Tax on food

The Finance Act, 2012, which came into force on 1.6.12 has overhauled the laws relating to service tax by making sure that everyone pays service tax. Even your chauffer or your neighbourhood auto rickshaw driver will be required to pay service tax in the near future, if not now!

What has the Finance Act, 2012 done? 

Prior to 1.6.12, there were specific varieties and categories of activities on which the service tax was leviable. It was a different issue that the number of varieties and categories were increasing every year. However, with effect from 1.6.12, you have a definition of “service”, “declared service”, “negative list”, “taxable service”, “taxable territory” etc. The term “service” has been defined in section 65B (44) of the Act. The definition begins with saying that it means any activity carried out by a person for another for consideration. The law makers were careful in not giving any meaning to the words “activity” or “consideration”. Then, there is an “inclusion clause” and an “exclusion clause”. 

“Service” includes “declared service” which is defined in section 65B(22) of the Act. However, for the purpose of this article, “service” excludes a transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of article 366(29A) of the Constitution.  Now the supply of food and drinks, by way of or as part of any service, is included in article 366(29A)(f) of the Constitution. Therefore, this should mean that no service tax can be levied on a hotel or restaurant which supplied food or drinks, by way or as part of service.  However, the law makers had other ideas. They introduced section 66E which gives a list of services called “declared services”. As per section 66E(i) of the Act, the service portion in activity wherein goods, being food or any other article for human consumption or any drink (whether or not intoxicating) is supplied in any manner as part of the activity has been treated as “declared service” for the purpose of levy of service tax. Therefore, what the Finance Act, 2012, seems to say is that you should pay service tax on the service part of the activity which involves supply of food or drinks for human consumption. If you are required to pay service tax only on the supply portion, then this should necessarily mean that you should pay sales tax/value added tax only on the supply portion. This, I believe, is the logical conclusion but what does the law say?

What is the “tax” you are required to pay for the food consumed by you in a hotel or restaurant – is it VAT or Service Tax or both?  If you are required to pay both, then what value you should pay both?  

Let’s start at the very beginning:

Decisions prior to the Constitution (46^th Amendment) Act, 1982

The Punjab and Haryana Court has the distinction of considering the question as to whether the tax can be levied on the food supplied to the guests who stayed in the hotel and were charged an all inclusive price which included the food supplied to the guests. The High Court had held that there was no sale of foodstuff by the dealers. The decisions of the High Court are reported in 17 STC 555 (Associated Hotels of India Ltd Vs. The Excise and Taxation Officer, Simla)  as confirmed in appeal in 20 STC 1 (State of Punjab Vs. Associated Hotels of India Ltd.). The issue was also confirmed by the Apex Court in 29 STC 474 (The State of Himachal Pradesh Vs. Associated Hotels of India Limited).

Certain principles were laid down by the Apex Court, namely, (a) nature of the contract has to be determined for the purpose of ascertaining whether it constituted a contract of sale or a contract of work or service, (b) mere passing of property in an article or commodity during the course of performance of the transaction in question does not render the contract a transaction of sale, (c) the courts will have to find out the primary object of the transaction and the intention of the parties while entering into it.  The Court finally held that the transaction between a hotelier and a visitor to his hotel was essentially of service in the performance of which and as part of the amenities incidental to that service, the hotelier serves meals. The revenue was not entitled to spilt up the transaction into two parts, one of service and the order of sale of foodstuffs and to spilt up also the bill charges by the hotelier as consisting of charges for lodging and charges for food stuffs served to him with a view to bring the hotel  for the purpose of levy of tax on the food supplied to guests. The Court seems to say that the dominant nature of the activity was one of service only and not sale.

The question whether tax could be levied on the customers who come to a hotel and restaurant  and consumes the food in the hotel was considered  by the Supreme Court in 42 STC 386 (Northern India Caterers (India) Ltd Vs. Lt. Governor of Delhi)  and the court held that the service of meals to visitors in the restaurant was not taxable under the Bengal Finance (Sales Tax0 Act as extended to the Union Territory of Delhi.  The Court held that in  M/s. Associated Hotels of India limited case [1], the concept of the English law that there was no sale when food and drink were supplied to guests residing in the hotel, was adopted and in the said decision, the court had pointed out that the supply of meals was essentially in the nature of service provided to them and could not be identified as a transaction of sale.  After stating so, the court finally held that if the principle was true in respect of hotels, a similar approach was called for on the principle in the case of restaurants.  The court accepted the classical view that a number of services are concomitantly provided by way of hospitality, the supply of meals must be regarded as ministering to a bodily want or to the satisfaction of a human need.  Again, the Court seems to say that the dominant nature of the activity was one of service only and not sale.

