EY Tax Alert. Executive summary

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1 7 November 2014 EY Tax Alert Levy of Service tax on services provided by AC restaurants and services by hotels, guest house etc. in relation to providing of accommodation, held to be unconstitutional by the Kerala High Court Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert gives an update on the decision of the Division Bench of the Kerala High Court in the case of UoI & Ors. vs. Kerala Bar Hotels Association & Ors. [TS-501-HC-2014-(KER)-ST]. In this writ appeal, the issue before the Division Bench was whether the Parliament had the legislative competence to levy Service tax on the services provided by air-conditioned restaurants, having a license to serve liquor and on the services provided by hotels, inns etc. in relation to short term accommodation. The Division Bench of the Kerala High Court held that the levy of Service tax by the Parliament on the said transactions is unconstitutional as such transactions were enumerated in List II (State List) and therefore, only the States have the legislative competence to impose tax on such transactions. The Kerala High Court has differed from the decision of the Bombay High Court in the case of Indian Hotels and Restaurant Association & Anr. vs. UoI & Ors. wherein the levy of Service tax on the services rendered by restaurants under clause (zzzzv) of section 65(105) of the Finance Act, 1994 was held to be constitutionally valid.

2 Background & Facts The petitioners were engaged in running air-conditioned restaurants having a license to serve alcoholic beverages. The petitioners filed a writ petition to challenge the validity of sub-clauses (zzzzv) and (zzzzw) of Section 65(105) of the Finance Act, 1994, which were inserted by the Finance Act, Section 65(105)(zzzzv) covered services provided by an air-conditioned restaurant, having the license to serve liquor. Section 65(105)(zzzzw) covered services provided by a hotel, inn, guest house etc. in relation to provision of accommodation for a continuous period of less than three months. The said services were brought within the Service tax net vide Finance Act, In the writ petition, the single Judge held that the matters covered in the said subclauses of Section 65(105) were enumerated in Entries 54 and 62 of the State List and hence, the Parliament did not have the legislative competence to levy tax thereon. The revenue, thus, went into appeal against the decision of the single Judge. The issue before the Division Bench in this writ appeal is whether the Parliament is competent to impose tax on the services provided by a restaurant and services provided by hotels, inns etc. in relation to accommodation for a short period. Petitioner s contentions List covers taxes on luxuries, including taxes on entertainment, amusement, betting and gambling. The State Government has the exclusive power to make laws in respect of these matters. The petitioners contended that the supply of food and beverages in a restaurant is deemed to be a sale by virtue of Article 366(29A) of the Constitution, enabling the States to levy tax thereon by invoking Entry 54 of the State List. Clause (f) of Article 366(29A) of the Constitution provides that tax on sale or purchase of goods includes 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 of human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration. Similarly, the petitioners argued that accommodation in hotels or inns is also covered under Entry 62 of the State List and the State Government had already enacted the Kerala Tax on Luxuries Act in this regard. The petitioners further contended that they were paying VAT and luxury tax on the entire value of consideration received by them for the supply of food and beverages in the restaurants and for providing accommodation in the hotels respectively. Hence, they were of the view that the Parliament has encroached upon the legislative powers of the States under entries 54 and 62 of the State list. The petitioners contended that the matters covered by the said sub-clauses were already enumerated in Entries 54 and 62 of the State List, and hence only the States can have the legislative competence to impose tax thereon. Entry 54 of the State List covers taxes on sale and purchase of goods other than newspapers, subject to the provisions of Entry 92A of List I. Entry 62 of the State High Court Ruling The High Court upheld the decision of the single Judge and confirmed that levy of Service tax on supply of food and beverages in an air-conditioned restaurant and on accommodation in hotels, inns etc. under sub-clauses (zzzzv) and (zzzzw) of Section 65(105) respectively is unconstitutional.

