DECEMBER 30, 2014

By S J Singh, Advocate

THREE recent judgements of two high courts have left a lot of confusion in the minds of taxpayers, tax collectors and tax practitioners about the constitutionality of the service tax on service provided in relation to serving of food or beverages, including alcoholic beverages or both by a restaurant.

The service provided in relation to serving of food or beverages by an air-conditioned restaurant was made taxable with effect from 01.05.2011 by insertion of sub-clause (zzzzv) in Clause 105 0f Section 65 of the Finance Act, 1994. The said sub-clause read as:

"taxable service" means any service provided or to be provided to any person, by a restaurant, by whatever name called, having facility of air conditioning in any part of the establishment, at any time during the financial year, which has license to serve the alcoholic beverages, in relation to serving of food or beverages, including alcoholic beverages or both, in its premises.

After, switching over to the regime of "negative list" of services, with effect from 01.07.2012, when many major amendments were made effective in the Finance Act, 1994, the service in relation to the supply of food and beverages has been incorporated in Section 66E (i)as a ‘Declared Service'. Clause (i) of Section 66E reads as under:

"service portion in any activity wherein goods, food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as part of the activity."

The disputes regarding the imposition of service tax under pre 01.07.2012 provisions have reached to the High Courts and two High Courts have adjudicated the disputes in different manners. Though the decisions of the High Courts are in relation to the provisions of the law as it stood before 01.07.2012 yet as the constitutionality of the service tax on the service of supply of food articles involved in these decisions shall have implications on the post 31.06.2012 provisions also.

At first instance, the learned single Judge of Hon'ble Kerala High Court allowed a batch of writ petitions, holding that sub clauses (zzzzv) of Clause 105 of Section 65 of the Finance Act, 1994, as amended by Finance Act, 2011, as unconstitutional, illegal and unenforceable as reported in 2013-TIOL-533-HC-KERALA-ST. It was held by the hon'ble court that the service tax on supply of food in the restaurants was beyond the legislative competence of Parliament.

At the second instance, the Hon'ble High Court of Bombay, in the case of Indian Hotels & Restaurants Association v Union of India - 2014-TIOL-498-HC-MUM-ST held that the imposition of service tax on service portion involved in service in relation to service of food and beverages is constitutionally valid and enforceable.

At the third instance, the Division Bench of Kerala High Court - 2014-TIOL-1913-HC- KERALA-ST heard the appeal of Union of India against the afore said single bench judge of the same High Court and the decision of single member bench has been upheld. What is interesting is that the decision of the single judge bench of Kerala High Court was cited before the Bombay High Court and the decision of division bench of Bombay High Court was cited before the division bench of Kerala High Court. The benches disagreed with the contrary decisions of the other High Courts.

The finality of the interpretation of the provision relating to imposition of service tax on service in relation to service of food shall be attained only when the Hon'ble Supreme Court of India renders its decision on the appeals filed by the aggrieved parties.

An attempt is being made to analyse the provisions of the law governing the imposition of service tax on service in relation to service of food or beverages and the constitution provisions relating to competence of the Parliament of India and the State Legislatures to impose taxes. In this analysis there shall be attempt to find out reasons behind Constitution (Forty-sixth Amendment) Act, 1982, which led to insertion of Clause (29A) in Article 366 of Constitution to ascertain the constitutionality of the imposition of service tax on service in relation to supply of food articles for human consumption.

Article 245 of the Constitution empowers the Parliament and State Legislatures to make laws. Article 246 lays down that the Parliament shall have exclusive power to make laws with respect to List I (Union List) and State Legislatures shall have exclusive power to make laws with respect to List II (State List) in Schedule VII of the Constitution. Both Parliament and the State Legislatures shall have power to make Laws with respect to List III (Concurrent List) in Schedule VII. Article 248 empowers the Parliament to make laws on any matter, including imposition of any tax, not enumerated in Concurrent List or State List.

