Overview of GST Issues In Corporate and Personal Guarantees

Table of Contents

1. Concept of Guarantee
2. Levy of GST – CGST Act, 2017
3. GST Implications
4. Issues
5. Way Forward

1. Concept of Guarantee

Indian Contract Act, 1872

• Sec. 126 – “Contract of guarantee”, “surety”, “principal debtor” and “creditor”.— A “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the “surety”; the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called the “creditor”. A guarantee may be either oral or written.
• Sec. 127 – Consideration for guarantee – Anything done, or any promise made, for the benefit of the principal debtor, may be a sufficient consideration to the surety for giving the guarantee.
• Sec. 140 – Rights of surety on payment or performance.—Where a guaranteed debt has become due, or default of the principal debtor to perform a guaranteed duty has taken place, the surety upon payment or performance of all that he is liable for, is invested with all the rights which the creditor had against the principal debtor.

1.1 Related Parties

Financial guarantee – Part of financing activity

A guarantee is a legally binding promise by another party to pay to the lender interest and/or capital if the borrower should not be able to make the payment. A guarantee therefore improves the credit rating of the borrower in the financing transaction and secures a larger volume of debt and/or a more favourable rate of interest.

Distinct from passive association (passive group association, letter of comfort, guarantee)

• Passive group association – Improvement in credit rating enabling borrowing on better terms
• Letter of comfort – Non-enforceable comfort provided to the lender
• Guarantee – Not affecting the borrowing but given primarily because of inflexibility in the lending bank’s administrative and security procedures or where the loan is categorized as equity contribution by the guarantor.

Distinct from non-financial guarantees (performance guarantee)

Key principle for the determination of guarantee fee (financial guarantee)

An arm’s-length guarantee fee must relate to the advantage secured by the borrower by reason of having the guarantee (i.e., the volume and price of debt that could be secured without the guarantee compared to the volume and price actually secured with the benefit of having the guarantee, in most cases) provided that this will not worsen its financial position due to guarantee-related costs.

Key methods for determination of guarantee fee (transfer pricing):

• Yield approach
• Cost approach
• Expected loss approach
• Capital support approach

2. Levy of GST – CGST Act, 2017

Charging provisions

• Sec. 9(1) Subject to the provisions of sub-section (2), there shall be levied a tax called the central goods and services tax on all intra-State supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, on the value determined under section 15 and at such rates, not exceeding twenty per cent, as may be notified by the Government on the recommendations of the Council and collected in such manner as may be prescribed and shall be paid by the taxable person.
• Sec. 7(1) For the purposes of this Act, the expression “supply” includes—
• 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;
• the activities specified in Schedule I, made or agreed to be made without a consideration

Schedule I – Activities to be treated as supply even if made without consideration

2. Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business:

Related persons

• Sec. 15 Explanation —For the purposes of this Act,—
• persons shall be deemed to be “related persons” if—
  • such persons are officers or directors of one another’s businesses;
  • any person directly or indirectly owns, controls or holds twenty-five per cent or more of the outstanding voting stock or shares of both of them;
  • one of them directly or indirectly controls the other;
  • both of them are directly or indirectly controlled by a third person;
  • together they directly or indirectly control a third person; or

GST is leviable on the supply between related persons when made in the course or furtherance of business even if made without consideration.

• Therefore, the existence of supply is a must to invoke the charging provisions.

Active association (Financial guarantee affecting the borrowing)

• Appears to be covered within the expanded scope of ‘supply’
• Hence the same shall be taxable

3. GST Implications

3.1 Personal Guarantee

Circular No. 204/16/2023-GST dt. 27/10/2023

• The activity of providing personal guarantee by the Director to the banks/financial institutions for securing credit facilities for their companies is to be treated as a supply of service, even when made without consideration.
• As per mandate provided by RBI in terms of Para 2.2.9 (C) of RBI’s Circular No. RBI/2021-22/121 dated 9th November, 2021, 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. When no consideration can be paid there is no question of such supply/transaction having any open market value. Accordingly, the open market value of the said transaction/supply may be treated as zero and therefore, taxable value of such supply may be treated as zero.
• There may, however, be cases where the director, who had provided the guarantee, is no longer connected with the management but continuance of his guarantee is considered essential because the new management’s guarantee is either not available or is found inadequate, or there may be other exceptional cases where the promoters, existing directors, other managerial personnel, and shareholders of borrowing concerns are paid remuneration/consideration in any manner, directly or indirectly. In all these cases, the taxable value of such supply of service shall be the remuneration/consideration provided to such a person/guarantor by the company, directly or indirectly.

