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Service tax on Restaurants : Debunking Myths


There has been an interesting anecdote , about restaurants, service tax and something akin to robbery that is doing rounds of internet-ville  at the moment.  In our opinion the account is a misunderstanding at best.

Let us explain :

Under the current legislation, there is a composite levy of both Service tax (“ST”) , as well as, Value Added Tax (“VAT”) on food and beverages served by hotels and restaurants. The charge of VAT has already been widely litigated, most notably in the case of Northern India Caterers Vs Lt.Gov. Of Delhi, wherein the honorable supreme court has held that, the supply of food was in fact a service and not a sale and therefore would not attract VAT. In a response which should appear familiar in the current circumstances surrounding tax regulation in India, the government went ahead and amended the constitution to include the supply of food and drinks as a deemed sale for the imposition of VAT. Subsequent rulings with respect to valuation of such goods held that even though the amount charged for food and drinks contains charges for bundled services, the entire amount would be subject to imposition of VAT.

The imposition of service tax on sale of food is therefore a logical consequence of the above mentioned line of thought. Service tax on supply of food and beverages was first imposed by the union government to be applicable with effect from 1-5-2011. An abatement of 70% was then provided, ostensibly to separate the sales of meals and beverages from the sale of services and thereby avoiding double taxation. Therefore the rate of tax on services provided is equal to 30% of the standard rate.

A clarification issued by the TRU in this matter reads as follows

“The exemption is available provided no Cenvat credit is availed either of inputs or input services. It is clarified that the exemption is available on the gross price charged by the restaurant for the taxable service, including any portion shown separately e.g. service charge. However the amount paid by the customer ex-gratia e.g. as tip to any member of the staff doesn’t constitute consideration paid to the restaurant and shall remain outside this levy.”

A new regime of service tax has been imposed with effect from 1-7-2012, under such new machinery the abatement allowed has been reduced to 60% from the previous 70% and unlike before, CENVAT credit can be now availed by the service providers (restaurants) . Accordingly the new rate as applicable on such establishments is 4.944% [40/100*12.36]

Therefore, supposing you went out dining last night and ran up a bill of Rs 1000 ( for food and drinks) and the restaurant, very kindly,  levied a service charge of 10% on such bill, the total service tax payable by you shall be as follows :

Bill Amount Rs 1000
Service Charge (10%) Rs 100
TOTAL Rs 1100
Service Tax

(effective rate = 4.944%) Rs 54.384

However, if you were to pay a tip, on your own accord there would be no service tax on the same. Going by the same logic there should not be any imposition of service tax on items sold on MRP such as packaged drinking water and other beverages.

We hope this solves a problem for many of you, do remember that collecting service tax in excess of what is due and the doctrines of “unjust enrichment” and conversely “unjust impoverishment” will apply to such transactions.

Update 28/2/2013 :

With the recent budget pronouncements, all restaurants with air conditioning shall be covered under the service tax ambit regardless of the fact if they possess a liquor license or not. Therefore service tax shall be applicable on almost all restaurants and there would be significant accretion to your eating out bills.

 Update 07/06/2016:  

With the imposition of the Swacch Bharat Cess (SBC) and the Krishi Kalyan Cess (KKC) the rate of service tax is 15%. With the benefit of abatement  ( 60% of value of bill) available to restaurants the effective rate is  6% ( 15%*40/100)  therefore the new calculation as applicable to restaurants is as follows :

Bill amount 1000
Service Charge 100
TOTAL 1100
Service Tax Break up
Service Tax (5.6%=14%*40/100) 61.6
SBC (0.2%=0.5%*40/100) 2.2
KKC (0.2%=0.5%*40/100) 2.2
Total (6%) 66

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