Issue Before Court
The challenge in this petition under Article 226 of the Constitution of India is to the constitutional validity of Section 65 (105) (zzzzv) of the Finance Act 1994 (FA) whereby the provision to any person by a restaurant, by having the facility of air-conditioning in any part of its establishment serving food or beverage, including alcoholic beverages or both, in its premises has been made amenable to service tax.
Also challenged is the constitutional validity of Section 65 (105) (zzzzw) of the FA whereby the provision by a hotel, inn, guest house, club or camp-site by whatever name called to any provision, accommodation for a continuous period of less than three months has been made amenable to service tax.
Case of the Petitioners
The case of the Petitioners in short is that after Constitution (Forty-Sixth Amendment) Act, 1982 which inserted clause 29A (f) in Article 366 defining „tax on sale or purchase of goods‟to include ‘a tax on the supply, by way of or as part of any service, of food or any drink for cash, deferred payment or other valuable consideration’, all aspects of the transaction of sale of food and beverages by the members of Petitioner No.1 to their customers fell within the meaning of ‘sale of goods’ amenable to sales tax i.e. value added tax („VAT‟) levied by taxing statutes of the States. It is submitted that the provision of food and beverages in a restaurant, even where it forms part of a hotel which provides lodging and meals is covered entirely by Entry 54 of List II read with Article 366 (29A) (f) and, therefore, it is only the State legislature that has the exclusive competence to legislate in respect of levy of tax on such sale or purchase of goods. It is contended that no part of the transaction of supply of food in a restaurant or hotel is now left out for being made amenable to service tax levied by a statute enacted by Parliament. Thus it is submitted that Section 65 (105) (zzzzv) of the FA is beyond the legislative competence of Parliament.
Further, it is pointed out that under Entry 62 of List II (State List) the States are empowered to impose tax on luxuries including taxes on entertainment, amusement, betting and gambling. In fact State Legislatures have enacted statutes in terms of which luxury tax is levied on hotel accommodation. It is submitted that the entire amount paid on provision of accommodation by hotels is also a matter falling exclusively in the State Therefore, the constitutional validity of Section 65 (105) (zzzzw) of the FA the above provision whereby Parliament seeks to levy service tax on a transaction which is completely covered by Entry 54 of List II is challenged for lack of legislative competence.
Held by High Court
a. Validity of Rule 2C of the Service Tax (Determination of Value) Rules, 2006;
Challenge to Rule 2-C of the 2006 Rules requires to be The case of the Petitioners is that the said rule is bad in law as it arbitrarily attributes 40% of the value of the composite contract of supply of food and drinks to the service component. The legal basis for this challenge is to be found in the following passage in Govind Saran Ganga Saran v. CST 1985 Supp SCC 205:
“6 The components which enter into the concept of a tax are well known. The first is the character of the imposition known by its nature which prescribes the taxable event attracting the levy, the second is a clear indication of the person on whom the levy is imposed and who is obliged to pay the tax, the third is the rate at which the tax is imposed, and the fourth is the measure or value to which the rate will be applied for computing the tax liability. If those components are not clearly and definitely ascertainable, it is difficult to say that the levy exists in point of law. Any certainty or vagueness in the legislative scheme defining any of those components of the levy will be fatal to its validity.”
What Rule 2C does is to enable the assessing 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. As rightly pointed out by learned counsel for the Respondent that such grant of abatement has the approval by the Supreme Court in Association of Leasing & Financial Service Companies v. Union of India (supra) wherein the abatement was 90% and the standard rate of service tax was applied on @ 10% of the cost of the leasing transaction which approximately represented the service element. It also requires to be kept in mind that the ready reckoner formula is useful where an assessee does not maintain accounts in a manner that will enable the assessing authority to clearly discern the value of the service portion of the composite contract. It hardly needs emphasis that when during the course of assessment proceedings an assessee is able to demonstrate, on the basis of the accounts and records maintained by it for that purpose, that the value of the service component is different from that obtained by applying Rule 2C the assessing authority would be obliged to consider such submission and give a decision thereon. With the machinery provision for the levy and determination of service tax on the service portion clearly being spelt out in the Rules themselves, the legal requisites highlighted in Govind Saran Ganga Saran v. CST (supra) stand satisfied.
