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 terms ‘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 defined 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.
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 deemed 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 provision 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 52nd 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.
The Background for Clarifying GST on Corporate Guarantees
The current law does not define the term “support services”. The definition of “support services” under the erstwhile service tax regime in India was primarily governed by Section 65B (104b) of the Finance Act 1994 as amended by Section 143(C) of the Finance Act 2012 This definition encompassed a broad range of services, such as infrastructural, operational, administrative, logistic, marketing, or any other form of support, aimed at sustaining and advancing an entity.
The expansive scope of this term in the previous tax regime and the extensive interpretations under the GST regime had given rise to a growing number of uncertainties and disputes concerning the taxation and valuation of support services. One of the focal points in this context was the taxation of a corporate guarantee provided in favor of related parties.
Recent developments under the GST law relating to corporate guarantee
Vide the CGST (Fourth Amendment) Rules, 2023, the Government has introduced 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:
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.
Corporate guarantee: Supply under Schedule I:
According to the GST framework, transactions of this nature might be covered by Schedule I, which encompasses activities treated as supplies even if executed without consideration. Clause 2 of this schedule stipulates that the supply of goods or services between related parties or distinct persons, as outlined in Section 25, is subject to GST regardless of whether or not there is consideration involved – as long as it occurs within the course or furtherance of business. Accordingly, actions such as providing corporate guarantees or guarantees for subsidiary companies, which entail agreements between two corporate entities without consideration and are conducted within the course or furtherance of business, may be covered under the said schedule and deemed as taxable supplies under GST.
Relying upon the said provision, the Directorate General of Goods and Services Tax Intelligence (DGGI) has recently issued tax demand notices to several local corporate houses and multinational companies in India. The DGGI contends that such practice of providing corporate guarantees – given on behalf of subsidiaries – qualifies as a ‘service’ and is thus subject to taxation under GST regime since it is undertaken by the parent company to maximize the returns on investment on these subsidiaries. Such notices have been sent to at least 14 companies, including automakers, FMCG, and electronic goods companies. The cumulative amount of demand notices sent in the past two months is estimated to be around INR 600-700 crores that would constitute a significant addition to the government treasury.
On the contrary, another school of thought is that the scope of supply under GST should not be stretched to include shareholder functions under its ambit. Further, it may be argued that corporate guarantees do not involve any element of ‘service’, and hence, GST is not applicable in such cases.
The above mentioned contrasting tax treatments may ignite a tug-of-war between service tax and GST eras, presenting a fresh challenge for businesses as they grapple with determining the appropriate tax implications associated with corporate guarantees.
Corporate guarantee: An actionable claim
Schedule III of the CGST Act enumerates a list of activities or transactions that fall outside the scope of the definition of supply and are exempt from GST. One such exclusion found in Schedule III pertains to the supply of actionable claims. In the context of a corporate guarantee, the entity providing the guarantee commits to paying a debt or fulfilling an obligation on behalf of another entity in the event of a default. Therefore, it could be argued that a corporate guarantee, which involves a contingent liability or a future obligation, qualifies as an actionable claim. If it is established that the issuance of a corporate guarantee indeed involves the transfer of an actionable claim, then such a transaction would not be subject to GST.
Based on the notices issued by tax authorities and the recommendations from the GST Council, it is evident that this interpretation lacks sufficient backing. To avoid potential legal disputes on this matter, it is crucial for the Government to provide clarification regarding why corporate guarantees are not classified as actionable claims. In the interim, we can operate under the assumption that corporate guarantees may not be actionable claims because they are contingent, secondary obligations that depend on the failure of a primary debtor. While they involve legal agreements and can be enforced through legal means, they do not represent independent rights to payment or performance like traditional actionable claims. Instead, they serve as a form of financial security and assurance in various business transactions.
Is corporate guarantee an actionable claim?
