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Excise and Service tax Audit in Manufacturing Industry-Ticklish things

on 18 December 2010


Our Audit performance (whatever the area may be) hinges on effective maintenance of records and documents otherwise the audit team is sure to take us for a ride. Not only this, the accounting department also has to have a good presence of mind as regards the manufacturing process! Of course the Central excise and service tax department are required to be intimated of the production process flows and also any future modifications. Here is an attempt to quickly share a few noteworthy experiences in a Manufacturing industry while facing these Annual excise or service tax audits. First of all let’s realize that in the department there is not only an Audit wing but also a Preventive wing which visits the Factory premises by surprise and with a better objectivity to plug the revenue leakage. We cannot feel sure that there would be respite on conclusion of the regular audit because at any time the Preventive unit might come blazing in with information that it has gathered at the customer or supplier end.



Excise duty framework in India is not so simply restricted to discharge of the Output duty by utilization of the Input duty (i.e. Cenvat Credit) upon the regular Sales to the Customer. As per Rule 5 of the Cenvat credit rules when there is clearance of the input goods 'as such' either to the customer or job worker (which is quite natural) an amount equivalent to the Cenvat credit availed at the time of the import or local procurement of the inputs needs to be paid. If the clearance is 'as such' i.e.on the basis of Invoice the Cenvat credit on the inputs (it may be a CVD or SAD etc) has to be paid through PLA by proper correlation to and description of the Input Bill of entries at the original duty rate. If the clearance is on the basis of 57F4 (challan prepared while dispatching to a Job worker), proper records have to be maintained to prove that the Intermediate product produced out of the Input has been received within 180 days. Either ways the assessee has got to do the homework. A challenging situation arises when the assessee attempts to prove that the inputs were not removed 'as such' at all! Consider a scenario where the inputs are subjected to some testing or packaging before dispatching to the Job worker. The audit team is highly unlikely to accept these processes as value additions and treat them like 'as such' removals. (The reason why an 'as such clearance' to a Job worker is treated indifferently to the 57F4 procedure is that there is no proof that the job worker has returned only the manufacturer's goods back to him after process i.e he could have cleared the manufacturers inputs outside or in other words resold not the same lot through an invoice back to the manufacturer. This only makes it a sale and repurchase transaction and not job work). To convince them the assessee has to have a very smart Cost sheet which somehow includes this process as an essential stage in the value chain and increments the market price. Even otherwise it becomes difficult since the law contains only a specific number of repacking or relabeling activities which can be regarded as 'deemed manufacture'. Therefore it is essential to thoroughly read the process, identify the various by products and intermediate products at every stage in the process flowchart and points of duty incidences at the inception itself.



If a company is into the practice of allowing input materials to be scrapped at the Jobworker end, it has to keep track of the quantities scrapped. In the absence of proper records maintained in this behalf, there will be two disadvantages,

1. The audit team may refuse to accept the quantity declared keeping in mind certain industrial norms. For e.g. they may pull off a reference to a 5% standard norm whereas the assessee would have declared 10% and the excess will not be validated.

2.  For calculation of the duty payable on such scrap items, there is every possibility that instead of the scrap value, the full market value of the item will be required to be reckoned for duty computation, for e.g where the scrap can fetch only Rs.10/- at the current condition, the department might insist taking into account Rs.100/- which is the current replacement cost or market value of the item. In most cases this differential amount will be very huge leading to duty loss.



A requirement is automatically thrust on the incumbent to know the circumstances when the Cenvat credit has got to be reversed and when 'an amount equivalent to the Cenvat credit availed has to be paid" in cash or cheque through PLA. For e.g as in the situation mentioned above under Rule 5 the amount has to be physically paid through PLA and not by debiting the Cenvat credit account, whereas in case of inputs sent to Job worker which have not been physically received back at the factory site within 180 days or where the assessee manufactures both Dutiable and exempted goods, he is given an option  to pay an amount equivalent to Cenvat credit on JW inputs or inputs relating to exempted goods as the case may be through PLA or by a debit to Cenvat credit account. This is required to be strictly followed i.e debit to Cenvat a/c is not an excuse when input duty is required to paid only through PLA.



The law has been tweaked to draw a line of distinction between 'Availment' and 'utilization' of Cenvat Credit. Currently the CBEC quite rigorously and disgustingly imposes an interest for even a wrong credit taken in records and returns (ie. RG 23A or RG23C) rather than a wrong utilization. To mention a live case; in a small company the concerned employee erroneously carried forward the balance of Cenvat Credit as Rs.77888833/- instead of Rs.7888833/- in the ER1 (excise return) of a particular month and the excise department slapped a demand notice for an interest of approx. Rs.350000/- with a hefty penalty! The difficulty here is that interest has to be paid only by way of cash and it cannot discharge the amount through PLA or reversal of existing credits.



Coming to the case of a Service tax audit. A manufacturing industry will be relatively less or not exigible to Service tax when compared to Excise Duty. But still law imposes a responsibility on them as far as foreign service receipt and GTA service is concerned to remit the service tax. This is purely from the point of administrative convenience and not intended to make the service recipient an output service provider. Unfortunately some audit teams have been insisting on a refrain from taking credit of these service tax paid, which is logically wrong according to professionals and lawyers. There would be serious repurcussions to a foreign subsidiary in India which sheds crores of Royalties and technical fees to its parent company abroad and receive SCN (Show cause notice) for taking credit of service tax paid on them (a company has infact received!).  Conventionally we understand that Royalty means payment for use of trademarks or license or a technology and is rightly attracting service tax as payment for an Intellectual property service. But take the case of a company paying Royalty on the basis of its Sales. It is hard to understand how service tax is attracted when such payments are actually in the form of a profit share. The argument that was put forth by the departmental auditor was that the company itself has chosen to account it as Royalty! (as if the focus seems to be on how an item is accounted rather than the real nature). Is there any other nomenclature available for these payments?. Not yet.



In the case of a Service tax on GTA (Goods transport agency) service both inward and outward, the service recipient is liable to discharge the service tax payment. It is a frequent incident that the auditor objects to taking Cenvat credit of the amount paid towards transportation to the final customer on the ground that only the input service upto the 'place of removal' (which is commonly understood to be a depot or factory) is allowed. But CBEC gives an exception to a 'destination sales' where the sale is said to happen at the customer doorsteps. In most cases where the BPA (Basic Purchase agreement) is silent on this aspect it will be difficult for the assessee to convince the auditor. Hence it is necessary to preserve all Bills, vouchers and tripsheets relating to these freight payments and more importantly to prove that the cost has not been passed on to the customer in the Invoice. Since otherwise it would mean that the risk and rewards of ownership have passed even before the buyers place and that is why the seller is recovering the freight from the buyer.



Payments to foreign consultants in the form of reimbursement of travel expenses also attract service tax treating them as Professional fees. Therefore companies may look to make payment directly to the travel agent towards air tickets and book the same as 'Travelling expense' which will not give any room for argument by the auditor. Invariably some business obligations might force the companies to bear the tax out of pocket which will be a loss to them. In the case of Directors, we have been taught of the distinction existing between a 'contract of service' and 'Contract for service'. In the latter case service tax is argued to be possibly attracted as service rendered as 'Management consultant'. Hence it would be advantageous if the company issues proper appointment letters to them and place them on rolls.


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