Three Lists in Schedule VII contain various entries with respect to which the competent legislature can enact laws. However, as the power to make laws with respect to List I is exclusively with the Parliament and with respect to Lists II exclusively with State Legislatures, the Parliament or the State Legislatures, as the case may be, cannot enact laws with respect to the entries respectively contained under List II and List I.

Power to impose "taxes on the sale or purchase of goods" has been endowed to State Legislatures by Entry 54 of List II of Schedule VII. Only States can levy and collect sales/purchase tax on sale or purchase of goods. Union has no power to impose tax on sale or purchase of goods except I the case of inter-state sale of goods. Power to impose service tax has not been covered by any of the entries in any of the Lists of Schedule VII. However, the Parliament under the residuary power bestowed on it under Article 248 read with Entry 97 of List - I has the power to impose any tax not enumerated in any of the Lists of Schedule VII. Entry 97 of List I reads as under:

"Any other matter not enumerated in List II or List III including any tax not mentioned in either of those Lists."

The competence of the Parliament to impose "service tax" in exercise of power under Article 248 read with Entry 97 of List I has been upheld by Hon'ble Supreme Court in number of cases. In fact, by the Constitution (Eight-eighth Amendment) Act, 2003 Entry 92C has been added to List I. Entry 92C enables the Parliament to impose taxes on services. Entry 92C, however, has not been brought into force so far. It appears that at one time the Parliament thought to have express power to impose service tax but as the challenge to the power to impose service tax under Article 248 read with Entry 97 of List I, stood the test of judicial review, the power assumed under Entry 92C seems to have become superfluous.

The power to impose "tax on sale or purchase of goods" is within the competence of State Legislature. The States started imposing taxes on sale or purchase of goods within their respective jurisdictions immediately after promulgation of constitution in certain situations.In certain other cases, they were already imposing and collecting sales/purchase tax under the provisions of laws prevailing before the promulgation of constitution.

Certain States imposed the tax on sale of food articles meant for human consumption served by the hotels to their guests during the lodging of the guests in the hotels. To such in house guests, the hotels were raising composite bills for boarding and lodging. The boarding could be full boarding (which included breakfast, lunch and dinner) or part boarding (which could be only breakfast or breakfast and lunch or dinner). The hoteliers resisted the payment of sales tax on the sale of food and beverages to their guests. They were of the opinion that they were not selling food and beverages to their guests but were providing services to their guests. The services provided were of various natures to make the stay of their guests comfortable. The provision of food and beverages was part of the services provided by them for the comforts of their guests.

In the case of Associated Hotels of India,the dispute between the revenue authorities in the State of Punjab and the hoteliers reached the High Court of Punjab. The High Court decided the issue in favour of hoteliers. The State of Punjab filed appeal before the Supreme Court of India (State Of Punjab vs M/S. Associated Hotels Of India: 1972 AIR 1131, 1972 SCR (2) 937) = 2002-TIOL-65-SC-CT-CB . The hon'ble Supreme Court, on the issue of imposition of sales tax on supply of food articles to the guests in the hotel, observed as under:

"…………The transaction in question is essentially one and indivisible. namely, one of receiving a customer in the hotel to stay. Even if the transaction is to be disintegrated, there is no question of the supply of meals during such stay constituting a separate contract of sale. since no intention on the part of the parties to sell and purchase food stuff supplied during meal times can be realistically spelt out. No doubt, the customer, during his stay, consumes a number of food stuffs. It may be possible to say that the property in those food stuffs passes from the hotelier to the customer at least to the extent of the food stuffs consumed by him. Even if that be so, mere transfer of property, as aforesaid, is not conclusive and does not render the event of such supply and consumption a sale, since there is no intention to sell and purchase. The transaction essentially is one of service by the hotelier in the performance of which meals are served as part of and incidental to that service, such amenities being regarded as essential in all well conducted modem hotels. The bill prepared by the hotelier is one and indivisible, not being capable by approximation of being split up into one for residence and the other for meals. No doubt, such a bill would be prepared after consideration of the costs of meals, but that would be so for all the other amenities given to the customer. ……………………." (Emphasis supplied)

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" The transaction between a hotelier and a visitor to his hotel is thus one essentially of service in the performance of which and as part of the amenities incidental to that service, the hotelier serves meals at stated above. The Revenue, therefore, was not entitled to split up the 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 stuffs served to him with a view to bring the latter under the Act." ( Emphasis supplied)

The Supreme Court, thus, held that there was no sale of food article to the guests in the hotel. The supply of food was part of the service that hotelier performs for making the stay of the guests comfortable. It was held that no sales tax was payable on such supply of food articles as there was no sale of such articles from the hotelier to the guests.

