[Opinion] Demystifying the Impact of GST on Corporate Guarantees

CA Sanchita Doshi – [2024] 159 taxmann.com 589 (Article)

Meaning of Guarantee and Corporate Guarantee

Guarantee or Corporate Guarantee has not been defined in the GST Law. The reference is to be taken from the Indian Contracts Act, 1872.

Guarantee is defined under Section 126 of the Indian Contracts Act, 1872. A guarantee is a promise made by one person to be responsible for the debt or obligation of another person. The three parties to the contract are:

a. the person who gives the guarantee (Guarantor),
b. the person on whose behalf the guarantee is given (Principal Debtor), and
c. the person to whom the guarantee is given (Creditor)

A Corporate Guarantee is an agreement in which the corporate guarantor, takes on the payments or responsibilities of a debt if the principal debtor defaults on the loan to the creditor. Corporate guarantees are often given without consideration by the parent/holding companies to the banking companies or financial institutions for credit facilities availed by the subsidiary companies.

Let us understand the GST implications on such corporate guarantees.

Recent Developments under GST pertaining to Corporate Guarantee

Under the Service Tax regime, corporate guarantees faced no taxes if no consideration was involved. Some taxpayers argued that these guarantees were akin to actionable claims and fell under Schedule III of the CGST Act, 2017. According to this view, as they neither constituted the supply of goods nor services, they were not liable to GST. Additionally, there was a lack of clarity on how to assess GST when a holding company provided a corporate guarantee to a subsidiary without receiving any consideration, as the GST Law lacked a specific valuation mechanism in such cases.

Nevertheless, the GST Department seems to interpret corporate guarantees as a type of service provided by the guarantor (holding company) to the principal debtor (subsidiary company), as indicated in Circular No. 204/16/2023-GST dated 27th October 2023. The primary aim of this circular is to ensure uniformity in the implementation of legal provisions by providing clarification on the taxability of corporate guarantees

Notification No. 52/2023 –Central Tax dated 26th October 2023 was issued for insertion of Sub Rule 2 of Rule 28 for valuation of corporate guarantee.

Extract of Rule 28(2) of the CGST Rules, 2017 is as follows:

(2) Notwithstanding anything contained in sub-rule (1), the value of supply of services by a supplier to a recipient who is a related person, by way of providing corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be one per cent of the amount of such guarantee offered, or the actual consideration, whichever is higher.

The above rule need to be read with Circular No. 204/16/2023-GST dated 27th October 2023.

Let us understand the implications of this development on various scenarios as below:

1. Impact of Valuation Rule on Existing Corporate Guarantees

The new Valuation Rule is effective from 26/10/2023 for the issuance of new corporate guarantees. For such services of corporate guarantee, the time of supply triggers when the Holding Company provides a corporate guarantee to the Banking Company. Since this rule was introduced on October 26, 2023, it does not impact existing corporate guarantees, as services for those were rendered prior to 26-10-2023. GST will not apply on existing Corporate Guarantees on a prorate basis. The mentioned valuation rule will not affect existing corporate guarantees and will be applicable prospectively.

2. Service Recipient in the Case of Corporate Guarantees

The circular stipulates that when a holding company offers a corporate guarantee for its subsidiary, both entities are considered ‘related persons’. Therefore, when a holding company provides a corporate guarantee to banks or financial institutions to secure credit facilities for its subsidiary company, even in the absence of any consideration, it is regarded as a supply of service by the holding company to the subsidiary company, being a related person, as per provisions of Schedule I of CGST Act.

In respect of such supply of services by a holding company to a subsidiary company, in form of providing corporate guarantee on the behalf of subsidiary company, to a bank/ financial institution, the taxable value will be determined as per rule 28 of CGST Rules.

This implies that in the corporate guarantee transaction, the subsidiary company is identified as the recipient of the service.

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