[Analysis] GST on Corporate Guarantees – Mystery Continues

Table of Contents

1. Introduction
2. Relevant Provisions Under GST Law
3. Intricacies Relating to GST on Corporate Guarantees

1. Introduction

The taxability of corporate guarantees under the Goods and Services Tax (GST) has been a contentious issue ever since the inception of the GST regime. This debate has persisted due to the absence of specific provisions addressing this matter.

The term ‘guarantee’ and ‘corporate guarantee’ are not defined under the GST law. In essence, corporate guarantee involves a corporate entity guaranteeing the performance of another corporate entity under any contract or discharge of the liability of the said corporate entity in case of any default. In this regard, reference can also be drawn from the Indian Contract Act, 1872 where term ‘contract of guarantee’ is defined¹ as a contract to perform the promise, or discharge the liability, of a third person in case of his default.

Typically, corporate guarantees are given by parent or holding companies on behalf of their subsidiary or joint venture companies for securing loans from financial institutions, often without charging any consideration.

Under the GST law, holding and subsidiary companies are considered as ‘related persons’, which give rise to the complexity to the GST treatment of corporate guarantees as transactions between related persons even without consideration is treated as a taxable supply under GST. Recently, amendments have been made to the Central Goods and Services Tax Rules, 2017 (‘CGST Rules’), introducing a specific valuation provision for the taxability of corporate guarantees extended by related persons.

In the above backdrop, it becomes important to understand the amendments and intricacies which may arise after the insertion of relevant amendments. In this article, we delve into the amendments and intricacies that arise in the context of corporate guarantees extended by holding companies on behalf of its subsidiary company.

2. Relevant Provisions Under GST Law

Under the GST law, the supply of goods or services between related persons in the course or furtherance of business is treated as supply even if it is carried out without any consideration².

Further, as per the GST law, persons are deemed³ to be ‘related persons’ where any such person directly or indirectly owns, controls or holds 25% or more of the outstanding voting stock or shares of both of them.

For the purpose of valuation of the supply between the related persons, the GST law specifically disregards the transaction value as per Section 15(1) of the Central Goods and Services Tax Act, 2017 (‘CGST Act’) and provides that the valuation shall be done in the manner as may be prescribed. In this regard, Rule 28 of the CGST Rules prescribes various methods of valuation, such as open market value, value of supply of like kind and quality, etc., which should be adopted in case of supply between related persons. Further, where the recipient-related person is entitled to the ‘full input tax credit’, the second proviso of Rule 28 allows to declare any value in the invoice which shall be deemed to be the open market value of the goods or services.

Now, based on the recommendation of the 52^nd GST Council meeting, amendments have been incorporated under the CGST Rules to prescribe specific valuation provision for corporate guarantees extended on behalf of a related person. Prior to insertion of the relevant amendments, the GST law did not provide any specific provision on the taxability and valuation of corporate guarantees.

2.1 Recent developments under the GST law relating to corporate guarantee

Vide the CGST (Fourth Amendment) Rules, 2023, the Government has introduced⁴ a new valuation provision for corporate guarantees provided on behalf of a related person.

In this regard, with effect from 26-10-2023, a new sub-rule (2) is inserted to Rule 28 of the CGST Rules to provide that the value of supply of services to a related person, by way of providing corporate guarantee to any banking company or financial institution on behalf of the said related person, is to be deemed to be the higher of the following amounts:

• 1% of the amount of such guarantee offered, or
• Actual consideration

The CBIC has also issued Circular No. 204/16/2023-GST, dated 27-10-2023 to clarify the taxability and valuation of corporate guarantee under GST. It is clarified that the activity of providing corporate guarantee to the bank/financial institutions for providing credit facility to the other company, where both the companies are related, is to be treated as supply of service. In case where no consideration is involved then also it is to be treated as a taxable supply of service as per provisions of Schedule I of CGST Act.

Notably, this new provision would have an overriding effect on the existing valuation methodology prescribed for transactions between related persons under Rule 28. Thus, for valuation of the corporate guarantees, the above-prescribed amount needs to be adopted irrespective of its open market value, value of supply of like kind and quality, value declared on the invoice, etc.

