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					                                           Monograph on Input Credits under Indirect Taxes




             MONOGRAPH ON INPUT CREDITS UNDER INDIRECT TAXES

                                             PREFACE

The cenvat duty credits, which are of recent origin are aimed to remove cascading of taxes by
providing credit not only for the duty paid on inputs and capital goods used for the manufacture of
excisable goods but also credit of service tax paid on input services received by a manufacturer
or provider of output services.        Unlike credit of CENVAT credit of excise duty paid on input
materials, which can be directly linked to a final product, the service tax is payable on a host of
services like advertisement or sales promotion, market research, storage upto the place of
removal, procurement of inputs, banking transactions, activities relating to business, such as
accounting, auditing, financing, recruitment and quality control, coaching and training, computer
networking, credit rating, share registry and security, inward transportation of inputs or capital
goods and outward transportation upto the place of removal, and these services cannot be
directly linked to a particular final product. This has given rise to the necessity of formulating
certain equitable basis for apportionment of the service tax paid on these services to the final
products or services of a manufacturer or service provider for claiming CENVAT of service tax
from its final products or services.

        This monograph aims to deliberate on the key issues relating to the distribution of service
tax credit by input service distributor, and arrive at a concerted approach which will remove some
of the contentious issues faced by the assessee. The approaches discussed are of suggestive
nature and open for further deliberations and improvement. Based on this the Institute also plans
to bring a detailed Guidance note on the issues, after wide discussions and deliberations.

We will be failing in our duty if we do not recognize the yeoman service rendered by senior
members of cost management profession, who are in the industry as well as in practice and who
provided vital inputs for the framing of this monograph, but do not want to be publicly recognized.

We are also grateful to Dr.H.R.Subramanya, President, ICWAI, who germinated the idea of
bringing out special publications on topical issues and which will form the plank on which the
future guidance notes and cost accounting standards will emanate.
M.GOPALAKRISHNAN
Chairman-Technical Committee
Diamond Jubilee Celebrations.




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                                Monograph on Input Credits under Indirect Taxes


          MONOGRAPH ON INPUT CREDITS UNDER INDIRECT TAXES




                                     INDEX




Sl.No                               Topics
1       Introduction to Cenvat Credit Rules
2       Objectives
3       Definition
4       Areas of Application
5       Identification of Input services on which credit may be
        availed
6       Methodology for Allocation and Apportionment of Costs




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                                Monograph on Input Credits under Indirect Taxes




     MONOGRAPH ON DISTRIBUTION OF SERVICE TAX CREDIT BY INPUT
       SERVICE DISTRIBUTOR UNDER CENVAT CREDIT RULES, 2004

1.   Introduction

     1.1 Service Tax was introduced for the first time in 1994 through the
         insertion of Chapter V in the Finance At 1994. The Service Tax is
         administered and collected by the Central Excise Department and the
         revenues collected by way of this tax forms a part of the shareable
         Union funds and devolve to the States as per formula prescribed by the
         Finance Commissions.

         Initially, the tax was levied on three services @ 5%, namely:

         1. General Insurance Services

         2. Stock-Broking Services

         3. Telephone Services

     1.2 Between 1994 and 2004 the tax was extended to 68 additional services
         and the rate of tax was enhanced to 8% (May 2003) and thereafter to
         10% from 10th September 2004. With the introduction of Education
         Cess @ 2% in the Union Budget of July 2004, the effective rate of
         service tax is 10.2% from 10th September 2004. [Details of Services
         attracting Service Tax as on 10th September 2004 are given in
         chronological order in Appendix 1 for ready reference].

     1.3 Unlike the Central Excise Act, which extends to the whole of India, the
         provisions relating to Service Tax do not extend to Jammu & Kashmir.
         Consequently, services provided within the territorial limits of Jammu &
         Kashmir are excluded from the purview of the levy of service tax,
         irrespective of whether the person rendering the service or the person
         receiving the service is residing within or outside that State.




