied for recovery of CENVAT Credit.

Lineage of the issue

As per the provision, recovery could be initiated if CENVAT Credit was wrongly availed or utilized. Thus, interest that should only be a consequence of a tax demand was eventually levied even in case where CENVAT Credit was taken wrongly but not utilized.

Even in case where CENVAT Credit was merely a book entry as it stood availed but not utilized, assessee was liable to pay interest. In the case of M/s Ind-Swift Laboratories Ltd Vs CCE – 2009 (240) ELT 328 (P&H), the Hon’ble High Court of Punjab & Haryana interpreted Rule 14 of CCR by noting that interest has compensatory character and liability to pay duty does not arise when credit is availed but arises in circumstances when the same is utilized. Thus, interest liability commences only in circumstances when the CENVAT Credit is utilized wrongly.

The aforesaid position was reversed by the Hon’ble Supreme Court of India in UOI Vs Ind-Swift Laboratories Ltd – 2011 (265) ELT 3 (SC) and held that the High Court had wrongly applied the principle of harmonious construction while reading Rule 14 of CCR along with Section 11AB of the Act. It was held that Rule 14 was wrongly read wherein the word “OR” was replaced by “AND” between the expressions “taken” and “utilized wrongly”. The Apex Court held that Rule 14 of CCR required strict construction wherein “AND” cannot replace “OR” to read down the provision. Accordingly, the Supreme Court laid that interest shall be recoverable from the date of wrongful availment of CENVAT credit.

However, the Hon’ble High Court of Karnataka in the case of CCE Vs Bill Forge Pvt. Ltd. – 2012 (279) ELT 209 (Kar) in slightly different set of facts distinguished the aforesaid decision of Supreme Court. The question before the Hon’ble High Court in current case was whether interest was payable where CENVAT credit was taken wrongly and reversed within a period of three months. The High Court held that when CENVAT Credit is availed, it represents a book entry/ an entitlement of the assessee to utilize the amount at a later stage to discharge its tax liability. Once the entry itself is reversed before utilization, there cannot be any availment of CENVAT Credit. Consequently, it was held by the High Court that where CENVAT credit is availed but not utilized and has been reversed before utilization stage has reached, interest shall not be leviable.

Amendment in the statute

The aforesaid decisions led to wide spread confusion in the industry upsetting litigation policies where CENVAT credit was disputed across industry. This confusion was cleared by the Central Government in Finance Bill, 2012. The amendment was exactly on the findings of Hon’ble Supreme Court in Ind-Swift Laboratories Ltd. case (supra). The replacement of word “OR” with “AND” between the expressions “taken” and “utilized wrongly”. Thus with effect from 01 April 2012, Rule 14 of CCR was read as under:

“RULE 14. Recovery of CENVAT credit wrongly taken or erroneously refunded. — Where the CENVAT credit has been taken and utilized wrongly or has been erroneously refunded, the same along with interest shall be recovered from the manufacturer or the provider of the output service and the provisions of sections 11A and 11AA of the Excise Act or sections 73 and 75 of the Finance Act, shall apply mutatis mutandis for effecting such recoveries.”

Going by the timing of the amendment, it was clear that there was a conscious effort on the part of the law makers to settle all disputes emanating from the decisions discussed above with regard to applicability of interest on CENVAT credit wrongly availed but not utilized. The Central Government seemed to be of the same view as the High Court of Karnataka in the case of Bill Forge Pvt. Ltd. It seemed that the Central Government as well did not want to burden the assessee for making an erroneous book entry.

The amendment did settle the aforesaid dispute of interest but everyone ignored that Rule 14 of CCR is not only the mechanism for recovery of interest but it is a mechanism for recovery of CENVAT credit which has been wrongly availed.

This minor amendment of 01 April 2012 paved way for a new litigation with respect to applicability of recovery provision itself. The following questions remain unanswered:

What would lead to initiating the recovery?
Would it be wrongful availment or wrongful availment along with wrongful utilization?
We were fortunate to handle one of such litigation wherein such dispute arose. A demand was issued against an assessee who had wrongly availed the CENVAT credit but did not utilize the same. The CENVAT credit was lying unutilized in assesse’s books of accounts at the time the demand notice was issued.

The assesse contested that recovery proceedings can only be initiated in circumstances where CENVAT Credit has been wrongly availed & utilized. Thus Rule 14 of CCR cannot be invoked for CENVAT Credit that is wrongly availed but has not been utilized. The Hon’ble CESTAT in the current case granted complete waiver of pre–deposit on merits of the case, however, on other grounds but was all ears for the aforesaid argument during the stay proceedings.

