Background
Food supplied by a restaurant is whether supply of goods or supply of services? This question has been hovering since last few decades. The Constitutional Amendment by inserting Article 366 (29A) (f) partially included it within the definition of deemed sale of goods. With introduction of service tax law, the service portion was separately identified in the restaurant services through deeming fiction provided in the Valuation Rule. Thus, both VAT and Service Tax were levied on the supply of goods being food or any other article for human consumption on the value determined under the respective laws. The view has been that it is not double taxation but tax on the respective portion of supply of goods and services in accordance with the “aspect theory”. The matter is pending before Honourable Supreme Court for final disposal in case of Kerala Bar Hotels Association.
The proposition under GST law so far as it pertains to the taxability of restaurant sector has been confusing since beginning. The confusion have been as to whether it constitutes supply of goods or supply of services, applicability of composition scheme, impact on ITC, taxability of alcohol supplies, legal validity of 5% rate of tax without ITC under rate notification and so on. The confusions have been haunting the industry. There could be many areas where this confusion could lead to divergent business practices leading to repercussions of department interventions.
Comparison of entry in the Constitution, Schedule II of Act and Rate Notification
The entry in the Article 366 (29A) (f) of the Constitution of India, Schedule II of CGST Act and rate notification entry is reproduced below for the readers to consider in the course of below discussion.
Article 366 (29A) (f) of Constitution of India (COI): supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration
S. No. 6 (b) of Schedule II to the CGST Act: supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (other than alcoholic liquor for human consumption), where such supply or service is for cash, deferred payment or other valuable consideration.
Rate Entry in Notification No. 11/2017:
?Restaurant service? means supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink, provided by a restaurant, eating joint including mess, canteen, whether for consumption on or away from the premises where such food or any other article for human consumption or drink is supplied
Some of important observations of the entries could be as under:
- Entry in Article 366 (29A) (f) of COI and S. No. 6 (b) of Schedule II to CGST Act although linguistically identical however is materially different in as much as while the former treats the supply as sale of goods, the latter stipulate the supply as supply of services.
- Definition of restaurant services given in the rate notification is different from the above entries in as much as:
- There is omission of “or in any other manner whatsoever”
- The class of service provider are specified in the entry (i.e. restaurant, eating joint, mess, canteen).
The similarities and differences between various entries are creating much confusion.
Some of the key issues faced by industry along with the possible views thereon are discussed by the author. It is expectation from Board to come out with detailed clarifications on these issues so that the sector with so many unorganized players could get benefitted and save themselves against possible departmental interventions. Need is felt more for this considering that the sector is reeling hugely from the negative impact of COVID-19.
Issues faced by Restaurant industry:
- Goods or services – conflict with Constitution Article: Article 366 (29A) (f) of Constitution of India still exits which provides definition for levy of tax on sale or purchase of goods on these activities whereas Schedule II of CGST Act provides such activity in the nature of supply of services. There is view of some of the experts that the article in the Constitution has been repealed by implication in view of the omission entry 54 in the Constitution which now gives power to State Government to levy tax only on the specified goods, however veracity of such view is questionable in as much as it is trite law that entries in Seventh Schedule to the Constitution do not restrict the right of parliament/ state legislature.
Whether schedule II is unconstitutional or not would get settled only at the Apex Court, not before that. Issue pending before Supreme Court in case of Kerala Bar Hotel Association for levy of service tax on restaurant services may have ramifications under GST also, if the Court declares the valuation mechanism under service tax as constitutionally unacceptable.
- Power to determine rate of tax with ITC condition– power under the law?: Restaurant sector has been made liable to tax @ 5% without input tax credit by inserting entry in the rate notification. Preamble to rate notification provides that the notification has been issued in exercise of power conferred upon inter-alia by section 16 (1) of CGST Act. If one peruses section 16 (1), it provides for availment of ITC on the supply used in the course or furtherance of business. Restriction on availment of ITC through rate notification without such provision under the law would create a dispute as to whether Government has power to issue rate notification with conditions on ITC availment and on this ground, it could be challenged in the Courts.
- ITC denial – retrograde step: The concept of taxation without providing ITC is contrary to the basic theme of the indirect taxation and statement of objects and reason for carrying out Constitutional Amendment at the time of GST introduction which clearly provided that the goods and services tax shall replace a number of indirect taxes being levied by the Union and the State Governments and is intended to remove cascading effect of taxes and provide for a common national market for goods and services. This indicates the backwardness in thought process of revenue. Prescription of rate is an essential function of the Parliament, which could not have been delegated to the Government without putting any controls/limits.