In this regard, the CBIC has clarified that valuation of such supply is to be done as per the newly inserted sub-rule (2) of Rule 28 only and this manner of computation of value of supply would be irrespective of whether full ITC of the GST paid to the supplier, is available to the recipient of services or not.

2.2 New valuation provision not applicable on personal guarantee

The CBIC vide Circular No. 204 ibid separately clarified about the taxability and valuation of ‘personal guarantees’ provided by a director on behalf of the company. The CBIC has taken reference from RBI Circular⁵ which clearly states that no consideration by way of commission, brokerage fees or any other form, can be paid to the director by the company, directly or indirectly, in lieu of providing personal guarantee to the bank for borrowing credit limits. Therefore, it is clarified that the open market value of the said transaction may be taken as zero and thus, the taxable value would be zero. In such a scenario, no tax is payable, except in exceptional cases where consideration is charged for undertaking the guarantee.

It has also been clarified by the CBIC that the new valuation provision prescribed in respect of corporate guarantee would not apply on transactions relating to personal guarantee.

In this way, the department has provided a relaxation in case of personal guarantees and the deeming fiction applies only to corporate guarantees and not to personal guarantees provided by a director.

3. Intricacies Relating to GST on Corporate Guarantees

Although the Government has attempted to clarify its position through recent amendments and the corresponding Circular to put a break on the endless litigations going on this contentious issue, certain intricacies exist that are left unaddressed. These lingering issues have the potential to unlock a Pandora’s box of litigation in the near future. The below-mentioned issues need immediate resolution to avoid unwanted litigations on the said subject matter:

• Whether there is any ‘service’ element involved in providing corporate guarantees to a bank on behalf of a related person?
• If at all there exists a service element, should the bank or the subsidiary company be considered as the actual recipient of such service?
• Since it is unclear as to who would be the recipient, it would be difficult to determine the place of supply, specifically in case of cross border transactions.
• Whether the activity of providing corporate guarantee is actually a ‘shareholder function’ as it is provided by the holding company on behalf of its subsidiary company whose shares are held by the holding company.
• Although the new provision is inserted with effect from 26-10-2023, however, it is unclear as to what would be the treatment in cases pertaining to prior period which are still under litigation.
• Whether a new specific valuation mechanism can be prescribed in respect of corporate guarantee carried out between related persons by carving out an exception out of a settled law in respect of other transactions between the related persons.
• Considering that the definition of ‘related persons’ does not distinguish between a director and a holding company while determining the relation with the company, whether it would be valid to differentiate between the taxability and valuation of personal guarantees vis-à-vis corporate guarantees in accordance with the new provisions.
• Whether the non-obstante clause in the new provision is against the general principle of seamless flow of credit and leads to blockage of working capital amongst group entities.
• Whether the deeming fiction of 1% of the guarantee amount is debatable as it lacks proper rationale.
• Whether the deemed value is to be adopted only in cases where the value cannot be ascertained as per accounting principles or other reasonable means.
• For the purpose of determining time of supply, the law is unclear on whether the service is considered to be supplied at the time of extending corporate guarantee or at the time when the guarantee is invoked upon occurrence of default.
• In cases where consideration is charged for personal guarantee in exceptional situations, the CBIC clarified that value shall be the consideration exchanged between the director and the company. Is it appropriate to adopt transaction value where the parties are related, instead of open market value or other valuation method as per Rule 28.
• In cases where consideration is charged by the directors for personal guarantee in exceptional situations, whether GST is to be payable by the companies under RCM in terms of the CBIC clarification⁶.

In view of the above, the validity of the new valuation mechanism and the taxability of GST on corporate guarantee may be questioned in the Court of law. Going forward, it would be interesting to see the fate of the new valuation mechanism and the Circular in the near future.

1. Section 126 of the Indian Contract Act, 1872
2. Section 7(1) of the CGST Act read with Schedule I of the CGST Act
3. Explanation to Section 15 of the CGST Act
4. Notification No. 52/2023-Central Tax, Dated 26-10-2023
5. Para 2.2.9 (C) of Circular No. RBI/2021-22/121 dated 09-11-2021
6. Circular No. 201/13/2023-GST dated 01-08-2023