Corporate Guarantee under GST: Legal Challenges and Taxation

GST UNDER CORPORATE GUARANTEE: THE ‘BAD’ AND THE ‘UGLY’, AND A TALE OF CONTINOUS CHALLENGES

INTRODUCTION

Recently, the Delhi High Court staying consistent with its streak, issued notice and granted an ad interim stay against the GST Department and its efforts for recovery of GST levied on Corporate Guarantee. In the writ petition of Jindal Stainless (Hisar) Ltd. (now merged with Jindal Stainless Limited)¹ the Court duly observed that it has found identical subject matters regarding the challenge to such levy of GST on Corporate Guarantee and has taken a similar stance as it did in Sterlite Power Transmission Limited vs. Union of India² establishing that the issue with regards to corporate guarantees and GST needs to be examined further and taxability should be in consonance with the GST Act as well as the Constitution of India.

WHAT IS CORPORATE GUARANTEE?

The genesis of corporate guarantee comes from the concept of contract of guarantee which is defined under Section 126 of the Indian Contract Act, 1872. A contract of Guarantee is a contract to perform the promise, or discharge the liability of a third person, in case the third person defaults on the promise. So basically, the contract of guarantee has four essentials; a principal debtor who is liable to fulfil a promise, a creditor, to whom the debtor owes the promise and the surety, who is the third party who makes the promise or give guarantee to pay or fulfil the promise if the debtor defaults and of course, a lawful consideration. Further, Section 127 of the Act states that any action or promise made for the benefit of the principal debtor is enough consideration for the surety to provide a guarantee. This means that the principal debtor becomes the third person in the contract of guarantee and it is primarily between the surety and the creditor. And it can also be implied that since the surety’s guarantee is based on the aim of benefitting the debtor, in terms of companies, the two companies must be associated with each other. hence, a corporate guarantee is generally given by inter-group companies, where a holding company gives a guarantee to the creditor i.e. financial institutions against loans taken by its subsidiary or associated enterprise.

The discussion around corporate guarantee keeps pestering from the decision by the Hon’ble Supreme Court in the case of Edelweiss Financial Services Ltd. of 2022³. In this particular decision the Hon’ble Court contemplated about the taxability of corporate guarantee in the service tax regime. In the case the department had issued Show Cause Notices and argued that Corporate Guarantee falls under the ambit of ‘Service’ alleging that the companies involved are under ‘Banking and financial services’ and that though there was no monetary consideration, advantages such as improved credit ratings of the subsidiary, capital expansion and market benefits etc. The apex court, however, ruled against the department and observed that, issuance of a corporate guarantee by an inter group company without any consideration cannot be considered as a taxable service, hence, cannot be taxed under the service tax regime.

THE POST-GST ERA

In the post-GST era, the definition of supply holds much importance as the levy of GST as supply of goods and services is the taxable event to charge GST.

The term Supply under Section 7(1) of the CGST Act encompasses, 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 and import of services with consideration which does not necessarily include course of business or furtherance as well. Also, sub-section c, specifies that certain activities included in schedule I can be without consideration as well.

The Schedule I herein, specifically para 2 states that supply of goods or services between related parties or distinct parties is deemed as a supply without consideration.

ISSUES REGARDING THE INTERPRETATION OF CORPORATE GUARANTEE

There were a lot of issues regarding the rules which governed such levy of corporate guarantee as well. As we saw earlier, under Section 7(1)(c) and Schedule I, all supplies made between related persons in the course of their business are taxable, though made without consideration.

The taxability of such services is governed by Rule 28 of the CGST Rules. Amendments were introduced in October 2023⁴ to treat the issuance of intra-group corporate guarantees as taxable service and its value to be at an amount equal to either 1% of the amount so guaranteed or any actual consideration, whichever is higher.

