Admissibility of Cenvat Credit on material used in testing of finished goods

PJ/Case Study/2011-12/41

CASE STUDY

Prepared By:
CA Pradeep Jain
CA Nishit Shah and
Sukhvinder Kaur LLB [FYIC]

Introduction:-

Under the Modvat scheme, credit will be available on goods which are inputs and which are used in or in relation to the manufacturing activity. The goods used as inputs can be ultimately included in finished goods or are used during the manufacturing activity. Therefore, the stage of testing the finished good can also be said to be a process in relation to manufacture and the inputs used for testing of the finished goods can be said to be inputs on which cenvat credit will be admissible, are the issues raised in the case under study.

M/s Flex Engineering Limited v/s Commissioner of Central Excise, U.P.
[2012-TIOL-01-SC-CX]

Brief Facts:-

- Appellant are engaged in the manufacture of various types of packaging machines which are marketed as Automatic form fill and seal machines falling under heading 8422.00. They claim to be pioneers in the concept of flexible packaging. From literature on record, it appears that appellant has prototype models of F7S machines with technical details like web width, Roll diameter, Core diameter, typical material range, the type of material to be packed, etc. As per appellant, the machines are ‘made to order’, inasmuch as all the dimensions of the packaging/sealing pouches, for which the F7S machine is required, are provided by the customer.

- The matter relates to period between August 1992 to June, 1996.

- The purchase orders contained an inspection clause which stipulated that the inspection/trial of the machines will be carried out in the premises of the appellant in the presence of purchaser’s engineer before dispatch of the machinery. For the testing, tuning and adjusting various parts of the F&S machine as per conditions, Flexible Laminated Plastic Film in roll form & Poly Paper on which duty was paid falling under heading 3920.38 and 4811.30 were used. If the desired result was obtained then the entry was made in RG-1 register declaring the machine as manufactured and ready for clearance. If any deficiency was found then the delivery of the same was done only after re-adjustment and tuning to make it match with the required size of the pouches as per purchaser’s requirement.

- Appellant filed declarations and availed Modvat credit in respect of Flexible laminated Plastic Film in roll form & Poly Paper used for testing the F7S Machine.

- Department issued Show cause notice dated 04.03.1993 proposing to deny the Modvat credit on the said goods on the ground that the appellant have used the said material for the purpose of testing the final product which cannot be treated as inputs as stipulated in erstwhile Rule 57A of the Central Excise Rules, 1994. Show cause notices were also issued for the period from August, 1992 to June 1996.

- The Adjudicating Authority denied the Modvat credit on the said items. Appeal before the Commissioner (Appeals) and later the Tribunal were also dismissed. Aggrieved the appellant filed applications for reference to the High Court, which failed. Thereafter, appellant moved High Court seeking direction to the Tribunal for reference.

- The High Court partly allowed the application and directed the Tribunal to draw statement of the case and refer the following questions of law for its opinion:

Question No. 1: Whether, in the circumstances of the present case, facts of which are not in dispute, duties paid on material, namely, plastic films/poly paper used for testing machines for forming commercial/technical opinion as to their marketability/excisability would be eligible to be taken as credit (sic) under Rule 57-A read with relevant notification?

Question No. 2: Whether such use of material in testing in view of the purposes mentioned above, could be said to be used (sic) in the manufacture of or use in relation to the manufacture of the final products viz., machines as assembled?

- The High Court answered both the questions in the negative. The Court was of the opinion that testing the performance of a final product is not a process of manufacture and therefore, materials used for testing the performance of the F7S machine cannot be termed as ‘inputs’ for the purpose of allowing Modvat credit. According to the High Court, anything required to make the goods marketable must form a part of the manufacture and any raw material or any materials used for the same would be a component part of the end product, viz. the F7S machine, is complete, is only to detect the deficiency in the final product and therefore, could not be the goods used in or in relation to the manufacture of the final product within the meaning of Rule 57A of the Rules.

- Hence, appellant is before the Supreme Court.

Appellant’s Contention:-

- Appellant submitted that the expression “in or in relation to” used in Rule 57A of the Rules is very wide and is used to expand the scope, meaning and content of the expression ‘inputs’ so as to include all inputs so long as these are used “in or in relation to the manufacture” of finished excisable goods.

- It was argued that since the machines are tailor made, as per the specifications provided by a customer to achieve a distinct and different result, it is of no used to any other customer. Therefore, unless each individual machine is tested by using the flexible plastic films in the presence of the customer or his representative, as per the terms of the contract, to satisfy him it is capable of being used for a particular packing as specified by him, the process of manufacture of the final product cannot be said to be complete.

- It was contended that the testing of the machine being an integral process of the manufacture and marketability of the final product, particularly in terms of the specific condition in the contract, the claim for Modvat credit was admissible on flexible plastic films consumed in the testing of the F&S machines. It was stressed that to avail of the Modvat credit in respect of an input, it is not necessary that such inputs must be physically present in the finished product.

