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RULE 3 (5B) of the CCR - Write-off or 'Provision to write-off' versus Cenvat Reversals, Analysis

Manoj Pala 
on 31 May 2013

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We refer to Sub-rule (5B) of Rule 3 of the CCR states that if the value of any:

(i) input, or

(ii) capital goods before being put to use,

on which CENVAT credit is taken is written-off fully or partially or where any provision to write-off fully orpartially (w.e.f., 1.3.2011) has been made in the books of account, then the manufacturer or service provider is required to pay an amount equivalent to the CENVAT credit taken in respect of said inputs or capital goods.

However, if these are subsequently used in the manufacture of final products or the provision of taxable service, the manufacturer or output service provider can take credit of the amount paid earlier.

  

To our knowledge, the precise and correct understanding of Rule 3 (5B) of the CCR, is as follows;;

If the value of unused inputs or unused capital goods on which CENVAT credit is taken is written-off fully or partially or whereany provision to write-off fully or partially has been made in the books of account  è then, YES the CENVAT Credit is to be reversed.

                                                                

Meaning of Write-off  or  provision to write-off à The write-off or any provision to write-off implies (a) the unused stock has been fully depreciated / written-off in the manner that it no longer has any book value and such nil value stock is deleted from the books or (b) provision to write-off fully or partially is been made from time to time with an intent to reduce the value of such stock to almost nil and thereafter delete such nil value stock from the books (c) to charge / write-off the whole of the value of an asset to expenses or loss (i.e. assign it zero value on balance sheet). Such write-off is also known as ‘charge off’.

When are Write-off / provision to write-off made à In case an item is not likely to be of any use for any reason i.e., “dead items”, then its value can be written off from the books of account and simultaneously also taken out physically from the closing stock and put in to the scrap bin / yard, where from such dead items may be disposed off as scrap. Such analysis is only after technical analysis of each individual item in stock.

If a dead asset is fully written off, then it no more remains in the books of account of the company. And if a dead asset is partially written off i.e., written down, then its value as shown in the books is reduced. And when a provision to write-off fully or partially made in books of account, then it is with the same intent to discard the asset from the books sooner or later.

In effect, it may therefore be gain said that when the stock of unused inputs or unused capital goods is declared dead / damaged / unfit for use, then its value is written-off fully or partially or a provision to write-off fully or partially is made in the books of account. And in that case, the CENVAT Credit taken in respect of such unused stock of inputs / capital goods is absolutely required to be reversed in terms of Rule 3 (5B) of the CCR.

Important NOTE :::: that the word “off” means to remove or removed from. Thus, the word “off” in Rule 3 (5B) is very akin to the Meaning of Write-off or provision to write-off … as stated above i.e., when an asset is damaged / defective / unfit for use then it is in the nature of a ‘dead stock’. And for the such dead stocks, the value is written-off or a provision to write-off is made in books of account and invariably such dead stock is removed from the books of account of the company. In fact, such dead stocks are also physically removed from the closing stocks and dumped in to the scrap bin for disposal as scrap.

However, in contrast to write-offs as aforesaid, we may now like to discuss the provisions.

As per AS-29, provision is a liability which can be measured only by using a substantial degree of estimation. Here, Liability means a present obligation of the enterprises arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. From the definition of Liability, it is clear that to become a liability there must be present obligation

Inventory provisions / provisions on unused stock è it is not unusual that manufacturers are often stuck with slow / non-moving stocks of inputs such as raw materials and components, due to change of models or change of processes or poor feedback from customers or obsolescence, etc. In such cases, the best accounting practices suggest making parallel provisions in the books of accounts, instead of carrying their value in the books as assets. Such stocks on which provisions are made are capable of and available for use and are not physically destroyed but are retained with the hope to be brought to better use in future.          

Important NOTE  that the word “of” means to be a part of something. Thus, when general accounting provisions are made in books of account, the asset continues to remain in books at its value. And such stock is very much retained and is freely available and capable of use.

Hence, inventory / stock provisions made in books of account to take into account the quantity risk (accounting prudence) / technical risk are made without any intention to “Write-off” the inventory. Provisions so made are charge against profit. Provisions are usually shown in the balance sheet in a separate line by way of deduction from the assets. Thus, when provision is made based upon accounting convention / prudence, the asset continues to be in the books of account of the company at its book value. And physically, such stock is retained which is freely available and capable of use.

Making general provision in books of account is not ‘write-off’ of the asset. Usually, majority of the inventory / stock for which a general provision has been made will be actually used at a later stage. When general accounting provisions are made in financial records for such stock of inputs which are physically available and capable of use, then such provisions do not amount to any “write-off” and therefore, the CENVAT Credit is not required to be reversed

The Conclusion

Wherever an item of inventory is clearly identified as dead or unusable, it should be written off (fully or partially) or a provision to write-off fully or partially is to be made in books of account. In such cases, Cenvat Credit of duty taken on such item should be reversed.

In case of other items, where only a general provision is made based upon accounting prudence, without removing that item from inventory and without reducing individual value of any item è then in my considered view, reversal of CENVAT credit of duty is not required

With my kind regards & JSK

Manoj Pala

SIEMENS LTD, Kharagpur


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