What is corporate guarantee?
When it comes to taxation, corporate guarantee arrangements are one of the most litigative and complex topics to comprehend. This has been a contentious matter under both tax regimes, viz. indirect and direct taxes.
‘Corporate Guarantee’ is a very common term used in the corporate world. It is an arrangement where the parent entity agrees to act as a guarantor for its subsidiary company or group entity while securing loans/finance/ debts from a financial institution. As the name suggests, in such an arrangement, one corporate entity stands as a guarantor for another corporate entity. These arrangements are usually executed without any charges or consideration. The objective of such guarantees is to facilitate the group entity in its smooth business operations. In the open market, no other identical transactions take place except when banks give guarantees for its customers for specific purposes i.e. in the nature of financial guarantees etc. and also charge commission for the same. But in the case of corporate guarantees, usually no charges are paid by the recipient for these services. Moreover, such arrangements are unsecured in nature in a sense that no security is offered by the recipient to guarantor.
Very recently, there were reports about Directorate General of GST Intelligence (DGGI) sending tax demand notices to several local corporate houses over corporate guarantees given on behalf of their subsidiaries and to multinationals where they have given such guarantees for their Indian units.
Corporate guarantee – A deep dive
Service tax
As per section 65B of the Finance Act, 1994, ‘service’ means any activity carried out by a person for another for ‘consideration’. To begin with, it is pertinent to mention that in a landmark judgment, the Supreme Court (SC) in the matter of M/s Edelweiss Financial Services Limited has recently held that service tax is not leviable on the corporate guarantee provided by the assessee to its group companies without consideration. The SC stated that consideration is a must for levying service tax on a corporate guarantee, and thereby, upheld the Customs, Excise and Service Tax Appellate Tribunal’s (CESTAT) order in the said matter. The CESTAT had earlier held that for the purpose of taxability under the Finance Act, 1994, any activity must not only in relation to another, reveal a ‘provider’, but also the flow of ‘consideration’ for rendering of the service. In the absence of any of these two elements, taxability under Section 66B of the Finance Act, 1994, will not arise. The SC observed that this was a case where the assessee had not received any consideration while providing a corporate guarantee to its group companies. Further, no effort was made on behalf of the Revenue to assail the above finding or to demonstrate that the issuance of a corporate guarantee to group companies without consideration would be a taxable service.
This is a significant ruling that will set a precedence in similar matters and help resolve long drawn litigations on the issue under the erstwhile service tax regime.
However, in addition to the above scenario where there is no consideration, analysis is required where there is a flow of consideration for providing the corporate guarantee. In fact, there have been divergent views in this aspect in the service tax regime too. For example, in the case of M/s Olam Agro India Ltd, the Delhi CESTAT upheld the demand of Service Tax on the Corporate Guarantee Commission. Emphasis needs to be placed on paragraph 9 of the order pronounced on 31 July 2018, viz.
“9. A corporate guarantee is used when a corporation agrees to be held responsible for completing the duties and obligations of debtor to a lender, in case the debtor fails to comply with the terms of the debtor- lender contract. Whereas a bank guarantee is a promise from a bank that the liability of the debtor will be met in the event the debtor fails to favour his contractual obligations. Therefore, the nature of corporate guarantee as well as of bank guarantee is one and the same i.e. for facilitation of the lending facilities. It was noticed that M/s Olam Agro India Ltd, Singapore, the parent company has executed corporate bank guarantee in favour of banks in India for facilitation of lending of funds to the appellant and in lieu of the said guarantee the appellant paid 1 per cent of value of guarantee as commission to their parent company at Singapore by way of foreign exchange remittance and their parent company provided them debit notes on quarterly basis. The copies of the said debit notes clearly indicate the transactions with regard to lending facilities in India and therefore through Corporate Guarantee Commission the appellant are chargeable to Service Tax. And the commission paid was taxable under ‘Business Auxiliary Service’. Merely because the name of the guarantee has been changed from ‘Bank’ to ‘Corporate’ it cannot be said that it won’t fall under ‘Business Auxiliary Service’ as defined under Section 65 (105) of the Finance Act, 1994.”
