Madan Dhungana vs. Green Valley Resort

Waitress handing bill to couple in restaurant

The Hero Madan Dhungana

A theme of an unsung hero is a repeated and overused trope but Mr. Madan Dhungana has really done something you would not do yourself. Like a scientist who does basic science for all humanity Mr. Dhungana really has taken the metaphorical use of the term “hero” and realized it to its full extent, doing a favor for us all. 

He has done national help to all consumers. We have seen restaurants and hotels levying service charges in the bill by default, defeating the meaning of service charges which must be voluntary, optional and at the discretion of the customers. Further we have seen service charges being levied in addition to the total price of the food items mentioned in the menu and applicable taxes, often in the guise of some other fee or charge. Mr Dhungana was not buying it anymore.

The Saga (in short summary)

On December 26 2021, Madan Dhungana, a consumer filed a complaint with the Department of Commerce, Supplies and Consumer Protection seeking action against him for cheating on the menu of a restaurant. In his complaint the consumer argued that the Green Valley Resort, Budanilkantha had closed the bill defrauding him by misinterpreting the service charges. He had filed a petition seeking action against the resort and compensation for the cheated amount.

The complaint was heard and according to the complainant’s office, an on-site inspection was conducted on its basis with the Inland Revenue Office found that the menu was taxed and service charges and VAT were added to it. The Inland Revenue Office also agreed that the practice was wrong and imposed a fine of Rs 1,000 on Green Valley Resort.

But the story doesn’t quite end there. Describing the internal action taken in the matter as weak, the complainant filed another complaint with the Department of Commerce, Supplies and Consumer Protection and demanded compensation. However, the department asked the complainant to approach the court and said that the claim of compensation would be awarded by the court itself. And so the dispute went into the hands of the judiciary for diagnosis.

The history of service charges in restaurant bills

There is a history of restaurant service charges in Nepal. Not surprisingly it stems from the unfair compensation to the workers in the early blooming days of the hotel and restaurant business in Nepal of the 2000s. The labor protection and compensation to the staff was quite low in the market. Employees in this industry often do receive tips from the customers. It became a practice in the hotel and restaurant business to collect the tips received and distribute it among the employees. Thus this practice of additional compensation to the staff was established informally in the business. Even the hoteliers who usually didn’t receive the service tip from the customers were persuaded to distribute some percentages of the turnover to the employees as an additional compensation to the employees. Say some 5% or 10% of the turnover amount.

But the practice came with its inconsistencies. The trade unions representing different workers, some facing customers and some not facing the customers, often disagreed with what was collected as service tips. Everyone wanted a well measured and sliced piece of this pie. It was another hassle for the hoteliers to have them allocated equitability among the employees. They too would want some management and establishment fees. Compensation averaging 10% of the amount would unsurprisingly see some further development.

Unsurprisingly, a mandatory service charge system came into force on January 1, 2007 via an agreement between the Hotel Association of Nepal and Trade Unions. Since then hotel and restaurant customers have been paying 10% service charges in addition to the listed price. As per the agreement signed in 2007, employees would receive 68 percent and management would receive 32 percent of the amount collected as service charge. The service charge was made mandatory in 2007 with the aim to resolve differences between hotel management and employees.

Again, in June 2018, Hotel Association Nepal and the Nepal Tourism and Hotel Laborers Association ended a long dispute that broke over the allocation of the percentages that would be shared between the employees and management. They agreed that hotel employees would get 72 percent, the hotel management would get 23 percent, Hotel Association Nepal would get 2 percent and the three trade unions affiliated to the Nepali Congress, CPN-UML and CPN (Maoist Center) would get 1 percent each. 
Announcement in Nepal Hotel Association’s Newsletter January 2017
Announcement in Nepal Hotel Association’s Newsletter June 2018

A valid argument that has already been tested in the consumer courts internationally is that a component of service is inherent in the price of food and beverages offered by the restaurant or hotel. Pricing of the product thus covers both the goods and services component. There is no restriction on hotels or restaurants to set the prices at which they want to offer food or beverages to consumers. Placing an order involves consent to pay the prices of food items displayed in the menu along with applicable taxes. Charging anything other than the said amount would amount to unfair trade practice under the Consumer Laws. 
News Link from Kathmandu Post

So again, in response to the decisions regarding the service charges all over the globe, the implementation of employee friendly labor laws and also the myriad of consumer complaints received in the sector, the Restaurant and Bar Association of Nepal announced in January 2019 that the 10 percent service charge added to the meal bill had been made optional, drawing smiles from many customers. The said service charge would be left to the discretion of hoteliers and no longer be mandatory.
News Link from Spotlight Nepal

Is VAT applicable in the Service Charges?

