Tax

Service Charge, its Similarity with Tax, and a ‘Double Whammy’ for Consumers: Some Thoughts

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Introduction 

The Delhi High Court (‘High Court’) recently ruled that levy of mandatory service charge by restaurants violates customer rights. The High Court’s reasoning, anchored in consumer protection laws, termed a mandatory service charge as deceptive and misleading for consumers. The High Court also made a few casual references to tax laws. For example, the High Court took umbrage at the nomenclature of ‘service charge’ and its potential to confuse customers with a tax levied by the Government. There is merit to the High Court’s observation, but service charge and tax have a deeper connection that is only superficially referred to in the judgment. In this article, I try to scratch the surface a bit deeper.  

I elaborate on two potential misgivings about service charge that the High Court’s judgment may entrench: 

First, the High Court noted that addition of service charge below the cost of food followed by levy of GST in the bill, created a ‘double whammy’ for the customers. I argue that restaurants by adding service charge before calculating GST were adhering to the mandate under CGST Act, 2017. In complying with GST laws, restaurants seem to have tripped over the Consumer Protection Act, 2019. Unless there is a change in any of the two laws, restaurants are now faced with the challenge of squaring a circle.  

Second, the High Court’s view that service charge can be confused for a tax prompted it to recommend that a change in nomenclature may be worth exploring. The High Court recommended that the Central Consumer Protection Authority (‘CCPA’) can permit restaurants to levy ‘tip’, ‘gratuity’, or ‘fund’ on a voluntary basis. The nomenclature issue was two-fold: first, service charge per being mistaken for a tax by customers; second, use of abbreviations by restaurants – such as ‘charge’, ‘VSC’, ‘SER’ – which further misled the customers if the levy was a mandatory levy by the State or restaurants. I query whether ‘confusion’ is the touchstone to determine if a levy by private entity should be disallowed or is its perceived mandatory nature?  

GST on Food Cost + Service Charge 

The High Court noted in its judgment that: 

Moreover, when the bills of establishments are generated, it is noticed that the service charge is added right below the total amount of the cost of the food, followed by GST and taxes. For any consumer who does not examine the bill thoroughly, the impression given is that the service charge is a component of tax; (para 122)

The High Court’s above observation hints at two things: 

one, the restaurants are trying to inflate the cost of food bill by calculating GST on the cumulative of food bill and service charge;  

second, the mention of service charge just before GST creates a confusion that the former is a tax. 

Let me examine the first implication in this section.  

Section 15(2)(c), CGST Act, 2017 states that the value of supply of goods or services or both shall include:

incidental expenses, including commission and packing, charged by the supplier to the recipient of a supply and any amount charged for anything done by the supplier in respect of the supply of goods or services or both at the time of, or before delivery of goods or supply of services; (emphasis added)

Thus, if a restaurant was adding service charge to the food bill before computing GST, it was adhering to the mandate of GST law and not trying to ‘inflate’ the bill on its own accord. Once a restaurant decides to levy any additional charge including packing charges, etc., then as per Section 15(2)(c) it needs to be added to the total cost in a bill before computing GST. Adding all the ancillary costs ensures that the base value for calculating GST is as high as possible. Enhancing underlying value of the supply is a statutory policy aimed to enhance revenue collections, and leaves business entities such as restaurants no option to exclude charges such as service charge from the cost. One could question the statutory policy, but I doubt restaurants at fault for adding service charge to the food cost before computing GST.   

In adding the service charge to food cost, as per the mandate of CGST Act, 2017, restaurants though seem to have tripped over the consumer protection law. How to ensure compliance with both? The High Court has offered a suggestion that service charge could be renamed to something that cannot be confused with a tax, though its payment should remain voluntary.    