Indeed a perusal of one of the bills produced by the Petitioners themselves reveals that of the total sale of food for Rs. 2300, food tax (i.e. VAT) is levied @ 12.5% and works out to Rs. 287.50, service tax is @ 4.94% which works out to Rs. 113.71. An abatement has been provided in the rate of service tax. Where the service tax should be @ 12.36% it is, after abatement, 4.94%. Therefore it is not right that the measure of tax is the same. This is notwithstanding the settled legal position that value of taxable service is not determinative of the character of the levy. In Association of Leasing & Financial Service Companies v. Union of India (supra) the Supreme Court observed:
“45 (i) The measure of taxation does not affect the nature of taxation and, therefore, the manner of quantification of the levy of service tax has no bearing on the factum of legislative competence.”
For all the aforementioned reasons, the Court upholds the constitutional validity of Section 65 (105) (zzzzv) and Section 66 E (i) of the FA read with Section 65 (22) and 65 (44) thereof and Rule 2 C of the 2006 Rules 2006.
b. Service Tax on supply of food and drinks in a restaurant
In outdoor catering there is an element of personalized service, it in no way suggests that there is no service element involved in the supply of food and drinks in a restaurant.
The Parliament has made the legal position explicit by inserting Section 66 E (i) of the FA read as it were with Section 65 (22) and 65 (44) of the FA. It states that the “service portion in an activity wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as a part of the activity”is a ‘declared’ service. The legislative carving out of the service portion of the composite contract of supply of food and drinks has sound constitutional basis as explained in the aforementioned decisions of the Supreme Court. Even if this is viewed as Parliament deploying a legal fiction, it is legally permissible. In State of U.P. v. Hani Ram (2013) 4 SCC 280 it was held:
“18. The legislature is competent to create a legal fiction, for the purpose of assuming existence of a fact which does not really exist. … In interpreting the provision creating a legal fiction, the court is to ascertain for what purpose the fiction is created and after ascertaining this, the court is to assume all those facts and consequences which are incidental or inevitable corollaries to the giving effect to the fiction.”
Thus it is not possible to accept the contention of the Petitioners that Parliament lacks the legislative competence to enact Section 65 (105) (zzzzv) of the FA with a view to bringing the service component of the composite contract of supply of food and drinks by an air-conditioned restaurant within the service tax net.
c. Provision of short-term accommodation in hotels
While Rule 2C provides the basis for determining the value of services for the purposes of Section 65 (105) (zzzzv), there is no corresponding provision for determining the value of the service in the case of Section 65 (105) (zzzzw) of the FA. In other words there is no machinery for the computation of the taxable value of the service of providing accommodation. In Commissioner of Income Tax v. B. C. Srinivasa Setty AIR 1981 SC 972 in the context of the absence of a machinery provision for computation of tax on goodwill, in the context of Section 45 of the Income Tax Act 1961, for the it was observed:
“The character of the computation provisions in each case bears a relationship to the nature of the charge. Thus the charging section and the computation provisions together constitute an integrated code. When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to fall within the charging section. Otherwise one would be driven to conclude that while a certain income seems to fall within the charging section there is no scheme of computation for quantifying it.”
The exemption from service tax on the provision of accommodation for a room having a declared tariff of less than Rs. 1,000 per day or equivalent is by Notification No. 12/2012 dated 17th March 2012. This is not provided in the Act or the Rules. In Commissioner of Central Excise and Customs, Kerala v. Larsen and Toubro Ltd. (2016) 1 SCC 170, the Supreme Court affirmed the decision of the Orissa High Court in Larsen and Toubro Ltd. v. State of Orissa (2008) 12 VST 31 to the effect that the machinery provisions for levy of the tax could not be provided by instructions and circulars. It was held by the Orissa High Court that “It is a well-settled principle that in matters of taxation either the statute or the Rules framed under the statute must cover the entire field. Taxation by way of administrative instructions which are not backed by any authority of law is unreasonable and is contrary to article 265 of the Constitution of India.”
Consequently, the Court is satisfied that the provision of short-term accommodation in hotels etc. envisaged in Section 65 (105) (zzzzw) of the FA read with Section 65 (44) of the FA is a taxable event that is entirely covered by the term ‘luxuries’ in Entry 62 of List II of the Seventh Schedule to the Constitution and therefore outside the legislative competence of Parliament.
The Court accordingly:
(i) upholds the constitutional validity of Section 65 (105)(zzzzv) read with Section 66E (i), Section 65 (22) of the Finance Act 1994 as well as Rule 2C of the Service Tax (Determination of Value) Rules, 2006;
(ii) strikes 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 operationalise the levy as unconstitutional and invalid.
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