Earlier, the issue is now ambiguous as there is no precedent at all about intra-group corporate guarantees under GST and service tax precedents cannot be applied here. Just like in service tax regime, corporate guarantees have been treated as “quasi-capital” or “shareholder activities Suzlon Energy Limited v. DCIT, ITA⁵ instead of services under income tax law. The OECD Guidelines for Multinationals and Tax Administration⁶ also finds reference to it.

In the present case of Jindal Stainless Steel, the petitioners have primarily contended against such taxability of corporate guarantee stating that, the activity of issuing a corporate guarantee does not qualify as a ‘supply’ under the CGST Act;

The petitioners have argued that as per section 7 of the CGST Act, ‘supply’ requires an actual positive act to be undertaken. Meaning of Supply under CGST Act Section 7 Under Section 7(1)(a) of the CGST Act, the term “supply” means “all forms of supply of goods or services or both”. The basic necessity for anything to be a “supply” is that it is a positive act of actual transfer, exchange or performance of goods or services. For the purpose of this section, a corporate guarantee will be considered a supply only if it is accompanied by an “actual act” of
the guarantor. Although a corporate guarantee is not, however, an instant service or act but a contingent commitment resting on the future event of the default by the borrower.

This, in turn, implies that without the default no actual service is rendered by the guarantor. During such a time when the borrower defaults, the role of the guarantor becomes passive; hence, under the terms required by Section 7 it is rather challenging to define a corporate guarantee as a “supply”. The argument, therefore is that the guarantee is not a positive action but a potential obligation contingent on an uncertain future event. Issuance of a corporate guarantee, according to the petitioners, a contingent contract under the Contract Act, 1872, wherein a guarantor enters to repay the loan only when the borrower defaults at the repayment stage. Under Section 31 of the Contract Act, the definition of a contingent contract is given: A contingent contract is a contract upon a mere happening of a specified event which may or may not happen. In essence, thus the action of a corporate guarantee matches this definition exactly since it is activated only at the time when the borrower defaults at the stage of the repayment. Because the guarantee is founded on an event that is uncertain, no liability arises immediately nor does any advantage to the creditor flow immediately from the guarantee. That is to say, until the contingency arises-that is, until the borrower defaults-the guarantor has not really provided any service. Thus, the supply under the CGST Act would essentially pertain to the offering of a tangible good or service, not merely an offer to supply the same, based on some event to be so, at a point of time in the future. In this regard, treating a corporate guarantee as a “supply” under the CGST Act would enlarge the definition of supply beyond the intended scope of the Act and in any case runs contrary to the principle that only upon real transactions and actual services can a tax be imposed.

Under the CGST Act, while considering whether a corporate guarantee is a supply, an element of “consideration” has to be taken into consideration. According to Section 2(31) of the CGST Act, “consideration” means any payment made or to be made, in respect of, in so far as relating to, any supply of goods or services. It also often does not involve an exchange of consideration between the lender and the guarantor, making it very hard to make the case for treating it as a supply. Other financial transactions, such as loans and even insurance, involve a direct mutual exchange of considerations, whereas a corporate guarantee itself will not give rise to any direct compensation except insofar as it is called upon. The lack of compensation at issuance reiterates the contingent nature of the contract. Even when a fee is applied, it doesn’t become “actual service” until the guarantee is performed. Thus, “supply” must coincide with an exchange in which the service or good is provided tangibly and not merely potential service.

However, the circulars of the Central Board of Indirect Taxes and Customs (CBIC) and the GST Council’s recommendations have made it clear that the legislature intends to tax such guarantees. However, many issues still continue to emerge and challenge such taxability
resulting into eminent litigation issues as discussed above.

