The Madras High Court has held that the stock transfer between units of the same manufacturer does not deprive the assessee of input credit when final products are excisable.

The bench of Justice G. Jayachandran and Justice R. Sakthivel has observed that a manufacturer is entitled to avail CENVAT credit on furnace oil used in the manufacture of an exempt intermediate product, where such intermediate product is stock-transferred to another unit of the same manufacturer and subsequently used in the manufacture of dutiable final goods. The Court set aside the contrary view taken by the Customs, Excise and Service Tax Appellate Tribunal (CESTAT), providing important clarity on the treatment of stock transfers under the CENVAT framework. 

The dispute related to CENVAT input credit of ₹52.51 lakh claimed on furnace oil used by the manufacturer at its Salem unit during the period March 2001 to February 2002.

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The Salem unit manufactured Dead Burnt Magnesite (DBM), which attracted a nil rate of excise duty. A portion of the DBM was used within the Salem unit to manufacture dutiable monolithic products, while the remaining quantity was stock-transferred to the company’s Belpahar unit in Odisha. There, DBM served as an intermediate input for manufacturing refractory mortars, ramming mass and refractory bricks, all of which were subject to excise duty at 16%. 

The Department issued a show cause notice alleging that since DBM was itself a nil-duty final product, the assessee was not entitled to claim CENVAT credit on furnace oil used in its manufacture under Rule 57AD of the Central Excise Rules and Rule 6 of the CENVAT Credit Rules. It demanded recovery of ₹52,51,685, along with interest and penalty. 

The department argued that DBM cleared from the Salem unit was itself the final product attracting nil duty. Rule 57AD prohibited CENVAT credit on inputs used in exempted goods. The exception contained in Rule 57AD(2) applied only to non-fuel inputs, making furnace oil ineligible. Since furnace oil was consumed in Salem while dutiable goods were manufactured in another unit at Belpahar, the statutory requirement that inputs be used “within the factory of production” was not satisfied. 

The manufacturer contended that DBM was merely an intermediate product, not the final product. Transfer from Salem to Belpahar was a stock transfer, not a sale. The ultimate excisable products were refractory mortars and refractory bricks manufactured using DBM. Since duty was paid on the final products, denial of CENVAT credit defeated the objective of the MODVAT/CENVAT scheme, namely, avoiding cascading taxation. 

The High Court framed the principal question as whether CENVAT credit on fuel must be denied merely because an exempt intermediate product manufactured at one factory was transferred to another factory of the same manufacturer where it was used to manufacture dutiable final goods. 

The Court relied extensively on the Supreme Court’s decision in Escorts Ltd., observing that an intermediate product does not become a “final product” merely because it is transferred from one factory to another unit of the same manufacturer.

The Bench noted that the entire manufacturing chain ultimately culminated in dutiable products on which excise duty was admittedly paid. Therefore, the exempt character of the intermediate product could not be used to deny credit on the inputs consumed in its manufacture. 

The Court also examined whether the movement of DBM constituted a sale. It found that there was no consideration involved, ownership remained with the same manufacturer, the goods were reflected as stock transfers, and both units formed part of the same corporate entity.

Accordingly, the Court held that the transfers were purely stock transfers and not sales. 

One of the most significant aspects of the judgment concerns the phrase “within the factory of production” appearing in the definition of “input.”

The Revenue argued that credit was unavailable because furnace oil was used in the Salem unit whereas the dutiable products were manufactured at Belpahar.

Rejecting this contention, the High Court adopted a purposive interpretation. It observed that insisting upon manufacture within the same physical premises would produce irrational consequences where different units of the same manufacturer formed part of a continuous manufacturing process.

The Bench held that where ownership is common, the manufacturing chain is integrated, the intermediate goods are merely stock transferred, and the ultimate products are dutiable,

the expression “within the factory of production” should receive a broader interpretation so as to include another manufacturing unit of the same assessee. Such an interpretation, the Court held, best advances the objective of the MODVAT/CENVAT scheme by preventing cascading taxation. 

The Court distinguished the Supreme Court’s decision in Ballarpur Industries, observing that the case primarily dealt with valuation of stock transfers for reversal of credit and not with the eligibility of CENVAT credit where an exempt intermediate product was subsequently used in manufacturing dutiable final products.

Similarly, decisions concerning exempt waste products or by-products were held to be factually distinguishable. 

The Madras High Court held that DBM remained only an intermediate product and not the relevant final product for determining CENVAT eligibility. Transfer of DBM from Salem to Belpahar constituted stock transfer, not sale. The ultimate dutiable products manufactured at Belpahar were the relevant final products. CENVAT credit on furnace oil could not be denied merely because the intermediate product was manufactured in one unit and the final goods in another unit belonging to the same manufacturer. 

The CESTAT’s order sustaining recovery of ₹52.51 lakh with interest was unsustainable and liable to be set aside. 

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