Assessee entitled to Cenvat credit on inputs utilized in the generation of electricity to the extent to which they are using the produced electricity within their factory

SUMMARY OF CASE LAW

The definition of “input” brings within its fold, inputs used for generation of electricity or steam, provided such electricity or steam is used within the factory of production for manufacture of final products or for any other purpose.

RELEVANT PARAGRAPH

2. The issue in the present civil appeal is : whether the Department is right in reversing proportionate CENVAT credit to the extent of power wheeled out by the appellant to its sister units, vendors, joint ventures. Basically, in both the civil appeals we are required to construe the word “input” as defined in Rule 2(g) of CENVAT Credit Rules, 2002.

3. M/s. Maruti Suzuki Ltd. (appellant) is engaged in the business of manufacturing motor vehicles falling under Chapter 87 of Central Excise Tariff Act, 1985. These motor vehicles are cleared on payment of duty. Assessee claimed CENVAT credit on “input” in accordance with CENVAT Credit Rules, 2002 (for short, “2002 Rules”). Assessee has installed three gas turbines in their factory for generation of electricity. All the three turbines have capacity to generate electricity of 20 MW each. Till June 2002, assessee was using natural gas as fuel for running the three gas turbines. No excise duty was leviable on natural gas and, therefore, there was no question of availing CENVAT credit on natural gas. During July 2002 to December 2002, assessee started using diesel as fuel to run the three turbines. In view of the said Rules barring availment of credit on diesel, the assessee did not avail any CENVAT Credit on diesel procured by them. From January 2003 onwards, assessee are using naphtha as fuel to run the gas turbines and they are availing CENVAT Credit on naphtha used for generation of electricity in gas turbines. Assessee also uses diesel generating set (DG set) for generation of electricity with the use of diesel for which they had not availed any credit. In their factory, assessee has a common distribution point for electricity generated in turbines as well as DG set and the entire electricity which is generated in the turbines and DG set(s), placed in the factory, is distributed through common distribution point.

4. During the disputed period assessee cleared a part of electricity generated in the factory to its joint ventures, vendors etc. In addition, assessee met its electricity requirements by electricity captively generated by the assessee in their turbines. During the said period, assessee generated 1,44,469.80 KWH of electricity out of which 18,838.49 KWH of electricity stood wheeled out (approximately 13% of total net power generation). This electricity stood cleared at the different rates for the entire period varying from Rs.4.65/KWH to Rs.9.72/KWH. It may be noted that even the joint ventures, vendors etc. to whom excess electricity is wheeled out in turn manufacture final products.

9. Coming to the statutory definition of the word “input” in Rule 2(g) in the CENVAT Credit Rules, 2002, it may be noted that the said definition of the word “input” can be divided into three parts, namely:

(i) specific part

(ii) inclusive part

(iii) place of use

10. Coming to the specific part, one finds that the word “input” is defined to mean all goods, except light diesel oil, high speed diesel oil and petrol, used in or in relation to the manufacture of final products whether directly or indirectly and whether contained in the final product or not. The crucial requirement, therefore, is that all goods “used in or in relation to the manufacture” of final products qualify as “input”. This presupposes that the element of “manufacture” must be present.

11. In the case of J.K. Cotton Spinning and Weaving Mills Co. Ltd. v. S.T.O. reported in 1965 (16) STC 563 this Court held that the expression “in the manufacture of goods” should normally encompass the entire process carried on by the dealer of converting material into finished goods. It was further held that where any particular process (generation of electricity) is so integrally connected with the ultimate production of goods, that, but for such process, manufacture of goods would be inexpedient, then goods required in such process would fall within the expression “in the manufacture of goods”.

12. In the case of Union Carbide India Ltd. v.Collector of Central Excise, Calcutta-I reported in 1996 (86) ELT 613 (Tri) a larger Bench of CEGAT observed that a wide impact of the expression “used in relation to manufacture” must be allowed its natural play. Inputs (raw materials) used in the entire process of conversion into finished products or any other process (like electricity generation) which is integrally connected with the ultimate production of final product has to fall within the above expression. It was observed that the purpose was to widen the scope, ambit and content of “inputs”. According to the Special Bench of CEGAT, the purpose behind the above expression is to widen the ambit of the definition so as to attract all goods, which do not enter directly or indirectly into the finished product, but are used in any activity concerned with or pertaining to the manufacture of the finished product.

