CMA Vignesh R, Chennai

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Background:

Not all manufacturers are fully equipped to manufacture and supply a particular product. Therefore,they send the semi-processed material or their raw materials to a job worker for carrying out the intermediate job work process. This is subject to certain procedures prescribed under Excise rules governing the movement of materials from and to the factory.

The Job work Process:

One such process undertaken by Job Worker is ‘machining’ of components which includes drilling, milling, boring, facing, etching etc. During this process, scraps are generated which in most of the cases are not taken back by the principal manufacturer. This is a widespread industrial practice as the scrap has no utility to the principal manufacturer. This residual scrap in the job workers place gets accumulated over time and is generally sold in the market for a nominal consideration by the job worker.

Liability of Excise on Scrap:

It is a common perception that sale of scrap is an excisable event. This is based on the twin considerations that it arises out of manufacture and that there is a separate HS code under the Central Excise tariff Act.

Here, one must appreciate that all scraps are not subject to Excise duty. Only Scraps that are generated from a manufacturing activity are subject to Excise duty.

What does the Charging section say?

As per the charging section (Section 3) of the Central Excise Act 1944, Excise duty will be levied and collected on all excisable goods that are produced or manufactured in India as per the rates specified under the Central Excise Tariff Act, 1985.

Now let us see what is manufacture?

As per section 2(f) of the Central Excise Act, 1944, “Manufacture” includes any process-

i) incidental or ancillary to the completion of a manufactured product;

ii) which is specified in relation to any goods in the Section or Chapter notes of the First Schedule to the Central Excise Tariff Act, 1985 (5 of 1986) as amounting to manufacture; or

iii) which, in relation to the goods specified in the Third Schedule, involves packing or repacking of such goods in a unit container or labelling or re-labelling of containers including the declaration or alteration of retail sale price on it or adoption of any other treatment on the goods to render the product marketable to the consumer;

How is ‘waste and scrap’ defined under Excise?

Note 8(1) to section XV of Central Excise tariff Act define Waste and Scrap as “metal waste and scrap from the manufacture or mechanical working of metals, and metal goods definitely not usable as such because of breakage, cutting-up, wear or other reasons.

From the foregoing provisions, it can be appreciated that Waste and Scrap will attract Excise duty only if the following conditions are satisfied:

a) It should be generated from the process of manufacture

b) It should be mentioned in the Excise Tariff

This reasoning is also well supported by various legal jurisdictions. Some of them are given below:

a) Markfed Vanaspati V. CCE 2000(116) LT 204 (CEGAT 3 member bench)

It has been held that waste will be dutiable only if there is ‘manufacture’. It was held that spent earth is not dutiable even if it is marketable and even if it is specified in tariff (as it is not manufactured)

b) CCE v. Dhillon Kool Drinks 2001(130) ELT 475 (CEGAT)

It was held that waste and scrap arising out of broken bottles through the process of filling/handling etc. neither generated in the course of manufacture of glass bottles nor it could be considered as a manufactured product.

c) Prism Cement V. CCE (2008) 232 ELT 564 (CESTAT)

Waste like MS scrap, borings, generated during maintenance and repair work is not excisable when the assesse is not involved in the manufacture of iron and steel products and no credit was taken on items used in repair and maintenance.

d) UOI V. Banswara Syntex (2008)221 ELT 360 (Rajasthan High Court DB)

Waste Material (MS Scrap) of building construction is not dutiable as it did not arise from the manufacturing process.

Therefore,it can be inferred that only those scraps generated from manufacture can attract excise liability.

Does machining constitute ‘manufacture’ or ‘production’?

Machining operations do not result in manufacture of a new product. There are several machining operations where drilling, boring, milling etc. are done on the semi-finished component which do not create a new product. As such machining operations do not constitute manufacture or production

Both the process of Production and manufacture are treated in the same parlance under Excise law. There is no separate definition for the term production under excise. However the term “process amounting to manufacture or production of goods is defined under section 65B (40) of the Finance act 1994 which reads as follows:

“process amounting to manufacture or production of goods means a process on which duties of excise are leviable under section 3 of the Central Excise Act (Emphasis mine), 1944 or the Medicinal and Toilet preparation (Excise Duties) Act, 1955 (16 of 1955, any process amounting to manufacture of opium, Indian hemp and other narcotic drugs and narcotics on which duties of excise are leviable under any State Act for the time being in force”

From this it is very clear that a production of goods also refer to a process on which duty of excise is levied under Excise law.

