K. Damodarsamy Naidu: the bar-tax composite-supply problem

The facts in brief

A consolidated batch of writ petitions and civil appeals from restaurant and bar owners across Tamil Nadu, Maharashtra and Uttar Pradesh was placed before the five-judge Constitution Bench. The lead petitioner, K. Damodarsamy Naidu & Bros — a long-standing Tamil Nadu restaurant chain — challenged the State of Tamil Nadu's levy of sales tax on food and drink served at its restaurants.

The Tamil Nadu General Sales Tax Act 1959, as amended in 1984, levied sales tax at varying rates on the supply of food and drink at hotels, restaurants and eating houses. The 1984 amendment, critically, sought to apply the levy with retrospective effect from 2 February 1983: the date the Constitution (Forty-sixth Amendment) Act 1982 came into force, inserting Article 366(29A)(f). The Maharashtra petitioners — boarding houses and residential hotels — challenged the parallel State statute; the Uttar Pradesh petitioners ran restaurants in Banaras and Lucknow under the UP Sales Tax Act 1948.

The petitioners ran three lines of argument. First, the consolidated restaurant bill could not be split between food and service for taxation purposes, with the consequence that a high-end restaurant or bar charging a premium for ambience and service was effectively being taxed on its service component. Second, retrospective application from 2 February 1983 was constitutionally impermissible where the State's own statute lacked an enabling pre-46th-Amendment provision — a point on which the Maharashtra and Uttar Pradesh petitioners leaned heavily. Third, the Northern India Caterers v. Lt Governor of Delhi (1978 and 1980) line, which had held that restaurant supply of food was a service rather than a sale, survived the 46th Amendment to the extent of the service-component within the restaurant transaction.

The States' answer was textual. Article 366(29A)(f) deemed the entire restaurant supply a sale of goods, with the entire price the taxable measure. Northern India Caterers had been overtaken by the constitutional amendment. Retrospective application from 2 February 1983 simply tracked the constitutional commencement date and was therefore unobjectionable.

The constitutional question

Two distinct questions were placed before the Bench. The first was textual: what is the proper construction of Article 366(29A)(f)? Does the deeming fiction operate on the entire restaurant supply or only on the food/drink component within it? The sub-clause's text was wide:

"the supply, by way of or as part of any service, of food or any other article for human consumption or any drink (whether or not intoxicating)"

The phrase "by way of or as part of any service" was particularly telling: it acknowledged that the supply might be wrapped in a service, but it brought the entire supply within the State's taxing power notwithstanding that wrapping.

The second question was retrospective effect. Could a State statute enacted in 1984 reach back to 2 February 1983 — the date the Constitution amendment came into force — even if the State's pre-1984 statute had no enabling provision corresponding to the new constitutional fiction?

What the Court held

The plate of cheese sandwiches

Bharucha J., writing for the Bench, rejected the split argument in the most memorable illustration in the modern jurisprudence of indirect tax.

The patron of a fancy restaurant who orders a plate of cheese sandwiches whose price is shown to be Rs. 50, that is to say a price higher than what the same sandwich would cost in a coffee shop perhaps because of the ambience and service provided in the fancy restaurant, pays Rs. 50 for its supply and it is on Rs. 50 that the restaurant owner must be taxed.

The fancy décor, the service, the ambience, the music — all of these bear on the price the patron is willing to pay. None of them, however, calls for a separate constitutional accounting. The drafters of the 46th Amendment chose, deliberately, to fold the entire restaurant supply into the State's taxing power and to track the consolidated price as the taxable measure.

Article 366(29A)(f) is structured differently from (b)

The Bench distinguished the restaurant-and-bar sub-clause from the works-contract sub-clause it had construed in Gannon Dunkerley v. State of Rajasthan (1993). Sub-clause (b) — the works-contract clause — speaks of "the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract", and the Gannon Dunkerley decision had read that text as confining the State's taxable measure to the value of goods at the time of incorporation. Sub-clause (f) — the restaurant-and-bar clause — speaks of "the supply, by way of or as part of any service, of food", and that text reaches the entire consolidated supply.

The tax, therefore, is on the supply of food or drink and it is not of relevance that the supply is by way of or as part of a service.

The constitutional architecture is sub-clause-specific. The drafters of the 46th Amendment understood that some composite transactions (works contracts) demanded a goods-services split and others (restaurant supplies) did not. They drafted accordingly.

Northern India Caterers is overtaken

The Northern India Caterers decisions of 1978 and 1980 — which had drawn a service-versus-sale distinction for restaurant supplies under the pre-46th-Amendment regime — were held to be overtaken by the constitutional amendment. The deeming fiction now operates whether or not the supply is "by way of or as part of any service". The pre-Amendment characterisation question, in other words, has no role to play under the post-Amendment text.

Retrospective application — two States lose

The retrospective application from 2 February 1983 was upheld only for States whose statutes contained an enabling provision corresponding to the constitutional fiction. Tamil Nadu's 1984 amendment was held to carry an enabling provision and survived. Maharashtra and Uttar Pradesh, however, whose statutes lacked such an enabling provision until later in the 1980s, could not retrospectively tax for the period before their enabling statutes came into force. A State cannot pick up a constitutional fiction and apply it backwards without a State-side statutory hook.

