Comprehensive Guidelines on GST for Corporate Guarantees Between Related Parties

Introduction:

Companies often use a corporate guarantee as a shield for their financial stakes. In this article, we are going to break down the idea of a corporate guarantee and see how the Indian Rules and Regulation play a role in it. Corporate guarantees within group structures facilitate business operations but trigger complex compliance requirements across multiple regulations. This article analyses the regulatory framework governing related party guarantees with special emphasis on GST implications, which have emerged as the most contentious aspect in recent years.

A corporate guarantee is like a safety net. It happens when a firm, known as the guarantor, promises to pay for a loan if the borrower doesn’t fulfil their duties. This kind of guarantee reassures the lender, reducing their risk level. Plus, it boosts the borrower’s trust factor when handling money matters.

PART I : MEANING OF CORPORATE GUARANTEE:

1.1 Definition and Structure:

A corporate guarantee is a contractual promise by one company (guarantor) to assume responsibility for another entity’s (principal debtor) obligations if that entity defaults, creating a tripartite relationship involving the guarantor, principal debtor, and beneficiary (lender/creditor).

Common Related Party Structures:

• Parent company guaranteeing subsidiary borrowings
• Holding company backing associate obligations
• Cross-guarantees between sister concerns
• Promoter entities supporting group companies

1.2 Business Rationale:

Legitimate Commercial Purposes:

1. Credit Enhancement: Enables entities with limited credit history to access institutional financing

2. Cost Optimization: Reduces borrowing costs through better interest rates (e.g., 2% annual savings on ₹100 crore = ₹2 crore)

3. Operational Necessity: Supports working capital facilities, performance guarantees, LC facilities

4. Strategic Requirements: Facilitates acquisitions, expansions, and project financing

5. Regulatory Mandates: Some sectors require parent guarantees for subsidiary operations

Critical Point: While “group benefit” is valid rationale, regulators increasingly demand demonstration of tangible benefit to the guarantor company itself, not just the group.

PART II: PROVISIONS UNDER COMPANIES ACT, 2013:

2.1 Section 186: Quantitative Limits:

Maximum Guarantee Limit = Higher of:

• 60% of (Paid-up Share Capital + Free Reserves + Securities Premium), OR
• 100% of (Free Reserves + Securities Premium)

Mandatory Requirements:

• Prior Board approval
• Special resolution if exceeding limits
• Complete disclosure in financial statements

Exemptions: Banking, insurance, NBFC, housing finance companies

Penalties: Company (up to ₹25 lakhs), Officers (up to ₹5 lakhs)

2.2 Section 188: Related Party Transactions:

Three-Tier Approval Process:

Tier 1: Audit Committee:

• Evaluates arm’s length nature and commercial rationale
• Assesses risk and compliance
• Provides recommendation to Board

Tier 2: Board of Directors:

• Considers after Audit Committee approval
• Interested directors must disclose interest and abstain
• Quorum excludes interested directors (minimum 2 independent directors required)

Tier 3: Shareholders (if Material):

• Required when transaction exceeds lower of:

– ₹1,000 crores, OR

– 10% of annual consolidated turnover

• Ordinary resolution (related parties cannot vote)
• Detailed explanatory statement required

Consequences of Non-Compliance:

• Transaction voidable at Board’s option
• Company can recover profits from related party
• Directors liable for losses
• Penalties up to ₹25 lakhs (company) and ₹5 lakhs (officers)

Professional Comment: The biggest mistake is assuming Section 186 approval alone suffices. Section 188 compliance is independent and mandatory for related party guarantees. Both must be addressed in approval documentation.

PART III: SEBI REGULATIONS (LISTED COMPANIES):

3.1 Material RPT Definition:

Materiality Threshold = Lower of:

• ₹1,000 crores, OR
• 10% of annual consolidated turnover

3.2 Enhanced Approval Requirements:

All RPTs:

• Prior Audit Committee approval mandatory
• Omnibus approval possible for repetitive transactions (valid one year)

Material RPTs:

• Shareholder approval through ordinary resolution
• Related parties must abstain from voting
• May require majority of minority approval
• Prior disclosure to stock exchanges

3.3 Disclosure Obligations:

Quarterly: Within 15 days of quarter-end, details of all RPTs to stock exchanges Annual: Comprehensive disclosures in Board Report and Annual Report Website: RPT policy publicly available

3.4 Practical Challenges:

Concentrated Promoter Holdings:

• When promoters hold 50-75%, their abstention significantly reduces voting pool
• Requires proactive engagement with institutional investors
• Need transparent disclosure and independent valuations

Professional Comment: SEBI’s 2022 amendments changed the game. Promoters with majority can no longer unilaterally approve material RPTs. If you can’t demonstrate genuine commercial benefit and fair pricing to minority shareholders, expect rejection. Transparency and robust justification are non-negotiable.

