Summary: The Gujarat High Court in Torrent Power Ltd Vs Union of India & Ors. held that corporate guarantees furnished by a holding company to its subsidiary constitute a supply of services under the CGST Act and are subject to GST. Rule 28(2) of the CGST Rules, 2017 was held intra vires the CGST Act and Articles 14, 19(1)(g) and 265 of the Constitution, except that the expression “whichever is higher” was read down as arbitrary and ultra vires. The Court held that the levy of GST under Rule 28(2) on corporate guarantees furnished before 26 October 2023 is violative of Articles 14 and 19(1)(g), while the levy applies from that date where guarantees continue. Section 15(4) of the GST Acts was upheld as intra vires. The Court also held that corporate guarantees are not continuous supplies of services and that the relevant service is rendered in the capacity of an Insolvency Professional? [Not applicable.] The impugned Circulars dated 27.10.2023 and 11.07.2024 were set aside to the extent they contradicted the Court’s observations and directions. The Court further found the invocation of Section 74 in respect of a pre-GST corporate guarantee to be arbitrary and tainted with non-application of mind.
Rule 28(2) Corporate Guarantee GST Levy Read Down; Pre-2023 Levy Set Aside: Gujarat HC
- Background
- Observation and Findings
- Meaning & Functional Operation of Corporate Guarantee
- Levy of GST Under Provisions of CGST Act
- Whether Issuance of Corporate Guarantee is “Business” of Holding Company
- Nature of Corporate Guarantee Goods vs Services
- Whether Corporate Guarantee is Actionable Claim
- Time of Supply of Service of Corporate Guarantee
- Whether Corporate Guarantee is Continuous Supply of Service
- Constitutional Validity of Rule Levying GST on Corporate Guarantee
- Retroactive vs Retrospective
- Validity of Circulars Dated 27.10.2023 & 11.07.2024
- Invocation of Section 74 of GST on the Corporate Guarantee
- Conclusion of the Court
Background
Group of writ petitions, challenging the Rule 28(2) of CGST Rules 2017 and CGST act 2017, declare the provisions of Rule 28(2) of the CGST Rules and Section 15(4) of the Act, as ultra vires to Articles 14, 19(1)(g) and 265 of the Constitution of India along with the validity of the Circulars dated 27.10.2023 and 11.07.2024 issued by Central Board of Indirect Taxes and Customs (CBIC) issued by the Central Board of Indirect Taxes and Customs(CBIC)
Observation and Findings
Meaning & Functional Operation of Corporate Guarantee
The corporate guarantees furnished without consideration are standard, non-commercial interventions within corporate groups. A Holding Company issues such guarantees in favour of financial institutions as collateral security to facilitate the smooth financial functioning of, and support the credit requirements of, its subsidiaries.
Structurally, a corporate guarantee is a tripartite arrangement involving the principal debtor, the creditor bank, and the surety i.e. the Holding Company. Such an arrangement effectively encompasses three distinct yet interlocking contracts:
1. Principal contract: a primary contract between the subsidiary company(principal debtor) and the creditor bank.
2. Secondary contract: A collateral agreement between the creditor bank and the surety Holding Company, which forms the primary basis of the corporate guarantee.
3. Implied contract: An implied agreement between the surety Holding Company and the subsidiary company, legally obligating the subsidiary to indemnify the surety if the surety is forced to perform or pay the debt.
Levy of GST Under Provisions of CGST Act
Section 145 of the Indian Contract Act, 1872 contains implied promise to indemnify surety, and prerogative of surety recover the sum from the principal debtor. Once the guarantor Holding Company settles the debt of the defaulting subsidiary, it steps into the shoes of the creditor bank. By operation of law, the surety Holding Company is then vested with all the rights that the creditor bank originally held against the principal debtor, namely, the subsidiary. This constitutes the connecting link for treating the arrangement as a ‘supply of service’ by the Holding Company to its subsidiary and, consequently, brings it within the scope of “supply” under Section 7(1)(c) of the CGST Act read with Article 2 of Schedule I to the CGST Act.
Whether Issuance of Corporate Guarantee is “Business” of Holding Company
Explanation to sub-section 5(a)(i) to (v) of the CGST Act would encompass a Holding Company and its subsidiary company, which provides that persons shall be deemed to be “related persons” if one of them directly or indirectly controls the other.
However, lending of money or loan is not holding company’s core or main business, the expression “in course or furtherance of business under Article 2 of Schedule, and definition of “business” will not get attracted.