ISSUES PERTAINING TO VALUATION

1. Overview of Valuation Rules related to Related Party Transactions Rule 28 of the CGST Rules prescribed guidelines under GST with respect to valuation of related party transactions. Rule 28(1) deems such transactions may be valued either at open market value or value of similar supplies. However where such values cannot be obtained, applications of Rule 30 or Rule 31 may be relevant. Rule 31 prescribes valuation by “reasonable means” in line with Section 15 of the CGST Act and also considering the broader provisions of the CGST Rules. In this context, Rule 31 is seen to relax Rule 30 in respect of suppliers who 5 need not resort to Rule 30 and instead adopt reasonable means under Rule 31 for services valuation.

2. This “reasonable means” approach, however, has been an area of concern, especially because open market or like-kind values are not readily ascertainable for corporate guarantees. However, if the recipient of the guarantee can claim full input tax credit (ITC), then “any value” on the invoice can be used as the deemed open market value under the second proviso to Rule 28(1).

NEW RULE 28(2) AND CBIC CIRCULAR NO. 204/16/2023-GST⁷

On 26th October, 2023, a new sub-rule (2) came to be added to Rule 28 wherein standard value is prescribed for corporate guarantee extended to related parties. The value for corporate guarantee should be either 1% of the amount of guarantee or actual consideration, whichever is higher. Circular No: 204/16/2023-GST clarifies that this rule is irrespective of whether the recipient is eligible for ITC or not.

1.) Impact and Industry Concern with Rule 28(2) While many taxpayers had been eager to hear some kind of guidance in setting clearer systems, Rule 28(2) has increased the burden which is cost-inefficient to taxpayers:

Industry’s Previous Approach: Earlier, the majority of taxpayers had maintained the GST on corporate guarantees at a very small percentage around 0.5% of the guarantee amount based on accepted transfer pricing practices or certified valuation reports. The rate was also accepted in earlier investigations as well wherein the authorities were generally closing the proceedings relating to such valuations. Rule 28(2) mandates a minimum of 1%, without any regard for such earlier practices. In Everest Kanto Cylinder Ltd. vs. Deputy/Assistant Commissioner of Income-tax [2024] (Bombay)[04-07-2024]⁸., the Bombay High Court had upheld 0.5% valuation of corporate guarantees differentiating them with an expensive bank guarantee. Similarly, the judicial ruling in Manugraph India Ltd. vs. Deputy Commissioner of Income-tax [2021] 126 taxmann.com 358 (Mumbai – Trib.)⁹ had approved a 0.5% valuation rate for arm’s length corporate guarantees. But rule 28(2), which does not include consideration for judicial precedents, would create the potential for controversy over the minimum 1 percent valuation requirement.

The effect would be the converse of that obtained in CBIC Circular No. 199/2023-GST ¹⁰, which had ruled that an even nil value could be taken as open market value under the proviso to Rule 28(1) when full ITCs are available to the recipient. Under the rules above, the operation of Rule 28(2) would override this requirement if the corporate guarantee need be valued at only 1% irrespective of availability of full ITCs. Such would lead to increased cost and burden of compliance and of course, litigation.

2.) Broader Consequences and Litigation Potential

Rule 28(2) may serve as an easier valuation where ITC is fully available since the additional GST paid would not result in cash outflow. Where the taxpayer cannot fully utilize ITC, the GST on corporate guarantees increases costs or results in an accumulation of unused ITC. The new rule would affect some taxpayers, appears to conflict with established judicial precedents, and deviates from earlier CBIC guidance. It may, therefore, attract court challenges from affected taxpayers. Taxpayers who cannot claim full ITC may experience cost increases, and this mandated 1% valuation is likely to become more of a point of contention than an initial grievance.

NEW NOTIFICTION 225/19/2024-GST¹¹

The GST council made a clarification during its 53rd meeting, held on June 22, 2024, that the facility of Rule 28(2) of the Central Goods and Services Tax Rules, 2017 concerning corporate guarantee issued between related persons is not available if either of the exports is involved, or recipient is eligible for complete ITC. After this recommendation, the Ministry of Finance issued Notification No. 12/2024 dated July 10, 2024 and Circular No. 225/19/2024-GST dated July 11, 2024 on taxability and valuation of intra-group corporate guarantees for GST purposes.