PART IV: GST IMPLICATIONS:

4.1 Corporate Guarantee as Taxable Supply:

Legal Position:

Under CGST Act, 2017:

• Section 7: Defines supply
• Schedule II, Entry 1(e): “Agreeing to obligation to refrain from an act, tolerate an act or situation, or to do an act” = Supply of services

Application: Corporate guarantee involves forbearance, tolerance of risk, and agreement to pay-constitutes supply of services

Classification:

• SAC Code: 997199 (Other financial services)
• GST Rate: 18% (9% CGST + 9% SGST or 18% IGST)

4.2 Valuation Scenarios:

Scenario A: Guarantee with Explicit Commission (Recommended):

When guarantee commission is charged:

• Taxable Value = Commission amount
• Tax Rate = 18%
• Time of Supply = Earlier of invoice date or payment receipt

• Total Invoice: ₹9.44 crores

ITC Availability: Recipient can claim Input Tax Credit if:

• Used for business purposes
• Making taxable supplies
• All Section 16 conditions satisfied

Group Impact: If subsidiary uses ITC, effective GST cost to group is minimal (only working capital timing difference)

Professional Comment: Charging explicit commission solves 90% of GST problems. Yes, it creates intra-group cash flow, but consolidated accounts eliminate it. The GST paid is recovered through ITC. Compare this with valuation disputes under Rule 28-explicit commission is the commercially prudent choice.

Scenario B: Guarantee Without Commission (Controversial):

The Problem: Many parents provide guarantees without charging commission, reasoning:

• “It’s our subsidiary”
• “Consolidated accounts eliminate it”
• “Group benefit is sufficient”

GST Law Response: Rule 28 Valuation

When supply is between related persons without consideration:

Step 1: Determine Open Market Value (OMV)

• What would unrelated parties charge?
• Bank guarantee rates provide benchmark

Step 2: If OMV unavailable, use:

• Value of like kind and quality supply, OR
• Cost-based valuation (110% of cost)

Tax Department Position: “Absence of consideration doesn’t mean absence of tax liability. Typical OMV: 1% to 2% of guaranteed amount per annum. GST @ 18% payable on this deemed value.”

Industry Counter-Arguments:

1. No Supply Without Consideration: Section 7 requires consideration; zero consideration = no supply

2. Corporate Benefit is Consideration: Parent benefits from subsidiary success

3. Double Taxation: Income Tax already imputes commission for TP purposes

4. Constitutional Issues: Taxing deemed supply may exceed GST constitutional limits

Current Status:

• Issue remains unresolved at policy level
• Authorities aggressive in assessments
• Litigation ongoing at various appellate levels
• No High Court/Supreme Court clarity yet

Typical Assessment Scenario:

For ₹500 crore guarantee over 3 years:

• Deemed commission @ 1% = ₹15 crores
• GST @ 18% = ₹2.7 crores
• Interest @ 18% for 3 years = ₹1.5 crores
• Penalty = ₹2.7 crores
• Total Demand ≈ ₹7 crores

Professional Comment: I’ve reviewed many show cause notices on this. Tax authorities apply 1% benchmark, demand GST retrospectively, add interest and penalties. Companies end up in lengthy litigation. All avoidable by charging nominal commission upfront. The “we didn’t know” defence doesn’t work-advance rulings have been public since 2018.