Service Charge Can be Confused With Tax 

The High Court, as noted above, was concerned about mention of service charge just above GST in the restaurant bill and its potential to confuse customers former with a tax. The High Court also noted that:     

In some cases, service charge is being confused with service tax or a mandatory tax imposed by the government. In fact, for the consumers, the collection of service charge is proving to be a double whammy i.e., they are forced to pay service tax and GST on the service charge as well. This position cannot be ignored by the Court. (para 123)

Latter part of the High Court’s judgment, of course, is a bit inaccurate. Service tax has been subsumed by GST since July 2017. Also, payment of GST on service charge is not a ‘double whammy’ as the High Court observes. It is, as noted above, payment of GST as per statutory mandate. It is simply, a ‘whammy’ as inclusion of service charge in value of supply though prejudices the taxpayer, is not qualitatively dissimilar from inclusion of any charges that suppliers compulsorily collect from their recipients.  

The first part of the observation points out that service charge can be confused with a tax by consumers who may think they have no option but to pay it, may be misled into paying a private compulsory levy. The misleading part is on two counts, as per the High Court. 

First, the mention of service charge just above GST. This can be corrected by tinkering billing software and doesn’t seem like a substantive issue that it beyond correction. One could perhaps mandate restaurants to specifically mention in the bill itself that service charge is discretionary and not a levy by the State.    

Second, is the phrase ‘service charge’ itself, which gives consumers the impression that it is a tax. But will a service charge by any other name taste just as bitter? Perhaps. 

Even if the CCPA permits restaurants to rename service charge to let us say a ‘tip’, it would have to be on a voluntary basis. Technically, as per CCPA guidelines, service charge was discretionary even before the Delhi High Court’s judgment. And if CCPA permits levy of ‘tip’, we would enter similar issues of restaurants arguing that the ‘tips’ are voluntary and customers can request it to be waived off while customers claiming that the voluntary nature is only a ruse. Restaurants effectively collect ‘tip’ as if it’s a mandatory charge. Equally, GST will have to levied on food cost and ‘tip’, if paid. Thus, the ‘double whammy’ may persist. 

Can consumers confuse a ‘tip’ with a ‘tax’? Well, ideally, they should not confuse a service charge with a tax either. Not after July 2017, since the terms service charge and GST are not eerily similar. However, one should not take the view of a tax professional but deploy the standard of an average reasonable consumer. It is difficult to predict with mathematical certitude, but a ‘tip’ or ‘gratuity’ seems like a relatively less confusing option. If CCPA can mandate that no restaurants cannot use abbreviations or alternate names which can lead to confusion as in the case of service charge. There should be one voluntary levy and its name uniform across all restaurants.  

Finally, I’m prompted to ask a question: do we mistake any other levy by private entity as a tax? Is there any comparable example? 

There have been instances of conmen masquerading as tax officers, and fooling people into paying money, but I cannot think of a comparable levy where an average person has been confused that the money is not being collected by the State, but a private entity. Perhaps some people were confused if the maintenance fee paid to their resident associations was a State levy, but the confusion doesn’t seem as widespread as for service charge. The confusion seems a rather peculiar and unique problem to service charge. And one that may require an innovative solution. Though, equally possibly, restaurants may eschew the path of levying or collecting any ‘tip’ and may simply raise prices of food to compensate. Wait and watch, I guess.  

Why Should Tax Lawyers Care About the Annual Budget?

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Tax law, especially Indian tax law discussions are far too often contained by self-sustaining logic of statutory provisions and case laws. Tax lawyers, including me, feel validated and satisfied having decoded a particular judgment or the meaning of a provision. The satisfaction is often short lived because another judgment or amendment is on the horizon. Else, another Press Release, Circular, Notification, Clarification of the Circular, Amendment to the Notification, Guideline, Order that needs to be read. If we don’t keep abreast, we risk losing clients for missing a deadline of tax return, or failure to obtain tax refunds, or for our failure to render a timely advice. Where does the Budget fit in such daily scheme of things for a tax lawyer? 

In not many places. But, it should.  

In the Budget of 2020-21, for example, it was announced that the Union of India has decided to abolish Dividend Distribution Tax (‘DDT’). It was crucial information. As a tax lawyer I certainly need to know that w.e.f. 1.04.2020, shareholders and not companies are obliged to pay income tax on dividends. Unfortunately, the curiosity of most tax lawyers stops here. 

