India: Judicial Tussle Over Service Tax On Restaurants

Last Updated: 15 October 2015
Article by Kumar Harshvardhan and Sourabh Yadav


The basic premise of any Welfare State is to fulfil the increasing developmental needs of the country and its citizens by way of public expenditure. Despite being a developing country, India still is striving to fulfil the prime responsibility and obligations of a welfare State within its limited resources. It is an irrefutable fact that in India, services constitute a larger proportion of the consumption of the rich rather than of the poor as the demand for services is income elastic. Depending upon the socio-economic conditions and compulsions, each country needs to devise a taxation mechanism that taxes its service sector, as it occupies the centre stage in almost all economies. Although there are countries that chose to tax all the services with very few and limited exemptions, India followed the approach of selective taxation.

Evaluating the figures taken from Economic Survey 2012-13, it was reported that, "Service tax has now emerged as a significant contributor to tax revenue over the last 19 years. Even compared to 2007-08, its share as a percentage of gross tax revenue has increased more, compared with that in excise and Customs. In 2007-08 the share of indirect tax revenue as a per cent of gross tax revenue was 47.0 per cent, which is now 46.8 per cent (BE) in 2012-13."

The concept of service tax was introduced in India by the Finance Act, 1994, where only three services were taxed, whereas it now covers around eighty-one services. The Service Tax is legislated by the Parliament under the residuary entry i.e. Entry 97 of List I of the Seventh Schedule to the Constitution of India. Service Tax was levied on the recommendations made by Dr. Raja Chelliah headed Tax Reforms Committee, who pointed out that the indirect taxes at the central level needed to be broadly neutral in relation to production and consumption of goods and should, in course of time, cover both commodities and services. Outlining the basic objective of Service Tax Regime in India, the committee stated that Service Tax Regime in India needed to broaden the tax base, augment revenue and involve larger participation of citizens in the economic development of the nation.

Since its inception, service tax law has undergone a huge paradigm shift from the selective approach to the negative list based approach of taxation of services. Further, Sec. 65 of the Finance Act deals with the taxable services, which describes "Taxable Service" as any service provided or to be provided to a business entity, by any other business entity, in relation to advice, consultancy or assistance in any branch of law, in any manner. Furthermore, the Central Government by the Finance Act, 2011, an amendment was made to Chapter V of the Finance Act 1994, relating to service tax, inserting sub clause (zzzzv) and (zzzzw) to clause 105 of Section 65, thereby, including the air conditioned restaurants which have license to serve alcoholic beverages within the service tax net. Restaurants / hotels provide a number of services in combination with the meal and beverages for consolidated charge. The services related to the use of restaurant space and furniture, air conditioning, well dressed waiters, linen, cutlery, crockery, music on a dance floor, etc. sub clause (zzzzv) authorise Central Government to levy service tax on service provided or to be provided to any person, by a restaurant, by whatever name called, having the facility of air conditioning in any part of the establishment, at any time during the financial year, which has licence to serve alcoholic beverages, in relation to serving of food or beverage, including alcoholic beverages or both, in its premises.

This issue of tax on restaurants / hotels or like institutions is multifaceted and controversial one. The Parliament of India by 46th Constitutional amendment inserted Article 366 (29A) (f), thereby allowing State Governments to levy Sales tax on the supply of food by restaurants / hotels and other like institutions, which was affirmed by the Supreme Court of India as well. As a result, restaurants paid sales tax to respective States as per respective State VAT Acts. In the year 2011, Chapter V of the Finance Act 1994, relating to service tax, was amended and Sec.65 (105) (zzzzv) was inserted. The insertion of this Sec.65 (105) (zzzzv) levied the service tax on the supply of the food by restaurant/ hotels or like institutions, as a result the food items sold by restaurants were charged for dual taxes one by Central taxing authorities and other by the State taxing authorities. However, the issue as to whether the sale of food and/or liquor made by Restaurants/ Hotels or like institutions would be levied for sales tax (VAT) by concerned State or leviable to Service tax by central government arisen which till date not resolved and various High Courts are holding different and contrasting view on the issue. It remains to be seen, if the legislature steps in to remedy this issue.

Position prior to Finance Act, 2011

To enter the domain into the field of taxation, States explore the same either through legislature or through interpretation; as sales tax is one of the major sources of the revenue for States. Constitution of India as per Entry 54 in List II (State List) allows the States to levy VAT on supply of food. In pursuance of this, State of Punjab levied VAT on the lodging/boarding facilities provided by hotels where food served (inclusive of accommodation + food + other incidental activities). SC, deciding on the said issue, held that transaction was essentially of service (accommodation) and additionally food was served at prescribed hours, which was incidental to the service of accommodation.1 Further, SC held that meals served to the casual visitors in the restaurant/ hotels would not amount to the sale, as the supply of food is the service rendered for the satisfaction of the human need (bodily want).2

Table below is the list of cases along with observations which lead to the Constitutional 46th amendment:

Table: 1

S. No. Case name Issue Observations
1. State of Punjab vs. Associated Hotels of India Limited.3 Whether or not the sales tax would be payable by the hotelier on meals at fixed hours served to the guests coming for stay.
  • Transaction was essentially of service in the performance of which hotelier serves the meals at stated hours.
  • The Revenue could not split transaction into two parts, one of service and the other of sale of food-stuffs, and to split up also the bill charged by the hotelier as consisting of charges for lodging and charges for food-stuff served.
2. Northern India Caterers (India) Ltd. vs. Lt. Governor of Delhi.4 "Whether or not the service of meals to casual visitors in the Restaurant is taxable as a sale when charges are lump sum per meal.
  • True essence of the transaction was service and it did not involve a transfer of the general property in the food supplied. Thus, could not be split up into two parts, one of service and the other of sale of foodstuffs.
  • Service of meals to non-residents in the restaurant was in the nature of service provided to the guests and was not taxable under sales tax. A restaurateur provides many services like linen, crockery, music, cutlery etc. in addition to the supply of food.
  • The supply of meals must be regarded as ministering to a bodily want or to the satisfaction of a human need.

