Indirect taxes: Rationalise CENVAT credit as a step to align with the proposed GST

While modalities for the Goods and Services Tax (GST) implementation are being worked upon, the Union Budget 2016/17 provides an excellent opportunity to the Finance Minister to rationalise as well as iron out the inconsistencies in the existing CENVAT credit scheme.

Almost a decade ago, in 2004, the Central government at that time had taken a major step to unify the credit regime for goods and services covered under the CENVAT Credit Rules, 2002 and Service Tax Credit Rules, 2002, respectively. The introduction of 'CENVAT Credit Rules, 2004' served to be instrumental in codifying the credit mechanism into a single law for availing and utilisation of credit of taxes paid on goods as well as services for both the manufacturers and the service providers.

Over the years, the government has made several changes to the CENVAT Credit Rules, considering both representations from the industry as well as to prevent misuse of the scheme. Noteworthy changes were made during 2011 and 2012 to the definitions of inputs, input services as well as capital goods.

Primarily, the changes related to extending the list of exclusions from the pool of eligible credits such as restricting the credit with respect to:

(a) Inputs and input services used for construction or execution of a works contract of a building or civil structure;
(b) Input service of renting a motor vehicle;
(c) Input services relating to outdoor catering, life insurance, health insurance, etc. when such services are used primarily for personal use or consumption of any employee;
(d) Any goods used in a guest house and residential colony, etc.; and
(e) Input services relating to setting up of a factory or premises of a service provider.

The industry was significantly impacted due to imposition of these restrictions on credit, especially when the coverage of service tax was thoroughly widened with the introduction of a negative list of service taxation and pruning of the list of both exempted goods and services.

With the proposed implementation of GST, it is expected that the central government will take necessary measures to achieve its motive of ease of doing business in India. In this direction, some of the key expectations from this year's Union Budget relating to rationalisation of CENVAT Credit include the following:

1. The restriction is currently imposed on availing credit with respect to goods and services used for construction or execution of a works contract of a building or civil structure, including laying down the foundation or making of structures for support of capital goods. This restriction on credit (a) leads to increased cost of operation (b) affects the financial viability of a project (c) suffers cascading of taxes and (d) enhances the cost of final products/services to the consumer.

As the definition of input services permits credit with respect to modernisation, renovation or repair of a factory or premises of the service provider, there is no reason for excluding the credit with respect to setting up activities.

2. Currently, Rule 5 of the CENVAT Credit Rules allows the refund of unutilised credit only to the exporters of goods and services. There are several reasons for accumulation of credit, including the inverted duty structure (where finished goods are taxed at a rate lower than the tax rate on inputs) which are beyond the control of the taxpayer.

Under such circumstances, it is critical that the refund mechanism is relaxed to allow for refund of unutilised credit accumulated for any reason to both the manufacturers as well as the service providers in line with the refund of input tax credit under the state VAT law.

3. The time limit of one year from the invoice date to claim the CENVAT benefit should be relaxed/deleted, as it causes undue hardship in genuine cases of delay in availment of credit for any reason, to provide parity with the provisions enabling tax demand for the prior period with interest/penalty.

4.  After withdrawal of the education cess and secondary and higher education cess on excise duty and service tax, it was expected that the government will allow the assessee to use his/her balance credit of such cess for payment of service tax/excise duty. However, Rule 3(7) (b) of the CENVAT Credit Rules, 2004 restricts the use of CENVAT credit of cess against excise duty or service tax liability.

This creates an uncertain tax environment and can be akin to changes with retrospective effect as the credit which was rightfully available to the taxpayer was withdrawn by issuance of a notification.

Considering the aim of the government is to enhance the ease of doing business, it is recommended that the credit of cess be allowed to be adjusted against the output excise duty and/or service tax without any restriction.

5. As a road map to the introduction of GST, there is an urgent need to broad base the credit mechanism and all business expenses such as renting of a cab, staff welfare expenses, etc. should be allowed as credit including the expenses incurred for setting up or construction of new factories/premises, etc. as ultimately they form part of the goods and services sold/provided by the assessee on which tax is discharged.

In this strenuous economic situation for trade and industry, rationalisation of the CENVAT Credit mechanism in line with the above recommendations is expected to provide the much sought after relief to the taxpayer. The government should seize this opportunity just before the introduction of GST to indicate the arrival of 'achhe din' for the taxpayer.

The author is Partner and Head, Indirect Tax, KPMG in India. Views expressed are personal.