Alternatively, if it is determined that the issuance of a corporate guarantee involves transfer of an actionable claim, then no GST would be applicable to such a transaction. However, it is worthwhile to note that such interpretation has not garnered support from the industry and the same may vary based on legal provisions, judicial decisions, and the perspective of tax authorities.
Rule 4 and Rule 5
Rule 4 and Rule 5 Rule 4 states that – Where the value of a supply of goods or services or both is not determinable by any of the preceding rules, the value shall be one hundred and ten percent of the cost of production or manufacture or cost of acquisition of such goods or cost of provision of such services.
In case of guarantees there cannot be a computation of costs. Therefore the rule is not relevant.
Rule 5 is the residual method of valuation and states that –
Where the value of supply of goods or services or both cannot be determined under rules 1 to 4, the same shall be determined using reasonable means consistent with the principles and general provisions of section 15 and these rules.
Rule 5 exposes the determination of value of supply to the discretion of the tax officer.
The officer can apply any methodology to arrive at the value of guarantee for the purpose of tax.
The definition of related persons and the rationale for valuation is in lines with the World Trade Organization Customs Valuation Agreement.
GST on Corporate Guarantee in case of Absence of Consideration
Let’s discuss the taxability of corporate guarantee arrangements given in favor of related parties where usually no consideration is involved. Under the GST law, clause (c) of Section 7(1) of the CGST Act provides that the activities specified in Schedule I, made or agreed to be made without a consideration are covered within the scope of the term ‘supply’. This includes supply of goods or services or both between related persons, when made in the course or furtherance of business.
To put it in perspective, under the GST regime, related party transactions even without consideration are treated as deemed supplies and are livable to GST. In this regard, it is pertinent to note that while the SC has ruled that consideration is a must to levy tax on a corporate guarantee (in the matter of M/s Edelweiss Financial Services Limited supra.), this may create problems for the businesses under the GST regime. Therefore, the decision is likely to open Pandora’s box in cases of corporate guarantees provided by related parties as more assesses are likely to come under the Revenue’s scanner.
The rationale of absence of consideration applied by the apex court in service tax regime may not be applicable to the GST regime as provisions of Schedule I are absolutely clear in this aspect. Accordingly, the earlier argument in the Service Tax Regime to counter the levy of tax on corporate guarantee may not hold ground. It appears that corporate guarantees, being a transaction between related persons without consideration, will be deemed as supply and will be taxable under GST.
In absence of consideration, one aspect that merits consideration is that corporate guarantee provided to a group entity located outside India may not qualify as ‘export of service’.
A number of infrastructure firms are likely to seek legal recourse on the recent decision by the Goods and Services Tax Council to levy 18% GST on corporate guarantees given by holding companies to their subsidiaries.
According to sources, several large infrastructure companies are set to file writ petitions in the Supreme Court seeking a review of the decision.
Experts point out that many corporations, especially in the energy and real estate sector, operate through special purpose vehicles for each project. “For funding purposes the main entity has to give guarantees to financial institutions to extend the funding to these SPVs. The industry’s plea is that giving guarantee is not a benefit that they are extending to their SPVs but a necessity for SPVs to remain operational. As the accounting and other regulatory requirements require them to maintain separate P&L for each project, therefore, it is feasible for them to have separate entities for each project so that they can meet the legal requirements. Since the entities are newly set up, raising funds becomes a challenge for banks hence the guarantee from an Indian holding company is preferred,” said Ankur Gupta, Practice Leader–Indirect Tax, at SW India.
Valuation is another challenge for the industry as the rate of 1% is quite steep given the market rate is less than 0.5%. “Therefore, defining a value specific to this service is arbitrary and beyond the legislative powers of the GST Council,” he said.
The GST Council in its meeting on October 7 had clarified on the taxability of personal guarantee offered by directors to the bank against the credit limits or loans sanctioned to the company as well as on the taxability of corporate guarantee provided for related persons including corporate guarantee provided by holding company to its subsidiary company.
