Air-conditioned restaurants with a licence to serve liquor were subjected to service tax from May 1, 2011. At the time it was clarified that the tax was on high-end restaurants with the prescribed facilities, where service assumed predominance over the food. And this should not be confused with mere food sales at ordinary eating houses, where such services are materially absent or minimal.

It was also clarified that the levy would be confined to the service value contained in the composite contract, and would not cover either the meal portion or mere food sales by way of pickup or home delivery, as also goods sold at maximum retail price (MRP). This means that the service element could likely be absent or minimal in certain restaurants.

In this year’s Budget, Finance Minister P. Chidambaram, in a complete volte-face, held that the distinction — between restaurants serving liquor and others — was artificial, requiring rationalisation. Thus, from April 1, 2013, service tax would apply to all air-conditioned restaurants, eating joints, or messes.

This could mean that a large number of new taxpayers will be brought into the tax net. Will there be another Voluntary Compliance Encouragement Scheme (VCES) after a few years? Has the Government bitten off more than it can chew?

The levy itself is restricted to the service portion in any activity where food or drink is supplied. Hence, there should be such an activity in the first place and, secondly, there should be a discernible service element in it for levying tax. Furthermore, the service tax valuation rules determine this value as 40 per cent of the total amount (which is not applicable for a mess or an inn).

In the case of K. Damodarasamy Naidu & Bros vs. the State of Tamil Nadu, the Supreme Court held that supply of food is the subject of the levy, even though it is part of the service rendered. The patron of a fancy restaurant who orders a plate of cheese sandwiches costing Rs 50 knows that the innate cost of the bread, butter, mustard and cheese served is far cheaper, but he/ she orders it all the same and pays for it. It is on this Rs 50 that the restaurant owner must be taxed.

In a similar review petition, the Apex court held that where food is supplied in an eating house or restaurant — and it has been established that the substance of the transaction is predominantly sale of food, and the rendering of services is merely incidental — that transaction would be subject to sales tax.

Based on the above, it can be held that the service element in some restaurants could be absent or minimal, and needs to be determined on a case-by-case basis. Hence, is it legally tenable to have an artificial basis of value determination at 40 per cent of the total amount (and not optional at that)?

The industry will be looking for clarity on several issues, including the taxability of takeaway sales and self-service restaurants, supply of food in non-air-conditioned hall in a restaurant that also has air-conditioning, justification for the one-abatement-fits-all mechanism, and whether mere provision of air-conditioning or central heating systems will make a sales transaction a service. It would be quite interesting to see how the courts view this new levy, given the new “service” definition under the Negative List-based service tax laws.