Based on various court decisions, basic criteria for excise chargeability should meet the following aspects

1) A process carried out must result in a new product than what was originally before.

2) The product so produced must have a marketability and commercial known and sold as such and

3) The product must be movable in nature

Since in case of machining, criteria 1 is not met, this will not be construed as a production or a manufacturing activity under excise law

If not manufacture, will it constitute service then?

However, machining does constitute a ‘Service’ under service tax Act. Prior to the Negative Scheme of Service Tax, machining was classified under ‘Business Auxiliary Services’ and after the introduction of the negative scheme, it falls under the taxable services. However, it needs to be appreciated that Sl.No.30 of Mega Exemption Notification 25/2012 dated 20th June 2012 as well as the erstwhile exemption notification 8/2005 dated 1st March 2005, exempts the activity of carrying out an intermediate production process as job work in relation to any goods on which appropriate duty is payable by the Principal Manufacturer.

The exemption para stated in both the above notifications are reproduced below

Notification 25/2012 – ST dated 20th June 2012 (Applicable from 1st July 2012)

“30. Carrying out an intermediate production process as job work in relation to –

a) agriculture, printing or textile processing;

b) cut and polished diamonds and gemstones; or plain and studded jewellery of gold and other precious metals, falling under Chapter 71 of the Central Excise Tariff Act ,1985 (5 of 1986);

c) any goods on which appropriate duty is payable by the principal manufacturer (emphasis mine);

d) processes of electroplating, zinc plating, anodizing, heat treatment, powder coating, painting including spray painting or auto black, during the course of manufacture of parts of cycles or sewing machines upto an aggregate value of taxable service of the specified processes of one hundred and fifty lakh rupees in a financial year subject to the condition that such aggregate value had not exceeded one hundred and fifty lakh rupees during the preceding financial year”

Notification 8/2005 – ST dated 1st March 2005 (Applicable upto 30th June 2012)

“ …….hereby exempts the taxable service of production of goods on behalf of the client referred in sub-clause (v) of clause (19) of section 65 of the said Finance Act, from the whole of service tax leviable thereon under section 66 of the said Finance Act:

Provided that the said exemption shall apply only in cases where such goods are produced using raw materials or semi-finished goods supplied by the client and goods so produced are returned back to the said client for use in or in relation to manufacture of any other goods falling under the First Schedule to the Central Excise Tariff Act, 1985 (5 of 1986), as amended by the Central Excise Tariff (Amendment) Act, 2004 (5 of 2005), on which appropriate duty of excise is payable.”

Taxability of Machining Service:

In most of the cases, the job worker who is engaged in machining operations does not collect service tax as the final product is cleared by the principal manufacturer subject to excise duty. This is owing to the specific circular and the mega exemption notification discussed above. In this context, where the principal activity of machining itself is not subject to Service Tax or Excise Duty, what is the fate of the scrap generated and sold by the Job Worker? Read on.

If it is not Excise, it is Service Tax!

There has been a recent trend in the Excise Department to assess the sale proceeds of machining scrap value of ‘Service’. The Department applies the principles of valuations stated under section 67 of the Finance act, 1994 and includes the value of scrap left over by the client in its job worker place as an additional non-monetary consideration flowing for the services received.

Extract of Section 67 – Valuation of taxable services for charging service tax is given below

“1) Subject to the provisions of this Chapter, where service tax is chargeable on any taxable service with reference to its value, then such value shall, —

(i) …….

(ii) in a case where the provision of service is for a consideration not wholly or partly consisting of money, be such amount in money as, with the addition of service tax charged, is equivalent to the consideration;

……………….”

Relying on the above, the department has been taking a stand that the sale proceeds of the machining scrap is really part of the consideration / additional consideration for which the machining activity is executed. In the process, what is lost on the department is that those machining activities covered under erstwhile Circular 8/2014 and the mega exemption are completely exempted from service tax. When an activity by itself falls outside the net of service tax, the value for which such a service is rendered should make no difference.

In my view, there can be no Service Tax on Scrap – if Final product at Principal Manufacturer’s place suffers Excise duty.