13. Electricity generation is a separate and distinct activity. It is an independent activity. It has its own economics. It does not form part of the process in which “inputs” are transformed into separate identifiable commodity, though it may stand connected to such processes. It may not have any concern with the manufacture of the finished product. However, it is an ancillary activity. It is an activity which is anterior to the process of manufacture of the final product. It is on account of the use of the above expression “used in relation to manufacture” that such an activity of electricity generation comes within the ambit of the definition because it is integrally connected with the manufacture of the final product.

14. In the case of Collector of Central Excise, New Delhi v. M/s. Ballarpur Industries Ltd. reported in (1989) 4 SCC 566 the difference between the expression “used in the manufacture” and “used as input (raw material)” was highlighted. In that judgment, it was held that undoubtedly the said two expressions are distinct and separate, but, when an ancillary process (like electricity generation) aids the making of an end product, then, the ancillary process gets integrally connected to the end product. In the said judgment, this Court applied what is called as “the dependence test”. It may, however, be noted that in the definition of “input” the expression “used in or in relation to the manufacture of final product” is not a standalone item. It has to be read in entirety and when so read it reads as “used in or in relation to the manufacture of final product whether directly or indirectly and whether contained in the final product or not”. These words “whether directly or indirectly” and “whether contained in the final product or not” indicates the intention of the legislature. What the legislature intends to say is that even if the use of input (like electricity) in the manufacturing process is not direct but indirect still such an item would stand covered by the definition of “input”. In the past, there was a controversy as to what is the meaning of the word “input”, conceptually. It was argued by the Department in a number of cases that if the identity of the input is not contained in the final product then such an item would not qualify as input. In order to get over this controversy in the above definition of “input”, the Legislature has clarified that even if an item is not contained in the final product still it would be classifiable as an “input” under the above definition. In other words, it has been clarified by the definition of “input” that the following considerations will not be relevant:

(a) use of input in the manufacturing process be it direct or indirect;

(b) even if the input is not contained in the final product, it would still be covered by the definition.

These considerations have been made irrelevant by the use of the expression “goods used in or in relation to the manufacture of final product” which, as stated above, is the crucial requirement of the definition of “input”. Moreover, the said expression, viz, “used in or in relation to the manufacture of the final product” in the specific /substantive part of the definition is so wide that it would cover innumerable items as “input” and to avoid such contingency the Legislature has incorporated the inclusive part after the substantive part qualified by the place of use. For example, one of the categories mentioned in the inclusive part is “used as packing material”. Packing material by itself would not suffice till it is proved that the item is used in the course of manufacture of final product. Mere fact that the item is a packing material whose value is included in the assessable value of final product will not entitle the manufacturer to take credit. Oils and lubricants mentioned in the definition are required for smooth running of machines, hence they are included as they are used in relation to manufacture of the final product. The intention of the Legislature is that inputs falling in the inclusive part must have nexus with the manufacture of the final product.

15. Coming to the analysis of the inclusive part of the definition one finds that it covers:

(a) Lubricating oils, greases, cutting oils and coolants;

(b) Accessories;

(c) Paints;

(d) Packing materials;

(e) Input used as fuel;

(f) Input used for generation of steam or electricity.

16. In our earlier discussion, we have referred to two considerations as irrelevant, namely, use of input in the manufacturing process, be it direct or indirect as also absence of the input in the final product on account of the use of the expression “used in or in relation to the manufacture of final product”. Similarly, we are of the view that consideration such as input being used as packing material, input used as fuel, input used for generation of electricity or steam, input used as an accessory and input used as paint are per se also not relevant. All these considerations become relevant only when they are read with the expression “used in or in relation to the manufacture of final product” in the substantive/ specific part of the definition. In each case it has to be established that inputs mentioned in the inclusive part is “used in or in relation to the manufacture of final product”. It is the functional utility of the said item which would constitute the relevant consideration. Unless and until the said input is used in or in relation to the manufacture of final product within the factory of production, the said item would not become an eligible input. The said expression “used in or in relation to the manufacture” have many shades and would cover various situations based on the purpose for which the input is used. However, the specified input would become eligible for credit only when used in or in relation to the manufacture of final product. Hydrogen gas used in the manufacture of sodium cyanide is an eligible input, since it has a significant role to play in the manufacturing process and since the final product cannot emerge without the use of gas. Similarly, Heat Transfer Oil used as a heating medium in the manufacture of LAB is an eligible input since it has a persuasive role in the manufacturing process and without its use it is impossible to manufacture the final product. Therefore, none of the categories in the inclusive part of the definition would constitute relevant consideration per se. They become relevant only when the above crucial requirement of being “used in or in relation to the manufacture” stands complied with. In our view, one has to therefore read the definition in its entirety.