3 Prior to 46 th amendment to the Constitution, supply of food and beverages in a restaurant was considered to be wholly a service and States were not empowered to impose tax on such a transaction. However, after the 46 th amendment, such transaction was deemed to be a sale, conferring authority on the States to tax the whole consideration received by the person for supplying food and beverages. The Court relied on the decision of the Constitution Bench of the Supreme Court in the case of K. Damodarsamy Naidu & Bros. vs. State of Tamil Nadu & Anr. 2 wherein it was held that the price that a customer pays for the supply of food and services in a restaurant cannot be split up and that the whole amount collected from the customer is liable for levy of sales tax. The Court also considered the decision of the Apex Court in the case of Gannon Dunkerley & Co. vs. State of Rajasthan 3, wherein the Supreme Court had laid down that the elements of service should be deducted from the value of the contract while determining the value of goods involved in the execution of works contract. Accordingly the Court held that after the 46 th amendment, the States could levy tax on the value of goods involved in the works contract whereas the Parliament could levy tax on the value of services involved in the works contract. However, in respect of supply of food and beverages in a restaurant, sales tax could be imposed on the whole amount of the consideration received by the person. Since the entire consideration is exigible to sales tax, the supply of food and beverages in a restaurant cannot be treated as a service for levy of Service tax. 2 K. Damodarsamy Naidu & Bros. vs. State of Tamil Nadu & Anr. [2000 (117) STC 1] 3 Gannon Dunkerley & Co. vs. State of Rajasthan3 [(1993) 88 STC 204]CESTAT] The services provided by restaurant and services provided by hotels, inns etc. in relation to accommodation were brought within the Service tax net by the Parliament by invoking the residuary Entry 97 of List I (Union List). A matter can be brought under Entry 97 only if it is not enumerated in List II (State List) or List III (Concurrent List) and in case of tax, if it is not mentioned in either of those Lists. Supply of food and beverages by a restaurant covered under Section 65(105)(zzzzv) is enumerated under Entry 54 of the State List and the States would have exclusive power to enact any law in that respect. Similarly, accommodation provided by hotels, inns etc. which is covered under Section 65(105)(zzzzw) is enumerated under Entry 62 of the State List. In this regard, the Court relied on the decision of the Supreme Court in the case of Godfrey Philips India Ltd. vs. State of U.P. 4 and held that hotels, clubs, inns etc. would be luxuries and hence, would get covered under Entry 62 of the State List. The Court did consider the decision of a European Court in the case of Faaborg- Gelting Linien A/S vs. Finanzamt Flensburg, which was relied on by the Revenue. In this case it was held that restaurant transactions should be held as supply of services and provision of food is only one component of such transaction. However, the Court rejected this proposition and held that, though this was the position in India prior to the 46 th amendment, the introduction of Article 366(29A) changed the characteristics of such a transaction for the purpose of levy of tax. The Court held that even the service part involved in the supply of food and beverages is deemed as a sale to enable the States to impose tax thereon. Hence, having characterised constitutionally the subject matter of supply of food in a restaurant, including the service part of 4 Godfrey Philips India Ltd. vs. State of U.P.4 [2005 (2) SCC 515]

4 it, as a sale, the Parliament cannot characterise the same transaction as a service for imposition and levy of Service tax. The Court also differed from the decision of the Bombay High Court in the case of Indian Hotels and Restaurant Association & Anr. vs. UoI & Ors. 5 In this writ petition, the Bombay High Court upheld the levy of Service tax on the services rendered by restaurants under clause (zzzzv) of section 65(105) of the Finance Act, Comments The constitutional validity of Service tax on restaurant services has been a subject matter of consideration before several High Courts. Though the Bombay High Court had ruled that Parliament is competent to levy Service tax on the services provided by restaurants, it had also pointed out that petitioners had not argued that the levy in question was hit by double taxation. In a recent Stay order passed by the Telangana and Andhra Pradesh High Court on the same issue, HC has stayed the coercive recovery of Service tax on supply of food and drinks in a bar. In view of the contrary judgements, finality on constitutional validity of Service tax on restaurant services may be expected only when the matter is decided by the Apex Court. However, appropriate legislative amendment is required to address the issue of double taxation. 5 Indian Hotels and Restaurant Association & Anr. vs. UoI & Ors.[2014-TIOL-498-HC-MUM-ST]

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