Navigating the Legal Labyrinth: Debonding of 100% Export Oriented Units in India

Introduction

The 100% Export Oriented Unit (EOU) scheme, introduced in India in 1980, has been a cornerstone of the nation's export promotion strategy. It aims to boost exports by providing a conducive environment for units undertaking to export their entire production of goods and services (Hindustan Granites v. Union Of India And Others, 2007). EOUs are granted significant fiscal and regulatory incentives, including duty-free import or domestic procurement of capital goods, raw materials, and components necessary for their export production (Siv Industries Ltd. v. Commissioner Of Central Excise & Customs, 2000 SCC 3 367). However, circumstances may necessitate an EOU to exit the scheme and transition into a Domestic Tariff Area (DTA) unit. This process, known as 'debonding' or 'de-bonding', involves a complex interplay of provisions under the Foreign Trade Policy (FTP), Customs Act, 1962, and Central Excise Act, 1944 (now subsumed under GST for most goods, but principles remain relevant for past periods and certain goods). This article undertakes a scholarly analysis of the legal framework governing the debonding of 100% EOUs in India, focusing on critical issues such as the determination of duty liability, procedural compliance, and judicial interpretations that have shaped this domain.

The EOU Scheme and the Concept of Debonding

The EOU scheme envisages an industrial unit offering for export its entire production, excluding permissible rejects or items specifically allowed for DTA sale (Siv Industries Ltd. v. Commissioner Of Central Excise & Customs, 2000 SCC 3 367, Para 3). Units approved by the Board of Approvals (BoA) are eligible for benefits like duty exemption on imports under relevant customs notifications (e.g., Notification No. 52/2003-Cus for capital goods). The entire operation is typically within a customs-bonded factory, and a bonding period, often ten years (reducible to five for certain sectors), is stipulated (Siv Industries Ltd. v. Commissioner Of Central Excise & Customs, Supreme Court Of India, 2000, Reference 7).

Debonding signifies the withdrawal of an EOU from the scheme. An EOU may opt out upon completion of the bonding period or, under certain conditions such as inability to achieve export obligations, may be permitted to debond prematurely (Siv Industries Ltd., Reference 7). The process typically involves an application to the Development Commissioner, leading to an 'in-principle' approval, followed by a final debonding letter upon fulfillment of stipulated conditions. A primary condition is the payment of all applicable customs and excise duties on imported and indigenous capital goods, raw materials, components, consumables, spares, and finished goods in stock, along with any penalties or other charges (Annexure to Letter dated 18-10-1993 in Siv Industries Ltd., Reference 7; Designer Suits Gokldas Images Pvt Ltd v. Bangalore-ii, CESTAT, 2024).

Determination of Duty Liability upon Debonding

The quantification of duty liability is a critical and often contentious aspect of EOU debonding. This involves duties on capital goods, raw materials, and finished goods.

Duty on Capital Goods

Upon debonding, an EOU is required to pay duties on capital goods (both imported and indigenous) that were initially procured duty-free. For imported capital goods, customs duty foregone at the time of import is payable, typically on their depreciated value as per norms laid down in the Foreign Trade Policy and relevant customs notifications, such as Notification No. 52/2003-Cus read with Section 72 of the Customs Act, 1962 (Designer Suits Gokldas Images Pvt Ltd v. Bangalore-ii, CESTAT, 2024). The rate of duty is generally that prevailing at the time of payment of such duty upon debonding (M/S PATIL ATLANTIC FORCE SUNUM LTD v. BELGAUM, CESTAT, 2018). In M/S PATIL ATLANTIC FORCE SUNUM LTD, the Tribunal referred to CCE, Vadodara v. Solitaire Machine (2003 (152) E.L.T. 384 (Tri.)), emphasizing that upon debonding, goods are treated as imported goods and subjected to duty, irrespective of export obligation discharge.

For indigenously procured capital goods, the excise duty foregone is payable. A significant issue has been the eligibility of the DTA unit (post-debonding) to avail CENVAT credit (now Input Tax Credit under GST) of the excise duty paid on these capital goods at the time of debonding. The CESTAT, in cases like Commissioner Of C. Ex., Pune v. Rajdhani Fab. Pvt. Ltd. (2007 SCC ONLINE CESTAT 302) and M/S Aarti International Ltd. (S) v. Cce Ludhiana (S) (CESTAT, 2017), has held that such credit is admissible, treating the duty paid at debonding as a valid payment of excise duty. These decisions often rely on Board Circulars (e.g., Circular No. 185/19/96-CX dated 19/03/96). The method of payment of such duties (cash v. CENVAT credit balance) has also been a subject of dispute, as seen in Dishman Pharmaceuticals & Chemicals Pvt. Ltd. v. Union of India (2016 ELT GUJ 332 242, Gujarat High Court, 2015), where the authorities insisted on cash payment of excise duty foregone during partial debonding.