17. As stated, the definition is in three parts, namely, specific part, inclusive part and place of use. All the three parts are required to be satisfied before an input becomes an eligible input.

18. It may be noted from the CENVAT Credit Rules of 2004 vis-a-vis CENVAT Credit Rules of 2002 that the word “for” in the inclusive part after the words “steam used” is substituted by the words “used in or in relation to the manufacture of final products”. In other words, the crucial requirement of the definition clause is restated by the Legislature. We may note that the CENVAT Credit Rules of 2004 came in force in September, 2004. In some of the cases in batch before us the show cause notice goes right up to January 2005, hence, CENVAT Credit Rules, 2004 also apply to those cases. In short, an item would fall within the category of “inputs” as defined only on compliance with all the three parts of the definition clause.

19. The question which still remains to be answered is: whether an assessee would be entitled to claim CENVAT credit in cases where it sells electricity outside the factory to the joint ventures, vendors or gives it to the grid for distribution? In the case of Collector of Central Excise v. Rajasthan State Chemical Works reported in 1991 (55) ELT 444 (SC) the test laid down by this Court is whether the process and the use are integrally connected. As stated above, electricity generation is more of a process having its own economics. Applying the said test, we hold that when the electricity generation is a captive arrangement and the requirement is for carrying out the manufacturing activity, the electricity generation also forms part of the manufacturing activity and the “input” used in that electricity generation is an “input used in the manufacture” of final product. However, to the extent the excess electricity is cleared to the grid for distribution or to the joint ventures, vendors, and that too for a price (sale) the “process and the use test” fails. In such a case, the nexus between the process and the use gets disconnected. In such a case, it cannot be said that electricity generated is “used in or in relation to the manufacture of final product, within the factory”. Therefore, to the extent of the clearance of excess electricity outside the factory to the joint ventures, vendors, grid etc. would not be admissible for CENVAT credit as such wheeled out electricity, cleared for a price, would not fall within the definition of “input” in Rule 2(g) of the CENVAT Credit Rules, 2002. This view is also expressed in para 9 of the judgment of this Court in the case of Collector of Central Excise v. Solaris Chemtech Limited – (2007) 214 ELT 481 (SC). Further, our view is supported by the observations of this Court in the case of Vikram Cement v. Commnr. Of Central Excise, Indore – 2006 (194) ELT 3 (SC) which is quoted below:-

“It appears to us on a plain reading of the clause that the phrase “within the factory of production” means only such generation of electricity or steam which is used within the factory would qualify as an immediate product. The utilization of inputs in the generation of steam or electricity not being qualified by the phrase “within the factory of production” could be outside the factory. Therefore, whatever goes into generation of electricity or steam which is used within the factory would be an input for the purposes of obtaining credit on the duty payable thereon.”

20. To sum up, we hold that the definition of “input” brings within its fold, inputs used for generation of electricity or steam, provided such electricity or steam is used within the factory of production for manufacture of final products or for any other purpose. The important point to be noted is that, in the present case, excess electricity has been cleared by the assessee at the agreed rate from time to time in favour of its joint ventures, vendors etc. for a price and has also cleared such electricity in favour of the grid for distribution. To that extent, in our view, assessee was not entitled to CENVAT credit. In short, (for captive consumption) . They are not entitled to CENVAT credit to the extent of the excess electricity cleared at the contractual rates in favour of joint ventures, vendors etc., which is sold at a price.

21. Before concluding, it may be clarified that on account of repeated amendments in the CENVAT Credit Rules, huge litigation in the country stands generated. In the circumstances, we are of the view that penalty is not leviable on appellant/assessee, particularly when in large number of other cases, on account of conflict of views expressed by various Tribunals/High Court, the assessees have also succeeded. Hence, although M/s. Maruti Suzuki Ltd. (appellant) has failed in their civil appeals the Department will not impose penalty.