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 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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 Cenvat Credit Rules

1.4 By virtue of Service Tax Credit Rules, 2002, with effect from 16th
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
services to such manufacturer or producer or provider, as the case
may be.

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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
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

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 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.

“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,

“Manufacturer” shall be construed in accordance with ‘manufacture’

and shall include not only a person who employs hired labour in the

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 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
goods and the bill/invoice in respect of input services is raised in the
name of head office/regional office/branch office/specific factory,

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 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.

5.2 In respect of a manufacturing entity the services on which credit of

service tax may be taken are:

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 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.

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.

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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.

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.

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 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.

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

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 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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