4.3 Place of Supply Rules:

Section 12 of IGST Act:

B2B Services: Location of recipient

Intra-State: 9% CGST + 9% SGST = 18% Inter-State: 18% IGST

Cross-Border Scenarios:

Export (Indian guarantor for overseas subsidiary):

• Zero-rated if consideration received in foreign exchange
• Conditions: Supplier and recipient in different countries

Import (Overseas parent for Indian subsidiary):

• Reverse charge mechanism
• Indian subsidiary pays GST @ 18%

4.4 Input Tax Credit Considerations:

ITC Available When:

• Used for business purposes
• For making taxable supplies
• All procedural requirements satisfied

ITC Blocked When:

• Personal use of directors/employees
• Non-business purposes
• Exempt supplies

Proportionate Reversal: If guaranteed entity makes both taxable and exempt supplies:

• ITC must be proportionately reversed (Rules 42 & 43)

4.5 Compliance Requirements:

Registration: Guarantor must have GST registration

Tax Invoice Must Include:

• Invoice number, date
• Parties details and GSTIN
• SAC Code (997199)
• Service description
• Taxable value, tax rate, tax amount
• Place of supply

PART V: INCOME TAX & TRANSFER PRICING:

5.1 Arm’s Length Principle:

Section 92, Income Tax Act: All transactions between Associated Enterprises must be at arm’s length price (ALP)

Application to Guarantees:

International Transactions: Always covered Domestic Transactions (SDT): If aggregate value exceeds ₹20 crores

5.2 Benchmarking Guarantee Commission:

Primary Method: Comparable Uncontrolled Price (CUP)

• Bank guarantee rates for similar credit profile
• Typical range: 0.5% to 2% per annum
• Adjust for risk factors

Factors Affecting Rate:

• Credit rating of principal debtor
• Guarantor’s financial position
• Quantum and tenure
• Collateral/counter-guarantees
• Industry norms

Recommended Rate Bands:

Risk Profile	Rate Range (p.a.)
Low Risk (AAA-rated, secured)	0.5% – 0.75%
Medium Risk (A-rated)	0.75% – 1.25%
Higher Risk (BBB-rated)	1.25% – 2.0%
High Risk (Below BBB)	2.0% – 3.0%

5.3 Consequences of TP Adjustment:

Primary Adjustment:

• Difference between actual price and ALP added to guarantor’s income
• Taxed at applicable rate (25.17% for companies)
• Interest under Sections 234A/B/C

Secondary Adjustment (Section 92CE):

• If primary adjustment exceeds ₹1 crore
• Excess deemed as loan/equity
• Additional tax implications

Section 56(2)(vii) Risk: If subsidiary receives guarantee without adequate consideration:

• Difference may be taxable as “income from other sources”
• Exception for 100% holding-subsidiary transactions

5.4 GST and Transfer Pricing Alignment:

Critical Convergence:

• Transfer pricing requires arm’s length commission
• GST requires open market value
• Rates should align to avoid dual disputes

Best Practice:

1. Conduct TP benchmarking study

2. Determine arm’s length rate (e.g., 1%)

3. Apply same rate for GST valuation

4. Document consistently across all filings

5. Maintain contemporaneous records

Professional Comment: Tax authorities increasingly coordinate. If you claim 0.5% for GST but TP study shows 1.5% as arm’s length, both departments will question. Conversely, if TP adds 1% but no GST paid, expect GST notice. Single rate, uniformly applied, comprehensively documented-that’s the safe approach.

PART VI: FEMA REGULATIONS:

6.1 Outbound Guarantees (Indian Entity for Overseas Entity):

Permitted Under:

• FEM (Non-Debt Instruments) Rules, 2019
• For direct investment in overseas JV/WOS
• For borrowings by overseas JV/WOS

Limits:

• Automatic Route: Up to 400% of net worth or USD 1 billion (whichever lower)
• Approval Route: Beyond automatic route (requires RBI approval)

Reporting:

• Form FC-GPR: Within 30 days of providing guarantee
• FLA Return: By July 15 annually

6.2 Inbound Guarantees (Overseas Entity for Indian Entity):

Generally Permitted, But:

• Should not create ECB implications
• If guarantee invoked and becomes debt:
  • ECB regulations apply
  • End-use restrictions must be satisfied
  • Minimum maturity requirements
  • Reporting mandatory

ECB End-Use Restrictions: Cannot be used for:

• Real estate activities
• Capital market investment
• Working capital (except specific conditions)
• Repayment of Rupee loans

Professional Comment: Inbound guarantees appear innocuous until invoked. Suddenly, corporate guarantee becomes ECB with all restrictions. If underlying loan was for prohibited end-use (e.g., working capital), company faces FEMA violation. Structure guarantees considering invocation scenario from day one.