- In support of the proposition that material used in testing, for the purpose of verification of certain characteristics of the final product, is an input in or in relation to the manufacture, appellant relied upon the decisions of the Supreme Court in the following cases:

1. Commissioner of Income Tax, Kerala v/s Tara Agencies [2007-TIOL-124-SC-IT]

2. Maruti Suzuki Ltd v/s Commissioner of Central Excise, Delhi-III [2009 (240) ELT 641 (SC)]

3. National Leather Cloth Manufacturing Company v/s Union of India & Anr [2010 (256) ELT 321 (SC)]

And reliance was placed on the decision of Bombay High Court in the case of Tata Engineering & Locomotive Co. Ltd v/s Commr. of C. Ex, Pune [2010 (256) ELT 56 (Bom)]

Revenue’s Contention:-

- Revenue contended that Modvat credit is available only on the inputs which are actually used in the manufacture of the final product. The testing of a machine can take place only after the manufacture of the machine is complete and therefore, any goods used in a process subsequent to the completion of the process of manufacture cannot be termed as inputs within the meaning of Rule 57A of the Rules.

Reasoning of the Supreme Court:-

- The Supreme Court observed that Modvat scheme introduced w.e.f. 1^st March 1986, was aimed at allowing credit to the manufacturers for the excise duty paid by them in respect of the inputs used in the manufacture of the finished product. The provisions of Rule 57A and 57C which make a manufacturer eligible to avail of the credit of duty paid on the inputs were perused.

- It was held that it is manifest that Rule 57A of the Rules entitled a manufacturer to take credit of the Central Excise duty paid on the inputs and the finished product are excisable goods and fall under any of the specified chapters in the tariff schedule. It was noted that vide Notification No. 28/95-CE(NT) dated 29.06.1995, the said Rules was amended and the phrase “whether directly or indirectly and whether contained in the final product or not” was inserted.

- It was held that there is no dispute that in the instant case, both the F&S machines and the flexible laminated plastic film and poly paper are excisable. Therefore, the short question to decide was whether the said material on which Modvat credit is claimed by the assessee, not physically used in the manufacture of the said machine but used for testing the F&S machines would be covered within the sweep of the expression “in or in relation to the manufacture of the final products”, as appearing in Rule 57Aof the Rules. The question involved in what meaning is to be assigned to the expression “in relation to the manufacture of final products”.

- In opinion of the Supreme Court, apart from the fact that the amended Rule itself contemplates that that physical presence of the input, in respect of which Modvat credit is claimed, in the final product is not a pre-requisite for such a claim, even otherwise this issue is no longer res-integra. It was noted that the Court in the case of Collector of Central Excise & Ors v/s Solaris Chemtech Ltd & Ors [2007 (214) ELT 481 (SC)] while examining the scope and purport of the expression “in or in relation to the manufacture of the final products” observed that these words have been used to widen and expand the scope, meaning and content of the expression “inputs” so as to attract goods which do not enter into finished goods.

It was observed in this judgment that the expression “in the manufacture of goods” indicates the use of the input in the manufacture of the final product. It normally covers the entire process of converting raw materials into finished goods such as caustic soda, cement etc. But the expression also covered inputs “used in relation to the manufacture of final products”. It was noted that the said expression i.e. “in relation to” also finds place in the extended definition of the word “manufacture” in Section 2 (f) of the Central Excise and Salt Act, 1944. It was held that the expression “in relation to” must be given wide connotation because of this. It was held that the words “in relation to the manufacture” have been used to widen and scope, meaning and content of the expression “inputs” so as to attract goods which do not enter into finished goods. Reliance was placed on the judgment given in J. K. Cotton Spg. & Wvg. Mills Co. Ltd v/s STO [2002-TIOL-116-SC-CT].

- The judgment given in Collector of Central Excise, Jaipur v/s Rajasthan State Chemical Works, Deedwana, Rajasthan [1991 (55) ELT 444 (SC)] was also examined which was referred to in Solaris Chemtech Limited’s case. In that judgment it was held that any operation which results in the emergence of the manufactured goods would come within the ambit of the term manufacture. This is because of the words used in Rule 57A, namely, goods used in or in relation to the manufacture of final products.

- Reference was also made to Board Circular No. 33/33/94/CX.8 dated 04.05.1994 relating to Modvat scheme wherein it was clarified that Modvat credit is available for all excisable goods used as inputs in or in relation to the manufacture of finished goods. It is therefore, clarified that the input credit is admissible whether such input is physically present in the finished excisable goods or not so long such inputs are used in or in relation to the manufacture of finished excisable goods. In this regard the definition of the term Manufacture given in judgment of the Supreme Court in Empire Industry’s case [1985 (20) ELT 179] and in CCE v/s Rajasthan state Chemical case [2002-TIOL-66-SC-CX] were said to be relevant.

