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Service tax on restaurants and hotels is not Constitutional

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In a recent ruling, the Kerala High court, in Kerala Classified Hotels and Resorts Association and others vs Union of India and others (2013-TIOL-533-HC-KERALA-ST), 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 two specific transactions related to restaurants and hotels on which the court was asked to rule on the Constitutional validity of levy of service tax by the central government on these businesses.

The first question was whether the central government has 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.

The second question was whether the central government has the Constitutional right to levy service tax under section 65(105)(zzzzw) of the Finance Act, 1994, (introduced by the Finance Act, 2011 with effect from May 1, 2011) on provision of accommodation by the hotel.

The Constitutional validity in this case was challenged on the basis that the entry 62 of list II of the seventh schedule to the Constitution of India exclusively empowers the state government to impose tax on "luxuries". The high court in this case relied on yet another landmark judgment by the Constitutional Bench of the apex court in Godfrey Phillips India Ltd vs state of UP (2005-TIOL-10-SC-LT-CB), wherein the apex court defined the word "luxuries" as the activities of enjoyment of or indulgence in that which is costly or which is generally recognised as being beyond the necessary requirements of an average member of society.

Keeping in view of the extended meaning of luxuries provided by the apex court, the high court was of the view that by imposing service tax on hotels, etc, the central government has departed from its Constitutional mandate and accordingly, liable to be held unconstitutional.

It is worth mentioning here that the 46th amendment to the Constitution which introduced clause 29A to the article 366 contained six transactions which were deemed to be a transaction of sale or purchase of goods. For example, tax on the transfer of property in goods involved in the execution of a works contract is one of the deemed sales under this amendment. Post this judgment by the high court, an old debate may have resurfaced.

Can, on similar grounds the levy of service tax on a transaction of works contract where the buyer only intends to buy, say for example a constructed building and pay consideration on per square foot of constructed building, be challenged? The buyer of the building has no interest in the services that the builder has used in construction of such building, merely in the completed building. Therefore, can the central government tax the services that are provided in a works contract when these transactions are deemed sales under the Constitution?

The clause 29A was introduced, as it was felt necessary by the experts to declare those transactions as deemed sale of goods which could otherwise lead to a dilemma in classification between sale of goods and/or services. Yet another question arising out of this situation is - shouldn't there be a similar provision in the Constitution to declare the other portion of such transactions as the deemed/declared services, before the same could be brought under the tax net of the central government?
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