A strict & literal interpretation of the aforesaid provision would restrict the recovery mechanism that can only be initiated in case of CENVAT Credit been wrongly utilized. Consequently, an assessee could always avail CENVAT Credit (disputed in similar circumstance of any other assesse) keep it unutilized for eternity until such dispute concludes. Once dispute concludes, the assessee shall have an option to continue keeping such CENVAT Credit or subsequently reverse it. In either case, there should be no adverse situation for the assesse (except Income Tax Department considering the reversed portion of CENVAT Credit as prioir period expense).

Dawn of new litigation

Through Finance Bill 2015, Rule 14 of CCR was amended as under:

“RULE 14. Recovery of CENVAT credit wrongly taken or erroneously refunded

(1) (i) Where the CENVAT credit has been taken wrongly but not utilized, the same shall be recovered from the manufacturer or the provider of output service, as the case may be, and the provisions of Section 11A of the Excise Act or Section 73 of the Finance Act, 1994, as the case may be, shall apply mutatis mutandis for effecting such recoveries;

(ii) Where the CENVAT credit has been taken and utilized wrongly or has been erroneously refunded, the same along with interest shall be recovered from the manufacturer or the provider of the output service and the provisions of sections 11A and 11AA of the Excise Act or sections 73 and 75 of the Finance Act, shall apply mutatis mutandis for effecting such recoveries.”

(2) For the purpose of sub-rule (1), all credits taken during a month shall be deemed to have been taken on the last day of the month and the utilization thereof shall be deemed to have occurred in the following manner, namely:

i. The opening balance of the month has been utilized first;

ii. Credit admissible in terms of these rules taken during the month has been utilized next;

iii. Credit inadmissible in terms of these rules taken during the month has been utilized thereafter;

In a nutshell, the intention of the legislature in the above case seemed that recovery mechanism should be in place for wrongly availed CENVAT Credit that remains unutilized. Further, such recovery should be without interest. However, in case CENVAT Credit is wrongly availed and utilized, then the amount should be recovered along with interest. The above position as was by High Court of Karnataka in the case of Bill Forge Pvt. Ltd. as well (supra).

It’s interesting to understand the above provision by applying some numbers:

For the sake of this example, we have bifurcated the amount of credit availed into two parts i.e. credit rightly availed of Rs. 60 and inadmissible credit of Rs. 20. In the month of March 2015, the assesse availed CENVAT Credit for INR 160 and utilized INR 110. Thus, closing balance of CENVAT Credit amounted to INR 50 (out of which INR 20 is inadmissible).

In the month of April 2015, opening balance of CENVAT Credit is INR 50, CENVAT Credit for the month of April 2015 is INR 70 and output liability is INR 120/-

The above utilization provision specifically mandates that CENVAT Credit availed till last date of the month can only be utilized for discharging tax liability of that particular month on 6th of subsequent month. Further, Rule 14(2) mandates that all credit availed in a month shall be deemed to be availed on the last month. Therefore, it would be presumed that the INR 120 of output liability for the month of April 2015 is discharged by first consuming the opening balance of CENVAT Credit i.e. INR 50/-.

Therefore, even in current case, where assesse has closing balance of INR 40 (out of which it may be considered that INR 20 is inadmissible), the assesse would eventually be charged interest for utilizing INR 20/- for discharging April 2015 liability.

Therefore, it is pertinent that the Government comes out with clarification whether it intends to follow the Supreme Court in the case of Ind – Swift Laboratories Ltd. and charge interest on mere wrong availment of CENVAT Credit or is it in favour of the decision in the case of Bill Forge Pvt. Ltd. and has merely failed to express the same in words. It is high time that law makers amend Rule 14 of CCR in the upcoming Budget or it will definitely open a Pandora’s box of unending litigation.

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Authored by Partner, Mimansa Law Offices and Ujjwal Pawra, Senior Manager, International Business Advisors. Bhishma can be reached at bhishm.ahluwalia@gmail.com and Ujjwal can be reached at ujjwal.pawra@ibadvisors.co
International Business Advisors (www.ibadvisors.co) is a boutique audit, tax and consulting firm run by ex-BIG4 professionals and working extensively with multinational companies operating in varied sectors including e-commerce, mobile, manufacturing, real-estate and hospitality. IBA operate out of its offices in Delhi, Mumbai and Bangalore.

Mimansa Law Offices is the legal arm of International Business Advisors that manages all tax litigations at CESTAT, High Court and Supreme Court. IBA along with Mimansa have litigated on various matters at different courts.