Corporate Guarantee GST: Can Taxable Event Recur Every Year? Gujarat HC

Corporate Guarantees under GST: If the Taxable Event Occurs on Execution, Can It Occur Again Every Year? – Analysing the Torrent Power Judgment

Summary: The Gujarat High Court’s judgment in Torrent Power Ltd Vs Union of India & Ors. provides important guidance on GST treatment of corporate guarantees between related entities, including the validity and operation of Rule 28(2) of the CGST Rules, 2017. While the Court upheld Rule 28(2), it read down the expression “whichever is higher” and also examined guarantees executed before the specific valuation mechanism took effect on 26 October 2023. This article focuses on an important issue arising from the judgment: whether a taxable event that crystallises when a corporate guarantee is executed can occur again every year merely because the guarantee continues. Paragraph 63 indicates that the levy gets attracted on execution because the creditor immediately acquires the contractual right against the guarantor and subsequent invocation does not create a new taxable event. Paragraph 114, however, observes that the taxable event occurs every year where the guarantee continues beyond the introduction of Rule 28(2). The article examines this apparent tension through the distinction between taxable event and time of supply, annual accounting disclosure, the annual valuation mechanism under Rule 28(2), Section 9, Section 13, Section 140(11)(b) and Article 265 of the Constitution. It also considers the position of guarantees executed in the pre-GST regime and the principle that a subsequent machinery or valuation provision cannot independently create a taxable event where the charging provision was not attracted.

This article does not attempt to analyse the entire judgment. Instead, it focuses on three interconnected aspects which, in my opinion, are particularly relevant for taxpayers having corporate guarantees that were executed before the introduction of the specific GST valuation mechanism.

A Brief Overview of the Torrent Power Judgment

In the Torrent Power case, the petitioners challenged, inter alia, the validity of Rule 28(2) of the CGST Rules, 2017.

Rule 28(2), as introduced for the valuation of services relating to corporate guarantees between related persons, provided a deemed value based on a percentage of the amount guaranteed or the actual consideration, whichever was higher.

The Gujarat High Court upheld the validity of Rule 28(2) but read down the words “whichever is higher“.

The reasoning was essentially that where actual consideration for the corporate guarantee is available, there appears to be no justification for requiring the taxpayer to substitute such actual consideration with a deemed valuation merely because the deemed value of 1% happens to be higher.

In other words, the deeming mechanism cannot operate to disregard actual consideration where such consideration is ascertainable[1].

The judgment also dealt with the question of guarantees issued prior to the introduction of Rule 28(2) and the GST implications of guarantees which continued beyond the date on which the amended valuation mechanism came into force.

The date 26th October 2023 therefore assumes considerable significance in the context of corporate guarantees.

The Court held that GST could not be demanded for the period prior to 26th October 2023, while recognising the permissibility of the levy in respect of continuing guarantees extending beyond that date, subject to the observations contained in the judgment.

However, certain observations concerning the taxable event and time of supply raise an important question which deserves closer examination.

Taxable Event and Time of Supply – Are They the Same?

One of the most important aspects of the judgment, in my view, is the distinction between the taxable event and the time of supply.

Paragraph 63 of the judgment contains an important observation regarding the point at which the levy in respect of a corporate guarantee gets attracted.

63. 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. Generally, in GST laws, a service ends when the service agreed under a contract has been completely performed and the contractual obligations are discharged. 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. Because this legal right materializes instantly on day one, tax levy gets attracted on the execution date. If the borrower defaults down the road and the guarantor actually has to pay the bank, that payment is merely a fulfilment of their pre-existing contract. It does not create a new taxable event or service.Hence, instead of leaving the determination of taxable event in a state of flux under Rule 13(5) in case of corporate guarantee, the taxable event and the time of supply have to be fixed on crystallised dates of execution of the corporate guarantee and its invocation.

From the above extract, it is clear that the taxable event occurs at the time of execution of the corporate guarantee deed and that any subsequent payment by the guarantor on default of the loan-taking company does not create a new taxable event.

For example, A, a holding company, executes a corporate guarantee agreement in the year 2016 in favour of XYZ Bank for a loan availed by its subsidiary company. In such a case, the taxable event, i.e., the supply of guarantee by the holding company, has happened in the year 2016 itself, as the bank gains the immediate right, on execution of the agreement, to demand payment if a default occurs.

Subsequently, if the subsidiary company defaults on the loan provided by the bank, the holding company, being the guarantor, is required to discharge the liability. Such payment by the guarantor would essentially be in fulfilment of an already existing contractual obligation. It does not, by itself, create a fresh corporate guarantee or a new taxable event.

Up to this point, it appears clear and there is no ambiguity.

The Observation in Paragraph 114

However, the very same Gujarat High Court, in paragraph 114, has held as follows:

114……..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 year as previously discussed.

Here comes the most conflicting point in the judgment.

In paragraph 63 of the judgment, the Hon’ble Gujarat High Court held that the taxable event is when the guarantee agreement is executed. However, in paragraph 114, the Hon’ble Gujarat High Court has held that the taxable event occurs every year. The judgement did not explicitly explain why the taxable event occurs every year. In this regard it is important to understand what led the Hon’ble Gujarat High Court to make these observations.