Ideally, and this is where I aspire to make my case: a tax lawyer should also know why the change was introduced? Union of India introduced DDT in 1997 reasoning that it was easier to collect tax on dividends in the hands of companies itself? It was easier to administer tax law over companies than large swathe of shareholders. Subsequently, ‘Buyback Tax’ was also introduced to plug the loophole of companies avoiding payment of DDT. What changed in 2020 to prompt the Union to upend its policy of taxing dividends in hands of companies? Especially when the no. of shareholders had increased multifold since 1997. Is it because the earlier was policy ill-conceived to begin with? Or is it that despite the large no. of shareholders it was easier track online payment of dividends? Dividends ‘should’ always be taxed in hands of shareholders is not a convincing explanation. For such an explanation impliedly castigates the introduction of DDT and its continuation for close to two decades. 

Now, of course, most practicing tax lawyers are likely to consider the above as superfluous inquiries. Or inquiries that are best addressed by academic lawyers. But that hardly changes the reality that most tax lawyers aren’t curious beyond the immediate needs of their clients. And many don’t have the luxury to meet such curiosity. But I would like to state that understanding reasons for major tax policy changes helps us better anticipate future changes, if not predict them. And ability to anticipate policy changes is an underrated but core quality for many lawyers, not just tax lawyers. 

To take another example, the Budget of 2022-23 revealed that cryptocurrency transactions are no longer in a tax vacuum and will be subject to a flat tax rate of 30%. Not much explanation was forthcoming for the punitive tax for cryptocurrency. But most tax lawyers worth their salt knew that the tax rate was a clear signal to discourage cryptocurrency transactions in India. The prelude to ‘crypto tax’ where RBI attempted to shackle cryptocurrency exchanges should have offered enough clue about the direction of regulatory environment for cryptocurrency in India. But, is it enough for a tax lawyer to know that the Budget has introduced new provisions relating to cryptocurrency transactions in the Income Tax Act, 1961? I guess you know my answer by this point. In my view, timely advice for clients for cryptocurrency transactions was ‘before’ the provision was introduced, not ‘after’. Thus, merely knowing the provisions once they are on the book is not enough. We need deeper and better understanding of the winds of change and their direction.       

But does the Budget tell us more? 

Yes, it does. (Especially if you can sit through the entire Budget Speech!)

Sometimes it tells us that when it comes to taxation, the Union of India operates in mysterious ways. And making anticipating changes may not always be a straightforward task. Because, I think, sometimes it is a mystery to the Union itself as to what tax policies it is enacting and why is it making certain tax policies. The Union of India, can, for example, attempt to ‘rationalise’ capital gains tax by completely doing away with indexation benefits in one sweeping announcement as in the Budget of 2024-25. Done and dusted. Or so it thought.   

And once the Union of India failed to fully explain its decision and received a wave of backlash, it amended its rationalization by introducing a grandfathering provision to ensure that the investments made before 23.07.2024 continued to receive the indexation benefits. 

One explanation for removing indexation benefits was to remove difficult and complicated calculations from the IT Act, 1961. Instead, the Union of India argued, it was better to prescribe a single capital gains tax of 12.5%. But what we now have instead is that for properties bought before 23.07.2024, taxpayers have the option of choosing between an indexation benefit or a capital gains tax of 12.5% from 2024 onwards. Simplification, they said. Dual options for taxpayers were created instead. And no, more is not merrier in every context.   

On second thoughts, maybe Union of India’s approach to tax policy is not a mystery. Maybe the goal is to try and see if through ‘shock and awe’ a policy change can be pushed through. If not, it is prepared make some prudent concessions that should have been incorporated in the first instance itself.    

Apart from the ‘whys’, Budget thus also reveals the ‘hows’ of tax policy changes. Is it a sledgehammer approach, a genteel incremental path, or a passionate persuasion for a change that the Government in power is advocating. Example: rumors that the Budget of 2025 will introduce a new Income Tax Bill. And there isn’t much disbelief about the rumor. An entirely new legislation on income tax is rumored to be introduced in a couple of days and the public is yet to see a draft version. When the Government in power is not averse to such a ‘hide and seek’ way of operating, it becomes a necessity for tax lawyers to be in tune with the Annual Budget. 

