The Service Tax Confusion

In the 2013 budget, the finance minister announced that all AC restaurants will be liable to pay service tax. 40% of the bill value will be assumed to be for service and service tax of 12.36% would be applicable on 40% of the bill value. So technically, a service tax component of 4.944% will need to be added to the bill value. If 40% of the bill value was for service, then shouldn't the VAT be applicable only on 60% of the bill value? But No - customers will have to pay VAT on 100% of the bill value and then service tax on 40% of the bill value.

For most restaurants, which add tax (VAT of 14.5%) as a separate component this is not too difficult to administer. Their bill will now look like this:

For restaurants which charge a service charge (now a common practice atleast in casual dining/fine dining restaurants), they will charge the service tax of 12.36% on this service charge amount, plus charge service tax on 40% of the bill value.

So for a customer, the bill value will go up by about 5%. For the restaurants, this may work out well as they can charge the customer this additional service tax, plus claim inputs credits. Most restaurants now pay service tax on the rental. They can now claim some input credit for this. So this may not necessarily be a bad things for restaurants and my assessment is that customers will get used to paying this 5% additional tax.The only impact could be a macro-level reduction in consumption - i.e. consumers reduce their eating out frequency owing to the higher costs. I believe that this will only be a short term behaviour.

For restaurants on the composite tax model, this will get a little more complicated and the government has not clarified how the service tax levy will work. The easiest way to do this would be for the government to say that the composite tax would now be increased by 40% - i.e. if it is 4% now, the new composite tax will be 5.6% out of which, 4% will be the VAT payable and the remaining 1.6% will be the service tax payable. It will be good to get a clarification on this.