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How relevant is the “relevant period” for credit distribution?

By Shweta Kathuria

Rule 7 of the Cenvat Credit Rules [‘Credit Rules’ for short] relating to distribution of credit by an Input Service Distributor (“ISD”) has always been a problem area of the Credit Rules. Ever since the inception of this concept, it has always been surrounded by doubts and confusions. To understand the issues, let us first understand the concept of ISD. This concept was first introduced in the year 2004 and it means an office of the manufacturer or service provider, which receives invoices towards purchases of input services from the providers of input service and further distributes the credit of service tax by issuing invoice, bill or challan to such manufacturer or service provider.

In many cases, a manufacturer/ service provider has different units or premises located in various parts of the country. It may happen that the bill/ invoice in respect of an input service is raised in the name of the head office, whereas credit can be availed only in a factory or a premises of the service provider. In order to provide for a mechanism whereby the tax credit could be passed on to the respective factory/ premises, such head office distributes the tax credit to these units through the medium of invoices.

Thus, as can be seen, an ISD has always been a conduit to pass on the credit on the services consumed at the manufacturing/ service providing locations but the invoice of which was not received at such locations.

One doubt that remained for a very long time was whether the ISD was entitled to distribute credit to any unit or only to those units to which the input service was related. For a very long time, the law was simple as it did not require the assessee to maintain a record for each input service and its relation with the units to which the credit had to be distributed. The Karnataka High Court also had also upheld this in the case of CCE, Bangalore v. ECOF Industries Pvt. Ltd. [2012 (277) ELT 317].

Therefore, even in a case where an input service did not have any nexus with such manufacturing unit, the credit thereon could still be distributed to such unit. Thus, even though such a situation was illogical, it was nevertheless benevolent.

The aforesaid possibility was removed in the Finance Act, 2012 and the Rule 7 was amended to allow distribution of credit on an input service only to such unit(s) to which it related. In order to find out the proportion in which the credit had to be distributed to these units, the rule required the turnover of respective units as the basis for determining the ratio. Vide Explanation 3 to the said rule, while determining the ratio, the turnovers of the “relevant period” had to be adopted.

The said amendment became the genesis of the next series of confusion. The said explanation provided that the relevant period shall be the month/ quarter (in case of SSI units) previous to the month/ quarter in which the credit has to be distributed. Therefore, if credit on any particular input service was earned in the month of April, 2012 and the assessee opted not to distribute it in April itself and instead waited till the month when the turnover of dutiable goods was more, the assessee was legally entitled to do so. Though the said distribution was legally valid, the same resulted in an illogical distribution.

To rectify the aforesaid inconsistency, Notification No. 5/2014-C.E. (N.T.) dated 24-2-2014 was issued to amend the definition of “relevant period” in Rule 7 of the Cenvat Credit Rules, 2004. The said amendment comes in effect from 1-4-2014. As per the amended rule, instead of distributing credit on the basis of turnover of the previous month/ quarter, credit shall now be distributed on the basis of the turnover of preceding financial year.  The amended rule also provides that if the assessee does not have turnover for some or all the units in the preceding financial year, the last quarter for which details of turnover of all the units are available shall be adopted.

Therefore, through the aforesaid amendment, the illogical distribution mentioned above was removed to some extent. Thus, now the assessee would necessarily be required to follow the turnover figures of the preceding financial year only irrespective of the month in which it distributes the credit. Further, a new assessee who starts its business would not be able to distribute the credit in the first quarter of its production.

But as the saying goes “the show must go on”, in respect of Rule 7, the saying should be “the controversies must go on”. The latest one being the second amendment made by Notification No. 5/2014-CE (NT). The second amendment in Rule 7 is that the Cenvat credit attributable to more than one unit shall be distributed by the ISD on pro-rata basis to such units divided by the total turnover of all its units.

A reading of the new rule indicates that if a service is common to more than one unit (but not common to all the units of the assessee), credit shall be distributed pro-rata to the units to which such service relates. However, the distributable credit shall be determined by applying the total turnover of all the units of the assessee, resulting in non-distribution of some portion of the credit. This implication can be understood with help of an example.

Assuming, an assessee has four units, say A, B, C and D. It is receiving advertisement service for a product which is manufactured only in A and C units. Credit on advertisement service is Rs. 10,000.

Turnover of A, B, C & D in FY 2013-14 (in Rs. Crores), respectively, is 150, 250, 400 & 200

Total Turnover of A, B, C & D = 1000

Since the advertisement service is common to Units A & C, the credit shall be distributed only to these units. The amount of credit distribution  =
Unit A =  10,000 x 150/ 1,000 = Rs. 1,500

Unit C = 10,000 x 400/ 1,000 = Rs. 4,000

Thus, out of the total credit of Rs. 10,000 attributable wholly to dutiable goods, Cenvat credit of Rs. 5,500 can only be distributed and Cenvat credit of Rs. 4,500 would not be distributed. Therefore, a plain reading of the amended rule can lead to an unfair situation. The trade has to, therefore, take up this anomaly for redressal.

[ The author is a Principal Associate, Tax Practice, Lakshmikumaran & Sridharan, New Delhi ]
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