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The Hon’ High court of Kerala in its recent decision dated 05/07/2013 in Kerala classified hotels and restaurants Association & others v Union of India (WPC No 14045/2011) struck down the levy of service tax on supply of food and beverages by air conditioned bar attached restaurants and also clubs, hotels etc providing the services of accommodation as unconstitutional. The court held that the parliament lacks legislative competence to levy the service tax and there is an encroachment into the legislative field exclusively meant for the states. The Hon court directed the department to refund the tax collected already if so sought by the writ petitioners. This article, however seeks to discuss the issues relating to supply of food/beverages only.


The petitioners challenged the constitutional validity of section 65 (105)(zzzzv) and section 65(105)(zzzzw) which provides for imposition of service tax and are set out below:

"(zzzzv) services 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 license to serve alcoholic beverages, in relation to serving of food or beverage, including alcoholic beverages or both, in its premises;

(zzzzw) Services provided or to be provided to any person, by a hotel, inn, guest house, club or camp-site, by whatever name called, for providing of accommodation for a continuous period of less than three months;".


The main contention urged by the petitioners is that the imposition of service tax in relation to serving of food or beverage including alcoholic beverages represents only sale of goods which transaction squarely falls under Entry 54 of List II (State List) of the 7th schedule to the Constitution of India and therefore within the exclusive competence of the State Legislature. By introducing service tax on the basis of sub clauses (zzzzv) and (zzzzw) to clause 105 of Section 65 the Parliament has encroached upon the legislative powers of the State under Entry 54 and 62 of List II. The main contention of the petitioners is with reference to the legislative competence of the Parliament to impose a tax on sale of goods which is absolutely the domain of the state.


The Union of India inter alia, contended that the legislation has been brought in terms of Article 248 of the Constitution read with Entry 97 of List I of the 7th schedule. Therefore according to the respondent, on a perusal of judgments cited by them it is all the more clear that service tax can be imposed on the service involved during the sale of a product and so long as the Statute does not transgress to any restriction contained in the Constitution, contentions regarding lack of legislative power cannot be sustained. It is further contended that the Sales Tax Act and the Kerala Tax on Luxuries Act are framed by the State Government. Service tax levied by the Government of India is not for serving alcoholic beverages and it is a tax on the services provided by restaurants and hotels. In that view of the matter, according to them, the challenge to the provisions aforesaid are absolutely baseless.


The Hon’ court then proceeded to analyze the decisions cited at bar in detail. The first decision considered was Association of Leasing and Financial services companies v UOI (2011) 2 SCC 352 wherein the Hon Supreme court looked into the entire history of service tax and made the following observations.

· The Hon Supreme court made a reference to its own decision in All India Federation of Tax practitioners v UOI ……..wherein the nature of service tax was considered. It was mentioned that service tax is a Value Added Tax and is a destination based tax. The demarcation line between “sale” and “service” is very thin and both satisfy human wants. It is a tax on an activity which provides value addition to the service receiver.

·  The court considered the scope of Article 366(29A) and observed that it has two limbs. The first limb says that the tax on sale or purchase of goods includes a tax on transactions specified in sub-clauses (a) to (f). The second limb provides that such transfer, delivery or supply of goods referred to in the first limb shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and purchase of those goods by the person to whom such transfer, delivery or supply is made.

· The court then made a reference to the concept of “deemed sale” which was brought in the constitution by 46th amendment to broaden the tax base which was narrowed down because of some of the judgments of the Supreme court and observed that article 366(29A) is sales tax specific.


Then, the Hon court made a reference to the decision of the Hon’ supreme court in All India federation of Tax practitioners V UOI (2007) 9 VST 126 wherein the controversy was whether service tax can be imposed on chartered accountants and architects in view of Entry 60 of List II of the 7th schedule. It was held that the word “profession” in Entry 60 is not synonymous with the word “service” and hence tax on services is quite distinct from the tax on profession and hence there is no encroachment by parliament into the field of legislation reserved for the states in Entry 60. In Gujarat Ambuja cements ltd case the Hon court held that service tax is not a tax on goods but it was on the activity of transportation which itself is a service.


In BSNL’s case (2006) 282 ITR 273 (SC) the Hon Supreme court had to consider whether any “sale” is involved in providing telephone connection and whether it is a composite contract of service and sale. The Hon court held relying on the “aspect theory” that the state can impose tax on “sale portion” involved while the union can impose service tax on the “service” portion therein. The court observed like this: “The amendment especially allows specific composite contracts viz. works contracts (Clause (b)), hire purchase contracts (Clause (c)), catering contracts (Clause (e)) by legal fiction to be divisible contracts where the sale element could be isolated and be subjected to sales tax.”

The Hon'ble court then made these important observations:

“We cannot presume that the Constitutional Amendment was loosely drawn and must proceed on the basis that the parameters of 'sale' were carefully defined. But having said that,  it is sufficient for the purposes of this judgment to find, as we do, that a telephone service is nothing but a service. There is no sales element apart from the obvious one relating to the hand set if any. That and any other accessory supplied by the service provider in our opinion remain to be taxed under the State Sales Tax Laws. We have given the reasons earlier why we have reached this conclusion.”


The Hon court was of the opinion that only two cases are relevant for the purpose of resolving the issue and those decisions are:

1) Tamilnadu Kalyanamandapam association v UOI (267 ITR 9 (SC)

2) K. Damodarswamy naidu and Bros v UOI  (1990)  76 STC 427.

