GST on restaurants: Why input credit must continue

In the last council meeting, a Group of Ministers was set up to determine, among other things, whether the goods and services tax (GST) rate on restaurants should be reduced from the existing 18 per cent to 12 per cent. While this is great news for the restaurant business as well as consumers, the catch lies in the treatment of input tax credits available to the restaurants under the new rate structure. 

Some media reports seem to suggest that a 12 per cent GST rate may come with a rider that restaurants cannot claim any input GST credit for any of the goods or services they source for running their operations.  

In such an event, would the total food bill of the consumer reduce or increase? Well, the answer depends on factors such as the scale of operations of the restaurant, location, sourcing pattern and, on a lighter note, whether you’re asking this question to the government or the restaurant chain. The last point is critical, as the government believes that with a seamless credit flow under the GST and an 18 per cent tax on the output, the overall tax incidence for restaurants has dropped substantially vis-à-vis the earlier regime. However, many restaurant owners are of the view that there are very limited incremental savings on account of input tax credits, which have been more or less offset by the increased cost of compliances under the GST. Therefore, prices have not dropped significantly under the GST.

Under the convoluted tax structure in a pre-GST era, the restaurant was artificially split into a manufacturing area (kitchen) and a service area (where consumers sit and enjoy the ambience).  All dishes prepared in the kitchen were considered to be “manufacture” for excise duty purposes and “sale” for value-added tax (VAT). As excise duty was exempted on food preparations, any central taxes attributable to kitchen operations (excise on kitchen equipment and food items, service tax on lease rentals for kitchen area, common overheads attributable to kitchen operations etc) became a cost to the restaurant.

Regarding the service area, the only tax applicable was service tax. Therefore, any central sales tax (CST)/VAT incurred on goods purchased for such area used to become a cost (for example. VAT on air-conditioning, furniture etc). As customers are invariably charged a single price for the dishes they order, 40 per cent of the price was deemed to be towards services and was subject to 15 per cent service tax, translating into an effect cost of six per cent. In absence of similar relief under VAT in most states, the bill would also attract a 12.5-15 per cent VAT, generally taking the overall tax incidence to more than 18 per cent.

As most restaurants follow a practice of charging taxes separately over and above the rates displayed in the menu, the GST saving on output has been passed on to customers from day one in most cases. The real controversy is around the quantum of savings accruing to restaurants on account of excise/service tax on kitchen operations and VAT on service area operations. For smaller restaurants, the savings may not be significant, as their spend on services (rentals, overheads etc) would have anyway been limited. Also, as most of their purchases are generally from unregistered suppliers, there would have been little blockage on account of VAT/CST/excise. However, for the bigger ones, the savings could be significant, specifically on the services front.  Customers would certainly want these savings to be transferred to them.  

Illustration: Ajaya Mohanty
Passing the GST benefits on to customers is also mandated by the GST law.  Anti-profiteering provisions under the GST require taxpayers to pass on any benefit arising on account of increase in input tax credit or reduced tax rates to customers. While the government has not been prescriptive about the manner of quantification of GST benefit and the mechanism for passing it on to consumers, any unfair practice in this regard could trigger a consumer compliant, resulting in detailed scrutiny.  

Against this backdrop, an option of reducing the GST rate to 12 per cent from 18 per cent without any input tax credit is being explored. For smaller restaurants with limited credit blockages, this should certainly translate into a reduction in total price (including taxes) to customers, without any major impact on their bottom lines. However, for bigger chains, any restriction on credits could significantly increase their capex/operating cost much more than what they might be willing to absorb. As a result, most of them would have no choice but to increase the base rates in the menu. Whether the hike would be more than six per cent (18 per cent existing GST less the proposed 12 per cent rate) is a matter of further debate and scrutiny.

From a structural standpoint, blockage of credit is not a good idea. It would promote cash economy as the attempt would be to reduce taxes on purchases. This would lead to the generation of more black money, which goes against the efforts the government is making to promote digital and banking transactions. It would also lead to complications from the compliance perspective, both for the GST Network and businesses, particularly those which have transactions other than the restaurant business.

Market forces, coupled with tighter enforcement of anti-profiteering provisions, will ensure that customers gain in all situations, without any adverse impact on the restaurants. Also, happy customers are likely to eat out more, thus pushing up sales.

Pratik Jain is leader and Siddharth Mehta is partner, Indirect Tax, PwC

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