- Meaning of restaurant – big dilemma:
a. The definition of restaurant has not been defined under the law and is subject to diverse interpretation. Does it require seating and serving facility mandatorily or take away of the food without having such facility would also get covered? Judgment of Honourable Supreme Court in case of Northern India Caterers (India) Ltd. (1978) 42 STC 246, that facilities provided in addition to the supply of food, furniture, furnishings, linen, crockery, cutlery, music, area for floor dancing, floor show etc., are the facilities that takes serving of food beyond just sale of goods (Food). The principle of the judgment could still be relevant under GST.
b. Perusal of definition of restaurant under dictionaries, Weekly Holidays Act or under Finance Act 1994 or for that matter, licensing and registration guidelines under FSSAI Act indicates that restaurants are places with reasonable infrastructure of serving the food. Take away counters or parlors with no serving facility may still be out of the rate entry or for that matter, out of Schedule II if item is not served “by way of” or “as part of” any service.
- Taxability – qua establishment or qua supply?: All supplies made by restaurant are deemed to be supply of services or it has to be determined based on case to case basis is another open question and has been one of the hot topic raised before Advance Ruling authority. To make it more complicated, one may find all type of possible conflicting decisions of advance ruling authorities on the subject. In view of the author, it would not be correct to say that once an establishment qualifies as restaurant etc., all supplies made by it would get covered in the definition of services and hence liable to tax @ 5% (Sale of chocolate, water bottles, cold drink at restaurant counter may not fall within supply of service by any imagination). Each supply has to be determined on case to case basis. Underlying criterion should be – whether supply of goods being food is by way of or part of any service – if yes, it should be treated as supply of service. In all other cases, supply should be treated supply of goods liable to tax as per applicable HSN of goods. Views of Appellate AAR in case of M/s Kundan Misthan Bhandar 2019 appears to be correct position of law. GST Council also acknowledged the proposition in 31st meeting. Thus, the classification and rate of tax has to be determined qua supply not qua establishment. It is needless to say that the “supply as goods” is always beneficial considering availability of ITC.
One need to consider various factors i.e. nature of infrastructure and facilities offered, compulsory or optional self- services, take away or dining, home delivery, prepackaged items or in-house manufactured, billing system, segregation of various supplies through various modes. Decision as to nature of supply to be taken after evaluating impact of above in line with the previous discussion.
- Take away vs dining: Clarification Letter No. 332/82/97-TRU dated 24/09/1997 in the context of outdoor catering services and in the context of Article 366 (29A) (f) had also observed that, mere food delivery (or delivery at nominal cost to cover transport charges) of food does not involve any service element and only constitute merely sale of food. Considering the fact that Entry 6 (b) ibid and Article 366 (29A) (f) ibid are pari materia, the clarification could still hold persuasive value under GST and could equally be applicable in case of mere sale of food not “by way of” or “as part of” any service. Similar rationale also pronounced in Circular No. F.No. 334/3/2011 dated 28/02/2011-TRU.
- Centralised Kitchen concept– benefit arising from economy of scale marred by increased cost due to GST:
a. The concept of centralized kitchen is widely prevalent wherein the semi cooked food/recipe is prepared in the central kitchen and supplied to serving location in the different States. This concept has gain more popularity due to associated benefits of economies of scale. Such supply of semi cooked food could be said to be in the nature of supply of goods and subject to GST with rate of tax applicable to such items. Classification of such items in semi processed stage could become very difficult.
b. Where such semi cooked items are supplied interstate, the recipient location may not avail the credit of the same. This poses question as to the manner of determination of value of such semi processed goods when supplied to distinct person especially considering the fact that such items are not in the position of sale to independent customers and thus market value may not be available. One might want to resort to valuation as per cost + 10%, however the anomaly lies with the fact that cost method comes 3rd in the sequence of valuation method. Unless the supplier could prove with tangible evidence that OMV of the supplies or value of like and quality was not determinable, the revenue is bound to argue that cost valuation was adopted in derogation of law.
c. Besides, even if one succeeds in adoption of costing method valuation, what elements to be covered in the cost or not may also become a subject matter of litigation in future.