PART VII: INSOLVENCY & BANKRUPTCY CODE:

7.1 Guarantor as Corporate Debtor:

IBC Position:

• Once guarantee invoked, guarantor becomes debtor
• Creditor can initiate CIRP if default exceeds ₹1 crore
• Moratorium declared; guarantor’s management suspended
• Resolution Professional takes control

7.2 Preferential & Undervalued Transactions:

Section 43 (Preferential Transactions):

• Lookback period: 2 years (related parties), 1 year (others)
• If guarantee given without consideration during lookback period
• Can be challenged if guarantor enters insolvency

Section 45 (Undervalued Transactions):

• Providing guarantee for inadequate consideration
• Within 2 years before insolvency
• May be declared void; restoration ordered

Defence: Transaction not avoidable if:

• In ordinary course of business
• Made in good faith
• For bona fide business purpose

Professional Comment: IBC changed everything. Previously, guarantors could delay and negotiate. Now, one default triggers insolvency weapon. This makes guarantee pricing critical-commission should reflect invocation risk. Also, documentation of commercial rationale is vital-not just for contemporary compliance, but for future defence if insolvency occurs.

PART VIII: BEST PRACTICES & RISK MITIGATION:

9.1 Pre-Guarantee Due Diligence:

Commercial Justification:

• Document specific business rationale
• Quantify benefits to guarantor
• Prepare risk-return analysis
• Board presentation with detailed analysis

Financial Assessment:

• Evaluate principal debtor’s creditworthiness
• Assess guarantor’s capacity to honour
• Stress test worst-case scenarios
• Analyse impact on financial ratios

Legal & Tax Structuring:

• Determine arm’s length commission rate
• Benchmark using TP study
• Align with GST valuation
• Draft comprehensive agreements

9.2 Approval Process Checklist:

Stage 1: Audit Committee

• Detailed proposal submitted
• Financial analysis reviewed
• Risk assessment conducted
• Arm’s length nature verified
• Recommendation documented

Stage 2: Board of Directors

• Audit Committee recommendation received
• Interested directors disclosed interest
• Interested directors abstained
• Independent directors participated
• Resolution passed with rationale

Stage 3: Shareholders (if Material)

• Notice with explanatory statement sent
• Ordinary resolution passed
• Related parties abstained
• Voting results documented

9.3 Ongoing Monitoring:

Quarterly Review:

• Financial health of guaranteed entity
• Loan repayment track record
• Covenant compliance
• Provision reassessment
• Early warning indicators

MIS to Board:

• Total guarantees outstanding
• Breakdown by entity
• Section 186 limit utilization
• Risk rating of each guarantee
• Defaults/concerns

CONCLUSION:

Corporate guarantees between related parties occupy the intersection of corporate law, tax regulations, and commercial reality. What begins as straightforward financial support creates compliance obligations across multiple frameworks-Companies Act, SEBI, GST, Income Tax, FEMA, IBC, and Accounting Standards.

The GST Challenge: The debate over guarantees without explicit consideration remains the most contentious issue. While industry awaits clarity, prudent approach is charging explicit commission at arm’s length rates-addressing both GST valuation concerns and transfer pricing requirements simultaneously.

Beyond Compliance: Corporate governance considerations demand that guarantees genuinely serve the guarantor’s interests, not merely facilitate related party benefit. Courts and regulators increasingly scrutinize commercial substance beyond procedural compliance.

IBC Impact: The Insolvency Code fundamentally altered risk calculations. Guarantee invocation can trigger swift insolvency proceedings, making comprehensive risk assessment essential rather than optional.

The Compliance Imperative: Companies approaching guarantees with proper evaluation, fair pricing, comprehensive documentation, and active monitoring will find them effective tools for group growth. Those treating them as routine formalities risk regulatory penalties, tax disputes, shareholder challenges, and insolvency consequences.

The regulatory landscape will continue evolving. Staying informed, adapting practices, and maintaining conservative compliance posture will serve companies well as they navigate this complex terrain.

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Disclaimer: This article is for informational purposes only and does not constitute legal, tax, or professional advice. Given rapid evolution in GST, transfer pricing, and corporate governance regulations, readers should verify current legal position and consult qualified professionals viz., company secretaries, chartered accountants, tax advisors, and legal counsel before implementing any guarantee structures.