3.2 Corporate Guarantee

Pre 26/10/2023

• GST shall be leviable on the supply
• Sec. 15(1) r/w Sec. 15(4) of the CGST Act, 2017 grants power to the Government to prescribe the manner in which the value of supply is to be determined in situations where supply is between related persons.
• Rule 28 of the CGST Rules, 2017 contains the manner in which the said value is to be determined. The value of supply shall-

1. • be the open market value of such supply;
   • if the open market value is not available, be the value of supply of goods or services of like kind and quality;
   • if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order:
   • Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.

On and after 26/10/2023 – Shift in the scheme of valuation

• Notification No. 52/2023 –Central Tax dt. 26/10/2023
  • Following sub-rule inserted into Rule 28
    • (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.

Circular No. 204/16/2023-GST dt. 27/10/2023

• The activity of providing corporate guarantee by a company to the bank/financial institutions for providing credit facilities to the other company, where both the companies are related is taxable.
• Considering different practices being followed by the field formations and taxpayers in determining such taxable value, in order to provide uniformity in practices and ease of implementation, sub-rule (2) has been inserted in rule 28 of CGST Rules vide Notification No. 52/2023 dated 26.10.2023, for determining the taxable value of such supply of services between related persons in respect of providing corporate guarantee.
• Accordingly, consequent to insertion of the said sub-rule in rule 28 of CGST Rules, in all such cases of supply of services by a related person to another person, or by a holding company to a subsidiary company, in the form of providing corporate guarantee on their behalf to a bank/financial institution, the taxable value of such supply of services, will henceforth be determined as per the provisions of the sub-rule (2) of Rule 28 of CGST Rules, irrespective of whether full ITC is available to the recipient of services or not.

4. Issues

Active vs. passive association (passive group association, letter of comfort, guarantee)?

• OECD Guidelines 2022

1. • (paragraph 7.13)… an associated enterprise should not be considered to receive an intragroup service when it obtains incidental benefits attributable solely to its being part of a larger concern, and not to any specific activity being performed. For example, no service would be received where an associated enterprise by reason of its affiliation alone has a credit-rating higher than it would if it were not affiliated, but an intragroup service would usually exist where the higher credit-rating were due to a guarantee by another group member …
   • (paragraph 1.158) … the term incidental refers to benefits arising solely by virtue of group affiliation and in the absence of deliberate concerted actions or transactions leading to that benefit. The term incidental does not refer to the quantum of such benefits or suggest that such benefits must be small or relatively insignificant.

• International jurisprudence

1. • General Electric Capital Canada Inc v The Queen 2009 TCC 563 (Canada)
   • Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (No 4) [2015] FCA 1092 (and subsequently upheld in the appeal court in Chevron Australia Holdings Pty v Commissioner of Taxation [2017] (Australia)

4.1 Personal Guarantee

Shareholders (other than directors)?

• Circular No. 204/16/2023-GST dt. 27/10/2023 relies on RBI’s Circular No. RBI/2021-22/121 dated 9th November, 2021 to conclude that the open market value is zero since no consideration can be paid.
• Para 2.2.9 of the RBI Circular indicates the considerations which should guide the banks while seeking personal guarantee. It cautions that the personal guarantee may be taken only when absolutely warranted after a careful examination of the circumstances of the case and not as a matter of course.
• Para 2.2.9 (C) of the RBI Circular appears to be broad enough to cover all personal guarantors to the effect that no consideration whether by way of commission, brokerage fees or any other form, would be paid or received.
• However, it is advisable that this requirement should be incorporated in the bank’s terms and conditions for sanctioning credit limits.

4.2 Corporate Guarantee

Time of supply

• Sec. 13(1) – The liability to pay tax on services shall arise at the time of supply, as determined in accordance with the provisions of this section.
• Sec. 13(2) – The time of supply of services shall be the earliest of the following dates, namely:—

(a) the date of issue of invoice by the supplier, if the invoice is issued within the period prescribed under section 31 or the date of receipt of payment, whichever is earlier; or

(b) the date of provision of service, if the invoice is not issued within the period prescribed under section 31 or the date of receipt of
payment, whichever is earlier; or

(c) the date on which the recipient shows the receipt of services in his books of account, in a case where the provisions of clause (a) or clause (b) do not apply:

• Sec. 142(11)(b) – Notwithstanding anything contained in section 13, no tax shall be payable on services under this Act to the extent the tax was leviable on the said services under Chapter V of the Finance Act, 1994 (32 of 1994);