The activity will encompass actions connected to the core business of the Holding Company, and will also include the action supporting the main business activity, which is connected to its subsidiary. the execution of the corporate guarantee by Holding Company is an integral part of safeguarding the financial interest of its subsidiary. The main activity of Holding Company may not be business of lending money, however, extending the guarantee is “business” even though the motive of profit is excluded, is an extension of its business interest. Thus, the activity of the Holding Company in giving the corporate guarantee to its subsidiary, which enables it to secure loan for its commercial activities will be an activity incidental to “similar activity” to trade, commerce etc., and hence qualifies “business”.
Nature of Corporate Guarantee Goods vs Services
Now to deliberate whether the activity of executing a corporate guarantee falls within the ambit of Section 7(1)(a) of the CGST Act,to be treated either as a supply of goods or a supply of services. a corporate guarantee as sought by the subsidiary from the Holding Company and acknowledged by the Holding Company for fulfillment of its financial security will fall within the expression “agreeing to do an obligation to do an act”.(Sch II, entry 5(e’).
Though the subsidiary company may not be a party to the contract of corporate guarantee, the supply of services ultimately accrues to and is rendered for the benefit of the subsidiary company. Accordingly, the subsidiary company would be a “recipient” of the services under the corporate guarantee, thereby satisfying the requirements of Section 2(93) of the CGST Act.
Whether Corporate Guarantee is Actionable Claim
A corporate guarantee is contingent in nature, it does not stricto sensu falls under actionable claim as defined under section 3 of the TP Act, 1882. A corporate guarantee cannot be dragged into an actionable claim, through definition of ‘debt’ under Article 366(8) read with IBC code, but its legal entity in context of GST laws is established through the provisions of TP Act and Contract Act.
The pledge agreement reveals the intention the holding-company-petitioner. It is manifest from the pledge agreement that the intention of the Torrent Power Ltd (Pledgor) is to secure the obligations and allows share appropriation upon default by its subsidiary (Jodhpur Wind Farms Pvt.Ltd) to satisfy the debt from the lender-bank-IDBI. This arrangement/obligation in the pledge agreement satisfies the ingredients of Sections 126 and 172 of the Contract Act. Since GST law is unconcerned with how a promise is secured, tax liability arises immediately upon extending the guarantee.
Time of Supply of Service of Corporate Guarantee
Section 13 of the CGST Act determines the time of supply of services, which is linked to invoice date or payment date, which would not be linked to the actually ending of service. The corporate guarantee is treated as a service provided by the guarantor (promisor) to the principal debtor/creditor. This service officially begins and fulfills its “time of supply” on the exact date the contract is signed (executed), not over time. The moment the contract is signed, the creditor gains the immediate right to demand payment if a default occurs. In case of execution of corporate guarantee, the provisions of Section 13(2)(a) and 13(2)(b) of the CGST Act will not apply, but the time of supply has to be determined by resorting to Section 13(2)(c) of the CGST Act which stipulates the date on which the recipient shows the receipt of services in his books of accounts, as the time of supply of services. The outstanding amount of debt as reflected in the books of accounts by the subsidiary for each financial year will be supply of service triggering the valuation mechanism under Rule 28(2) of the CGST Rules.
Where there is no actual consideration involved, once the corporate guarantee deed is executed by the guarantor, the activity of provision of guarantee is crystallized. It is only the operation of the guarantee that is continuous over a period. Thus, the benefit of the guarantee accrues to the principal debtor at the time of execution of the contract of guarantee by the surety with the creditor.
Whether Corporate Guarantee is Continuous Supply of Service
In a corporate guarantee, the Holding Company undertakes a continuous obligation to support the subsidiary until the guarantee is invoked, revoked, expires or is discharged. The guarantor-Holding Company does not render supply of service continuously or on recurrent basis with periodic payment obligations. Therefore Corporate guarantee is one time undertaking, with continuing obligation, the quintessential feature of periodic payment is absent. And hence corporate guarantee do not bring it within the scope of the definition of continuous supply under Section 2(33) of the CGST Act.
Constitutional Validity of Rule Levying GST on Corporate Guarantee
Rule 28 of the CGST Rules governs the valuation of supplies of goods and services between distinct or related persons. Rule 28(1)(a) of the CGST Rules stipulates the “open market value” as the principal yardstick. Section 15 of the CGST Act deals with the ordinary transaction-value principles under Section 15(1) of the CGST Act and specialized valuation methodologies prescribed under Sections 15(4) and 15(5) of the CGST Act for unique or complex commercial supplies. A combined reading of the provisions of Section 2(87), Section 15(5) of the CGST Act manifest that valuation of supply of corporate guarantee culminates in Rule 28(2) of the CGST Rules between related persons like Holding Company and the subsidiary. And therefore rule 28(2) is statutorily valid, as the same is sourced from Sec 164.