How to prove that the final product of Principal Manufacturer has suffered Excise duty?

It is important for the job worker to prove that the final product at the Principal manufacturer’s place suffers excise duty. This is the precondition for claiming exemption. If that is established, it follows that when the main activity itself is exempted from service tax, whatever amount added as an additional consideration would also get automatically exempted.

The best possible way to establish this is to get a declaration from the Principal Manufacturer about the dutiabilty of his final product which would help as evidence when the department officials verify the correctness of exemption route. Any further evidences for discharge of excise liability by the Principal Manufacturer will be welcome, but most job workers may not have enough bargaining power to go beyond the Declarations.

What happens if the Principal Manufacturer does not give even the declaration? Is there an alternative way the Job Worker can fortify his stand even when a declaration is given? We discuss this point.

Most of the intermediate goods that are sent by the Principal Manufacturer to the Job Worker are under cover of Sec4(5) (a) challan. This is nothing but the challan prepared and sent along with the goods following the prescribed procedures. Let us see what sub-rule 5(a) of Sec 4 says:

Extract of Sub-rule 5(a) of Rule 4 of CENVAT Credit Rules, 2004

“The CENVAT credit shall be allowed even if any inputs or capital goods as such or after being partially processed are sent to a job worker for further processing, testing, repair, re-conditioning, or for the manufacture of intermediate goods necessary for the manufacture of final products or any other purpose, and it is established from the records, challans or memos or any other document produced by the manufacturer or provider of output service taking the CENVAT credit that the goods are received back in the factory within one hundred and eighty days of their being sent to a job worker and if the inputs or the capital goods are not received back within one hundred eighty days, the manufacturer or provider of output service shall pay an amount equivalent to the CENVAT credit attributable to the inputs or capital goods by debiting the CENVAT credit or otherwise…….”

The compliance under Rule 4(5) (a) is required only if CENVAT credit is to be availed on the inputs. It accords to reason that it is only when the final product is excisable that the question of availing Cenvat credit on inputs arises. Therefore, to claim CENVAT credit on the products sent to job worker, the Principal Manufacturers bring back the materials within the stipulated period of 180 days through challan 4(5)(a). Based on the above, we can logically deduce that the Principal Manufacturers are availing CENVAT credit and that the final product in relation to which these inputs/components are used, suffers excise duty.

How safe is this route?

As already mentioned, if the Job Worker is in possession of a declaration or any other direct proof that the final product suffered excise duty that would be conclusive. In the absence of such a proof, the above alternative should generally be acceptable.

But is the Job worker responsible to account for the scrap?

Let us look at the whole issue from another angle. Whenever goods are sent out to Job worker u/s 4(5) (a) of CENVAT credit rules, it is the responsibility of the Principal Manufacturer to account for the goods. This is because, it is the Principal Manufacturer who avails the input credit on the materials used to manufacture the goods. In cases where due to machining or otherwise, there is a loss of weight in the goods received back from the Job worker, it is incumbent on the Principal Manufacturer to reverse the CENVAT credit in respect of the loss of weight. This is because the said rule 4(5)(a) of CENVAT credit rules stipulates that, if the inputs on which CENVAT credit taken are not received back within one hundred eighty days then the manufacturer or provider of output service shall pay an amount equivalent to the CENVAT credit attributable to such inputs by debiting the CENVAT credit. Similar point was also existed in the old CENVAT credit rules.

Further Board has also clarified this point in Circular No.B/4/7/2000-TRU, dated 3-4-2000 that the credit has to be reversed on that quantity of inputs not returned within 180 days.

Of course, one cannot be accurate in such matters, but a consistent and scientific way of determining the Cenvat component of the ‘lost’ material can be helpful.

I am of the view that such an approach would save the small scale Job Worker from the demand and harassment of the Excise Officials. At the same time, there is no loss of revenue also for the excise department. This obviously means that the commercial terms between the Principal and the Job Worker would need to factor in the loss of Cenvat credit to the former. But that is far better than having to deal with excise department considering the mental harassment, financial outgo etc.

Conclusion:

The above paper is based on a real experience in handling such a case and it is hoped that this paper would prove useful to Job workers as well as Principal Manufacturers in arranging their affairs so as to avoid the incidence of tax or duty.

(Author can be reached at vignesh@gsvassociates.com)

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