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Last time when you had visited an air-conditioned restaurant did you notice 4.94% service tax on your food bill apart from the local VAT charges? Well with effect from 1st April 2013 Service Tax is applicable on sale or supply of food stuff in air-conditioned restaurants whether or not part of any hotel. Even the eating joints in air-conditioned malls and eateries like Pizza Hut, Mc Donald’s, Coffee Cafe day etc are also liable to Service Tax on supply of food in their premises as all of these are air-conditioned.

Let us take a quick look in the history Service Tax on Restaurants in India.

Service tax prior to Negative List

For the first time a new category of taxable service for levy of service tax on restaurants was introduced by insertion of sub-clause (zzzzv) in clause (105) of Section 65 of the Finance Act, 1994.

This made restaurant service a taxable service with effect from 01/05/2011. Since in a restaurant service sale element is also involved, an abatement of 70 per cent was provided for the purposes of valuation vide Notification No. 34/2011-ST. Thus, service tax was levied on 30 per cent of Gross amount charged by the service provider.

Under Negative List regime

With effect from 1st July 2012, Section 66E was inserted for introducing the new concept of DECLARED SERVICES under the service tax legislature. According to that, restaurant services were held as declared services. However, Mega Exemption Notification No. 25/2012 entry no. 19 provided that restaurants, eating joints or mess other than those having the facility of air conditioning or central air-heating in any part of the establishment, at any time during the year and a license to serve alcoholic beverages shall be exempt from service tax.

Further, for the purpose of valuation, Rule 2C of Service Tax (Determination of Value) Rules, 2006 provided that service tax would be levied on 40% of gross amount charged by the service provider. Thus under negative list, restaurant industry was imposed to additional service tax on 10% of value on gross amount charged as compared to earlier levy. Effectively customers had to shell out additional 4.94% on their food bill.

As service tax is levied only on the service portion involved in a transaction, in this case, we fail to understand, how the service portion involved in a particular  Industry increased (30% to 40%) due to major change in legislation(Introduction of Negative list Regime).

After the Budget of 2013

Subsequently, Notification No. 3/2013 has amended Notification No. 25/2012(Mega exemption) according to which service tax will be levied even on the restaurants which do not have a license to serve alcoholic beverages. This is a major change for the industry as thousands of restaurants and eating joints including small and medium have come within the ambit of Service Tax. The Change was effective from 01/04/13. This change did have a direct impact on the pocket of common man. Due to this change, even a small eating joint having a seating arrangement and the facility of air conditioning in the establishment shall be liable to service tax even if operating in places like hospitals, temples etc.

No specific definition of "Restaurant" has been prescribed under the service tax regulations containing any limitation to any area, number of seats or otherwise. It covers all restaurants, eating joints or a mess. Therefore, it seems to cover almost all the following categories of restaurants, having the facility of air conditioning or central air heating in any part of the establishment at any time during the year:

· Restaurants

· Cafes

· Food Courts

· Food Kiosks

· Pubs etc.

Isn’t not strange both Service Tax as well as VAT was charged on the same food? Well that is when The Honourable High Court of Kerala stepped in.

Service tax on restaurants and hotels not Constitutional

On 3rd July 2013, the Kerala High court, in Kerala Classified Hotels and Resorts Association and others vs Union of India and others  (HC-KERALA-WP(C) No.14045 /2011 Dt.3rd July 2013 ), held the levy of service tax on supply of food and beverages by restaurants and services of lodging provided by hotels as unconstitutional.

The petitions before the high court involved the specific question of whether the central government had the Constitutional right to levy service tax on the service portion involved in the transaction of sale of food and beverages by restaurants.

As per the Constitution of India, the definition of tax on sale or purchase of goods was expanded by the 46th amendment to the Constitution, which inserted the clause 29A to the article 366, to include: "(f) 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),…"

The high court, while adjudging the levy of the service tax on transaction of sale of foods and beverages by the restaurants as unconstitutional, has relied on the judgment of the Constitutional Bench of the apex court, in K Damodarasamy Naidu and Bros vs state of Tamil Nadu (2002-TIOL-884-SC-CT-CB). There, the apex court held that the Article 366(29A)(f) empowers the state government to impose tax on supply of food and beverages whether it is by way of service or as a part of a service. Such transfer delivery or supply is deemed to be a sale of those goods and the provision of service is only incidental to such sale. Accordingly, it was held that the price paid by the customer for supply of foods in a restaurant cannot be split-up.

Thus, levy of service tax by the Centre on your restaurant bill is unconstitutional.

Since the decision is a consequence of a writ petition and as there is no other conflicting high court decision, the favourable Kerala HC decision constitutes law of the land. Restaurants across India can rely on the decision. The ruling also holds good for current provisions, where the service tax ambit has been expanded to cover all air-conditioned restaurants.

However, while the Kerala HC order said the petitioners were entitled to seek refund of service tax collected and paid by them, it may not be practically feasible. "Restaurants merely collect service tax from customers and pass it on to the government. It would be impossible for them in turn to refund each customer from whom service tax has been collected

When Adam Smith wrote about the four important canons of taxation — equity, certainty, convenience and economy — in the book The Wealth of Nations, he would have expected all nations to, by and large, follow them However, it appears that lawmakers in India often ignore these canons while formulating their tax laws. Retrospective amendments — just to show their angst over landmark decisions of the Supreme Court and High Courts — and frequent tinkering with laws are examples of this attitude. Service tax laws follow this pattern as well so it is a matter of time before this Order is challenged. Until then enjoy your Christmas and New Year Parties in your favorite Air Conditioned Restaurant without paying the Service Tax.

Wish you all Merry Christmas and a Happy New Year 2014.


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