Use of Power at Any Stage Disqualifies Exemption Under Excise Law: Supreme Court Reiterates in Fabric Processing Case

“Manufacture is the end result of one or more processes... even if carried out by separate units, if the chain is continuous and uses power at any stage, exemption is not available” – In the latest judgement, Supreme Court of India delivered a significant judgment in Commissioner of Customs Central Excise & Service Tax Rajkot v. Narsibhai Karamsibhai Gajera & Ors., resolving a long-standing excise exemption dispute related to the processing of cotton fabrics and the clubbing of two separate industrial units for tax liability. The Court allowed the appeal filed by the Revenue and restored the Commissioner’s Order-in-Original dated 27.09.2006, ruling that the exemption under Notification No. 5/98-CE was not available since the manufacturing process, though spread across two registered entities, collectively used power.

The ruling reinforces the strict interpretation of exemption notifications in taxation, particularly when integrated manufacturing processes are split between entities within the same premises.

Exemption Denied If Power Used At Any Stage, Even In Interlinked Units

At the heart of the judgment was the interpretation of Entry No. 106 of Notification No. 5/98-CE dated 02.06.1998, which grants excise exemption to cotton fabrics processed “without the aid of power or steam”. The Revenue had denied the exemption to Unit No.1 (Bhagyalaxmi Processor Industry), arguing that though formally distinct from Unit No.2 (Famous Textile Packers), both operated within the same compound and executed an interdependent manufacturing process that involved use of power—particularly at the stentering stage in Unit No.2.

The Apex Court ruled:

“What is to be seen is whether the distinct processes undertaken by the two Units formed part of a continuous chain that culminated into the final product or not? If the various processes were so interlinked… it would be clear that the entire activity of undertaking the various processes amounted to ‘manufacture’ for the purposes of Section 2(f) of the Act of 1944.”

The Court firmly concluded that use of power at any stage disqualifies the unit from claiming exemption, regardless of whether the units were formally separate concerns.

Clubbing of Units and Excise Liability

The case arose after intelligence officials inspected both units on January 21, 2003, and found that Unit No.1 was engaged in bleaching and mercerizing, while Unit No.2 handled squeezing and stentering. After the fabrics were dried at Unit No.2, they were returned to Unit No.1 for bailing and packing. Both units had industrial electric connections, and machinery like electric motors, squeezing machines, and stentering machines powered by electricity and oil engines were installed.

The Commissioner issued a show cause notice demanding duty under Section 11-A(1), interest under Section 11AB, and penalty under Section 11AC of the Central Excise Act, 1944. Upon adjudication, the Commissioner held that Unit No.1 was liable, as it was the entity that received grey fabrics and cleared the final product.

However, the CESTAT set aside this finding, treating both units as independent legal entities, and held that exemption under the notification was valid because Unit No.1 had not used power on its own.

Supreme Court Overrules CESTAT: Integrated Process Means Clubbing Is Justified

Rejecting the CESTAT’s reasoning, the Supreme Court held that formal separateness cannot overshadow factual integration of processes:

“The CESTAT misdirected itself while emphasizing upon the distinct identities of the two Units and in the process ignored the fact that both the Units were together involved in the process of manufacture of cotton fabrics from grey fabrics.”

The Court reiterated the principle laid down in CCE v. Rajasthan State Chemical Works (1991) and Impression Prints v. CCE (2005), that manufacture is a cumulative effect of several interdependent processes, and power used in any part of this chain vitiates exemption.

Quoting with emphasis, the Court reiterated:

“It is the cumulative effect of the various processes to which the raw material is subjected, after which the manufactured product emerges... each step towards such production would be a process in relation to the manufacture.”

The Court rejected the contention that liability could not be fastened on Unit No.1 merely because the stentering (power-driven) occurred in Unit No.2. It noted that:

“The demand against Unit No.2 not being confirmed would not be relevant in these facts… The process of manufacture was cumulatively undertaken at Unit Nos.1 and 2 and the final product was being cleared from Unit No.1.”

Statements and Retractions: CESTAT Erred in Ignoring Evidence

Another point of contention was the evidentiary value of statements recorded from the partners of both units during the inspection. These statements, admitting to the integrated process, were retracted six months later via affidavits. The Supreme Court found the retractions to be afterthoughts, affirming the Commissioner’s finding.

It held:

“There was no protest lodged by the noticees immediately after the said statements were recorded and hence the retraction was by way of an afterthought.”

Thus, the CESTAT’s reliance on the retracted affidavits was held to be erroneous.

Judicial Review under Section 35-L(b): Supreme Court Justified in Interfering

The Supreme Court also clarified its jurisdiction under Section 35-L(b) of the Central Excise Act, holding that:

“The CESTAT’s finding ignoring binding precedents and factual integration of processes was not a ‘possible view’… A case for interference has been made out.”

Order-in-Original Restored, Exemption Denied

The Supreme Court set aside the CESTAT’s judgment dated 05.10.2011, and restored the Order-in-Original dated 27.09.2006, holding Unit No.1 liable for duty, interest, and penalty under the Central Excise Act.

This judgment is a stark reminder that exemption notifications must be interpreted strictly, and that even indirect or intermediate use of power in an integrated manufacturing process will disentitle the benefit. The Court’s decision sets a clear precedent on how functional integration between separate units within the same premises must be viewed in light of excise law.

Date of Decision: 02 December 2025