Further, the Budget reveals a lot about the nature of time. 

It is trite that laws can be amended or repealed. Statutory provisions can be replaced. And effect of unfavorable judgments can be nullified. But each year the Budget tells us that time does not move only in one direction. Linearity of time is a myth. Tax laws can be amended in 2025 ‘with effect from’ 2017, 2000 or even 1961. For example, there is a distinct possibility that through the Budget of 2025, CGST Act, 2017 will be amended to replace the words ‘plant or machinery’ with ‘plant and machinery’ to negate Supreme Court’s judgment in Safari Retreats case. The GST Council has recommended the amendment be effectuated retrospective effect, i.e., from 2017. Tax lawyers are so used to retrospective amendments that they no longer battle an eyelid when another such amendment is announced. But maybe we should battle an eyelid and more. And ask the tough question: why? Why is it not enough to amend the law w.e.f. 2025? Why do we have to travel back in time and amend it w.e.f. 2017? Can the Union of India, for once, accept it made a legislative oversight/error, change the law and move forward.    

English grammar tells us that conjunctions are important. The expected turn that the Safari Retreats case will take can tell us that conjunctions can be fulcrum of a long litigation battle that may award half a win to the taxpayer, but the Budget will convert it into a full loss. And tax lawyers are none the wiser. Not a great commentary on tax law and its practitioners.  

In formal legal language, Annual Union Budget is many things at the same time. It is the Annual Financial Statement as per Article 112 of the Constitution, Finance Bill when introduced, Finance Act once Parliament approves it, a tool to amend past financial mistakes, and a platform to unveil not a financial but also socio-economic vision of the future. 

In common parlance, Annual Union Budget presents an opportunity to demand ‘relief for middle class’, ‘create investment opportunities’, ‘attract FDI’, and of late hurtle us towards the promised land of ‘Viksit Bharat’. 

But for us tax lawyers, the Budget is also an opportunity to examine if the tax policies are adhering to the enduring canons of taxation propounded by Adam Smith. About time that the examination is public, expressive, and articulate instead of just being reactionary.  

Finally, Budget reveals numbers. It a statement of expenditures and revenues of the past financial year. And proposed expenses for the upcoming financial year. But that’s only one part of a larger story. 

Of late, tax collections are soaring. Undoubtedly. GST collections have only shown an upward trend post-COVID. And the trajectory will likely continue in that direction if there an income tax relief in the Budget of 2025. Income tax relief generally increases cash in hand for taxpayers which in turn will likely spur consumption and generate revenue via GST. So, a further bump in GST collections means a chance to spin the success story of Indian tax policy, including but specifically of GST. But numbers should never be enough. 

To use an analogy: as a tax lawyer, receiving client fee is crucial. Even necessary. But fee cannot be the only barometer of success, no matter how tempting it is to equate money with success.    

If numbers were the ‘be all and end all’, equalization levy was a roaring success and angel tax mopped up some revenue as well. Former is being phased out and latter was abolished via the Budget of 2024-25. Ending the life of both taxes should not be a cause for celebration if numbers are the only touchstone on which success of taxes is to be judged.  

Numbers reveal a story and hide another one. It is upto us what we make of them. If the no. of people filing income tax returns has increased, it is worth applauding. Not so, if they are only filing returns and not paying any effective income tax. Reducing corporate tax rates was supposed to be an incentive for spurring investments, but reduced corporate tax collections since the rate reductions may tell a different story. Ever increasing GST collections may reveal success, but if the burden of GST is primarily being borne by low earning groups, it calls into question the fairness of such a tax. And as much as tax lawyers believe that questions of fairness, justice, and equity are outside their realm, they stare us back in the face every now and then. We may choose to ‘hide’ behind the ‘logic’ and ‘coldness’ of statutory provisions, it won’t change the reality. And neither can we deny how Indian tax policy is increasingly being shaped without a meaningful contribution from tax lawyers.  