Important amendments and clarifications are summarized as follows;

1.) Key additions to the Valuation Rules

The Notification made several amendments to Rule 28(2) relating to intra-group corporate guarantees, which are hereby retroactive to October 26, 2023. Key amendments:

a. Proviso to Rule 28(2): This proviso stipulates that if the recipient of the corporate guarantee can claim full ITC, the value in the guarantor’s invoice is deemed the value of supply. This mirrors similar provisions for related-party transactions under Rule 28(1). But this benefit might not be attained by sectors whose receivers cannot exercise full ITC, such as the renewable energy and real estate sectors-whose supplies are either exempt (electricity) or whose ITC are blocked (construction services).

b. Limiting Applicability to Domestic Transactions: The amendment limits the applicability of the valuation rule to corporate guarantees issued to related persons “located in India.” This would benefit domestic corporates issuing guarantees for their offshore affiliates, as this does not apply to exports of services. Generally, export of services is zero-rated, subject to conditions like receipt of payment in foreign exchange or compliance with the exchange control laws. This change resolves issues on offshore guarantees issued without consideration.

c. Annual Valuation Basis for Corporate Guarantees: It is observed that in the amendment that the supply value for the intra-group guarantees is at 1% of the guarantee amount per year or actual consideration, which is more. Nothing is clarified as to whether there is an annual liability with regard to GST on corporate guarantees or the GST liability to be proportionally distributed during the guarantee’s term. It is a liability every year based on 1% of the guaranteed amount for each active year.

2.) Important Clarifications in the Circular

The Circular addresses concerns of the industry, though some matters, especially those related to previous periods, are left unresolved.

1. Guarantees issued or renewed prior to October 26, 2023: The valuation in cases of guarantees issued or renewed prior to October 26, 2023 must follow the pre-insertion of sub-rule (2) previous Rule 28. This would clarify subsequent periods but leave any uncertainty on earlier periods where practices varied risking potential litigation.

2. Partial Loan Disbursements and loan taken by new lender: In partial loan disbursements, GST is payable on the entire guaranteed amount when compared to the disbursed amount. The original understanding by the GST regarding the value of a corporate guarantee being independent of loan utilization is considered. There arises no additional GST liability where existing loan is taken over by a new lender, other than the situation wherein there is issuance of a new or renewed guarantee. That helps borrowers in bargain while availing of the better loans terms without facing the burden of extra GST.

3. If there are several co-guarantors to a loan, the GST paid would be based on each guarantor’s proportionate share of 1% of the amount guaranteed (or actual consideration if higher). In this way, there will not be a cascading GST levy across co-guarantors because the total GST on the guaranteed amount will not exceed 1%.

4. Reverse Charge Mechanism (RCM): GST on domestic corporate guarantees is payable under the forward charge mechanism, i.e., where an invoice is issued by the guarantor to the recipient. However, if a guarantee is issued by a foreign entity, the Indian recipient must pay GST in RCM. Industry stakeholders had demanded an RCM for domestic guarantees that should have lightened compliance burdens; it was not granted.

5. One-Time vs. Annual GST Payment: GST is paid in full at the time of issuance for guarantees issued for multiple years, although it is still calculated at 1% of the guarantee amount multiplied by the number of years. This obligates a bigger up-front GST liability, as the liability for the full term of the guarantee is payable in the first year. This is a huge burden on the taxpayer and is draconian in nature. Also, no justification has been given regarding perpetual/eternal guarantees, which may pose an issue when the guarantee contains no term limit and this will lead to litigation further.

