MARCH 22, 2012
Slow Poison to Input Service Distributor
By Nithyananda Shetty & Divya Pahwa
RULE 7 of CENVAT Credit Rules, 2004 (CCR) provides that an Input Service Distributor (ISD) may distribute CENVAT credit in respect of the service tax paid on input service to its manufacturing units or units providing output service subject to two conditions:
1. the credit distributed should not exceed the amount of service tax paid thereon and
2. the credit should not be distributed to a factory/premises exclusively engaged in the provision of exempted goods/services
[Refer the case of Commissioner of Central Excise vs. ECOF Industries Pvt. Ltd 2011-TIOL-770-HC-KAR-ST which has reiterated that only the above two restrictions are imposed on ISD for distribution of CENVAT credit ].
Vide Union budget 2012-13 an amendment has been introduced in Rule 7 of CCR by which two new conditions have been inserted effective from 1 April 2012:
3. Credit of service tax attributable to service used wholly in a unit shall be distributed only to that unit; and
4. Credit of service tax attributable to service used in more than one unit shall be distributed prorata on the basis of the turnover of the concerned unit to the sum total of the turnover of all the units to which the service relates.
Further, following two explanations have been inserted:
Explanation 1:- For the purposes of this rule, – unit includes the premises of a provider of output service and the premises of a manufacturer including the factory, whether registered or otherwise.
Explanation 2:- For the purposes of this rule, the total turnover shall be determined in the same manner as determined under rule 5
The proposed amendment seems to have been introduced to overcome the judgment of ECOF Industries and other Tribunal judgments. However, we anticipate that an ISD shall face immense difficulty in implementing the fourth condition in Rule 7.
Let us take an example. A manufacturer has five units manufacturing product X in units 1, 2 and 3 and product Y in units 4 and 5. The manufacturer incurs common market research/advertising services for both product X and Y for which the invoice is received at the head office registered as ISD. The ISD shall have to distribute CENVAT credit of the service tax prorata on the basis of the turnover of each unit to the sum total of all the units.
Further, continuing the above example, it is possible that the head office may also incur certain product specific services (like marketing of product X) or unit specific services (like engaging the consultants for excise audit of units 2, 3 and 4), etc. Therefore, the amendment obligates the ISD to maintain invoice-wise ISD ledger folio wherein the CENVAT credit of service tax shall have to be recorded and accordingly be distributed in the following manner:
- The credit of service tax on the services exclusively relating to units 1, 2, 3, 4 and 5 to be distributed only to the concerned units entirely.
- The credit of service tax of the services commonly relating to units 1, 2, 3, 4 and 5 to be distributed prorata on the basis of their turnover to the total turnover. (It is to be noted that the combination of the units to be considered for distribution of credit and consequently for calculation of total turnover will change depending on the units amongst 1,2, 3, 4 and 5 which relate to such input services)
Therefore, in order to arrive at the quantum of CENVAT credit relating to common input services amongst the units to be distributed, the ISD is required to work out the computation on the basis of the formula under Rule 5 invoice-wise in respect of input services depending on the units to which such common input services relate. However, the input service invoice-wise computation is not required only in case where common input services relate to all the units.
We further move on to Explanation 2 which adds fuel to the fire caused by fourth condition. Explanation 2 provides that the total turnover shall be determined in the same manner as determined under Rule 5 of CCR. Rule 5 deals with refund of unutilized accumulated CENVAT credit to a manufacturer or service provider engaged in export of dutiable goods and taxable services respectively. Rule 5 has provided for a new mechanism for computation of total turnover which is as under:
Total turnover means sum total value of -
a. All excisable goods cleared during the relevant period including exempted goods, dutiable goods and excisable goods exported
b. Export turnover of services to be in the manner prescribed under Rule 5 and the value of all other services, during the relevant period and
c. All inputs removed as such under sub-rule (5) of Rule 3 against an invoice, during the period for which the claim is filed.
The relevant period has been defined under Rule 5 of CCR as the period for which the claim is filed.
Computation of total turnover under Rule 7 has been linked with the formula prescribed under Rule 5. The question that remains unanswered is what will be the relevant period for which the total turnover has to be considered i.e. – one month, one quarter or one year and whether preceding or current, as the period of claim is not relevant under Rule 7. Further, clause c which is included in the total turnover for the purpose of Rule 5 does not seem to have any rationale for inclusion in the total turnover when it has to be applied for ISD. Further, the formula prescribed on the basis of prorata turnover will not allow the ISD to distribute CENVAT credit in the middle of the month in case it is intended to be computed on the basis of current month's turnover.
This new amendment to Rule 7 has opened a can of worms. With the above discussed issues, ISD may not be any more a feasible option in view of the stringent conditions stipulated and will become only a theoretical concept in case the manufacturers or service providers have multiple units.
(The views are authors' personal views)