The implementation of Rule 28(2) in the CGST Rules, brought into effect by Notification No. 52/2023-CT dated October 26, 2023, marked a pivotal moment by introducing a valuation mechanism for the deemed service of Corporate Guarantee. The rule, per the notification, took immediate effect upon publication. Notably, prior to the enactment of Rule 28(2), there was an absence of a specific mechanism for valuing the service associated with Corporate Guarantee. Consequently, the argument stands that no Goods and Services Tax (GST) should be imposed for the period preceding the incorporation of Rule 28(2), as any tax levy lacks a sustainable foundation without a valuation mechanism. Despite recent media reports indicating show-cause notices from GST authorities to infrastructure companies proposing GST levies even for transactions predating October 26, 2023, the absence of a valuation mechanism until that date is a crucial factor. Even though the Revenue may assert the inherent taxable nature of Corporate Guarantee transactions under Entry 2 of Schedule I of the CGST Act, the absence of a valuation mechanism until October 26, 2023, is likely to render the pre-rule imposition of GST legally untenable.
Vide Rule 28(2) of the CGST Rules, the Government has stated that the companies will have to pay 18% GST on a minimum of 1% of the value of the Corporate Guarantee. There is absolutely no rationale behind fixing the minimum percentage as 1%.Therefore, manifest arbitrariness is a strong ground on which this rule could be challenged.
Infra companies likely to approach courts on 18% GST on corporate guarantee
A number of infrastructure firms are likely to seek legal recourse on the recent decision by the Goods and Services Tax Council to levy 18% GST on corporate guarantees given by holding companies to their subsidiaries.
According to sources, several large infrastructure companies are set to file writ petitions in the Supreme Court seeking a review of the decision.
Experts point out that many corporate, especially in the energy and real estate sector, operate through special purpose vehicles for each project. “For funding purpose the main entity has to give guarantees to financial institutions to extend the funding to these SPVs. The industry’s plea is that giving guarantee is not a benefit that they are extending to their SPVs but a necessity for SPVs to remain operational. As the accounting and other regulatory requirements require them to maintain separate P&L for each project, therefore, it is feasible for them to have separate entities for each project so that they can meet the legal requirements. Since the entities are newly set up, raising funds becomes a challenge for banks hence the guarantee from an Indian holding company is preferred,” said Ankur Gupta, Practice Leader–Indirect Tax, at SW India.
Valuation is another challenge for the industry as the rate of 1% is quite steep given the market rate is less than 0.5%. “Therefore, defining a value specific to this service is arbitrary and beyond the legislative powers of the GST Council,” he said.
The GST Council in its meeting on October 7 had clarified on the taxability of personal guarantee offered by directors to the bank against the credit limits or loans sanctioned to the company as well as on the taxability of corporate guarantee provided for related persons including corporate guarantee provided by holding company to its subsidiary company.
It had said that 18% GST would be levied on the parent company’s corporate guarantee for its subsidiary that gets a bank loan. The taxable value of the supply of the guarantee would be taken as 1% of the amount of guarantee offered or the actual consideration, whichever is higher.
When service is charged on value, which is more than the actual consideration, paid and agreed mutually between the service recipient and the service provider, the question of manifestly arbitrariness of taxing the higher value will always come into play“, said Abhishek A Rastogi, founder of Rastogi Chambers, who believes that the rules cannot go beyond the statutory provisions. “Once the value of the service is fixed beyond the price paid or payable, the essence of the statutory provisions get diluted,” he further said
INFRA COMPANIES TO MOVE TO COURT AGAINST GST ON CORPORATE GUARANTEE
Multiple real estate and infrastructure companies plan to file writ petitions in several High Courts in the days ahead, challenging the 18% Goods and Services Tax levied on corporate guarantees issued by parent companies to their subsidiaries and connected parties in order to improve lenders’ confidence.