It may be argued that the above case is with respect to the hotels and the in house guests and has no application in case of walk in guests in a restaurant. On the face of it the argument looks to be somewhat convincing. However, the hon'ble Supreme Court had not agreed with such an argument. In the case of Northern Indian Caterers, where sale tax was levied on sale of food articles in restaurants by the Delhi government under the Bengal Finance (Sales Tax) Act, 1941, as extended to the Union Territory of Delhi, the revenue authorities had better luck with the High Court. However, on appeal by the Northern Indian Caterers [Northern India Caterers (India) vs Lt. Governor Of Delhi, 1978 AIR 1591, 1979 SCR (1) 557], the hon'ble Supreme Court followed the aforesaid decision in the case of Associated Hotels of India and observed as under:

"Like the hotelier, a restaurateur provides many services in addition to the supply of food. He provides furniture and furnishings, linen, crockery and cutlery, and in the eating places of today he may add music and a specially provided area for floor dancing and in some cases a floor show. The view taken by the English law found acceptance on American soil, and after some desultory dissent initially in certain states it very soon became firmly established as the general view of the law. The first edition of American Jurisprudence sets(3) forth the statement of the law in that regard, but we may go to the case itself, Electa B. Merrill v. James W. Hodson(4), from which the (1) Innkeepers & Hotels, para 169.

(2) 4 Burr. 2065.

(3) Vol. 46 p. 207 para 13.

(4) 1915-B L.R.A. 481.

statement has been derived. Holding that the supply of food or drink to customers did not partake-of the character of a sale of goods, the Court commented:-

"The essence of it is not an agreement for the transfer of the general property of the food or drink placed at the command of the customer for the satisfaction of his desires, or actually appropriated by him in the process of appeasing his appetite or thirst. The customer does not become the owner of the food set before him, or of that portion which is carved for his use, or of that which finds a place upon his plate, or in side dishes set about it. No designated portion becomes his. He is privileged to eat, and that is all. The uneaten food is not his. He cannot do what he pleases with it. That which is set before him or placed at his command is provided to enable him to satisfy his immediate wants, and for no other purpose. He may satisfy those wants; but there he must stop. He may not turn over unconsumed portions to others at his pleasure, or carry away such portions. The true essence of the transaction is service in the satisfaction of a human need or desire, ministry to a bodily want. A necessary incident of this service or ministry is the consumption of the food required. This consumption involves destruction, and nothing remains of what is consumed to which the right of property can be said to attach. Before consumption title does not pass; after consumption there remains nothing to become the subject of title. What the customer pays for is a right to satisfy his appetite by the process of destruction. What he thus pays for includes more than the price of the food as such. It includes all that enters into the conception of service, and with it no small factor of direct personal service. It does not contemplate the transfer of the general property in the food supplied as a factor in the service rendered."

……………………………………………

"It has already been noticed that in regard to hotels this Court has in M/s. Associated Hotels of India Limited (supra) adopted the concept of the English law that there is no sale when food and drink are supplied to guests residing in the hotel. The Court pointed out that the supply of meals was essentially in the nature of a service provided to them and could not be identified as a transaction of sale. The Court declined to accept the proposition that the Revenue was entitled to split up the transaction into two parts, one of service and the other of sale of foodstuffs. If that be true in respect of hotels, a similar approach seems to be called for on principle in the case of restaurants. No reason has been shown to us for preferring any other. The classical legal view being 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. What has been said in Electa B. Merrill (supra) appears to be as much applicable to restaurants in India as it does elsewhere. It has not been proved that any different view should be taken, either at common law, in usage or under statute.