Further, it was held in paragraph 67 of the judgment that the guarantee service is not a continuous supply of services.

Why Did the Court Consider the Taxable Event Occurs Every Year?

In my humble opinion, the Hon’ble Gujarat High Court considering the following aspects might have stated that the taxable event occurs every year:

1. Continuing guarantee;

2. Section 13(2)(c) of the CGST Act, 2017 considers the date on which the recipient discloses the receipt of services in its books of accounts

3. Thereby the date on which the recipient discloses the guarantee will constitute time of supply

4. This disclosure is a continuing, recurring accounting obligation, not a one-time disclosure

5. Thereby time of supply to be determined in each year, as disclosure is made by the subsidiary company in each year

6. Rule 28(2) of the CGST Rules, 2017 provides for annual valuation.

In my understanding, the Hon’ble Gujarat High Court, after considering all the above aspects, has stated in paragraph 114 that the taxable event occurs every year.

Can Delegated Legislation Create a New Taxable Event?

However, the judgment raises an important question as to whether delegated legislation, such as Rule 28(2) of the CGST Rules, 2017, can create a fresh taxable event.

Section 9 of the CGST Act, 2017 provides for the levy of GST on the supply of goods or services or both. Therefore, there must be a taxable supply for the levy to arise. In the case of a corporate guarantee executed in 2016, if the taxable event is considered to have occurred on the date of execution, the question is whether GST can subsequently be levied in later years when there is no fresh supply or taxable event.

If the observation in paragraph 114 that the taxable event occurs every year is based on factors such as the continuing nature of the guarantee, annual disclosure in the books, the time-of-supply provisions and the annual valuation mechanism under Rule 28(2), a further question arises as to whether a valuation rule can itself result in a fresh taxable event.

Whether such an annual levy can be sustained merely on the basis of a rule providing for valuation, when the charging provision in the Act requires the existence of a taxable supply, is a matter that may require examination in the context of Article 265 of the Constitution, which mandates that no tax shall be levied or collected except by authority of law.

Delegated legislation is required to operate within the framework of the charging provisions of the parent Act. While Rule 28(2) may prescribe the manner of valuation of a taxable supply, whether it can create a fresh taxable event every year in respect of a guarantee executed earlier requires careful examination. Such a levy may also raise a question under Article 265 of the Constitution, which requires every tax to be levied and collected by authority of law.

Similarly, Section 13 of the CGST Act deals with the time of supply and determines when the tax becomes payable. It may therefore be argued that the time-of-supply provision cannot, by itself, create a new taxable event where there is no fresh supply.

Accordingly, if the taxable event occurred at the time of execution of the corporate guarantee and GST was not attracted at that point, it is necessary to examine whether the same levy can subsequently arise merely because the time-of-supply or valuation mechanism operates in a later period.

Corporate Guarantees Executed During the Pre-GST Regime

For a corporate guarantee executed back in 2016, the levy gets attracted in 2016 itself, i.e., in the pre-GST regime.

Further, as per Section 140(11)(b) of the CGST Act, 2017, no tax shall be payable on the services under the CGST Act, 2017 to the extent tax was leviable under the Finance Act, 1994, i.e., Service Tax.

As stated earlier, for a corporate guarantee executed back in 2016, the levy gets attracted in the Service Tax regime. GST cannot therefore be levied and collected even though the time of supply falls in the GST regime, as Section 140(11)(b) has an overriding effect on Section 13 of the CGST Act, 2017, which contains the time-of-supply provisions.

The Relevance of Vazir Sultan Tobacco

In the Vazir Sultan Tobacco judgment, the Hon’ble Supreme Court has held that when the levy is not attracted at the time of the taxable event, the same cannot be levied subsequently.

In other words, the levy that is attracted at the time of the taxable event will be final.

Applying this principle to a corporate guarantee executed in 2016, if the taxable event occurred when the guarantee deed was executed, the levy applicable at that point in time should determine the tax treatment. A subsequent provision relating to the time of supply should not, by itself, create a new taxable event.

The above is my understanding of the relevant observations in the Torrent Power judgment. The intention is not to question the judgment as a whole, but to examine and understand the distinction between the taxable event and the time of supply, particularly in the case of continuing corporate guarantees.

This issue, in my humble opinion, deserves further discussion and judicial consideration.

Summary of Taxability of Corporate Guarantee

Further to summarise the taxability of Corporate Guarantee

However, the above view can be highly disputable by the department and the views expressed in this article should be tested judicially

I would like to thank CA Shilpi Jain, Partner, HNA & Co LLP for her valuable insights and also my dear friends CA Divya Bala Vundipalli, and CA Vinay Kumar. J for their valuable inputs and reviewing this article.

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Disclaimer

The views expressed in this article are the author’s personal understanding and are intended for academic and professional discussion. They should not be construed as a definitive statement of law.

[1] Munjaal Manishbhai Bhatt Vs Union of India – 2022 (5) TMI 397 – GUJARAT HIGH COURT.