d. Many of the raw materials used for preparing such semi processed food are exempted and thus supplying central kitchen may not have much ITC to avail. But when the semi processed foods are supplied to other State, the tax has to be discharged at rate of tax as applicable for classification of particular goods at transfer value. Further, when restaurant services are provided to the customer by recipient State, again tax has to be charged without taking ITC on interstate inward supply. This makes the business of having centralized kitchen less lucrative. Job work model could possibly reduce the cost which could be looked into by such businesses
- Bigger restaurant chain – bigger problem of ITC attribution: In case of big chain engaged in manufacturing of such items for serving in their restaurant viz a viz sale as packaged food, the allocation of ITC between eligible and ineligible credit becomes very difficult. One need to understand the relationship and difference between erstwhile Rule 6 of CCR viz a viz Rule 42/43 of CGST Rules and the manner of application of rules under GST. (i.e. whether rule has to be applied at store level, registration level or items level?). Further, the assessee may not have option to forego mandate of Rule 42/43 when the legislator have provided it to be applied in particular manner. Their own logic and convenience may be rejected.
The Rule 42/43 compliance coupled with the ISD distribution could multiply the challenge of the sector. Countless calculation, and
- A slight error in law [though correct on logic] could have revenue repercussions
- While, a slight error in logic [though correct on law] may result in foregoing of humungous amount of ITC, which could have been availed by proper legal remedy
- Cost optimization by restaurant: Considering that ITC may not be admissible, it become imperative for the sector at consciously looking at cost to optimize the cost. Possible areas which could be looked at may be lease arrangement with returnable deposit, branded disposal material at concessional rates by brand owner, job work model, outdoor catering through joint execution or so on. The planning should be within four corner of law to ensure that it does not partake the tax evasion.
- Sale through delivery partners – TCS compliance?: Sales are effected through zomatto/swiggy etc. where such delivery partners are liable to deduct TCS on payment to be made to the restaurant. Restaurants have to reconcile the receipts collected through such delivery partners and TCS deducted thereon. This has to be claimed as adjustment by the restaurant in making payment of tax to the Government. Considering that the restaurants are not entitled to claim ITC and in order to avoid the compliance burden on such non ITC sector, it is suggested to do away the requirement of TCS deduction.
- Non GST items with GST items: mixed or composite or something else? Many bars and restaurants offer liquor along with the food. Charges for the liquor may be either be subsumed in the price of products or charged separately from the customer. This also poses challenge as to the taxability of liquor considering that it is subject to levy of state VAT. Further, whether ITC required to be reversed proportionate to sale of liquor in case of suppliers with ITC available with them also require proper evaluation.
- Cross charge or ISD?: Ineligibility of ITC at recipient location poses a problem of valuation of supplies of services between distinct persons. One need to understand the relationship and differences between ISD and cross charge in order to have a proper combination thereof aiming at reducing the cost.
- Cost for wrong treatment of supplies having goods with compensation cess: Compensation cess is applicable on the supply of some of the products (i.e. aerated water, lemonade etc.). If the products are supplied as part of restaurant services, there may not be any cess liability. However, if sold as supply of goods, the same would be subject to compensation cess and corresponding ITC would be eligible. Any error in classification under wrong nature of supply could cost substantially for the supplier.
- Free supply during covid – whether GST? – Many restaurants providing free food during covid. Restaurants with no ITC may not have implications in the absence of consideration and hence not treated as supplies. But with restaurant with eligible ITC, dilemma as to charge GST on free supplies at market value or reversal of ITC is another challenge. Manner of giving away such items could have a bearing on the treatment. Furthermore, free items food given to NGO etc with commercial mileage, GST treatment in both the hand would be critical.
- Restaurant within hotel – associates challenges:
a. Serving of complementary food: Restaurant may be located within the hotel premise. Food may be served to the guest in the room where charges for such foods are recovered as part and parcel of room rental. Once the tax is charged from the customer on room rental which includes the value of supply of food also as composite supply, ITC of the same may be allowed. Similarly, could be the case where complimentary breakfast is served along with the stay. ITC of the same could be optimized.
b. Separate registration for restaurant – feasible?: It could be economical to have separate registration for restaurant business and hotel. One needs to look at the feasibility of the same especially in cases where both are located within the same premise considering amendment in the law to provide for premise wise registration. It is further critical to determine meaning and scope of “premise” considering that applicable rate of tax and ITC is linked to status of supplier of services i.e. whether provided by suppliers providing “hotel accommodation” at “specified premise”, or suppliers located in “specified premises”.
c. Banquet service: Hotels and restaurants provide the services of composite supply of outdoor catering together with renting of premises. By way of deeming fiction, such services have been classified as outdoor catering service which is blocked u/s 17 (5). Recipients may be availing such services in the course or furtherance of their business which is eligible for ITC as banquet or convention service. The classification at the end of supplier should not disentitle the ITC to the recipient, though, the amended category may create dispute between business and department.