It was urged for the respondent that in Associated Hotels of India Ltd. (supra) this Court drew a distinction between the case of meals supplied to a resident in a hotel and those served to a customer in a restaurant. We are unable to find any proposition of law laid down by the court there which could lead to that inference. ………………In the result, we hold that the service of meals to visitors in the restaurant of the appellant is not taxable under the Bengal Finance (Sales Tax) Act, 1941, as extended to the Union Territory of Delhi, and this is so whether a charge is imposed for the meal as a whole or according to the dishes separately ordered." (Emphasis supplied)

So, both in case of hotels, in respect of the in-house guests and also in case of restaurants when they supply food to the walk in guests, the supply of food to the guests was not held to be sale of food articles but service. The Supreme Court found the legal position to be identical in England and the USA.

The supply of food in hotels/restaurants to the guests was held not amenable to tax on sale or purchase of goods. The above said decisions were followed in number of cases. The States were losing revenue due to judicial interpretation of the transaction of supply of food and other articles for human consumption in hotels and restaurants as service and not as sale of goods. Corrective steps were required to be taken to overcome the judicial decisions.

There were other issues on the levy of sales tax by the States, such as, tax on the transfer of property in goods involved in the execution of works contract, tax on transfer of right to use any goods for any purpose, tax on the delivery of goods on hire purchase basis etc. All these issues were addressed by insertion of Clause (29A) in Article 366 of the Constitution of India by Constitution (Forty-sixth Amendment) Act, 1982. Article 366 deals with "Definitions" of certain terms and phrases used in the constitution. By insertion of Clause (29A), the ambit and scope of phrase, "tax on the sale or purchase of goods" has been amplified to include certain transactions in the ambit of phrase "tax on the sale or purchase of goods" which were not considered by the Courts as included in the ambit of the said phrase.Here, we are concerned with supply of food or any other article for human consumption. Sub-clause (f) of Clause (29A) deals with the situation. When we read sub-clause (f), in the manner in which the framers of Clause want us to read it, it shall reads as under:

"tax on the sale or purchase of goods" include a tax on the supply, by way of or part of any service or in any other manner, what so ever, 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 and such supply of any goods shall be deemed to be sale of those goods by the person making supply and a purchase of those goods by the person to whom such supply is made.

By this definition, the tax on the sale or purchase of food or any other article for human consumption includes the supply of food or any other article for human consumption even when such supply is made by way of or part of any service or in any other manner. Thus, all activities, by way of service or in any other manner, connected with the supply of food for human consumption get included in the concept of sale or purchase of goods by a fiction created by law. The law that created the fiction has become the part of Constitution of India and hence other laws enacted by competent legislatures have to conform to this law.

The Constitution (Forty-sixth Amendment) Bill, 1981 (which subsequently became Act in 1982) contained following, among others, object and reason for insertion of Clause (29A) in Article 366:

"8. Besides the above mentioned matters, a new problem has arisen as a result of the decision of the Supreme Court in Northern India Caterers (India)Ltd.Vs.Lt.Governor of Delhi (A.I.R.1978 S.C.1591). States have been proceeding on the basis that the Associated Hotels of India case was applicable only to supply of food or drink by a hotelier to a person lodged in the hotel and that tax was leviable on thesale of food stuffs by a restaurant. But over-ruling the decision of the Delhi High Court, the Supreme Court has held in the above case that service of meals whether in a hotel or restaurant does not constitute asale of food for the purpose of levy of salestaxbut mustbe regarded as the rendering of a service in the satisfaction of ahumanneed or ministering to the bodily want of human beings. It would not make any difference whether the visitor to the restaurant is charged for the meal as a whole or according to each dish separately."

From the Statement of objects and reasons it is clear that Sub-clause (f) of Clause (29A) was inserted only to nullify the decision of Supreme Court of India, which is law in terms of Article 141 and binding on all courts in India. The Supreme Court had unequivocally declared that supply of food articles for human consumption was provision of service and not sale of food articles. By framing the provision of Constitution in a manner that the supply of food articles as service or part of service shall be deemed to be sale of such articles, the Parliament intended to tax value of service in the supply of food articles in the value of food articles provided to the guests for their consumption.