Duty on Raw Materials and Components

Similar to capital goods, duties foregone on imported raw materials (customs duty) and indigenously procured raw materials (excise duty) lying in stock, whether as such or as part of work-in-progress, become payable upon debonding (Siv Industries Ltd., Reference 7, Annexure). The valuation and rate of duty would generally follow the principles applicable to capital goods, considering the policy prevalent at the time of debonding.

Duty on Finished Goods

The levy of excise duty on finished goods lying in stock at the time of debonding has been a major area of litigation. The core issue revolves around whether such goods are chargeable to duty under the main Section 3(1) of the Central Excise Act, 1944, or under the proviso to Section 3(1). The proviso stipulates that excise duty on goods produced or manufactured by a 100% EOU and "allowed to be sold in India" shall be an amount equivalent to the aggregate of customs duties leviable on like goods if imported into India.

The Supreme Court, in the landmark case of Siv Industries Ltd. v. Commissioner Of Central Excise & Customs (2000 SCC 3 367), provided crucial clarification. The Court held that the expression "allowed to be sold in India" in the proviso to Section 3(1) applies specifically to sales made by an *existing and operational* EOU in the DTA, typically up to a prescribed limit (e.g., 25% of production) with the permission of the Development Commissioner. The Court distinguished this from the clearance of finished goods stock upon debonding. It reasoned that debonding and permission to sell in India (by an EOU) are distinct processes governed by different authorities and criteria. Permission to debond, granted by the Board of Approvals, does not equate to permission to sell goods in India under the EOU scheme's DTA sales provisions. Therefore, finished goods cleared from an EOU at the time of debonding are liable to excise duty under the main Section 3(1) of the Act, and customs duty would be separately leviable on the imported raw materials used in their manufacture (Siv Industries Ltd., 2000 SCC 3 367; C.T. Cotton Yarn Ltd. v. Commissioner of Central Excise, Patna, CESTAT, 2000).

This position was reiterated by the Supreme Court in Sarla Performance Fibers Limited Etc. (S) v. Commissioner Of Central Excise, Surat-Ii (S) (2016 SCC ONLINE SC 593). The Court analyzed Siv Industries and affirmed that for the proviso to Section 3(1) to apply, two conditions must be met: (1) goods are produced by an existing 100% EOU, and (2) these goods are "allowed to be sold in India" under the specific DTA sales provisions of the EOU scheme.

However, some Tribunal decisions have interpreted the scope of the proviso differently in certain contexts. For instance, LAVINO KAPUR COTTONS PVT LTD v. PALGHAR (CESTAT, 2021, Reference 22) cited a Larger Bench decision in M/s. Himalaya International Ltd. v. Commissioner of Central Excise, Chandigarh (2003 (154) E.L.T. 580 (Tri.-LB)), which held that the rate of duty as per the proviso to Section 3(1) would apply to all excisable goods cleared by a 100% EOU to DTA *before final debonding*, whether in terms of permission or in excess thereof. This suggests that any DTA clearance by an EOU *while it is still an EOU* (i.e., before the final act of debonding and clearance of residual stock as part of exit) would attract the proviso. This interpretation, if confined to sales made by an *operative* EOU (even if in the process of seeking debonding), may not directly contradict Siv Industries, which primarily addresses the nature of duty on the *final stock clearance upon exit*. The crucial distinction remains between sales *by* an EOU under its operational framework and the one-time clearance of stock *upon ceasing to be* an EOU.

The case of Maral Overseas Ltd. v. C.C.E., Indore (CESTAT, 2016) further supports the Siv Industries principle by holding that concessional duty notifications applicable to DTA sales by a *functioning* EOU (under specific FTP paragraphs) do not apply to goods cleared at the time of exit from the EOU scheme. The FTP provisions regarding goods "allowed to be sold in India" pertain to an active EOU, not to the stock at the point of debonding.

If finished goods are exported after in-principle approval for debonding but before the final debonding order, questions regarding refund of any duty paid on such stock (if insisted upon by authorities) can arise, as seen in Jubilant Life Sciences Ltd. v. Commissioner of C. Ex., Meerut-II (CESTAT, 2013).