A quick answer would be “obviously yes, as service charges added on top of the menu price is still a value addition for VAT purposes”. But why stop the discussion there? We have noticed many differing views in the market regarding the application of indirect taxes over the amount of 10% service charges in the hotel and restaurant bills. But where does this come from?

One could argue that the 10% service charge is utilized as a compensation to the employees as per the Agreement between the Hoteliers and the Trade Unions. It has no alternative purpose. It should therefore not be treated as a value creation but be treated simply as transfer of value (like any employee compensation would be) and thus would not fall under the purview of the indirect taxes. The argument was pretty reasonable as the amount is aimed only to compensate the employees (management employees and other employees). This had even created some non uniformity in the hotel bills – some charging VAT over the amount and some not – and few disputes even reached Inland Revenue Department, who for the purpose of consistency and for the reason that 10% service charge was not a statutory requirement, argued that the the amount should be subjected to value added taxes. But had it been a statutory requirement rather than hoteliers requirement – it could quite possibly be exempted from indirect taxes as the reasoning for its exemption from indirect taxes is quite valid.

The Spirit of Indirect Tax and Consumer Laws

We know that the practice of the 10% service charge came deprecating the practice of permitting serving staff to take individual tips and implementation of the continental system of service charge both with regards to its collection as well as disbursement.

No doubt any levy of extra charges would push up the price of the product in all circumstances, the practice is to be seen in the context and pretext it has been questioned. It must be borne in mind that the hoteliers often argue that there has to be some difference in price in respect of food served in the restaurant itself and packed food. For the food which is served in the restaurant itself, the owner of restaurant has to incur money for furniture, carpets, Air-conditioners, fans, waiters, cleaning, mopping and dusting the restaurant, maintenance of reception etc.; for packed food, there is no need to give such services. The hoterlies and trade unions add their voice to generally dismiss customer complaints against these issues.

Consumer Activists have an even better explanation. Yes, the customer has ample choice to select any one of the restaurants he would like to visit. It is true that the kinds of facilities like maintenance of hygienic conditions, provision of toilet tissues, hand dryers and others (much can be said about them) are separately accounted for while arriving at the profit of the restaurant but one needs to remember that it is for the trader to decide how to manage its business and not compromise the right of the consumer for fully disclosed pricing. Normally understood, service charges are levied for the service of food at the table in the restaurant or caretaker in the hotel. Obviously it is an integral business function but should definitely be priced in the menu. Customers cannot be expected to compensate every business process individually and involuntarily. Breaking prices of a indistinguishable business process into components is not how a business works and is often discouraged by tax and consumer laws.

The indirect tax law of Nepal (Value Added Tax Act, 2052) states that an additional amount cannot be charged by adding VAT. Rule 14Kha of the Value Added Rule 2053 specifies a provision in this regard, which states: The selling price (tag price, menu price and the price itself) should include the price inclusive of tax. This also has been the view of the Inland Revenue Department for quite some time.

A relevant decision from Delhi High Court: National Restaurant Association vs Union Of India & ANR which also had motivated the hoteliers association to reverse the mandatory requirement for the service charges.

The Decision from Kathmandu District Court

Diners for long have been paying 24.3 percent more than the menu price- 10 percent compulsory service charge, 13 percent VAT, and 1.3 percent service tax. But no more. In a landmark ruling, the Kathmandu District Court has ordered restaurants, hotels, and resorts not to charge their customers more than the price listed on the menu. The court delivered this verdict on an August 21 consumer case filed by journalist Madan Dhungana against Green Valley Resort, after it added the aforementioned charges on his menu price. According to lawyers, if restaurants are found to be charging more than the menu price, owners can be jailed for three to six months and fined Rs. 2,00,000 to Rs.250,000. As expected, this ruling has brought smiles on the faces of customers but has been condemned strongly by the restaurant owners.

Link to the decision from Kathmandu High Court: Madan Dhungana vs. Green Valley Resort

Forum for Protection of Consumer Rights v/s OPMCM et. al.

Summary of the Case

A decision to similar effect has also been made from the Supreme Court in the case of Forum for Protection of Consumer Rights v/s OPMCM et. al. 

Through the decision, the Supreme Court of Nepal has declared Section 87(3) of the Labour Act, 2074 and Rule 82 of Labour Rules 2075, null and void with effect from 2079.10.11 (25-Jan-2023). Hotels and restaurants will no longer be permitted to charge 10% of the bill as a service charge or share such proceeds with employees and labor unions. In its decision, the court has also explained the difference between taxes and service fees.