- The Supreme Court held that it is trite to state that “manufacture” takes place when the raw materials undergo a series of changes and transformation that result in the formation of a commercially distinct commodity having a different name, character and use. It is equally well settled that physical presence of an input in the final finished excisable goods is not a pre-requisite for claiming Modvat credit under Rule 57A of the Rules. It may very well be indirectly related to manufacture and still be necessary for the completion of the manufacture of the final product. It needs little emphasis that the process of manufacture is complete only when the product is rendered marketable. Thus, manufacture is intrinsically integrated with marketability. In this regard, the observations made in judgment of Union of India & Ors v/s Sonic Electrotherm (P) Ltd & Anr [2002-TIOL-212-SC-CX].It was held that it is difficult to lay down a precise test to determine marketability of articles. Marketability of goods has certain attributes. The essence of marketability is neither in the form nor in the shape or condition in which the manufactured articles are to be found, it is the commercial identity of the articles known to the market for being bought and sold. The fact that the product in question is generally not being bought and sold or has no demand in the market would be irrelevant.

- Reliance was placed on judgment given in Collector of Central Excise, Calcutta-II v/s Eastend paper Industries Ltd [2002-TIOL-379-SC-CX] wherein it was held that wrapping of finished products by wrapping paper is process incidental and ancillary to completion of the manufactured product under Section 2 (f) of the Act. Thus, The Court held that, anything required to make goods marketable, must form a part of manufacture and any raw material or any material used for same would be a competent part of the final product.

- It was noted that in the judgment given in Dharanpal Satyapal v/s Commissioner of central Excise, Delhi-I, New Delhi [2005-TIOL-75-SC-CX-LB] the term marketable has been held to mean saleable. It was held that “..Marketability is an attribute of manufacture. It is an essential criteria for charging duty. Identity of the product and marketability are the twin aspects to decide chargeability. Dutiability of the product depends on whether the product id known to the market. The test of marketability is that the product which is made liable to duty must be marketable in the condition in which it emerges. Marketable means saleable. The test of classification is, how are the goods known in the market.”

- It was held that thud, if a product is not saleable, it will not be marketable and consequently the process of manufacture would not be held to be complete and duty of excise would not be leviable on it. The corollary to the above is that till the time the step of manufacture continues, all the goods used in relation to it will be considered as inputs and thus, entitled to Modvat credit under Rule 57A of the Rules. In the present case, each machine is tailor made according to the requirements of individual customers. If the results are not in conformity with the order, then the machine loses its marketability and is of no use to any other customer. Thus, the process of manufacture will not be said to be complete till the time the machines meet the contractual specifications and that will not be possible unless the machines are subjected to individual testing. Even though the revenue has alleged that the process of manufacture is complete as soon as the machine is assembled, yet it has not discharged the onus of proving the marketability of the machines thus assembled, prior to the stage of testing. Moreover, as has been held in the case of Hindustan Zinc Ltd v/s Commissioner of Central Excise, Jaipur [2005-TIOL-39-SC-CX-LB], the burden of proving whether a particular product is marketable or not is on the department and in the absence of such proof it cannot be presumed to be marketableng adduced any such evidence or contorted the assessee’s claim that the machines cannot be sold unless testing is done with some alternative evidence as to their marketability, the stand of Revenue in the absence of evidence cannot be accepted.

- Thus, the Supreme Court held that the process of testing the customized F & S machines is inextricably connected with the manufacturing process, in as much as, until this process is carries out in terms of the afore-extracted covenant in the purchase order, the manufacturing process is not complete; the machines are not fit for sale and hence not marketable at the factory gate. The Court was, therefore, of the opinion that the manufacturing process in the present case gets completed on testing of the said machines and hence, the afore-stated goods viz. the flexible plastic films used for testing the F7S machines are not fit for sale and hence not marketable at the factory gate. Thus, the opinion of the Court was that the manufacturing process in the present case gets completed on testing of the said machines and hence, the afore-stated goods viz. the flexible plastic films used for testing the F7S machines are inputs used in relation to the manufacture of the final product and would be eligible for Modvat credit under Rule 57A of the Rules.

- In the end the Court held that the opinion rendered by the High Court on questions referred was not sustainable. It was held that the process of testing the customized machines is integrally connected with the ultimate production of the final product viz. the F&S machines and therefore, that process is one in relation to the manufacture, falling within the sweep of Rule 57A of the Rules.

Decision of the Supreme Court:-

Impugned orders set aside. Appeals allowed.

Conclusion:-

This is landmark judgment of the Apex Court. The testing of the final product has been held to be a process integrally connected with final production of the finished goods and it was held that the process is one in relation to the manufacture. Thus, the modvat credit of duty paid on goods used for testing the customs made machinery/goods will be available to the assessee. It is rightly held that marketability is one of the test to hold the goods falling under definition of “manufacture” under the Act and unless the product is marketable the process utilized till that stage will be in relation to manufacture of goods.

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PJ/CASE STUDY.2011-12/41
18 January 2012

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PJ/CASE STUDY.2011-12/41
18 January 2012