Following the GST Council‘s decision to tax these guarantees in late October, as many as 50-60 of these companies received tax notices. According to experts, the new tax would generate stress in the infrastructure sector because many firms rely largely on external financing for mega projects.
According to the sources, companies are going to challenge the basis of taxing corporate guarantee as a service given. The petitions will also raise concerns about the valuation mechanism for taxing such transactions, as well as the latest set of notices’ retroactive effect.
A government official said that almost 5 dozen companies, including some in the power and other infrastructure sectors, as well as real estate firms, have been issued notices requesting tax on corporate guarantees, adding that the total tax claims raised through these notices may exceed Rs. 1,000 crore.
DLF, IL and FS Ltd., India bulls Real Estate, and Super tech are among the companies that have received the notices, according to an official who commented on the condition of anonymity.
One of the aforementioned companies confirmed receiving such a warning. “…like many others, we received it (the GST notice).” On the condition of anonymity, a source within the company said, “We will all move the court…. this notice will not stand in court.”
When contacted, a Super tech representative stated, “We are unaware of any such notices.” Queries submitted to others received no response.
As stated in a notification issued on October 26 by the Central Board of Indirect Taxes and Customs (CBIC), GST will apply at an 18% rate on corporate guarantees involving parents, subsidiaries and other related parties. The levy will be based on either the financial consideration charged by the guarantor for the service or 1% of the guarantee’s value, whichever is higher.
The new rule would govern the value of such supply of services of corporate guarantee supplied between related parties, regardless of whether full Input Tax Credit (ITC) is accessible to the recipient of services or not, according to the notification.
Earlier, in its 52nd meeting, the GST Council announced that no GST would be payable on corporate guarantees granted to a bank by a director against loans sanctioned to a company if no fee is paid to the director for such service.
Ankur Gupta (Practice leader, Indirect Tax at SW India) stated that numerous companies, particularly those in the energy and real estate sectors, create a special purpose vehicle for each project. As a result, the primary business must provide guarantees to financial institutions in order for them to grant funding to these SPVs.
The industry’s petition is that providing guarantees is not a benefit extended to its SPVs but rather an essential requirement for SPVs to remain functioning. Because the SPVs are new, raising funding is difficult for them, hence the assurance from Indian holding companies.
According to Manish Mishra, Partner at JSA Advocates and Solicitors, the valuation mechanism of 1% of the borrowed amount is arbitrary and problematic. He stated that transfer pricing assessments are typically performed at 0.25-0.30%. Tax experts have also stated that because the revisions are prospective, no requests should have been made for previous periods.
Various tax and corporate laws have been increasingly regulating related party transactions. With increased participation of investors and other stakeholders, it is important to ensure that such transactions are carried out with complete transparency, at arm’s length price and after obtaining necessary approvals. One of the common transactions between group entities can be observed in the form of financial corporate guarantees provided by one entity to another group entity to boost its credibility. For a better understanding, it is an arrangement wherein one of the entities agrees to act as a guarantor for another group entity while seeking funds from a financial institution.
Conclusion
Corporate guarantee (CG) arrangements are emerging as complex topics to comprehend under indirect tax laws and transfer pricing (TP). Often, these transactions are undertaken without consideration due to which tax authorities are becoming watchful when it comes to reporting and taxability of these arrangements. As the tax administrative ecosystem has become agile, taxpayers may face challenges in determining taxability and valuation of such arrangements.
A provision such as Rule 28(2) of the CGST Rules is always susceptible to challenges for being arbitrary and unreasonable. It will be hard for the Government to defend the levy of GST on a minimum of 1% of the guaranteed amount. Though the levy of GST on Corporate Guarantee per se might not be held illegal. However, if the valuation provision, i.e., Rule 28(2) of the CGST Rules, is held to be arbitrary then the Revenue will have to either amend the provision or introduce a new one. Till then, it will be difficult for the Government to levy GST on the Corporate Guarantees.
Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates
