Supreme Court clarifies Input Tax Credit on By-Products under KVAT Act: State of Karnataka vs. M/S. M.K. Agro Tech Pvt. Ltd. (22 September 2017)

Introduction

Date of the Judgment: 22 September 2017
Citation: Civil Appeal Nos. 15049-15069 of 2017
Judges: A.K. Sikri, J. and Ashok Bhushan, J. (authored by A.K. Sikri, J.)

When a company manufactures a product, and in that process, a by-product is created, can the company claim full input tax credit if the by-product is exempt from tax? The Supreme Court of India recently addressed this question in a case concerning the Karnataka Value Added Tax Act, 2003 (KVAT Act). The core issue revolved around whether a manufacturer of sunflower oil could claim full input tax credit on the purchase of sunflower oil cake, when a by-product, de-oiled cake, was also generated and sold, but was exempt from tax. The Supreme Court bench comprising Justices A.K. Sikri and Ashok Bhushan, with the judgment authored by Justice A.K. Sikri, overturned the High Court’s decision, ruling that partial input tax credit was applicable in such cases.

Case Background

M/S. M.K. Agro Tech Pvt. Ltd. (referred to as the ‘assessee’) is a company that manufactures sunflower oil by extracting it from sunflower oil cake. The assessee purchases sunflower oil cake, which is subject to Value Added Tax (VAT) under the KVAT Act. After extracting the oil, they sell it, which is also subject to VAT. In this process, a by-product, de-oiled sunflower oil cake, is also produced. This de-oiled cake is sold by the assessee, but it is exempt from VAT under the KVAT Act. The dispute arose because the State of Karnataka contended that the assessee was eligible only for partial input tax rebate due to the sale of the tax-exempt de-oiled cake. The assessee argued that the input (sunflower oil cake) was entirely used in the extraction of sunflower oil, and the de-oiled cake was merely a by-product, not a result of a separate manufacturing process.

Timeline:

Course of Proceedings

The prescribed authority, after scrutinizing the returns filed by the assessee for the period from March 2005 to March 2007, concluded that the assessee was eligible only for partial input tax rebate as per Section 17(1) of the KVAT Act, read with Rule 131(3) of the KVAT Rules, 2005. This was because the assessee, while extracting sunflower oil from sunflower cake, also obtained de-oiled cake, which was exempt from tax. The First Appellate Authority and the Karnataka Appellate Tribunal upheld this decision. However, the High Court of Karnataka, in its judgment dated July 17, 2014, allowed the assessee’s revision petitions, holding that the assessee was entitled to full input tax deduction. The High Court interpreted Section 11(a)(1) and Section 17(1) of the KVAT Act, read with Rule 131 of the KVAT Rules, 2005, applying the principle of purposive construction, concluding that since the sunflower oil cake was entirely used for the manufacture of sunflower oil, the generation of de-oiled cake as a by-product did not warrant partial input tax credit.

Legal Framework

The key legal provisions in this case are:

• Section 2(6) of the KVAT Act, 2003: Defines “business” broadly to include any trade, commerce, or manufacture, as well as any transaction incidental to it.
• Section 2(15) of the KVAT Act, 2003: Defines “goods” as all kinds of movable property, including materials, commodities, and articles.
• Section 3 of the KVAT Act, 2003: Levies tax on every sale of goods in the State by a registered dealer.
• Section 5 of the KVAT Act, 2003: Provides for exemption of certain goods from tax, as specified in the first schedule or by notification. De-oiled cake was exempted under this provision vide a government notification in 2005.
• Section 10 of the KVAT Act, 2003: Defines “output tax,” “input tax,” and “net tax.” It allows for the deduction of input tax from output tax, subject to certain restrictions.
  • (1) Output tax in relation to any registered dealer means the tax payable under this Act in respect of any taxable sale of goods made by that dealer in the course of his business…
  • (2) Subject to input tax restrictions specified in Sections 11,12,14, 17 and 18, input tax in relation to any registered dealer means the tax collected or payable under this Act on the sale to him of any goods for use in the course of his business…
  • (3) Subject to input tax restrictions specified in Sections 11, 12, 14, 17, 18 and 19, the net tax payable by a registered dealer in respect of each tax period shall be the amount of output tax payable by him in that period less the input tax deductible by him as may be prescribed in that period…
• Section 11(a)(1) of the KVAT Act, 2003: Restricts input tax deduction on purchases attributable to the sale of exempted goods.
  • (a) Input tax shall not be deducted in calculating the net tax payable, in respect of: (1) tax paid on purchases attributable to sale of exempted goods exempted under Section 5, except when such goods are sold in the course of export out of the territory of India;
• Section 17 of the KVAT Act, 2003: Deals with partial rebate, applicable when a registered dealer makes sales of both taxable and exempted goods.
  • 17. Partial rebate.- Where a registered dealer deducting input tax.- (1) makes sales of taxable goods and goods exempt under Section 5…apportionment and attribution of input tax deductible between such sales…shall be made in accordance with Rules…
• Rule 131 of the KVAT Rules, 2005: Prescribes the method for apportioning input tax when a dealer makes sales of both taxable and exempted goods.
  • (1) All input tax directly relating to sale of goods exempt under section 5…is non-deductible.
  • (2) All input tax directly relating to taxable sales may be deducted…
  • (3) Any input tax relating to both sale of taxable goods and exempt goods…may be calculated on the basis of the following formula: (Sales of exempt goods + non-taxable transactions) X Total input tax / Total sales (including non-taxable transactions)

Arguments

Arguments by the State of Karnataka (Appellant):

• The State argued that Section 2(15) of the KVAT Act covers all movable properties without distinguishing between by-products, ancillary products, or intermediate products. Any marketable and sold product falls under the definition of ‘goods’.

• Section 2(13) defines ‘input’ as any good purchased for use in manufacturing or processing other goods, implying that input can be used for more than one good.

• Section 3 stipulates that ‘sale’ is the point of levy, making the sale of goods relevant irrespective of whether the goods are manufactured by the seller.

• Section 11(a)(1) states that input tax paid for manufacturing or processing exempted goods cannot be credited while calculating net tax. The term ‘attributable to’ in Section 11(a)(1) implies purchases should be attributed to the sale of exempted goods, not merely the manufacture of exempted goods.

• Section 17(1) applies when a dealer sells both taxable and exempt goods, requiring an ‘apportionment and attribution’ of input tax between such sales. This section gives practical effect to Section 11 by providing a formula in the rules for calculating input tax attributable to exempt and taxable goods.

• Rule 131 completes Section 17 by prescribing a formula for apportioning input tax between taxable and exempt goods. Sub-rule (3) covers situations where input tax is not directly relatable to exempt or taxable goods, providing a formula to attribute and apportion the quantum of input tax.

• The High Court erred by focusing on ‘manufacture’ rather than ‘sale’. Section 17 applies whenever there is a sale of an exempted item, regardless of whether it is a by-product. The de-oiled cake, even as a by-product, is sold in the market and thus attracts Section 17.

• The de-oiled cake is not a waste product but a marketable commodity that yields substantial earnings for the assessee. The assessee cannot be given the benefit of full input tax reduction in such a situation.

• The de-oiled cake is an outcome of the ‘solvent extraction process’, and the assessee is also engaged in the manufacturing of de-oiled cakes.

• The State relied on the case of Commissioner of Central Excise, Jaipur v. Mahavir Aluminum Ltd. [(2007) 5 SCC 260], to argue that de-oiled cake and oiled cake are separate and distinct products with different marketability and commercial uses.

• The State also referred to Ravi Prakash Refineries Private Ltd. v. State of Karnataka [(2016) 12 SCC 193], to support the argument that oiled cake and de-oiled cake are two different commercial commodities.

• The State also cited State of Gujarat v. Raipur Manufacturing Co. Ltd. [(1967) 19 STC 1; AIR 1967 SC 1066], to argue that when a subsidiary product is turned out regularly and sold, the intention to sell both the main and subsidiary products can be attributed to the manufacturer.

Arguments by M/S. M.K. Agro Tech Pvt. Ltd. (Respondent):

• The assessee argued that Section 10 of the KVAT Act provides for the deduction of input tax from output tax, and therefore, the assessee was entitled to deduct the input tax paid on the purchase of sunflower oil cake.