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                            Monograph on Input Credits under Indirect Taxes




     Cenvat Credit Rules

1.4 By virtue of Service Tax Credit Rules, 2002, with effect from 16 th
     August 2002 an output service provider became eligible to claim credit
     in respect of input services availed by him provided both the input and
     output service were under the same category of services. With effect
     from 14th May 2003 the stipulation that both input and output services
     have to be under the same category was done away with. Accordingly,
     from that date an output service provider could claim credit in respect
     of service tax paid on input services availed by him and use the credit
     to discharge service tax liability incurred by him. However, the Service
     Tax Credit was allowed only to output service providers and not to
     manufacturers of goods paying service tax for input services availed for
     manufacture of finished goods.

1.5 New Cenvat Credit Rules 2004 have been introduced with effect from
     10th September 2004, to provide for extension of credit of service tax
     and excise duty across goods and services. The Cenvat Credit Rules,
     2004 aims to remove cascading of taxes by providing credit of not only
     Cenvat paid on inputs and capital goods used for the manufacture of
     excisable goods but also credit of service tax paid on input services
     received by a manufacturer or provider of output services. Like Cenvat
     credit on goods, the manufacturer or output service provider can also
     utilize the credit of service tax to offset liability of Central Excise Duty
     and/or Service Tax that may be incurred.

1.6 The Rules also provide for distribution of service tax credit by an Input
     Service Distributor (ISD), i.e., an office of the manufacturer or producer
     of final products or provider of output service, which receives invoices
     issued under rule 4A of the Service Tax Rules 1994 towards purchase
     of input services and issues invoice, bill or, as the case may be, challan
     for the purposes of distributing the credit of service tax paid on the said




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                                Monograph on Input Credits under Indirect Taxes


          services to such manufacturer or producer or provider, as the case
          may be.


2.   Objective

     The objective of this monograph is to provide uniformity in the principles and
     methods used for distributing the credit of Service Tax by an Input Service
     Distributor across multiple business Units engaged in manufacture of goods
     and/or providing output services.


3.   Definitions

     For the purpose of this guidance note, the following terms are used with the
     meanings specified:

     3.1 “Input Service” means any service –

          a. used by a provider of taxable service for providing an output
             service; or,

          b. used by the manufacturer, whether directly or indirectly, in or in
             relation to the manufacture of final products and clearance of final
             products from the place of removal,

          and includes services used in relation to setting up, modernization,
          renovation or repairs of a factory, premises of provider of output
          service or an office relating to such factory or premises, advertisement
          or sales promotion, market research, storage up to the place of
          removal, procurement of inputs, activities relating to business, such as
          accounting, auditing, financing, recruitment and quality control,
          coaching and training, computer networking, credit rating, share
          registry and security, inward transportation of inputs or capital goods
          and outward transportation up to the place of removal.

     3.2 “Input Service Distributor” means an office of the manufacturer or
          producer of final products or provider of output service, which receives
          invoices issued under rule 4A of the Service Tax Rules 1994 towards


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                           Monograph on Input Credits under Indirect Taxes


    purchase of input services and issues invoice, bill or, as the case may
    be, challan for the purposes of distributing the credit of service tax paid
    on the said services to such manufacturer or producer or provider, as
    the case may be.

3.3 “Job Work” means processing or working upon of raw material or
    semi-finished goods supplied to the job worker, so as to complete a
    part or whole of the process resulting in the manufacture or finishing of
    an article or any operation which is essential for aforesaid process and
    the expression “job worker” shall be construed accordingly.

3.4 “Output Service” means any taxable service provided by the provider
    of taxable service, to a customer, client, subscriber, policyholder or any
    other person, as the case may be, and the expressions “provider” and
    “provided” shall be construed accordingly.

    Explanation – For the removal of doubt it is hereby clarified that if a
    person liable for paying service tax does not provide any taxable
    service or does not manufacture final products, the service for which he
    is liable to pay service tax shall be deemed to be the output service.

3.5 “Manufacture” includes any process –

    a) incidental or ancillary to the completion of a manufactured product;
       and,

    b) which is specified in relation to any goods in the Section or Chapter
       notes of the First Schedule to the Central Excise Tariff Act, 1985 as
       amounting to manufacture; or

    c) which, in relation to the goods specified in the Third Schedule,
       involves packing or repacking of such goods in a unit container or
       labeling or re-labeling of containers including the declaration or
       alteration of retail sale price on it or adoption of any other treatment
       on the goods to render the product marketable to the consumer,




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                                 Monograph on Input Credits under Indirect Taxes


     3.6 “Manufacturer” shall be construed in accordance with „manufacture‟
         and shall include not only a person who employs hired labour in the
         production or manufacture of excisable goods, but also any person
         who engages in their production or manufacture on his own account.