- Supplies to SEZ:
a. Nature of supplies: Place of supply in such cases have been a matter of litigation. Some of the advance rulings have held that these would be treated as intra state supply, liable to CGST:SGST. Considering the damage which could have caused by such rulings, Government clarified vide circular 48/22/2018 that such services to be treated as inter state supply and liable to IGST.
b. Zero rating of supplies – restaurant vs outdoor catering: SEZ units may be availing services of restaurant or outdoor catering for their employees. It becomes relevant to define and distinguish between the two considering that outdoor catering is covered in the specified list of services for authorized operation of SEZ and eligible for benefit of zero rating whereas restaurant is not covered within such eligible list. Proper planning could reduce the cost considering that such services are blocked for ITC u/s 17 (5). It would not be proper to take a view that food provided to the employee of unit is not for authorized operation.
- Canteen in school, colleges etc: Services provided by educational institution to its student, faculty and staff is exempted from levy of GST. The canteen facility may be run by educational institute itself or may be run through contractor on contractual basis. Circular 85 has clarified that when the services are provided by educational institution, it would be exempted from GST whereas if it is provided by contractor to the students of educational institute, it would be liable to tax @ 5%. It is worthwhile to note that if the prepackaged food etc is supplied by education institution to its students, faculty and staff – it may not fall within exemption. One also needs to understand and distinguish carefully between the term ‘catering’ referred to in s. no. 66 of exemption notification 12/2017 viz a viz term ‘outdoor catering’ used in rate notification 11/2017 before claiming the exemption.
- Serving of food in canteen of factory etc.: The supply of services in the canteen operated in the factory premises fall within definition of restaurant services and thus liable to GST @ 5%. Recoveries made by the companies from employees, whether full or partial, could examine if it falls within the definition of wages as per labour laws and accordingly not liable to GST under schedule III. One may evaluate the judgment of Telangana High Court in case of Bhimas Hotels Pvt. Ltd and appropriately correlate it under GST law to claim the benefit. If not treated as supplies, the factory would be entitled to claim ITC also wherever it is mandatory to have such canteen as per any law for the time being in force. There may be possible saving of 8-10% which could be sizeable for cost reduction.
- Taxability of free food to drivers: - An informal arrangement between the restaurant and bus drivers often exists, where the restaurant provides free food to drivers, if they stop the bus loaded with passengers at their restaurant. At times, it appears that such supply of food to drivers is without considerations and hence not leviable to tax, however the UK Courts in multiple decisions have held that the transaction has the inherent consideration in the form of driver’s act of stopping the bus, leading to increased customers. And therefore holding that tax is leviable on food supplied free of cost to drivers. The food chains also need to re-think their procedures on this aspect also.
- Composition Scheme – really required for restaurant?: Supplier providing restaurant services are entitled to opt for composition scheme. However, after amendment to 5% without ITC, there is no benefit to continue in the composition scheme considering that the tax may not be recovered from customer. Some of the restaurants in the industry are still continuing with the composition scheme making their business less competitive. Perhaps, it is time to discontinue the composition scheme for restaurant sector to reduce the confusion in industry.
The open issues under GST for the restaurant sector has made it complicated and in disadvantageous position especially after ITC restriction. There is need for Government to relook at the decision of disallowing ITC with 5% rate of tax as it is clearly contrary to principles of tax on value addition. Various issues discussed in the article should also be addressed by CBIC so that the sector is not flooded with the undesirable litigation in future. One may have to get the business practices independently examined to ensure that these are in line with the law so as to avoid any potential litigation with department and at the same time, to ensure that transactions are structured in the most cost effective manner.
Author may be reached at [email protected]
(special thanks to CA Anil Kumar Bezwada and CA Manish Sachdeva for their valuable inputs)