[Opinion] “Parental Corporate Guarantee” – is a Landmine for Corporates? – GST Implications

M.S.Venu Gopal – [2022] 143 taxmann.com 234 (Article)

1. Background:

Parental Corporate Guarantees are commonly known as intercompany transactions. Recently, Tax and Regulatory have been quite vigilant about these transactions and have been scrutinizing more closely.

Related party transactions are always followed with the presumption that it is not an arm’s length principles and thus the provisions of tax allow prescribe that any transaction done at the open market value of the good or service and is also based on the regular commercial terms will be considered as a transaction made with a third party.

The transactions made with the related parties have always been a subject of scrutiny and thus, they require demonstration that the transactions are basically made by commercial understanding. Here, the related party can be a subsidiary, Joint venture or a sister concern of a business.

2. What is “Corporate Guarantee”

Corporate Guarantees is a guaranty by one business entity or by one Corporate entity or by a Holding company for another group company or subsidiary company or Joint venture company. Generally, guarantee by one Corporate entity for other Corporate entity is given at the time of Term Loan/Working Capital loan/Other Special purpose loans are being availed by other group company. In other words, when any subsidiary/Joint Venture company availed any loan i.e Term Loan or Working capital loan from any Financial Institute Then Holding company stands as guarantor for subsidiary company/ Joint Venture Company. Such understandings are covered or termed as “Corporate Guarantee”. Means one corporate entity stands as guarantor for another corporate entity. If the subsidiary company fails to repay the debt, the holding company who stood the guarantee will pay the debt on behalf of the subsidiary company.

Normally Financial institutions are creating the charge on Assets / Book debts/stocks of the loan availed entities. Additionally they take the corporate guarantee from the holding company as additional security.

These guarantees are mostly given by holding company/group companies without any charges or consideration. The objective of such guarantees is to felicitate the subsidiary company or group company for its smooth function. In open market no parallel or identical transactions happens except when Banks give guarantees for its customers for specific purposes i.e Financial Guarantees, Performance guarantees, Earnest money Deposit guarantee etc and charge commission for the same. Various Banks are charged the commissioner in different manner. Under GST such services of bankers are treated as supply of services and subject to GST.

3. Provisions Under Companies Act, 2013

Section 185/186 of Companies Act enumerated inter- corporate loans which are prohibited to be offered by any company. This provision specifically disallows the companies from providing loans, guarantees and securities in favor of its directors or to any other person in whom the director is interested in. However, the provision makes a few exceptions as following:

• Any loan made by a holding company to its wholly owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary company; or
• Any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company

Therefore, the Companies Act, 2013, allows for Inter- Corporate guarantees among related parties subject to the condition that such loans when provided by the holding companies be used by the subsidiary companies for its principal business activities

4. Provisions under GST Act

Corporate guarantee or guarantee for subsidiary company is an activity agreed upon between two corporate entities without consideration and is in course or furtherance of business. Corporate Guarantees without consideration are quite generic transaction among companies wherein holding or parent companies issues corporate guarantee to various Banks or other Financial Institutions as a collateral security for the credit facilities availed by its subsidiaries. Also, corporate guarantee, is unsecured, which means it is not secured by or tied to any specific asset of the surety. Its just an share holding activity of the holding company.

Is Corporate Guarantee a supply? It’s a big debatable issue if Corporate Guarantee is a supply.

The meaning or scope of supply as per GST laws is as under:

Section 7 of CGST Act, defines scope of Supply as under:

(1) For the purposes of this Act, the expression ―supply includes–

(a) all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;
(b) import of services for a consideration whether or not in the course or furtherance of business and
(c) the activities specified in Schedule I, made or agreed to be made without a consideration;
(d) omitted

(1A) where certain activities or transactions constitute a supply in accordance with the provisions of sub-section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II.
(2) Notwithstanding anything contained in sub-section (1),

(a) activities or transactions specified in Schedule III; or
(b) such activities or transactions undertaken by the Central Government, a State Government or any local authority in which they are engaged as public authorities, as may be notified by the Government on the recommendations of the Council, shall be treated neither as a supply of goods nor a supply of services

Whereas in case of Corporate Guarantee as provided by a holding company for subsidiary is a need base arrangements and that too free of any fee or charges. These guarantees are unsecured in nature. So in absence of any fee or commission, its valuation for levy of GST is another litigation.

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