Compounding Fee is Not Tax

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In a recent judgment[1], the Delhi High Court clarified that merely because appellants paid a compounding fee after initiation of legal proceedings against them, does not permit the State to retain the said amount if there was no legal provision under which the appellants were obligated to make the payment. The High Court clarified that in order to successfully claim the refund of compounding fee, it was not necessary for the appellants to have stated that it was paid under protest.   

Introduction 

The appellants imported fuel dispensing equipment for use at retail outlets in the country but without obtaining registration under the Legal Metrology Act, 2009. The respondents – Director of Legal Metrology and Others – took the view that appellants did not comply with the statutory requirements under Legal Metrology Act, 2009 and initiated proceedings against the appellants. During proceedings, the appellants paid compounding fee to the respondents. 

On examining the issue as to whether appellants need to obtain registration before importing the equipment, a Single Judge of the Delhi High Court held that the appellant was not liable to register under the Legal Metrology Act, 2009. However, the Judge refused to accept the appellant’s plea for refund of the compounding fee reasoning that the payment was not made under coercion, but voluntarily. The judge observed, that at the time of making payment, the appellants did not communicate that they were making the payment under coercion or under protest. 

Decision 

The Division Bench of the Delhi High Court held that it was unable to sustain the conclusions reached by the Single Judge. As per the Division Bench, once it was clear that the appellants were not liable under the Legal Metrology Act, 2009 it was difficult to accept the proposition that they should be held liable to pay the compounding fee.  

The Division Bench concluded: 

We also deem it pertinent to observe that the respondents being “State” cannot be countenanced to retain monies which are otherwise not payable by the appellants under the provisions of the 2009 Act. When viewed in that light, it is evident that the issue of deposit without demur or protest could not have justified the retention of compounding fee. (para 8)

It is evident that the retention of money by the Metrology Department – termed as State – by the Division Bench by viewed as illegal. The Division Bench was clear in stating that a compounding fee was not in the nature of a tax or duty but a payment made to avoid the rigours of a legal proceeding. Payment of compounding fee should not be understood mean acceptance of violation of the statutory provisions or an acceptance of guilt. 

The Division Bench adopted a comparatively more coherent approach in ordering the refund of the compounding fee. If the action of respondents was held to be not violative of the impugned statute, there was little to no reason for disallowing their request to refund the compounding fee paid to thwart legal proceedings initiated under the said statute. Merely not stating that the compounding fee was paid under protest was not a valid ground to deny the refund of compounding fee, and the Single Judge Bench erred in denying the refund.   

[1] Indian Oil Corporation Ltd v Director of Legal Metrology & Ors 2023 LiveLaw (Del) 654. 

Interface of IBC and Tax: Supreme Court Clarifies

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In a notable judgment[1], the Supreme Court has clarified the waterfall mechanism under Insolvency and Bankruptcy Code, 2016 (‘IBC’) vis-à-vis the claims of secured interests and the place of the Revenue Department in the pecking order. 

Introduction 

The appellant, PVVNL was aggrieved by an order of the NCLAT directing release of the corporate debtor’s property. The property was attached by the District Magistrate in favor of the appellant, but NCLAT ordered its release for sale in favor of the liquidator to distribute the proceeds in accordance with the IBC.  

The appellant raised bills for supply of electricity to corporate debtor but since the bills remained unpaid, the appellant attached the properties of the corporate debtor and restrained transfer of property by sale, donation, or any other mode. The corporate debtor underwent a resolution under IBC failing which it became subject to liquidation. The liquidator took the plea that unless the attachment orders were set aside no one would purchase the property of the corporate debtor. Further, the appellant would be classified in the order of priority prescribed under waterfall mechanism of IBC. Both, NCLT and NCLAT endorsed the view that appellant was an operational creditor and would realize its due in the liquidation process as per the law.   

