Input Tax Credit on Composite production of Taxable/Tax Free goods under PVAT Act, 2005

Section 13 of the PVAT Act, 2005 provides for the entitlement of Input Tax Credit on the purchases made by a Taxable Person subject to such Conditions as may be prescribed. However when a person uses taxable goods for the production of both taxable and tax free goods Section 13(5) & Rules 23 & 24 of the PVAT Rules, 2005 comes into play. The word USE is of prime importance and the availability of the Input Tax Credit on full basis or on proportionate bases depends on use of raw material. The Excise & Taxation Department, Punjab without actually understanding the true sense of these sections is disallowing the Input Tax Credit on the raw material qua Tax Free goods on basis of Rule 23 & 24 of the Punjab VAT Rules, 2005. Relevant portion of Section 13 (1) & 13(5) are reproduced as under:

“Section 13(1)  A taxable person shall be entitled to the input tax credit, in such manner and subject to such conditions, as may be prescribed, in respect of input tax on taxable goods, including capital goods, purchased by him from a taxable person within the State during the tax period:

Provided that such goods are for sale in the State or in the course of inter-State trade or commerce or in the course of export or for use in the manufacture, processing or packing of taxable goods for sale within the State or in the course of inter-State trade or commerce or in the course of export:

Provided further that a taxable person shall be entitled to partial input tax credit in any other event, as may be provided in this section in such manner and subject to such conditions as may be prescribed:

Provided further that if, purchases are used partially for the purposes specified in this sub-section and the taxable person is unable to identify the goods used for such purposes, then the input tax credit shall be allowed proportionate to the extent, these are used for such purposes, in the prescribed manner:

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Section 13(5) A taxable person under this section, shall not qualify for input tax credit in respect of the tax paid on purchase of, –

(h)    goods used in manufacture, processing or packing of goods specified in Schedule ‘A’;”

Rule 23 of the Punjab VAT Rules, 2005 provides for the availability of Input Tax Credit where identification of goods is possible whereas Rule 24 provides for the availability of Input Tax Credit where identification of goods is not possible.”

The word USE here show the control or willingness of a person to use the raw material according to his wish for the production of taxable or tax free goods. Where the person has authority over the quantity and can decide the amount of raw material to be used in production of taxable or tax free goods there the Principle of Apportionment can be applied and proportionate Input Tax Credit can be given but where he does not have the control over the raw material used for the purpose of taxable or tax free goods i.e. in case of Composite Production where he cannot control the quantity at his own will no Input Tax Credit can be disallowed on proportionate basis.

Let’s understand this with examples:

Let us take case of a Publisher

A publisher of books/notebooks by using paper can produce books, periodicals, Journals which are tax free and can also produce other stationary items like exercise books, graph books which are taxable. Now it is upon his will or under his control that he can use 100 rims of paper for the production of books/ note books and 50 rims of paper for production of other taxable items or vice-versa or any other quantity which he may decide. Here he has the choice to use these goods in the manner he wants. He has the control over the quantity of the raw material used in the production of taxable goods and tax free goods. Here Input Tax is to be allowed proportionately depending upon the quantity used by him.

Now let us take the case of Rice Sheller:

A Rice Sheller shells paddy to produce Rice and along with it Phak, Rice Husk, Nakuu & Kinki are also produced. Here he has no control over the raw material which has gone into the production of Rice. He cannot choose certain quantity of paddy of only producing Rice and some quantity of Paddy for production of tax free goods. It is a composite production where each stick of paddy has gone into the production of Rice which is taxable and Phak, Rice husk and other products which are tax free. Here he has no choice to use these goods in the manner he wants. He has no control over the quantity of the raw material used in the production of taxable goods and tax free goods. Here no Input Tax Credit can be disallowed on proportionate basis. He is entitled to full amount of Input Tax paid on the raw material used.

Similar is the case with the Sugar Industry where Sugar is tax free and Molasses & Bagasse are Taxable.

In case of Composite production of taxable and tax free goods no Input Tax Credit can be disallowed on proportionate basis. Where the person has no option or cannot use the raw material at his will Section 13(5) & Rule 23 & 24 are not applicable there.

Hon’ble Supreme Court of India in case of Bharat Petroleum wherein Kerosene Oil was produced by Refining of Crude Oil with the help of Sulphuric Acid. Kerosene and Acid Sludge were produced. Kerosene was not taxable and Acid Sludge was sold as taxable commodity. The Department was disallowing set-off qua Kerosene Oil and was only allowing set-off to the extent of Acid Sludge sold. Here the Hon’ble Apex Court held that in the Composite production of Kerosene and Acid Sludge full amount of Set-off on the tax paid on Sulphuric Acid will be allowed.

Similar view was taken by Madhya Pradesh High Court following the judgment of Hon’ble Supreme Court where in in the manufacture of taxable Edible Oil tax free De-Oiled Cake was also produced. The Hon’ble Court held that the petitioner is entitled to full amount of set-off as it was a composite production of both taxable and tax free goods and authority cannot apportion the tax liability after deducting the percentage of raw material used for production of De-Oiled cake.

Karnataka High Court also took the same view in case of M.K. Agro Tech (P) Ltd Vs State of Karnataka and allowed full amount of Input Tax Credit on the raw material in case of composite production of both taxable and tax free goods.

So on the basis of the these judgments no Input Tax Credit can be disallowed where there is a composite production of taxable as well as tax free goods. Need of the hour is to understand the true sense of the Section 13 and the Rules made there under as interpreted by the Hon’ble Courts so as to give them proper applicability in the interest of general public.