Reversal of Cenvat credit for Trading

[JAMES PG]

 Effective from 1^st April, manufacturers or service providers doing trading activities were required to reverse Cenvat credit with the addition of the term “trading” to the following explanation in Rule 2(e) of   Cenvat Credit Rules ( Not No 3/2011(NT) dated 1.03.11) which defined exempted service.

“Exempted service means taxable service which are exempt from the whole of the service tax leviable thereon and includes services on which no ST is leviable under Sec 66 of the F Act and taxable services whose part of value is exempted on the condition that no credit of inputs and input services used in providing such taxable service shall be taken.

Explanation: For the removal of doubts, it is hereby clarified that “exempted services” includes trading”

Consequent to the above amendment, provisions of Rule 6(3) regarding reversal of credit for trading also introduced through Cenvat Credit (Third Amendment) Rules, 2011. (Not 13/2011 dated 1.04.11)

"Value" for the purpose of sub-rules (3) and (3A)-

In case of trading shall be the difference between the sale price and the purchase price of the goods traded”, the words “shall be the difference between the sale price and the cost of goods sold (determined as per the generally accepted accounting principles without including the expenses incurred towards their purchase) or ten per cent. of the cost of goods sold, whichever is more” 

As per Cenvat Credit (Sixth Amendment) Rules, 2012 brought about by Not 28/2012- CX., (N.T.),  dated 20th June,2102, definition of exempted service as per Rule 2 (e) reads as follows:

(e) "exempted service" means a-

(1) taxable service which is exempt from the whole of the service tax leviable thereon; or

(2) service, on which no service tax is leviable under section 66B of the Finance Act; or

(3) taxable service whose part of value is exempted on the condition that no credit of inputs and input services, used for providing such taxable service, shall be taken; but shall not include a service which is exported in terms of rule 6A of the Service Tax Rules, 1994.

Earlier explanation -“exempted services includes trading” is deleted from the amended Rule

 But in Rule 6(3) D regarding reversal of Cenvat credit for exempted product/services, manner of determining the value for the purpose of reversal of credit in the case of trading is still continued

Explanation I. - "Value" for the purpose of sub-rules (3) and (3A),

(a) shall have the same meaning as assigned to it under section 67 of the Finance Act, read

(c) in case of trading, shall be the difference between the sale price and the cost of goods sold (determined as per the generally accepted accounting principles without including the expenses incurred towards their purchase) or ten per cent of the cost of goods sold, whichever is more.

This would imply that even though trading is excluded from the ambit of exempted services, as per the provisions of Rule 6(3) D, reversal of Cenvat credit has become expedient.

The issue with regard to the reversal of Cenvat credit for trading originated from the decision of CESTAT, Ahmedabad in the case of Orion Appliances Ltd Vs CCE, Ahmedabad (2010 (5) TMI 85 (Tri)) wherein it was held that trading activity cannot be called a service and therefore it cannot be considered as an exempted service also.

The Hon Tribunal held that:

“In cases where an assessee is undertaking activities which cannot be called a service or which cannot be called manufacture that activity goes out of the purview of both Central Excise Act as well as Finance Act, 1994. Therefore, we have a situation where an assessee would not be eligible to take input service tax credit on an output which is neither a service nor excisable goods and at the same time there is no provision to cover situations where an assessee is providing a taxable service and is undertaking another activity which is neither a service nor manufacture. In such a situation the only correct legal position appears to be that it is for the appellant to choose and segregate the quantum of input service attributable to trading activity and exclude the same from the records maintained for availment of credit. …….The only obvious solution which would be legally correct appears to be to ensure that once in a quarter or once in a six months, the quantum of input service tax credit attributed to trading activities according to standard accounting principles is deducted and the balance only availed for the purpose of payment of service tax of output service”

The genesis of the well thought out formula of cenvat reversal for trading contained in Rule 6(3) is learnt to be from the above CESTAT decision.

A manufacturer having own Depots in multi locations may trade in goods, other than manufactured by him, also so as to augment customer’s requirements and to serve them in an efficient way. Whether there is trading business or not, definitely there will be common expenses and fixed cost like rent, security, telephone etc which are being incurred in the normal course of business. Applying 6% reversal on the value of trading business which is arrived   at by deducting cost of goods sold from the Selling Price as determined by GAAP or 10% of COGS whichever is higher as prescribed in Rule 6(3) D, will only lead to cascading of taxes which is against the very purpose of Cenvat scheme.

It is only logical and reasonable to have the option of not to take credit on the services which are exclusively used for trading or to reverse proportionate credit attributable to trading wherever taxable and non taxable good/ services are involved. Common and fixed costs should be kept out of the purview as these are incurred irrespective of the fact that trading is carried out or not

Ideal tax system, as per Kautilya (Arthashastra), should be based on the following objectives:

-gaining as much as tax revenue as possible for king,

-promoting economic growth and development within the kingdom,

-ensuring that resources are used efficiently and;

-applying taxes that are ‘fair and just’

It is hoped that necessary clarifications will be issued by the Board in this regard so as to have ‘fair and just’ tax treatment instead of passing the burden to Hon Tribunals and Courts with the so called policy of ‘let them decide’