Nimish Chitalia
Before understanding GST aspects on Corporate Guarantee, it is important to understand the Corporate Guarantee. The term ‘Guarantee’ is defined in the Indian Contract Act, 1872 that is a “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default. This article delves into the complexities of Corporate Guarantees under GST, examining the legal nature, tax implications, and recent legislative clarifications.
Although guarantees are common, the tax treatment of Corporate Guarantee arrangements can be complex. However, before jumping to the tax analysis, it is first important to understand the nature of the Corporate Guarantee arrangements and their legal effect. Once the legal nature of the various Corporate Guarantee relationships are understood, the tax analysis can be applied. However, even then difficulties can emerge in determining the tax effect of Corporate Guarantee arrangements given the lack of case laws, guidance and legislative provisions specific to Corporate Guarantees.
The Corporate e Guarantee is a legal instrument (Surety instrument) is issued by holding company (Guarantor) on behalf of its wholly owned / subsidiary / associated company who enters into a contact with its client. The Corporate Guarantee is characterized with a feature which is spell out explicitly to indemnify the interest of the client if wholly owned / subsidiary / associated company fails to perform its obligations in terms of the contract with its client. In case a failure to perform, then Guarantor compensates to the client the amount mentioned in the Corporate Guarantee. The client may be a domestic bank, F.I, lender or provider of money or any party which is a firm, a company which enters into supply / service agreement with wholly owned / subsidiary / associated company. The moot question arises how can Corporate Guarantee qualifies for taxability under GST laws. The Scope Of Supply under Section 7(1)(a) of CGST reads as
“ (1) For the purposes of this Act, the expression “supply” includes (a) 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;”
On reading, Section 7(1)(a) it is clear that Corporate Guarantee is not a sale as Corporate Guarantee is not a commodity / article / materials which can be sold in the market, Corporate Guarantee is not transferable in any forms, nor can be put up for barter exchange, is not a licence, not rental, not a lease or nor disposal made or agreed for any considerations, nor it is in ordinary course of business and nor its tantamount to furtherance of business. So guiding principles to qualify a Corporate Guarantee as a scope supply under this section of CGST is misleading and misnomer.
The bank guarantee (BG) has similar features as that of Corporate Guarantee, however BG is governed as per RBI rulesThe Corporate Guarantee cannot be at par with bank guarantee as bank guarantee is governed by RBI and it is referred in Section 2(75) of CGST Act also. GST is applicable on commission / fees paid by the applicant of the bank guarantee. Corporate Guarantee is in house arrangement does not attract commission / fees.
As mentioned above Corporate Guarantee is to protect interest of the client, if fellow group company fails to perform contractual obligations entered into with its client. For the holding company the Corporate Guarantee is a contingent liability which reflects in the balance sheet of the company. There cannot be any GST on the contingent liability.
Under the Service Tax regime, Corporate Guarantee faced no taxes if no consideration was involved. Some taxpayers argued that these guarantees were akin to actionable claims and fell under Schedule III of the CGST Act, 2017. According to this view, as they neither constituted the supply of goods nor services, they were not liable to GST. Additionally, there was a lack of clarity on how to assess GST when a holding company provides a Corporate Guarantee to a subsidiary without receiving any consideration.
Vide Circular No. 204/16/2023-GST dated 27th October 2023, CBIC clarified that where the Corporate Guarantee is provided by a company to the bank/financial institutions for providing credit facilities to the other company, where both the companies are related, the activity is to be treated as a supply of service between related parties. Further, in case where no consideration is charged for the said activity, it still falls within the ambit of ‘supply’ in line with Schedule I to the CGST Act. For valuation of this supply, a new sub-rule was inserted to Rule 28 of the CGST Rules, 2017 vide Notification No. 52/2023-Central Tax dated 26th October 2023. Vide this Rule, the value of supply of such services was prescribed as 1% of the amount of such guarantee offered, or the actual consideration, whichever is higher.
Rule 28(2) of CGST is in contradiction of Section 7(1)(a). When Corporate Guarantee is not defined under ‘scoprr of supply’ then its valuations is not possible. The insertion of sub rule (2) of Rule 28 of CGST is by forceful on holding company as Corporate Guarantee is not service at all in the hands of the recipient which is the related person (fellow group company / subsidiary of the holding company) as this Rule states.