Rule 28(2) of the CGST Rules, which begins with non-obstante clause completely bypasses this flexibility stipulated under Rule 28(1) of the CGST Rules, and the taxable value for a corporate guarantee is mandated to be deemed at 1% of the total guarantee amount offered, or the actual consideration, whichever is higher. In the provision of Rule 28(2) of the CGST Rules, after deeming fiction of one per cent per annum, expression “actual consideration” is separated by word “or” and followed by “whichever is higher”. The fixation of benchmark of value of corporate guarantee at 1 per cent, even if the “actual consideration” may be lower than 1 per cent appears to be unreasonable and arbitrary. if the actual values are not ascertainable, a uniform charge can be applied. there will also be scenarios wherein different charges/commissions charged by Banks/financial institutions can also be higher than 1% as recognised by the GST council. This may also lead to litigation. The Supreme Court in case of Coal India Limited Vs. Saroj Kumar Mishra, 2007 (9) SCC 625 has held that “Only because, there is a possibility of floodgate litigation, a valuable right of a citizen cannot be permitted to be taken away.”. Hence, court find that the expression used in Rule 28(2) of the CGST Rules to the extent “whichever is higher” after fixing 1% flat value along with “actual consideration” is arbitrary and is hit by Article 14 and 19(1)(g) of the Constitution of India, and is ultra vires to the extent of ““whichever is higher” in the rule.
Retroactive vs Retrospective
introduction of Rule 28(2) of the CGST Rules w.e.f 26.10.2023 is retroactive, as it applies to those corporate guarantees which are executed prior to its introduction. “Nova constitutio futuris formam imponere debet, non praeteritis”, which means a new law should be prospective, regulating future conduct rather than altering past transactions. The retroactive effect impinges the fundamental rights under Article 14 and 19(1)(g), since the levy is unduly harsh and unfair, as taxpayers arrange their financial affairs based on the prevailing law.
The collection of tax for the period prior to introduction of Rule 28(2), will also be hit by the doctrine of unjust enrichment, since the revenue had no legal basis or authority to levy GST on corporate guarantee, which were executed prior to the date of introduction. However, the levy is permissible, if the period crosses the date of introduction of Rule 28(2), as the taxable event occurs every years as previously discussed.
Validity of Circulars Dated 27.10.2023 & 11.07.2024
The source of levy is imbued in the statutory provisions, and as held by the Apex Court the Circulars merely operationalise and clarify the statutory framework, and FAQ incorporated there is only a guide to understand the provisions and would not confer any independent right contrary to the enactment. Since, we have explained the working of the statutory provisions, by adopting the rule of harmonious constructions, and have read down the expression “ whichever is higher”, the same would alter the FAQs of the Circulars.
Invocation of Section 74 of GST on the Corporate Guarantee
The show cause notice under Section 74 of the CGST Act and order passed, is premised on the expression “suppression of facts” and demands interference by this Court in light of the foregoing observations. In the instant writ petitions, there is a disputed interpretation about the operation of Rule 28(2) of the CGST Rules read with the enabling provisions of the GST Acts along with the provisions of the Transfer of Property Act. In such a scenario, the observations of the Supreme Court, “When facts were known to both the parties, the omission by one to do what he might have done and not that he must have done, would not render it suppression,” may come to the aid of the petitioners. It further held that mere failure to declare does not amount to willful suppression. the critical facet of ‘willful suppression’ executed with a specific intent to evade tax must be rigorously examined. In one of the captioned writ petitions, the revenue has invoked the provisions of Section 74 of the CGST Act by issuing a show cause notice to the corporate guarantor, in respect of a corporate guarantee which was executed pre-GST regime on 12.02.2012. Hence, the action of the revenue in resorting to the provisions of Section 74 of the CGST Act is arbitrary and is tainted with non-application of mind.
Conclusion of the Court
A. The provision of Rule 28(2) of the GST Rules, 2017, is held to be intra vires CGST Act and Article 14, 19(1)(g) and 265 of the Constitution of India, except to the extent that the expression “whichever is higher” shall be read down.
B. The levy of GST on the corporate guarantee furnished prior 26th October, 2023 under Rule 28(2) is declared violative of Article 14 and 19(1)(g) of the Constitution of India, however, levy gets attracted from this date in case the guarantees continue.
C. Section 15(4) of the GST Acts is held to be intra vires.
D. The clarification issued vide impugned Circulars dated 27.10.2023 and 11.07.2023 is set aside to the extent it runs contrary to the observations and directions issued by this Court.
