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Service Tax On Hotels And Restaurants Recent Delhi High Court Judgment
October, 19th 2016

Prior to 1st July 2012, short term accommodation (upto three months) provided by hotels, inn, guest house, club or campsite, by whatever name called, for providing of accommodation for  continuous period of less than three months were exigible to Service Tax under Section 65(105) (zzzzw) of the Finance Act, 1994. Also, Service Tax was payable on provision to any person by restaurant having facility of air conditioning in any part of its establishment towards serving of food or beverages, including alcoholic beverages, or both.

W.e.f. 01.07.2012 with the enactment of negative list, these categories were replaced by a comprehensive definition of 'service' alongwith a negative list of services on which no Service Tax is levied and exemptions provided by way of an exemption notification. The restaurant services are included as a declared service (Section 66E) and service portion in an activity wherein goods, being food or any other article of human consumption or any drink supplied in any manner as a part of the activity, are taxable for the purpose of Service Tax.

Under the negative list regime, the taxability of hotel and restaurant services are subject to following exemptions –

  • Services provided in relation to serving of food or beverages by a restaurant, eating joint or a mess, other than those having the facility of air-conditioning or central air-heating in any part of the establishment, at any time during the year.
  • Services provided in relation to serving of food or beverages by a Canteen maintained in a factory covered under the Factories Act, 1948, having the facility of air-conditioning or central air-heating at any time during the year.

In order to ensure transparency and standardization in the manner of determination of the

value of such service provided in a restaurant or as outdoor catering, rule 2C was inserted in the Service Tax (Determination of Value) Rules, 2006 w.e.f. 1.7.2012 by the amendment rules of 2012.

The value of service in this case shall be determined as per Rule 2C of the Service Tax (Determination of Value) Rules, 2006. In terms of the said rule, value of the service portion shall be determined in the following manner:-

Value of service portion…..

Shall be ….. percentage of the total amount charged:

In a restaurant


By an outdoor caterer


‘Total amount’ (referred to in the second column of the table above) means the sum total of gross amount charged and the fair market value of all goods and services supplied by the service receiver in or in relation to the supply of food or any other article of human consumption or any drink (whether or not intoxicating), under the same contract or any other contract, less (i) the amount charged for such goods or services provided by the service receiver; and (ii) the value added tax or sales tax, if any, levied to the extent they form part of the gross amount or the total amount, as the case may be.

In Ballal Auto Agency v. Union of India 2014 (11) TMI 1021 - KARNATAKA HIGH COURT , it was held that services of restaurants, hotels, inns, guest houses of clubs with air conditioning facility are liable to service tax and Parliament is competent to levy it. The High court confirmed the legislative competence of Union by placing relevance on ‘aspects theory’ whereby the same transaction can have two taxable events of different nature. Under this theory, the taxes are imposed by two different statutes for two different reasons. Therefore, in transactions of composite nature like restaurant service, both legislatures have power to tax it and not solely the State Government.

In one of the recent landmark judgments of Delhi High Court in Federation of Hotels & Restaurant's Association of India v. Union of India ( 2016 (8) TMI 502 - DELHI HIGH COURT , court observed and held that while Service Tax on restaurants providing supply of food is valid, Service Tax on hotels etc for accommodation deserve to be struck down.

In case of hotels etc which are also subject to levy of state luxury tax, it has been held that accommodation in hotels  is a taxable event that is fully covered by the term 'luxuries' in Entry No. 62 of List-II of the Constitution of India and therefore, outside the legislative competence of Parliament. The provision of short term accommodation of less than three months is not exempt from luxury tax. For both, taxable event is same.

There is no machinery for the computation of the taxable value of the service of providing accommodation. The exemption from service tax on the provision of accommodation for a room having a declared tariff of less than 1,000 per day or equivalent is by Notification.

It was held that that the provision of short-term accommodation in hotels, etc., envisaged in Section 65(105)(zzzzw)of the Finance Act, 1994 read with Section 65(44) is a taxable event that is entirely covered by the term 'luxuries' inEntry 62 of List II of the Seventh Schedule to the Constitu­tion and therefore, outside the legislative competence of Parliament.

Section 65(105)(zzzzw) of the Finance Act, 1994 fails the foremost test of constitutionality of a Union tax as highlighted in International Tourist Cor­poration v. State of Haryana 1980 (12) TMI 191 - SUPREME COURT , that "before exclusive legislative competence can be claimed for Parliament by resort to the residuary power, the legislative incompetence of the State Legislative must be clearly established." Here, the Act which provides for levy of luxury tax on provision of the service of accom­modation in a hotel, etc., is traceable to Entry 62 of List II aid the State is, there­fore, competent to levy and collect luxury tax on such taxable event.

In case of restaurant services [Section 65(105) (zzzzv) and / or section 66E as a declared service, of the Finance Act, 1994, the court observed that legislative carving out of service portion of composite contract of supply of food and drinks has sound constitutional basis. Even if this is viewed as Par­liament deploying legal fiction, it is legally permissible. Key expression in Article 366(29A)(f) of the Constitution of India is not just 'supply' but 'sup­ply of goods', which connotes that dominant nature of transaction is transfer, delivery or supply of goods and provision of service is only incidental to such transfer, delivery or supply. By same logic even if some part of composite transaction involves rendering of service, Union Government has power to bring to tax that portion. In catering contract, there is no overlapping between Entry 54 of List II which relates to tax on sale and purchase of goods and has to be read with Article 366 Clause 29A(f) and Entry 97 of List I which covers tax on service portion of such contract.

Rule 2C of the valuation rules enable the accessing authority to put a def­inite value to the service portion of the composite contract of supply of goods and services in an air-conditioned restaurant. Correspondingly, there is an abatement for that portion which pertains to the supply of goods in the form of food and drink which would be amenable to Sales Tax or Value Added Tax.

The court thus held as follows  –

  1. upheld the constitutional validity of Section 65(105)(zzzzv) read with Section 66E(i), Section 65(22) of theFinance Act, 1994 as well as Rule 2C of the Service Tax (Determination of Value) Rules, 2006.
  2. struck down Section 65(105)(zzzzw) of the Finance Act, 1994 per­taining to levy of service tax on the provision of short-term accom­modation and the corresponding instructions / circulars seeking to operationalize the levy as unconstitutional and invalid.
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