It should be well understood that Corporate Guarantee is not the service but it is surety. The surety has a future tense does not qualify for GST at all in current context. Can GST on future liability be measured at current date. The Corporate Guarantee is in the nature of a contingent which is not enforceable till the guarantee is enforced by the client.
The value of enforcement is not dependent on the value of the guarantee and it is only where the guarantee is enforced that the issue of service may arise in form of liquidated damages under para 5 (e) of Schedule II of CGST Act in hands of fellow associate company by whose default the Corporate Guarantee is encashed by the client. There are many questions associated whether the clarification on taxability and deemed valuation of this activity on Corporate Guarantee is justified especially in light of the ongoing lack of clarity surrounding the basic parameters for levy of GST viz. ‘supply’, ‘recipient’, ‘valuation’, ‘time of supply’ (that is when to pay now or at time of actual consideration that is at time of invocation), ‘place of supply’ and of course ‘retrospective application of the amendment’.
There are few landmark judgments on Corporate Guarantee such as the judgment by CESTAT, Chennai in one of its own case M/s Sterlite Industries India Ltd vs Commissioner of GST & Central Excise (Appeal No. ST/40042/2013 dated 19th February 2019), wherein it was observed that provision of a Corporate Guarantee to an associate company is like an in-house guarantee and does not amount to providing any services as such. The Supreme Court Order in Commissioner of CGST & Central Excise Vs. M/s. Edelweiss Financial Services Ltd [Civil Appeal (Diary No). 5258/2023 dated 17th March 2023] wherein it was held that issuance of Corporate Guarantee to a group company without consideration would not fall within banking and other financial services and was thus held to be non-taxable service.
If Deptt wants to levy GST 18% on 1% of the amount of such guarantee offered, or the actual consideration, whichever is higher, then holding company is allowed to factor Net present value (NPV) concept to arrive at GST liability in books at present context. Let us see this with a simple example.
Holding company say ‘X’ issued Corporate Guarantee on behalf of its subsidiary company ‘Y’ in favour of a bank (beneficiary) for loan agreement between ‘Y’ and beneficiary. The loan amount is INR 300 Cr to finance a renewable solar project. The loan agreement is for tenure 10 years for which Corporate Guarantee is issued for underlying transaction for 10 years to the lender. As per Rule 28(2) of CGST, X is now liable to pay 18% GST on 1% of Rs. 300 Cr that is Rs. 0.54 Cr or Rs. 54 Cr as actual consideration (whichever is higher) payable say at end of 10 year. The X will land up paying Rs. 54 Cr as GST amount to the Ex Chequer. The GST liability to X which is to be paid at end of 10 th year assume that Y will default on repayment of Rs. 300 Cr loan to the bank. The X will discount the interest rate @12% p.a for 10 years of GST liability of Rs. 54 Cr and shall pay now to the tune of Rs. 17 Cr (18% of Rs. 97 Cr).
In absence of applicability of Section 7(1)(a) on Corporate Guarantee, the Section 9 of CGST cannot be applied. Further, Corporate Guarantee is contingent in nature if at all GST to be levied for future transaction then N.P.V. of future GST liability be considered to discharge it in present context. The period of invocation of Corporate Guarantee will determine timing of supply of service to the beneficiary while timing of supply of service is unascertainable in today’s context. What if holding company issued Corporate Guarantee to foreign banks / FII or lenders? Is it then considered as import of services?
In 53rd GST Council meeting, it is clarified that In respect of valuation of Corporate Guarantee, existing rule 28(2) is to be amended (retrospectively from 26 October 2023) and a circular to be issued to address various issues regarding valuation of Corporate Guarantee. But the Council needs to weigh the pros and cons before taking any decisions on taxability on Corporate Guarantee.
In conclusion, unraveling the impact of GST on Corporate Guarantee has revealed crucial insights into the GST tax implications associated with this legal instrument (Surety instrument). By doing so, the tax revenue share in GDP may increase at cost of doing business in India.
Since Corporate Guarantee is considered in transfer pricing under Income Tax Act, should it be necessarily included in Indirect Tax laws. Qualifying Corporate Guarantee as ‘business service’ is flawed and skewed approach to get tax revenue. Chargeability of GST on Corporate Guarantee is against Constitution of India Article 269A.
It is urged to the Ministry of Finance to look into arbitrary nature of GST provisions related to Corporate Guarantee and focus on easy of doing business and not to easy of penalizing the businesses to company.