         Explanation: For removal of doubts it is clarified that the term
         „manufacturer‟ includes persons engaged in manufacturing on their
         own accounts, i.e., in their own manufacturing facilities as well as in
         manufacture through job-work.


4.   Areas of Application

     4.1 The Cenvat Credit Rules 2004 allows distribution of credit of service
         tax paid on input services. The need for distribution of Cenvat credit
         can arise in the following situations.

         a) A service provider has provided a service that is used in or is
             attributable to different factories of the manufacturer, but the service
             provider has raised a common invoice for the same on an office of
             the manufacturer.

         b) The nature of the service provided in such that it is common to the
             activities undertaken by the manufacturer in more than one
             location/factory all of which are manufacturing excisable goods.
             Therefore, the credit of service tax mentioned in the common
             invoice issued for the service is required to be distributed.

         c) The service availed by an office of the manufacturer is indirectly
             related to the manufacture of excisable final products and therefore,
             there is a need to distribute the Cenvat credit.

         d) The input services are used for manufacturing both excisable and
             exempted goods or for providing both taxable and non-taxable
             services.

         e) The input service distributor has different units spread over various
             parts of the country manufacturing both excisable and exempted


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                                Monograph on Input Credits under Indirect Taxes


             goods and the bill/invoice in respect of input services is raised in the
             name of head office/regional office/branch office/specific factory,
             etc., while the services are actually received in the factory/factories
             or premises of the service provider.

          f) Common services, which are not specific for any particular factory
             or premises (such as advertising, market research, audit fees,
             management consultancy, etc.) the bills/invoices may be received
             in the head office/regional offices of the organization.

     4.2 The Rules do not state anything on the subject of apportionment. This
          guidance note aims to provide for a mechanism and a basis for
          allocation and apportionment of the utilization of input service so that
          the tax credit could be passed on to the respective factory/premises
          based on principle of commercial and generally accepted accounting
          principles, which should enable anyone, particularly tax authorities and
          auditors, to be convinced that the apportionment satisfies the
          requirements of law and is consistently followed.

     4.3 The head office/regional offices necessarily have to take up the
          responsibility of „distributing‟ the tax credit to its respective units
          through the medium of invoices.

     4.4 This guidance note is applicable in all cases wherein an Input Service
          Distributor, being a “going concern” distributes service tax credit across
          one or more Units (such Units being manufacturing units and/or units
          providing output services and/or units engaged neither in manufacture
          nor providing output services).


5.   Identification of Input Services on which Credit may be availed

     5.1 In respect of an entity providing output services the input services that
          qualify as services on which credit of service tax may be taken are all
          the taxable services used by the entity for providing the output
          services.




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                            Monograph on Input Credits under Indirect Taxes


5.2 In respect of a manufacturing entity the services on which credit of
     service tax may be taken are:

     a) input services used in or in relation to the manufacture of final
        products. Such use could either be direct or indirect.

     b) input services used in or in relation to the clearance of the final
        products up to the place of removal. Such use for clearance of final
        products could either be direct or indirect.

5.3 In respect of an entity engaged in both manufacture and providing
     output service, services on which the credit of input tax may be taken
     are those used specifically for providing output service as well as
     services used in or in relation to manufacture or clearance of final
     products.

5.4 The above indicates that the input service must be a service used in or
     in relation to the manufacture of final products. It further specifies that
     such use could be either direct or indirect.

     Explanation:

     a. Input service used „in or in relation‟ to manufacture or clearance
        means an input service that is so integrally connected with the
        process of manufacture or clearance that without which such
        manufacture or clearance would be commercially inexpedient.

     b. Input services includes services used in relation to various other
        activities related to the business of manufacture / providing output
        service, as illustrated in the definition of „input service‟.

5.5 The other conditions for availing credit of Service Tax are:

     1. The input service must be received by the manufacturer of final
        product on or after 10th September 2004.

     2. The invoice must be issued by the Input Service provider on or after
        10th September 2004.


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                                Monograph on Input Credits under Indirect Taxes


          3. Credit shall be taken only on or after the day on which payment of
             the value of service and service tax paid thereon is made.