The bar tax

The supply of intoxicating drinks in bars falls equally within Article 366(29A)(f). Sub-clause (f) expressly extends to drink "whether or not intoxicating". The State sales-tax regime operates alongside State excise duty regimes on the same liquor — the two run in parallel, the first attaching to the supply value at the bar, the second attaching at the manufacturing or wholesale stage.

What the judgment did not decide

The Bench did not address the Union-side service-tax counterpart for restaurant supply. Service tax on restaurant services was eventually introduced by Finance Act 2011, with Notification 1/2006-ST giving a 70 per cent abatement; the Kerala High Court in Kerala Classified Hotels v. Union of India (2013) held that the Union levy overlapped impermissibly with the State sales tax, partially reading down the Union levy by relying centrally on Damodarsamy Naidu. The federal-overlap question was definitively resolved only by the GST regime.

The Bench did not split the food-versus-liquor tax base for State excise versus sales-tax purposes — that arithmetic was left to State excise statutes. Outdoor catering was untouched and was picked up only in subsequent Article 366(29A)(f) jurisprudence. Online food delivery and cloud kitchens — phenomena that emerged a decade and a half later — were obviously not before the Bench; they were addressed under CGST s.9(5) reverse-charge for e-commerce operators.

The constitutional treatment of service charges — the 10 per cent gratuity-style addition many restaurants levy on the bill — was not before the Bench. That question travelled, twenty-three years later, to the Central Consumer Protection Authority guidelines of 2022.

The doctrinal architecture

Damodarsamy Naidu is the doctrinal precursor of the composite supply and mixed supply architecture under CGST Act 2017 s.8 read with s.2(30) ("composite supply") and s.2(74) ("mixed supply"). The cheese-sandwich illustration travels directly into the GST treatment of restaurant supply under CBIC Notification 11/2017-CT(R): restaurant supply is taxed at 5 per cent GST (without input tax credit) on the entire bill value, tracking precisely the no-split rule the Constitution Bench laid down.

The Article 366(29A)(f) framework operates alongside Article 246A under GST. The constitutional deeming fiction is preserved, but its operational significance is folded into CGST s.7's definition of "supply". For liquor and bar supply, the Article 366(29A)(f) deeming fiction continues to operate alongside State excise: alcohol remains outside GST under Article 366(12A) read with the GST (Compensation to States) Act 2017, and the Damodarsamy Naidu rule remains the live tax architecture for State sales tax on bar supply.

The composite-versus-mixed-supply discipline derived from Damodarsamy Naidu was later refined in BSNL v. Union of India (2006) — which articulated the dominant-nature test for transactions outside Article 366(29A) — and in Mohit Minerals v. Union of India (2022), which applied composite-supply analysis to CIF imports under CGST s.8. The cheese-sandwich is, in this lineage, the original.

After the judgment

For twenty-five years, Damodarsamy Naidu has been the most-quoted authority on restaurant and bar taxation. State VAT regimes through the 2000s and early 2010s applied the no-split rule across food, beverage and combined catering. The Union's 2011 service-tax foray into restaurant services was reframed multiple times — by Notification 1/2006-ST, by the Bombay HC's Indian Hotels and Restaurants Association litigation, by the Kerala HC's Kerala Classified Hotels reading-down — but it never displaced the State sales-tax measure on the bill value.

The GST regime in 2017 consolidated the position. Restaurant supply is now taxed at 5 per cent GST on the bill value (with limited ITC), tracking the cheese-sandwich rule. The composite-supply / mixed-supply rules under CGST s.8 are the modern statutory expression of what Bharucha J. articulated as a constitutional rule in 1999. The retrospective-application discipline travelled into State VAT amendments through the 2010s — every State that sought to retrospectively pick up a CGST or SGST fiction had to carry a State-side enabling provision.

The five-judge Bench's contribution is doctrinally compact and operationally durable. The constitutional measure of a restaurant or bar tax tracks the consolidated price the patron pays. Décor and ambience and service shape that price, but they do not call for a separate constitutional accounting.

Related on Valkya

• State of Madras v. Gannon Dunkerley (1958): the original works-contract decision
• Gannon Dunkerley v. Rajasthan (1993): five permissible deductions
• BSNL v. Union of India: composite transactions and the aspect doctrine
• Mohit Minerals v. Union of India: ocean freight IGST and cooperative federalism

Sources

1. SCC OnLine Blog — composite-supply trajectory and restaurant tax: https://www.scconline.com/blog/post/2015/08/27/no-service-tax-can-be-levied-on-indivisible-works-contracts-prior-to-june-1-2007/
2. LiveLaw — "Composite contracts and the dominant nature test": https://www.livelaw.in/top-stories/supreme-court-service-tax-not-leviable-composite-work-contracts-finance-act-2007-205536
3. Bar and Bench — Arvind Datar column on Article 366(29A) jurisprudence: https://www.barandbench.com/columns/legal-notes-by-arvind-datar-the-gannon-dunkerley-test-incorrect-and-unnecessary-dilution
4. Supreme Court of India — official judgment archive (JUDIS): https://api.sci.gov.in/jonew/judis/16834.pdf
5. Taxsutra — case digest and post-judgment State VAT impact: https://www.taxsutra.com/gst/news/damodarsamy-naidu-composite-supply-restaurant