Accordingly, after the 46th Amendment of the Constitution, value of the food articles supplied in hotels and restaurants,which intrinsically included the value of services, became the assessable value for the purposes of levy of sales tax. At this point of time, the owners of hotels and restaurant, in order to reduce the incidence of sales tax, started arguing that the value of services should not form part of the assessable value for levy of sales tax as the States have no power to levy tax on the services.

In Tamil Nadu, the Tamil Nadu General Sales Tax Act was amended by the Tamil Nadu General (Sales Tax) Fourth Amendment Act, 1984. The definition of "sale" now included a 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. When the revenue authorities started collecting sales tax on the invoice value of the food articles for human consumption, it was argued that, in the eye of the law, the tax on food served in restaurants could not be levied on the sum total of the price charged to the customer. The restaurants provided services in addition to food, and these had to be accounted for. Thus, restaurants provided an elegant decor, uniformed waiters, good linen, crockery and cutlery. It could even be that they provided music, recorded or live, a dance floor and a cabaret. The bill that the customer paid in the restaurant had, therefore, was required to be spilt up between what was charged for such service and what was charged for the food. Dealing with such argument, the hon'ble Supreme Court observed in K. Damodarasamy Naidu And Bros. vs State Of Tamil Nadu And Anr. Etc .[1999 (3) Suppl. SCR 597] as under:

"The provisions of sub-clause (f) of clause (29A) of Article 366 need to be analysed. Sub-clause (f) permits the States to impose a tax on the supply of food and drink. The supply can be by way of a service or as part of a service or it can be in any other manner whatsoever. The supply or service can be for cash or deferred payment or other valuable consideration. The words of sub-clause (f) have found place in the Sales Tax Acts of most States and, as we have seen, they have been used in the said Tamil Nadu Act. The tax, therefore, 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 as suggested by learned counsel. The supply of food by the restaurant owner to the customer, though it may be a part of the service that he renders by providing good furniture, furnishing and fixtures, linen, crockery and cutlery, music, a dance floor and a floorshow, is what is the subject of the levy. The patron of a fancy restaurant who orders a plate of cheese sandwiches whose price is shown to be Rs. 50 on the bill of fare knows very well that the innate cost of the bread, butter, mustard and cheese in the plate is very much less, but he orders it all the same. He pays Rs. 50 for its supply and it is on Rs. 50 that the restaurant owner must be taxed."

In view of the clear provisions of sub-clause (f) of Clause (29A) of Article 366, so long as there is supply of food articles for human consumption, it does not matter if such supply is by way of a service or part of a service or is in any other manner. In all such situations,it is deemed a sale. It is sale, in all circumstances mentioned in sub-clause (f), of food articles and the sales tax is to be paid on the value charged for such supply. The restaurant is not permitted to split the value into two parts, one for sale of food articles and other for the service and pay sales tax on the value attributable to sale of food articles.

The power to levy tax on the sale and purchase of goods is with the State Legislatures as per Entry 54 of List II of Schedule VII of the Constitution. The scope of the phrase "tax on the sale or purchase of goods" has been amplified by Clause (29A) of Article 366. Hon'ble Supreme Court has held at number of times that the entries in all the three Lists in Schedule VII of the Constitution must receive liberal construction inspired by a board and generous spirit and not in a narrow pedantic sense. In this background, even if a narrow pedantic construction is placed on Entry 54 of List II read with Clause (29A) of Article 366, supply of food articles for human consumption even by a way of service or part of a service is sale of those articles. This interpretation is explicit in the aforesaid decision of the Supreme Court in the case of K. Damodarasamy Naidu.

Section 66E of the Finance Act, 1994 that deals with "Declared Services", in clause (i) makes service portion in the activity of supply of food articles for human consumption as a declared service.