The provision from Labor Laws that were nulled

८७. पर्यटनसँग सम्बन्धित श्रमिक सम्बन्धी विशेष व्यवस्था:
(३) होटल, मोटल, रेष्टुरेण्ट, जंगल सफारी वा अन्य व्यवसाय गर्ने रोजगारदाताले सामूहिक सम्झौता बमोजिम लिइएको सेवा शुल्क रकम तोकिए बमोजिम वितरण गर्नु पर्नेछ ।
Section 87: Special provisions relating to tourism labors:
(3) The employer operating any hotel, motel, restaurant, jungle safari or other business shall distribute, as prescribed, the service fees collected pursuant to the collective agreement.

८२. सेवा शुल्कको वितरण
होटल, मोटल, रेष्टुरेन्ट, जंगल सफारी वा यस्तै अन्य व्यवसाय गर्ने रोजगारदाताले ग्राहकबाट कुनै सेवा शुल्क लिएको भए त्यस्तो सेवा शुल्क रकम देहाय बमोजिम श्रमिकलाई वितरण गर्नु पर्नेछ
(क) यो नियमावली प्रारम्भ भएपछि रोजगारदाता संगठन तथा सम्बन्धित व्यवसायसँग सम्बद्ध अधिक प्रतिनिधिमुलक ट्रेड यूनियन संघबीच संझौता भएकोमा सोही बमोजिम,
(ख) खण्ड (क) बमोजिम संझौता नभएको सेवाशुल्क बापत उठाइएको मासिक रकमलाई शत प्रतिशत मानी देहाय बमोजिम वितरण गर्ने:
(१) प्रतिष्ठानमा कार्यरत श्रमिक, ऐनको दफा १८ बमोजिम कार्यरत तालिमी वा श्रम आपूर्तिकर्ता मार्फत कार्यरत श्रमिकलाई दामासाहीले कुल रकमको एकहत्तर प्रतिशत रकम,
(२) ब्रेकेज तथा अपरेशिल लिकेज व्यवस्थापनको लागि रोजगारदातालाई कुल रकमको चौबीस प्रतिशत रकम,
(३) होटल व्यवसायसँग सम्बन्धित रोजगारदाताको संगठनले दुई दशमलब पाँच प्रतिशत तथा होटल क्षेत्रका अधिक प्रतिनिनिमूलक ट्रेड यूनियन संघले दुई दशमलब पाँच प्रतिशत ।
Rule 82: Distribution of Service Charge
For businesses such as hotels, motels, restaurants, jungle safaris, and other similar ventures, if the employer collects any service charge from the customers, the following amounts shall be distributed to the workers:
(a) Once this regulation comes into effect, based on the agreement reached with the employer organization and employee trade union association.
(b) In cases where there is no agreement as per Rule 82(a), the monthly amount collected as service charge shall be distributed according to the following percentages:
(1) 71% to the working staff, including the trainees and labors hired from labor supplier
(2) 24% percent for management towards management of breakages and leakages.
(3) 2.5% to the employers union of the hotel business and 2.5% to the employee trade union association. 

Decision from Supreme Court

This case involves a writ petition filed in the Supreme Court of Nepal. The petitioner is the National Consumer Forum, represented by its President Premlal Maharjan. The writ is filed against various government bodies, including the Federal Legislature (Federal Parliament), the Office of the Prime Minister and Council of Ministers, the Ministry of Law, Justice, and Parliamentary Affairs, and the Ministry of Labour, Employment, and Social Security.

The petition challenges the legality of Section 87(3) of the Labor Act, 2074, and Rule 82 of the Labor Regulations, 2075. These provisions pertain to the distribution of service charges collected by employers from customers in hotels, motels, restaurants, jungle safaris, and similar businesses. The petitioner argues that such collection and distribution of service charges are unconstitutional and violate the rights of consumers protected under Article 44 and Article 115 of the Constitution of Nepal.

After considering the arguments and relevant laws, the Supreme Court, in its judgment, declares Section 87(3) of the Labor Act, 2074, and Rule 82 of the Labor Regulations, 2075, as null and void. The court finds that these provisions are inconsistent with the spirit and intent of Article 44 and Article 115(1) of the Constitution of Nepal. Consequently, the court orders that employers are not allowed to collect service charges based on collective agreements, except in cases where the law explicitly authorizes the collection of such fees – based on the reasoning that the amount in the nature of taxes are not allowed to be recovered by anyone other than the executive organ of the body. A tax is an amount that is paid to the state by law without expecting a definite consideration in return – unlike service fees that are collected in “quid pro quo” principle – i.e. there is a mutual exchange of the price and goods/services.