The Federation of Hotels and Restaurants Association of India (“Petitioner”) is an association of hotels and its members (spread all over the country) are engaged in providing both lodging and meals to the residents across the country.

The Petitioner challenged the constitutional validity of Section 65(105)(zzzzv) of the Finance Act, 1994 read with Rule 2C of the Service Tax (Determination of Value) Rules, 2006 (“Valuation Rules”), under Article 226 of the Constitution of India. Under the said provision, serving food or beverages by a restaurant having air-conditioning facility has been made amenable to service tax on 40% of the total transaction value attributable to the value of the services provided.

Validity of Section 65(105)(zzzzw) of the Finance Act was also challenged, whereby provision of accommodation for a continuous period of less than three months has been made amenable to service tax.

ISSUE IN SHORT

Whether the Parliament was competent to levy Service Tax on activities covered under the aforesaid provisions?

SUBMISSIONS MADE BY THE APPELLANT

The Petitioner contended that clause 29A(f) of Article 366, inserted by the Constitution (Forty-Sixth Amendment) Act, 1982, includes taxation of the supply (including service) of food or drinks for consideration as part of “tax on sale or purchase of goods”. Thus all aspects of such transactions fall within “sale of goods” amenable to VAT, which is levied by the States. The Petitioner further contended that supply of food and beverages in restaurants, which form part of a hotel providing lodging and meals, is covered by entry 54 of List II. Thus, it was contended that no part of the transaction would be made amendable to Service Tax being levied by the Parliament, and Section 65(105)(zzzzv) of the Finance Act is, therefore, beyond the Parliament’s legislative competence.

The Petitioner also contended that under Entry 62 of List II, States are empowered to impose tax on luxuries, including taxes on hotel accommodation. Therefore, the entire amount paid on provision of accommodation by hotels is also a matter falling exclusively in the State List. Therefore, levy of the service tax on the same under section 65(105)(zzzzw) is also beyond the Parliament’s legislative competence.

The Petitioner argued that both VAT and luxury tax are collected by the State on both aspects, therefore, service tax would not be levied on either, as it would lead to double taxation of the same transaction.

On the other hand, the Respondent contended that certain taxable services, such as catering contracts, constitute composite contracts. The term ‘service’ used in Article 366 (29A)(f) emphasizes the segregable nature of such contracts. The objective was to levy service tax only on the service component of the transaction, with an abatement being allowed for the value of the goods supplied. In the case of the short-term accommodation (hotel) service, the abatement method is followed to arrive at the value of the service portion.

The Respondent further contended that the legislative competence is to be determined with reference to the object of the levy and not with reference to its incidence for collection of tax. It is emphasized that only the supply of goods as part of any service is amenable to tax/VAT under Article 366(29A)(f), and the service portion is excluded from the supply. What is being taxed by the Union is the activity of providing short-term accommodation and not luxury provided in a hotel.

HELD BY THE HON’BLE BENCH

(I)        Validity of Section 65(105)(zzzzv) of the Finance Act

The Hon’ble Delhi High Court observed that before exclusive legislative competence could be claimed by Parliament by resorting to the residuary power, the legislative incompetence of the State legislature must be clearly established. The expression “supply of goods” connotes that the dominant nature of the transaction is the transfer, delivery or supply of goods and the provision of service is only incidental to the same. The High Court held that the pith and substance of the contract must be ascertained. Even if only some part of the composite transaction involves the rendering of service, there should be no difficulty in recognizing the power of the Union to bring to tax that portion.

The High Court held that the Parliament had made the legal position explicit by inserting section 66E (i) of the Finance Act, which 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. Therefore, the legislative carving out of the service portion of the composite contract, even if viewed as deploying legal fiction, has sound constitutional basis.

(II)       Validity of Rule 2C of the 2006 Rules

The Delhi High Court held that Rule 2C enables 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. Consequently, there is abatement for the portion, which pertains to the supply of goods. The High Court noted that the measure of taxation does not affect the nature of taxation and therefore, the manner of quantification of levy and determination of service tax has no bearing on the factum of legislative competence. In view of these, the High Court upheld the constitutional validity of Rule 2C.

(III)      Validity of Section 65(105)(zzzzw) of the Finance Act

The Delhi High Court, in this regard, noted that section 65(105)(zzzzw) of the Finance Act defines and levies tax on the same service as is defined and taxed in the Delhi Tax Luxuries Act, 1996 (“DTL Act”) under “luxury provided in a hotel”.

The only additional pre-pre-fix is the hyphenated word “short-term” in section 65(105)(zzzzw), for a period of less than three months. Therefore, it is difficult to discern any real difference in the subject matter of both the levies. It was observed that the taxable event of providing service by way of accommodation in a hotel etc. is the subject matter of both levies, and such accommodation is by no means exempt from luxury tax under the DTL Act.

The High Court, therefore, held that the DTL Act was traceable to entry 62 of List II and it was held that the State is competent to levy and collect luxury tax on above-stated taxable event. Further, the above-said provision of the Finance Act fails the foremost test of constitutionality of a Union tax i.e. to show the legislative competence of the State on the same. Therefore, it is outside the legislative competence of Parliament to levy a tax on the same. Hence, the High Court held that section 65(105)(zzzzw) of the Finance Act is thus unconstitutional and invalid.