In the recent past, several judicial pronouncements have emerged in the field of CENVAT credit. Shorn off the legalese, the core issue in all these pronouncements boils down to this question – should credit be available for any tax cost (on any goods or services procured on the input side) that forms a part of the value of the final output (whether manufacture of goods or provision of services) or should it be restricted only to the tax costs on goods and services that have an integral connection/nexus with the output of manufacture of goods or provision of services.

To illustrate, a life insurance service for employees may not have an integral connection / nexus with the activity of manufacture, but the manufacture would certainly build the cost of the same in the value of the goods manufactured and sold by him. The issue that begs consideration is whether credit of such services should be allowed or not.

Given the phraseology and the declared objective of the CENVAT Credit Rules, both the above interpretations appear tenable. While the judiciary may arrive at the correct interpretation of the existing CENVAT Credit Rules in due course, the objective of this article is to discuss the ‘ought' and not the ‘is' in this context.

A ‘value added tax' regime is considered laudable from a fiscal policy perspective given such regime's key economic trait of neutrality. As per the relevant OECD guidelines, it is the full right to deduction of input tax through the supply chain, with the exception of the final consumer, that ensures the neutrality of a value added tax, whatever the nature of the product, the structure of the distribution chain and the technical means used for its delivery – clearly, an unhindered flow of credit throughout the supply chain is an essential feature of a ‘value-added tax'.

While India is not a signatory to the OECD model, it is trite to point out that both service tax and excise duty are intended to be value-added taxes and the CENVAT Credit Rules is the mechanism intended to achieve a ‘value-added tax' regime for excise and service tax. In this regard, reference may be had to the Supreme Court decision in the case of All India Federation of Tax Practitioners and the clarificatory circular of the CBEC clearly stating that “Service Tax like CENVAT (i.e. excise duty) is basically a value added tax which is operated through credit mechanism."

It is in the light of the points crystallised in the foregoing paragraph, that the Bombay High Court in the Coca-Cola decision upheld the principle that credit should be available for any tax cost (on any goods or services procured on the input side) that forms a part of the value of the final output. However, given the extant phraseology of the CENVAT Credit Rules, the Bombay High Court (in the case of Ultratech Cements) had to partially qualify its pronouncement in the Coca-Cola decision and lean in favour of the restrictive interpretation that the benefit of credit should be restricted only to those tax costs that are integrally connected with the output of manufacture of goods or provision of services. Given these divergent pronouncements, there is ambiguity in the mind of the trade as to what would be the apt touchstone for determination of legally tenable availment of credit.

The above backdrop presents an opportunity for Budget 2011 to eliminate the above ambiguity and push towards a closer approximation of an ideal ‘value added tax' regime by amending the CENVAT Credit Rules to clearly specify that credit should be available for any tax cost that forms a part of the value of the final output. Not only would this ease out the existing credit woes for the taxpayers, it would also be consonant with the fiscal policy objective of achieving a ‘value added tax regime'. Further, such a move would also make it easy to transition into the unhindered credit regime envisaged under GST.

comment COMMENT NOW