Write down and do not write off Inventory – Review of the Rule 3(5B) of Cenvat Credit Rules, 2004
Change of models, customer requirements, change of processes, poor inventory management can increase a business’s obsolete inventory levels. In such cases, the best accounting practices suggest writing off / provision for the value of such stocks in the books of accounts. The stocks are not physically destroyed but retained with the hope that they can be put to better use in future. AS (Accounting Standard) -2 on Valuation of Inventories issue by Institute of Chartered Accountants of India requires inventories to be valued at the lower of Cost and Net realizable Value. Inventories are usually written down to net realizable value on an item by-item basis. In some circumstances, however, it may be appropriate to group similar or related items. This may be the case with items of inventory relating to the same product line that have similar purposes or end uses and are produced and marketed in the same geographical area and cannot be practicably evaluated separately from other items in that product line.
CBEC has always taken a view that write off amounts to abuse of the system and that the credit taken on inputs on such stocks must be reversed.
This led to the introduction of Rule 3(5B) of Cenvat Credit Rules, 2004 (CCR, 2004). Rule 3(5B) reads as follows:
If the value of any,
(i) input, or
(ii) capital goods before being put to use,
on which CENVAT credit has been taken is written off fully or partially or where any provision to write off fully or partially has been made in the books of account then the manufacturer or service provider, as the case may be, shall pay an amount equivalent to the
CENVAT credit taken in respect of the said input or capital goods:
Provided that if the said input or capital goods is subsequently used in the manufacture of final products or the provision of output services, the manufacturer or output service provider, as the case may be, shall be entitled to take the credit of the amount equivalent to the CENVAT credit paid earlier subject to the other provisions of these rules.]
[Explanation. — If the manufacturer of goods or the provider of output service fails to pay the amount payable under sub-rules (5), (5A) and (5B), it shall be recovered, in the manner as provided in rule 14, for recovery of CENVAT credit wrongly taken.]
Rule 3(5B) was introduced by Notification No. 26/2007 –C.E. (N.T) dated 11th May 2007.
The original Rule Contemplated reversal of CENVAT Credit of Inputs or Capital Goods fully written off or provision to write off fully has been made in the books of accounts.
As regard writing off work in progress (WIP), it is stated that if the WIP has reached the stage, when it can be considered as manufactured goods, in that case, the same treatment as applicable to finished goods will be apply.
With effect from 1st Mar 2011, reversal of Cenvat credit on partial write off / provision was introduced vide Notification no. 3/2011-C.E. (N.T.).
The Rule as read before and after the change is given below.
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Prior to March 2011 |
From March 2011 |
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Rule 3 (5B) of CENVAT Credit Rules, 2004 states that if the value of any, 1. input, or 2. capital goods before being put to use, on which CENVAT credit is taken is written off fully or where any provision to write off fully has been made in the books of account then] the manufacturer or service provider, as the case may be, shall pay an amount equivalent to the CENVAT credit taken in respect of said inputs or capital goods |
Rule 3 (5B) of CENVAT Credit Rules, 2004 states that if the value of any, 1. input, or 2. capital goods before being put to use, on which CENVAT credit is taken is written off fully o*r partially or where any provision to write off fully or partially has been made in the books of account then] the manufacturer or service provider, as the case may be, shall pay an amount equivalent to the CENVAT credit taken in respect of said inputs or capital goods. |
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Hence, with effect from 1 March 2011, even partial write-off or partial provision for write-off would attract reversal of credit under Rule 3(5B) of CCR,2004. |
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Whether amendment to Rule 3(5B) of CCR, 2004 would have a retrospective impact?
Rule 3(5B) of CCR,2004 as amended vide Notification No. 3/2011 C.E. (N.T.) with effect from 1 March 2011 provides for reversal of CENVAT credit even when inputs are partially written off or provision for partial write-off is made.
Since the amendment has come into effect only with effect from 1 March 2011, partial write-off and provision for partial write-off of inputs prior to such date would not attract reversal of credit under Rule 3(5B) of CCR, 2004.
Whether Semi-finished and Finished Goods are covered?
Inputs and Capital Goods have been defined by Rule 2(k) and Rule 2(a) respectively of CENVAT Credit Rules 2004. With respect to applicability of Rule 3(5B) to WIP/FG, clarification has been issued by CBEC vide Circular No. 907/27/2009- CX. As per the Circular, if the goods have been manufactured, in that case, a manufacturer is liable to pay excise duty unless duty is remitted under Rule 21. Therefore, if the value of finished goods is written off, the manufacturer would be liable to pay excise duty or he would be required to reverse the credit on the inputs used, if duty has been remitted on finished goods
As regard writing off work in progress (WIP), it is stated that if the WIP has reached the stage, when it can be considered as manufactured goods, in that case, the same treatment as applicable to finished goods will be applicable, However, if the activity carried out on the WIP goods cannot be considered as amounting to manufacture, in that case, the said goods should be considered as input and the treatment for reversal of credit applicable to input would be applicable.
Rule 3(5) of CCR, 2004 provides that if the inputs or capital goods on which CEVNAT credit is taken are removed as such, then the CENVAT credit so taken has to be reversed.
Alternatively, where inputs are used in the manufacturing process and removed as manufactured scrap, the Company shall pay applicable excise duty and CENVAT shall not be reversed.
Whether write down of Inventory as per As – 2 attracts Rule 3(5B)?
Write down in common business parlance represents restating the value with a lower amount, While Write off generally results in permanent ‘de-recognizing ’ or bring down to Zero or negligible amount with no intention of
writing back unless situation otherwise warrants, write down is temporary reduction in value. On the other hand, in the case of provision, it is shown as a deduction from Gross amount in the books of accounts. While Rule 3(5B) covers write off and provision, write down is not covered within the scope.
The different scenarios and treatment of CENVAT is summarized below.
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Scenario |
Implications |
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Inputs fully written off or provision for write-off done prior to March 2011 |
CENVAT availed on such inputs shall be reversed. |
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Inputs put to use in manufacture (as WIP) and then fully written off or provision for write-off done prior to March 2011 |
If the WIP has reached a stage, when it can be considered as manufactured goods, reversal of credit under Rule 3(5B) of CCR,2004 would not be attracted. |
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Inputs partially written off or provision for partial write-off done prior to March 2011 |
Since the amendment is effective only from March 2011, provisions made prior to such date would not attract reversal of CENVAT credit under Rule 3(5B) of CCR,2004 |
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Inputs partially written off or provision for partial write-off done prior to March 2011 and subsequently removed as such (without being used in manufacture) |
Provisions of Rule 3(5) of CCR, 2004 would be applicable and the Company would be required to reverse CENVAT credit availed on such items. |
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Inputs partially written off or provision for partial write-off done prior to March 2011 and subsequently removed as manufactured scrap (after use in manufacture) |
Rule 3(5) of CCR,2004 would not be applicable and hence CENVAT shall not be reversed. The entity would be required to discharge applicable excise duty. |
Conclusion
CENVAT credit on inputs / capital goods is based on the “use concept” (i.e., used in the factory of the manufacturer). Although CENVAT credit can be taken immediately on receipt of inputs / capital goods in to the factory premises, the credit is eventually dependent on the actual use of such inputs / capital goods in or in relation to the manufacture of dutiable final products. Thus, in any given scenario, where the inputs are not used in the process of manufacture and removed as such, CENVAT credit availed on such inputs shall be reversed.
Disclaimer: The views expressed in this write up are personal. No responsibility for loss arising to any person acting or refraining from acting as a result of any material contained in this fortnightly feature will be accepted by the author. It is recommended that professional advice be sought based on the specific facts and circumstances.
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