The Hon court further noted that out of the above two decisions the decision in Damodarswamy’s case is almost similar to the situation of the writ petitioners. Then the court made these important concluding observations:

“The very purpose of incorporating the definition of tax on sale or purchase of goods in Article 366 was to empower the State Governments to impose tax on the supply, whether it is by way of or as a part of any service of goods either being food or any other article for human consumption or any drink either intoxicating or not intoxicating whether such supply or service is for cash, deferred payment or other valuable consideration. The words "and such transfer delivery or supply of goods" is deemed to be a sale of those goods by the person making the transfer. Therefore the incidence of tax is on the supply of any goods by way of or as part of any service. When food is supplied or alcoholic beverages are supplied as part of any service, such transfer is deemed to be a sale. Apparently, the transfer is during the course of a service and when the deeming provision permits the State Government to impose a tax on such transfer, there cannot be a different component of service which could be imposed with any service tax in exercise of the residuary power of the Central Government under Entry 97 of List I of the Constitution.”

Therefore it can be seen from Article 366(29-A) (f) that service is also included in the sale of goods. If the constitution permits sale of goods during service as taxable necessarily Entry 54 has to be read giving the meaning of sale of goods as stated in the Constitution. If read in that fashion, necessarily service forms part of sale of goods and State Government  alone will  have the legislative competence to enact the law imposing a tax on the service element forming part of sale of goods as well, which they have apparently imposed. I am supported to take this view in the light of the Constitution Bench judgment in K. Damodarasamy Naidu (Supra).f India.

Hence on the basis of the above reasoning that there cannot be splitting of the composite contract value the impugned amendments were struck down as unconstitutional.


I am of the view that the matter requires to be finally decided by the Hon Supreme court as the same involves complicated legal and constitutional issues. It appears that the well settled “aspect theory” has not been considered by the Hon court. The union may take the argument that article 366(29A) (f) enables the states to impose sales tax on what is otherwise not possible being predominantly service contracts. The said article cannot be read as a provision to disable the union to impose service tax. The impact of the decision in BSNL wherein the split was held to be permissible has also not been properly considered.

At this juncture it is worthwhile to make a reference to the para 1.4 of the departmental clarification in DOF 334 /3/2011-TRU dt 28/2/2011 which is as follows.

“1.4 The new levy is directed at services provided by high-end restaurants that are air-conditioned and have license to serve liquor. Such restaurants provide conditions and ambience in a manner that service provided may assume predominance over the food in many situations. It should not be confused with mere sale of food at any eating house, where such services are materially absent or so minimal that it will be difficult to establish that any service in any meaningful way is being provided.

1.6 The levy is intended to be confined to the value of services contained in the composite contract and shall not cover either the meal portion in the composite contract or mere sale of food by way of pick-up or home delivery, as also goods sold at MRP. Finance Minister has announced in his budget speech 70% abatement on this service, which is, inter-alia, meant to separate such portion of the bill as relates to the deemed sale of meals and beverages.”

In the light of the above provisions, the union may argue that it seeks to levy tax only on the service portion and hence did not encroach upon the legislative powers of the states.

It may also be noted that the very same judgement in Damodarswamy’s case heavily relied upon by the Hon court contains in Para 25 the following observations:

“The State of Maharashtra is directed henceforth not to make assessments of the tax on the supply of food and drink on hotel owners who provide lodging and boarding for a composite sum until it frames Rules that set out formulae for such assessment which take account of the fact that residential hotels may provide lodging and full or part board”.  This direction of the Hon supreme court indicates that splitting is permissible.

Finally it can also be argued by the union that a deeming provision should be allowed to operate only in the limited sphere indented for it and cannot be allowed to control the residual powers of the parliament in Entry 97 of List 1. The union may argue that the service aspect is still open and is in no way affected by the provisions in Article 366(29A) which enables the states to tax the sales aspect in the contract. The union may also argue that the whole value is taken into account at the first instance (without abatement) only as a matter of measurement of the levy and cannot be taken as a case of encroachment into the power of the state. The pith and substance of the levy is quite different and there is also no colorable exercise of legislative power and 70 % abatement is also provided in Notification No 34/2011 dated 25/4/2011.

Attention is also invited to the decision of the Rajasthan taxation Tribunal in Gem cinema restaurant (1997) 106 STC wherein it was held that sale of food is always exigible to tax if the dominant intention is sale.  Attention is also invited to the decision of the Hon Supreme court in CST v Northern Railway catering Department, U.P reported in ) (1994) 95 STC 569 where the court remanded the matter in view of the clarificatory order passed by the Supreme Court on a review in NORTHERN INDIA CATERERS' case [1980] 45 STC 212 as the Hon court was of the opinion that the matter requires reconsideration in view of the changed legal position pursuant to the constitution 46th amendment. Hence all these developments in law indicate that services can be taxed if the predominant intention is to render service.

In any view of the above discussion, I am of the opinion that the matter requires more elaborate consideration as the issue has wider dimensions and has to be looked into from different angles. This is all the more important since the new regime of negative list based service tax law may also be impacted because of the decision of the Kerala high court. I have touched upon only some of the matters and this discussion is not exhaustive. A clear pronouncement of the law in this regard is to be laid down by the Hon Apex court and till then there will be a situation of uncertainty.



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sivadas chettoor
Category Service Tax   Report

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