The two judgments from the Apex Court creates confusion as to whether, while taxing sale or purchase of goods the State Legislature can impose a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration. Therefore, Parliament of India, to put an end to the said confusion, amended the Article 366 of the Constitution to include a tax on the supply of food or drinks by way of service or as a part of service (Deemed sale) within the exclusive power of the State Legislatures under Entry 54 of the List II.5 As amended, Article 366(29A) defines the term 'tax on the sale or purchase of the goods' and empower the State to impose sales tax on sale/ purchase of all kinds of goods except the newspaper and inter-State sale. Furthermore, Article 366(29A) (f) permits the State to impose a tax on the supply of food and drink by whatever mode it may be made.

In addition, Article 366 (29A) (f) of the Constitution made it possible for the State to levy sales tax on the food served by hotels/ restaurants where the sale of food was made as part of the service by hotels/ restaurants. This, 46th Amendment was further challenged on the ground of nature of activity and scope of the Entry 54 of second list of 7th Schedule, which allows the State to levy taxes on the sale or purchase of goods other than newspapers, introduced the concept of deemed sale as to include the transactions of nature of predominant service, where along with service sale of some eatable made.

Following are the leading cases on the validity of the Article 366 (29A) (f), which levies sales tax on the supply of food items by restaurant to its patrons.

Table: 2

S. No. Case name Issue Observations
1. K. Damodarasamy Naidu and Bros etc. vs. State of Tamil Nadu anr. etc.6 Whether or not the States are entitled to levy sales tax on the sale of food and drink as per the Entry 54 of the List-II of the Seventh Schedule to the Constitution, which allows the State to levy 'taxes on the sale or purchase of goods other than newspapers'.
  • While selling food items, soft drinks, water and other edibles at such counters the services are materially absent or minimal. Therefore, the tax is on the supply of food or drink and it is not of relevance that the supply is by way of a service or as part of a service. In our view, therefore, the price that the customer pays for the supply of food in a restaurant cannot be split up.
2. Tamil Nadu Kalyana Mandapam Assn. vs. Union of India.7
  1. Whether or not the imposition of service tax on the services rendered by the mandap-keepers was intra vires the Article 366 (29A) (f) of the Constitution.
  2. Whether or not the imposition of service tax on the catering services, would amount to a tax on sale and purchase of goods.
  • A tax on services rendered by mandap-keepers and outdoor caterers is in pith and substance, a tax on services and not a tax on sale of goods or on hire purchase activities.
  • Article 366(29A) (f) permits the State to impose a tax on the supply of food and drink by whatever mode it may be made. It does not conceptually or otherwise includes the supply to services within the definition of sale and purchase of goods.
  • Taxable services, therefore, could include the mere providing of premises on a temporary basis for organizing any official, social or business functions, but would also include other facilities supplied in relation thereto. No distinction from restaurants, hotels etc. which provide limited access to property for specific purpose.
  • Levy of service tax on Kalyana Mandapams upheld; Tax on catering services is not a tax on sale and purchase of goods

Post the Kerala HC ruling, leading tax expert, posed a strong question in relation to declared service and stated, "the clause 29A was introduced, as it was felt necessary by the experts to declare those transactions as deemed sale of goods which could otherwise lead to a dilemma in classification between sale of goods and/or services. Yet another question arising out of this situation is - shouldn't there be a similar provision in the Constitution to declare the other portion of such transactions as the deemed/declared services, before the same could be brought under the tax net of the central government?"

It is interesting to note that the observation of the Apex Court in abovementioned two cases were contradictory and the question as to whether the transaction is sale or service and whether the bill be allowed to split-up again raised with the inception of the sub clause (zzzzv) and (zzzzw) to clause 105 of Section 65, of Finance Act 1994, by Finance (Amendment) Act, 2011. The Court, in Damodarasamy Naidu case (supra), held that State can levy sales tax on sale of food by restaurant/ hotel, and observed that hotels/ restaurants provide service as part of the sale and the transaction cannot be split up, whereas, in TN Kalyana Mandapams association (supra) the SC observed that catering services rendered would not amount to sale of goods. Although

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1. State of Punjab v/s M/s Associated Hotels of India Limited reported in (1972) 1 SCC 472.

2. M/s Northern India Caterers (India) Limited v/s Lt. Governor of Delhi, reported in (1980) 2 SCC 167.

3. Supra 1

4. Supra 2

5. Article 366 (29A), inserted by Constitution (Forty Sixth Amendment) Act, 1982,

6. 1999 (3) Suppl. SCR 597

7. (2004) 5 SCC 632

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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