6.   Methodology for Allocation and Apportionment of Credits

     6.1 In any entity, the methodology followed by an Input Service Distributor
          for distribution of service tax credit would depend upon whether the
          entity has:

          1. a single Unit engaged in manufacture of some product, or,

          2. multiple Units engaged in manufacture of a homogenous product,
             or,

          3. multiple Units engaged in manufacture of heterogeneous products,
             or,

          4. a single Unit engaged in providing output services, or,

          5. multiple Units engaged in providing output services, or,

          6. multiple Units, some of which are engaged in manufacture of a
             homogenous product while other Units are engaged in providing
             output services, or,

          7. multiple Units, some of which are engaged in manufacture of
             heterogeneous products while other Units are engaged in providing
             output services.

          8. multiple Units, falling under any of the categories 3 to 7 above
             where some of the products are exempted from payment of excise
             duty and some are not.

     6.2 Allocation of service tax credit by the Input Service Distributor should,
          therefore, be based on the following methodology:

          1. In case the input service provided is identifiable to a specific Unit,
             the service tax credit must be allocated to that particular Unit.



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                           Monograph on Input Credits under Indirect Taxes


    2. In case the input service is identifiable to a group of Units under a
        particular business, the service tax credit must be allocated to that
        business and apportioned to the Units under that business.

    3. In case the input service is common to all Units or is in relation to all
        the businesses of the entity, the service tax credit must be
        apportioned first across all the businesses and, thereafter, be
        apportioned to the specific Units under different businesses.

6.3 The methodology of allocation and apportionment to be adopted by the
    Input Service Distributor should be as under:

    1. Apportionment of service tax credit across the various businesses
        of the entity or across Units engaged in the manufacture of
        heterogeneous products should be done on the basis of previous
        financial year‟s audited sales revenue (net of excise duty) of each
        business.

    2. Allocation of service tax credit across Units engaged in manufacture
        of a homogeneous product should be done on the basis of previous
        year‟s audited production quantities of such Units.

    3. Allocation of service tax credit across Units engaged in providing
        different output services should be done on the basis of previous
        year‟s audited sales revenue (net of excise duty) of such Units.

6.4 Previous year‟s audited figures are the only commercially viable basis
    for ensuring equitable allocation for all industries including seasonal
    industries.

6.5 In addition to above, there are manufacturers coming under the
    category as described above under item 6.1.8, i.e., companies having
    multiple Units engaged in manufacture of heterogeneous products or
    providing output services some of which are exempted from paying
    excise duty or are not taxable under Service Tax Rules.




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                                  Monograph on Input Credits under Indirect Taxes


     6.6 In such cases the quantum of service tax credit allocated and
          apportioned to such Units (on the basis of apportionment methodology
          stated above) must be absorbed in the expense head under which the
          procurement cost of the input service has been booked since such
          Units will not be in a position to avail any service tax credit.

     6.7 It may be noted that the above allocation and apportionment for credit
          of service tax should be done individually based on the type of input
          service availed and should not be applied in totality. For example,
          service tax paid on sales promotion and advertising expense cannot be
          apportioned in the same ratio among different Units as that of service
          tax on audit fees. The nature and type of service should be the guiding
          criteria for determining whether the service tax on such service should
          be apportioned to a particular unit or not.


7.   Disclosure and Reporting Requirements

     7.1 The details of basis for arriving at the quantum of service tax credit
          available for allocation must be disclosed.

     7.2 Once the basis of apportionment and allocation of service tax credit
          across different businesses and within that different Units are selected,
          the same must be followed consistently and uniformly.

     7.3 Any change in the basis of apportionment or allocation can be adopted
          only when it is compelled by the change in circumstances like change
          in the nature of business, divestment of businesses, closure or
          acquisition of businesses or a particular Unit, etc. and the change
          would provide a more true and fair approach. In case of such changes,
          proper disclosure is essential.

     7.4 Any change in basis of apportionment or allocation of service tax credit
        that has a material effect on the cost of the product(s) and/or services
        should be disclosed. Where the effect of such change is not
        ascertainable wholly or partly, the fact should be reported.




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