A review petition was filed for seeking review of the principle stated in the Northern India Caterers case. The review petition was dismissed by the Apex Court in 45 STC 212 (Northern India Caterers (India) limited Vs. Lt. Governor of Delhi). The Court held that the preparation and service of food  to the residents of the hotel as well as to non residents remained a supply and service of food not amounting to a sale. The court however held that if it was established upon the facts that the substance of the transaction, evidenced by its dominant object, is a sale of food and the rendering of service was merely incidental, then the transaction would undoubtedly be exigible to sales tax. Therefore, it seems that the Court had placed importance for determining the dominant nature of the transaction for ascertaining the nature of the transaction – whether sale or service.

The decision of the Supreme Court in Northern India Caterers (India) Limited case [2] was distinguished  by the Apex Court in 121 STC  46 (East India Hotels Limited Vs. Union of India), in para 13 of the report, on the ground that in Northern India Caterers’s case,  the court did not have occasion to consider either the definition of “dealer” or a provision similar to section 4 of the Delhi Sales Tax Act, 1975.  

Decisions After the Constitution (46^th amendment) Act, 1982.

The Article 366 of the Constitution was amended. Article 366(29A) was amended so that the tax on the sale or purchase of goods included “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”. The validity of the levy was upheld by the Apex Court in 117 STC 1 (K. Damodarasamy Naidu & Bros. Vs. State of Tamil Nadu and another). One of the contentions urged before the Court was that the tax on food served in restaurants could not be levied on the sum total of the price charged to the customer as the restaurant provided services in addition to food, and these had to be accounted for. It was therefore contended that the bill had to be split up between what was charged for such service and what was charged for the food.  The court at para 9 of the report did not accept the contention. The court held that the tax was on the supply of food or drink and it was not relevant that the supply was by way of a service or as part of a service. The price that the customer pays for the supply of food in a restaurant cannot be spilt up as suggested by the petitioners. The court after also giving  an example of a customer paying Rs. 50 for a plate of cheese sandwiches to the patron of a fancy restaurant, held that the restaurant owner must be taxed on Rs. 50.  The decision of the court was rendered on 12.10.99.

Decisions under the Finance Act, 1994    

Now comes the Finance Act, 1994, which provides for levy of service tax. In the decision reported in 135 STC 480 (Tamil Nadu Kalyana Mandapam Association Vs. Union of India), it was contended that the Parliament cannot impose tax on sale of food items, drinks etc.  in view of the 46^th amendment to article 366(29A)(f) of the Constitution and the decision of the Court in K. Damodarasamy Naidu & Bros., was relied upon. The court held that Article 366 (29A)(f) only permitted the State to  impose a tax on the supply of food and drink by whatever mode it may be made. It does not include the supply of services within the definition of sale and purchase of goods.  It is only the supply of food and drinks and other articles for human consumption that is deemed to be a sale or purchase of goods.  It was further held that the concept of catering included the concept of rendering service. The fact that tax on the sale of the goods involved in the same service can be levied does not mean that a service tax cannot be levied on the service aspect of catering.  The Apex court has categorically held that the State legislatures can levy tax on the supply of food and drinks only.  

The Apex Court in K. Damodarasamy Naidu & Bros., at para 9 of the report that held that a hotel has to pay tax on the entire invoice value and it was not open to the dealer to spilt up the transaction into 2 parts – one for supply of food and the other for services rendered. The court in para 9 had categorically held, after giving an example, that the tax had to be paid on the entire invoice value.  However, in Tamil Nadu Kalyana Mandapam Association Vs. Union of India case, the apex Court did not specifically refer to para 9 of the decision in K. Damodarasamy Naidu & Bros. case before coming to the conclusion that service tax can be levied on the service aspect of catering. The Apex court did not lay down any guideline for ascertaining the turnover/value on which sales tax and/or service tax can be levied.  Does it mean that VAT and service tax can be levied for one and the same transaction and for the same value?  