• The assessee emphasized the word ‘attributable’ in Section 11(a)(1), arguing that tax paid on purchases attributable to the sale or manufacture of exempted goods is not deductible. The High Court rightly observed that the condition for input tax deduction is that the goods sold or manufactured should be liable to tax, and if no output tax is payable, the question of deducting input tax would not arise.

• The assessee contended that the High Court correctly interpreted Section 17 in conjunction with Rule 131, arguing that the assessee was only in the sale or manufacture of one product (sunflower oil) which is taxable. The emergence of a by-product (de-oiled cake) did not attract Section 17.

Submissions by Parties

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the assessee was entitled to full input tax credit on the purchase of sunflower oil cake, when a by-product, de-oiled cake, was also generated and sold, but was exempt from tax under the KVAT Act.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• The Court relied on Commissioner of Central Excise, Jaipur v. Mahavir Aluminum Ltd. [(2007) 5 SCC 260] and Ravi Prakash Refineries Private Ltd. v. State of Karnataka [(2016) 12 SCC 193] to establish that de-oiled cake and oiled cake are distinct commercial commodities.
• The Court cited State of Gujarat v. Raipur Manufacturing Co. Ltd. [(1967) 19 STC 1; AIR 1967 SC 1066] to support the view that the intention to sell both the main and subsidiary product can be attributed to the manufacturer.
• The Court emphasized the principle of literal interpretation of taxing statutes, citing Commissioner of Income Tax-III v. Calcutta Knitwears, Ludhiana [(2014) 6 SCC 444], State of Madhya Pradesh v. Rakesh Kohli & Anr. [(2012) 6 SCC 312], and V.V.S. Sugars v. Government of Andhra Pradesh & Ors. [(1999) 4 SCC 192].
• The Court also relied on Godrej & Boyce Mfg. Co. Pvt. Ltd. & Ors. v. Commissioner of Sales Tax and Others [(1992) 3 SCC 624], Hotel Balaji & Ors. v. State of Andhra Pradesh & Ors. [(1993) Supp 4 SCC 536], and Jayam and Company v. Assistant Commissioner and Another [(2015) 15 SCC 125], to emphasize that tax credit is a concession and the legislature has the power to determine the extent of such credit.
• The Court considered Section 2(6), 2(15), 3, 5, 10, 11(a)(1), 17 of the KVAT Act, 2003 and Rule 131 of the KVAT Rules, 2005 to interpret the provisions of the Act and Rules.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following:

• Literal Interpretation: The Court emphasized the importance of a literal interpretation of taxing statutes, stating that Section 17 of the KVAT Act clearly applies to the ‘sales’ of taxable and exempt goods, not just the ‘manufacture.’
• Sale of Goods: The Court focused on the fact that de-oiled cake is a saleable commodity, and its sale attracts the provisions of Section 17, regardless of whether it is a by-product.
• Rule 131(3): The Court highlighted that the High Court failed to consider the import and effect of sub-rule (3) of Rule 131 of the KVAT Rules, which provides a formula for apportioning input tax when both taxable and exempt goods are sold.
• Purpose of Section 17: The Court stated that Section 17 is designed to address situations where a dealer sells both taxable and exempt goods, and the provision for partial rebate is meant to take care of such situations.
• Tax Credit as a Concession: The Court reiterated that tax credit is a concession and the legislature has the power to determine the extent of such credit.

Sentiment Analysis of Reasons Given by the Supreme Court:

Fact:Law Ratio:

Conclusion

The Supreme Court held that the High Court erred in its interpretation of Section 17 of the KVAT Act and Rule 131 of the KVAT Rules. The Supreme Court set aside the High Court’s order and affirmed the original order of the prescribed authority, which allowed only partial input tax rebate. The Court emphasized that when a manufacturer sells both taxable and exempt goods, the input tax credit must be apportioned based on the formula provided in the rules. The judgment clarifies that the sale of by-products, even if exempt from tax, should be considered when calculating input tax credit, and the focus should be on the ‘sale’ of goods, not just the ‘manufacture.’ This decision has significant implications for businesses that generate by-products during their manufacturing processes and sell them as exempted goods.

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