Arguments and Supreme Court’s Observations 

One of the appellant’s arguments was that the charge on property was created under the Electricity Act, 2003 and it being a special legislation should have priority over general legislation such as IBC. Supreme Court did not accept the appellant’s argument claiming priority of Electricity Act, 2003 over IBC. However, Supreme Court acknowledged that a reading of the relevant provisions of the agreement between the appellant and corporate debtor revealed that the appellant could create a charge on the property of the latter in event of unpaid bills. And that a valid charge was created in favor of the appellant. The crucial question was the priority that the appellant would acquire under the IBC. 

The counsel for liquidator argued that the amount due to the appellant was ‘government dues’ and low in priority as per the waterfall mechanism of Section 53, IBC. Supreme Court disagreed and noted that dues payable to statutory corporations were on a different footing compared to the amounts payable to the central and state governments. Supreme Court observed that: 

PVVNL undoubtedly has government participation. However, that does not render it a government or a part of the ‘State Government’. Its functions can be replicated by other entities, both private and public. The supply of electricity, the generation, transmission, and distribution of electricity has been liberalized in terms of the 2003 Act barring certain segments. Private entities are entitled to hold licenses. In this context, it has to be emphasized that private participation as distribution licensees is fairly widespread. For these reasons, it is held that in the present case, dues or amounts payable to PVVNL do not fall within the description of Section 53(1)(f) of the IBC. (para 47)

The appellant – PVVNL – on the other hand, relied on Rainbow Papers case which had held that the debts owed to a secured creditor included tax due to the Government under the Gujarat VAT Act, 2003. The Rainbow Papers case was an anomaly as the waterfall mechanism clearly prescribes priority to secured creditors while placing the government dues lower in the pecking order. The Supreme Court refused to adhere to the Rainbow Papers case and observed that the Court in that case ‘did not notice’ Section 53, IBC. Commenting on the Rainbow Papers case, Supreme Court observed:

Furthermore, Rainbow Papers (supra) was in the context of a resolution process and not during liquidation. Section 53, as held earlier, enacts the waterfall mechanism providing for the hierarchy or priority of claims of various classes of creditors. The careful design of Section 53 locates amounts payable to secured creditors and workmen at the second place, after the costs and expenses of the liquidator payable during the liquidation proceedings. However, the dues payable to the government are placed much below those of secured creditors and even unsecured and operational creditors. This design was either not brought to the notice of the court in Rainbow Papers (supra) or was missed altogether. In any event, the judgment has not taken note of the provisions of the IBC which treat the dues payable to secured creditors at a higher footing than dues payable to Central or State Government. (para 49)

The above observations are a categorical rejection of the inadequate reasoning adopted in Rainbow Paperscase whereby government was equated as a secured creditor and helped the government claim tax dues on priority by ‘jumping’ the queue. The Supreme Court in the impugned case was accurate in its observation that if there was no specific and separate enumeration of government dues under Section 53(1)(e) of IBC, it would be possible to hold that the government is a secured creditor. However, the enumeration of separate categories of a secured creditor and government dues under Section 53 indicates the Parliament’s intent to treat the latter differently and at a lower priority. 

Conclusion

The Supreme Court’s observations in the impugned case are welcome. The Revenue has in various attempts tried to bypass the waterfall mechanism of IBC by making various arguments such as tax dues should be treated as part of the insolvency costs as the latter are first in priority under the waterfall mechanism. It is important to recognize the importance of the observations in in the impugned case and yet be mindful that the Supreme Court has not expressly overruled the Rainbow case. For example, the Supreme Court did add that the observations made in the Rainbow case were in the context of resolution process while the impugned case involved liquidation. (para 49) We are likely to witness more disputes on the interface of IBC and tax in the future. Though, a more reasonable interpretation of the waterfall mechanism under Section 53, IBC suggests that the Supreme Court’s observations in the impugned case are more reasonable and accurate.     

[1] Paschimanchal Vidyut Vitran Nigam Limited v Raman Ispat Private Limited 2023 LiveLaw (SC) 534. 

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