In 145 STC 91 (SC) ( Bharat Sanchar Nigam Limited Vs. Union of India) (a decision rendered by a bench 3 Judges), the court held, in para 87, that no one denied the legislative competence of States to levy sales tax on sales provided that the necessary concomitants of a sale are present in the transaction and the sale is distinctly discernible in the transaction. Again, in para 88, the court held that the State cannot be allowed to entrench upon the Union List and tax services by including the cost of such service in the value of the goods. “Even in those composite contracts which are by legal fiction deemed to be divisible under article 366*29A), the value of the goods involved in the execution of the whole transaction cannot be assessed to sales tax”.  Dr. Justice AR Lakshmanan, who, while  rendering a separate but concurring judgment had observed in para 119 of the report as under:

“Nor can the service element be disregarded and the entirety of the transaction be treated as a sale of goods (even when it is assumed that there is any goods at all involved) except when it falls under sub-clause (f)”

Does not the above observation, in para 119 of the report, mean that in respect of transactions falling under article 366(29A)(f), the entire consideration inclusive of the service portion, can be taxed as representing sale of goods ? Does not the above observation go contrary to the principles stated by the remaining 2 Judges of the Bench in para 88 of the report that State cannot entrench upon the Union list and tax services by including the cost of such services in the value of the goods?  The observations made in paras 87 and 88 seem to convey the impression that in respect of supply of food and drinks, only the supply portion can be taxed and not the service portion.  It has to be remembered that prior to the Constitution 46^th amendment, the supply of food and drinks in a hotel and restaurant was not made taxable as the main intention  was not sale of goods simplicitor but supply and service of goods. Therefore, it was recognized from the very beginning that service element was predominant in such transactions.

After referring to the above decisions, the Delhi High Court in 32 VST 162 (Indian Railways Catering and Tourism Corporation limited Vs. Government of NCT of Delhi), held that it was open to the States to levy sales tax/value added tax, on the whole of the consideration, in transaction of sale of goods, such as sale to a customer in a restaurant, irrespective of the incidental element of service which was necessarily involved in sale of this nature. The court further held that if the transaction between the parties was covered under article 366(29A) of the Constitution, it is permissible for the states to levy and collect sales tax/value added tax on the value of the goods involved in the execution of the transaction. It was not permissible to levy sales tax/value added tax in respect of service component of such composite transactions. This principle was also stated by the Karnataka High Court in 46 VST 35 (Sky Gourmet Catering Private limited Vs. Assistant Commissioner of Commercial taxes, Bangalore). The court in para 26 of the report held that the entire consideration cannot be the subject matter of service tax nor can it be the subject matter of sales tax. Otherwise, it will amount to double taxation. It was further held that as the catering contract involved supply of goods and service, the consideration received under such contract has to be apportioned between the part of the contract involving supply of goods and the part involving supply of service and appropriate rate to be levied separately.

Therefore, the decisions of the 2 High Courts seems to be authorities for the view that in case of hotels and restaurants where the value of service is predominant or substantial, then the authorities cannot levy sales tax or value added tax on the entire consideration shown in the invoice but only on the value of the goods. In other cases, it would not be open to the sales tax authorities to levy tax on the entire consideration.  It would then be necessary for the authorities to examine the nature of the transaction for ascertaining whether the dominant nature of the transaction is sale or not, before proceeding to levy sales tax or value added tax. 

In addition to the questions raised in the preceding paragraphs, the following questions need answers, namely,  Are the decisions of the Delhi High Court and of the Karnataka High court  contrary to the decision of the Supreme Court in K. Damodarasamy Naidu & Bros., case ?   As the High Courts have expressed the view that a bifurcation of the invoices are necessary before levying sales tax/value added tax or service tax,  what will happen if there are no provisions in the local sales tax/value added tax enactments providing for such apportionment?  Will  it not possible to say that till such procedure is adopted by the authorities, it will not be open to the authorities to levy sales tax or value added tax at all?  Will not the decision of the Supreme Court in Northern India caterer’s case then become applicable once again?  Till such exercise if carried out, has the State the legislative competence to levy tax even after the 46^th amendment?  Has the amendments caused by the Finance Act, 2012, implied overruled the principle stated in K. Damodarasamy Naidu & Bros., case?  Is it not necessary to revisit K. Damodarasamy Naidu & Bros., case  especially after the amendments made by Finance Act, 2012 to the Finance Act,1994?  Are the powers of the State legislature to make laws in respect of matters specified in the State list subject to the powers of the Parliament to make laws in respect of matters specified in the Union List and if so, can it then be said that the power of the State legislature to levy sales tax on the supply of food and drinks is subject to the power of the Parliament to levy service tax on the service portion of the supply of food and drinks?  If the power of the State to levy tax is subject to the power of the Parliament to levy service tax on the same transaction, then does the State legislature possess the competence to levy sales tax or value added tax on the entire value?