Levy of tax

• Pre 01/07/2017
• Between 01/07/2017 and 25/10/2023
• On and after 26/10/2023

Value of supply

• Fundamental principle
  • Sec. 9(1) – Levy on supply on the value determined u/s 15 and shall be paid by taxable person.
  • Sec. 13(1) – Liability to pay tax arises at the time of supply.
  • Hence the valuation provisions applicable at the time of supply are to be applied.
• Valuation provisions
  • Between 01/07/2017 and 25/10/2023
    • Sec. 15(4) r/w Rule 28
    • Circular No. 199/11/2023-GST dt. 17/07/23 – Nil value if full ITC available
  • On and after 26/10/2023
    • Rule 28 as amended by Notification No. 52/2023 –Central Tax dt. 26/10/2023
• Whether the amended valuation rule is to be applied to a corporate guarantee issued between 01/07/2017 and 25/10/2023
  • Circular No. 204/16/2023-GST dt. 27/10/2023 recognizes different practices being followed by the field formations and taxpayers in determining such taxable value and in order to provide uniformity in practices and ease of implementation sub-rule (2) has been inserted in rule 28 of CGST Rules vide Notification No. 52/2023 dated 26.10.2023.
  • Substantial amendment and can be said to apply prospectively qua the taxable supplies made on and after 26/10/2023.
• Rule 28(2) – The deeming fiction of 1% of the amount of guarantee offered, or the actual consideration, whichever is higher.
  • Whether 1% is to be charged on the amount of guarantee offered or only to the extent of the obligation of the guarantor (due amount of the borrower)?
  • Whether 1% is to be charged by all guarantors (when there is more than one guarantor)?
  • Whether 1% is to be charged per annum or one time?
• Rule 28(2) – The deeming fiction of 1% of the amount of guarantee offered, or the actual consideration, whichever is higher.
  • Sec. 15(4) vs. Rule 28(2)
    • Actual value where ascertainable and found to be less than 1%
      • Whether recourse to deeming fiction mandatory?
• Ambit of Notification No. 52/2023 –Central Tax dt. 26/10/2023
  • Applies qua 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.
  • Explanation to Sec. 13(8) of the IGST Act, 2017 – Explanation.—For the purposes of this sub-section, the expression,—
    • “banking company” shall have the same meaning as assigned to it under clause (a) of section 45A of the Reserve Bank of India Act, 1934 (2 of 1934);
    • “financial institution” shall have the same meaning as assigned to it in clause (c) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934);
  • Relevance of the aforesaid Explanation qua Notification No. 52/2023 –Central Tax dt. 26/10/2023
    • Group NBFC?
    • Foreign banking companies or financial institutions not having any place of business in India?

ITC

• Sec. 16(1) – For use in course or furtherance of business
• Sec. 16(2) – Failure to pay the consideration within 180 days
  • Proviso to Rule 37(1)
    • Provided that the value of supplies made without consideration as specified in Schedule I of the said Act shall be deemed to have
      been paid for the purposes of the second proviso to sub-section (2) of section 16
• Sec. 16(4) – Limitation for taking the ITC linked with the invoice date
• Sec. 17(5)(d) – Financing cost if capitalised to immovable property (other than plant and machinery)?
  • “For construction” – Degree of nexus to trigger the provision?

Export of services – Sec. 2(6) of the IGST Act, 2017

• “export of services” means the supply of any service when,—
• the supplier of service is located in India;
• the recipient of service is located outside India;
• the place of supply of service is outside India;
• the payment for such service has been received by the supplier of service in convertible foreign exchange or in Indian rupees wherever permitted by the Reserve Bank of India; and
• the supplier of service and the recipient of service are not merely establishments of a distinct person in accordance with Explanation 1 in section 8;

Sec. 16 of the IGST Act, 2017 grants the benefit of zero-rating

Pre 01/07/2017

• GST not leviable

Between 01/07/2017 and 25/10/2023

• Deemed supply (Sec. 7(1)(c) r/w Sr. No. 2 to Schedule I)
• Valuation mechanism (Rule 28)
• Benefit of zero-rating?

On and after 26/10/2023

• Application of NN 52/2023 – Central Tax dt. 26/10/2023?

Other relevant aspects

• Contracts
• Transfer pricing documentation under Income Tax
• Accounting entries

5. Way Forward

Taxpayer to assess the respective facts qua each individual guarantee to apply the law

Consider taking a position after evaluating all the ramifications

• Past transactions
• Blockage of funds
• Availability of ITC
• Benefit of zero-rating