Let us examine, what can be the service portion in the activity of supply of food articles. It would be bouquet of activities and not be limited to placing of food articles on the table for consumption of the customer. The culinary skills of the chefs and gastronomy would naturally be part of it. Certain other factors such as location of the restaurant, its décor, well trained waiter and other staff in unique livery, good linen, crockery and cutlery, music (recorded or live), a dance floor, a cabaret etc. would be part of service portion of the supply of food articles. Supreme Court in the case of K. Damodarasamy Naidu has already considered all the above factors. It has been held that the value of services are included in the value of supply of food articles. Despite a specific plea that value of services should not be included in the aggregate value which is charged for supply of the food articles in the hotels and restaurants for the purposes of levy of sales tax, the Court had not agreed with the plea and had ordered that the sales tax was payable on the gross value charged for supply of food articles. For arriving at the conclusion the Court had relied on the language of Sub-clause (f) of Clause (29A) of Article 366.

In my humble opinion, the Clause (i) of Section 66E is not in conformity with afore said Entry 54 read with Clause (29A) of Article 366. The constitutional provision is very clear. Whenever there is supply of food article whether by way of service or as part of service, it is deemed to a transaction for sale of food articles. The provisions of constitution do not permit to segregate the service portion involved in the supply of food articles from the sale of food articles. Only the State Legislatures have power to impose tax on sale or purchase of goods.The Parliament is neither empowered to impose tax on sale of goods nor empowered to transgress the provisions of Constitution. The fact that under the delegated legislation, the value of food articles is sought to be excluded from the gross value of the supply of food articles and tax is sought to be charged only on service portion is not sufficient to save the transgression of the provisions of constitution by clause (i) of Section 66E. The provision of the constitution makes service portion involved in the supply of food articles as part of sale or purchase of those articles.

The above position in law is supported by the provisions of Sub-clause (b) of Clause (29A). As already stated, the said Sub-clause was inserted along with other Sub-clauses of Clause (29A) to overcome interpretations placed by the higher judiciary on the nature of certain transactions. When certain States wanted to tax transfer of goods involved in execution of works contract, the higher courts including the Supreme Court, held that ‘works contract' was indivisible and composite contract. In the execution of a works contract both services and goods were involved, hence it was not a contract for sale of goods. The States were, as held by the courts, not empowered to impose sales tax on the goods involved in the execution of works contract. To overcome the hurdle the aforesaid Sub-clause (b) was inserted to include the transfer of property in goods involved in execution of a works contract within the ambit of "tax on sale or purchase of goods" to enable the States to collect sales tax on transfer of property in such goods. The said Sub-clause reads as under:

"a tax on the transfer of property in goods (whether as goods or in some other form) involved in execution of a works contract."

It is a matter of common knowledge that the execution of a works contract involves both goods and services. The legislature, in its wisdom, has not included the value of services involved in the execution of a works contract in the ambit of "tax on the sale or purchase of goods", even when it was known that services were involved in the execution of a works contract.

There is a reason for adopting different approaches in Sub-clause (b) and Sub-clause (f) of Clause (29A). The supply of food articles in hotel and restaurants was always known as service and not as sale of goods. It was observed by hon'ble Supreme Court in the case of Northern Indian Caterers Pvt. Ltd. that the position in law was similar in English and American laws. At the time of enactment of the Constitution (Forty-sixth Amendment) Act, 1982, by which Clause (29A) was inserted, the Parliament, in its wisdom, thought to include the portion of value of service involved in the supply of food articles in the concept of sale or purchase of goods to enable the States to collect sales tax. It is possible that in 1982, as there was no tax on the services and the Parliament wanted that supply of food articles, whether by way of service or part of service, should be taxed albeit by States to garner the revenue. But now when the provision of the Constitution is framed in a particular way, it is not possible for Parliament to transgress it in the ordinary exercise of its legislative power. Amendment of the Constitution is the way out. However, as the government of the day is keen to introduce GST as early as possible, it is doubtful if government would even think of bringing Constitution amendment, as such a move would shrink the revenue base of States and States are very grudgingly guarding their turf.