Procedural Aspects and Compliance

The debonding process is governed by the Foreign Trade Policy and the Handbook of Procedures, requiring meticulous compliance. An application is made to the Development Commissioner, who, upon satisfaction, grants in-principle approval, outlining the conditions to be met, including duty payments (Siv Industries Ltd., Reference 7). The unit must then approach the jurisdictional customs and central excise authorities for assessment and payment of duties on capital goods, inputs (in stock, in process, or in finished goods), and finished goods (Designer Suits Gokldas Images Pvt Ltd v. Bangalore-ii, CESTAT, 2024). A 'No Dues Certificate' from these authorities is typically required before the Development Commissioner issues the final debonding letter.

Failure to adhere to the conditions of the EOU scheme or exemption notifications can lead to adverse consequences. As held in Sheshank Sea Foods Pvt. Ltd., Karnataka v. Union Of India And Others (1996 SCC 11 755), a breach of a condition in an exemption notification (which might also be a term of the EOU license) can empower Customs authorities to take action, including confiscation of goods under Section 111(o) of the Customs Act, 1962. Furthermore, any fraudulent misdeclarations or manipulations to evade duties during the debonding process can attract severe penalties and legal action, as underscored by the Supreme Court's stance on fraud in customs matters in Commissioner Of Customs, Kandla v. Essar Oil Ltd. And Others (2004 SCC 11 364).

The principle that public notices or subsequent policy changes generally do not affect rights accrued under licences issued prior to such changes, as discussed in M/S. VIDEOCON INTERNATIONAL LTD. & ANR. v. UNION OF INDIA & ORS. (Bombay High Court, 2017) concerning import licences, might also be relevant in ensuring that debonding applications are processed based on the policy framework under which the EOU operated and sought debonding, unless specifically provided otherwise with retrospective effect.

Judicial Scrutiny and Interpretation

The judiciary has played a vital role in clarifying the complex legal provisions surrounding EOU debonding. The Supreme Court's decisions in Siv Industries Ltd. and Sarla Performance Fibers Ltd. have been pivotal in settling the interpretation of Section 3(1) of the Central Excise Act, 1944, and its proviso concerning duty on finished goods at the time of debonding. These judgments emphasize the distinction between regular DTA sales by an operational EOU and the clearance of stock upon exiting the scheme.

Tribunals have consistently addressed issues like the admissibility of CENVAT credit on capital goods upon payment of duty at debonding (Rajdhani Fab. Pvt. Ltd.; Aarti International Ltd.), the valuation methodology for capital goods including depreciation (M/S PATIL ATLANTIC FORCE SUNUM LTD), and the non-applicability of DTA sale concessions at the time of final exit (Maral Overseas Ltd.). The courts have also scrutinized procedural fairness; for example, the principle of judicial propriety requiring a bench to refer a matter to a larger bench if it disagrees with a co-ordinate bench's earlier decision (Mercedes Benz India Pvt. Ltd. v. Union Of India And Others, Bombay High Court, 2010) ensures consistency in legal interpretation, which is crucial in such complex fiscal matters.

Disputes regarding Modvat/CENVAT credit, such as those involving alleged non-receipt of inputs as seen in Viraj Alloys Ltd. v. Commissioner of Central Excise, Thane-II (CESTAT, 2004), highlight the importance of maintaining proper records, as the burden of proof for eligibility often rests with the assessee. The applicability of end-use based notifications for DTA clearances by EOUs, treated on par with "imports" (Handum Industries Ltd. v. Commissioner Of Central Excise, Hyderabad, CESTAT, 2005), further illustrates the nuanced duty calculations involved, though this primarily relates to DTA sales by an active EOU rather than debonding per se.

Conclusion

The debonding of a 100% Export Oriented Unit in India is a multifaceted legal and procedural exercise, primarily centered around the correct determination and payment of customs and excise duties foregone. The Supreme Court's pronouncements, particularly in Siv Industries Ltd., have provided significant clarity on the levy of excise duty on finished goods stock, distinguishing it from DTA sales made by an operational EOU. While the proviso to Section 3(1) of the Central Excise Act, 1944, governs permitted DTA sales by an active EOU, the main Section 3(1) applies to the clearance of residual stock upon debonding.

Key considerations for a debonding EOU include the accurate calculation of duties on capital goods (often on depreciated value), raw materials, and finished goods; understanding the eligibility for CENVAT/ITC on duties paid at debonding; and meticulous adherence to procedural requirements stipulated under the Foreign Trade Policy and tax laws. Given the complexities and the potential for disputes, a thorough understanding of the prevailing legal framework, supported by judicial precedents, is indispensable for a smooth transition from EOU status to a DTA unit. As tax laws and export-import policies are dynamic, continuous vigilance regarding amendments and clarifications is crucial for all stakeholders involved in the EOU scheme.