CONSTITUTIONAL CHALLENGES TO THESE NOTIFICATIONS

The petitioners, in the case of Jindal Stainless Steel¹², have challenged the circular no. 204/16/2023, stating that it is ultra-vires of the provisions of the CGST Act. The justification given by them is that the levy of transaction does not fall into the ambit of supply. They have also argued that the said circular tries to eliminate the adjudicating authorities’ jurisdiction by issuing notifications which are adjudicatory in nature by placing reliance on Union of India v. Karvy Stock Broking Ltd.[2019] 11 SCC 631. They have also alleged that the circular no. 225/19/2024 is also ultra-vires as it involves retrospective application of tax.

In the said rules, in rule 28, with effect from the 26th day of October, 2023, –

a.) after the words, “who is a related person”, the words “located in India” shall be inserted.

b.) after the words “amount of such guarantee offered”, the words, “per annum” shall be inserted.

The petitioners have also alleged that Rule 28(2) of the CGST Rules are in contravention with Article 14 of the Constitution of India as it deliberately distinguishes in its approach with the nature of corporate guarantee between related persons and all other supplies of goods or services made between related persons. Further, the petition also states that corporate guarantees are actionable claims and therefore, do not fall under the ambit of supply as stated in Schedule III to the CGST Act. It can be argued that since it involves a contingent liability i.e., only to be fulfilled if a default is done by the subsidiary entity, hence, such transaction may be considered as actionable claim. But it is open to interpretation of the Courts. It is to be seen how the Hon’ble Delhi High Court deciphers the matter or the Hon’ble Apex Court jumps in.

CONCLUSION

While some certainty and relief was recognized from the recent clarifications, for instance, on exports and co-guarantors with split liabilities, significant parts of the guidance place additional GST burdens on intra-group guarantees. More broadly, this means other forms of contractual obligations such as put options in loan agreements, letters of comfort, indemnity bonds, and shortfall undertakings would also be liable to GST for intra-group guarantees. Judicial precedents in some cases have treated such obligations as “guarantees,” depending on contractual intentions. In summary, while the GST Council’s guidance clarifies several aspects of intra-group corporate guarantees, certain unresolved issues around timing, compliance, and taxation of complex guarantees remain and may lead to further industry discussions and potential legal challenges. The recent rulings will surely reach the Hon’ble Apex Court and perhaps the issue of applicability of GST on Corporate Guarantees shall be laid to rest. What shall be challenging after that, would be restructuring the Rules and clarifications according to the judgement.

Notes:

¹ W.P.(C) 14622/2024 Jindal Stainless Hisar Ltd. now merged with Jindal Stainless Ltd. v. Union of India & ors

² W.P(C) 2966/2024

³ [2023] 149 taxmann.com 76 (SC)

⁴ CIRCULAR NO. 204/16/2023-GST [F.NO. 20/06/22/2023-GST-CBEC], DATED 27-10-2023

⁵ Suzlon Energy Ltd. vs. Deputy Commissioner of Income-tax [2018] 95 taxmann.com 500 (Ahmedabad – Trib.)[22-12-2017]

⁶ OECD (2022), OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, OECD Publishing, Paris, https://doi.org/10.1787/0e655865-en.

⁷ Ibid pg.3

⁸ Everest Kanto Cylinder Ltd. vs. Deputy/Assistant Commissioner of Income-tax [2024] 165 taxmann.com 192 (Bombay)[04-07-2024]

⁹ Manugraph India Ltd. vs. Deputy Commissioner of Income-tax [2021] 126 taxmann.com 358 (Mumbai – Trib.)[10-09-2020]

¹⁰ CIRCULAR NO. 199/11/2023-GST [F. NO. CBIC-20001/5/2023-GST], DATED 17-07-2023

¹¹ CIRCULAR NO. 225/19/2024-GST [F. NO. CBIC-20001/4/2024 – GST], DATED 11-07-2024

¹² Taxsutra, “Delhi HC’s interim-relief in challenge to GST on Corporate Guarantee by Jindal Stainless Ltd. Oct 22, 2024”. https://www-taxsutra-com./news/delhi-hcs-interim-relief-challenge-gst-corporate-guarantee jindal-stainless-ltd