However, the matter is pending at the Supreme Court level for disposal.
On the contrary, in the matter of M/s Sterlite Industries India Ltd, the Chennai CESTAT ruled in the favor of assessee. Reference may be given to below paragraphs quoted from the order dated 19 February 2019.
“6.6 From the facts on record, it is evident that the appellants did not provide “bank guarantee‟ to their associate companies in India, neither did they receive any “bank guarantee‟ from parent company abroad. What they provided / received was only a corporate guarantee to /from their associate companies for which exercise they had received / paid guarantee commission. The department has taken the view that Corporate Guarantee and Bank Guarantee are one and the same. We are however unable to agree to this proposition that a corporate guarantee is nothing but bank guarantee by another name. A bank guarantee is given by a bank on behalf of the customer to the beneficiary bank guaranteeing the payment in case of default by customer. A corporate guarantee is a guarantee given by the corporate to cover their own exposure or exposure of some other related entity to their bank. Bank guarantees are issued by Bank on a regular basis as part of their business of Banking. It is nobody’s case that appellant is doing the business of providing corporate guarantee on a regular basis. The corporate guarantee that was entered into by appellant is only for the limited purpose of securing loans to its subsidiaries. Corporate guarantees are issued in order to safeguard the financial health of their associate enterprises and to provide it support. For banks, providing bank guarantee is part of their regular course of business and they charge rate on the higher side. Further, these are fool proof instruments of security of the customer and failure to honour the guarantee is treated as a deficiency of services of the bank under banking laws. Corporate guarantee is actually an in-house guarantee and is not issued to customers generally.”
“7. Viewed in this light, we are of the considered opinion that the activity of issue of corporate guarantees by the appellant from their associate / subsidiary companies in India and also the procurement / receipt of corporate guarantee from their parent / associate company abroad will not come within the fold of section 65(12)(a) ibid and in particular sub-clause (ix) of that provision. The appellant succeeds on merits.”
Such conflicting decisions by the authorities have created doubts on the issue of taxability of corporate guarantee in cases where consideration exists in the transaction. The same may have bearing on litigations pending in the erstwhile regime.
Goods and Services tax (GST)
Under GST, supply is the taxable event for levying tax on goods and services. As per section 7 of the Central Goods and Services Tax Act, 2017 (CGST Act), supply includes all forms of supply of goods or services or both made or agreed to be made for a consideration by a person in the course or furtherance of business. Even under GST, there can be different arguments in relation to taxability of corporate guarantee. However, on plain and conjoint reading of relevant provisions, supply of corporate guarantee for a consideration does appears to qualify as a supply of service under GST.
- GST on corporate guarantee in case of absence of consideration
Let’s discuss the taxability of corporate guarantee arrangement given in favor of related parties where usually no consideration is involved. Under the GST law, clause (c) of Section 7(1) of the CGST Act provides that the activities specified in Schedule I, made or agreed to be made without a consideration are covered within the scope of the term ‘supply’. This includes supply of goods or services or both between related persons, when made in the course or furtherance of business.
To put it in perspective, under the GST regime, related party transactions even without consideration are treated as deemed supplies and are leviable to GST. In this regard, it is pertinent to note that while the SC has ruled that consideration is a must to levy tax on a corporate guarantee (in the matter of M/s Edelweiss Financial Services Limited supra.), this may create problems for the businesses under the GST regime. Therefore, the decision is likely to open Pandora’s box in cases of corporate guarantees provided by related parties as more assessees are likely to come under the Revenue’s scanner.
The rationale of absence of consideration applied by the apex court in service tax regime may not be applicable to the GST regime as provisions of Schedule I are absolutely clear in this aspect. Accordingly, the earlier argument in Service Tax Regime to counter the levy of tax on corporate guarantee may not hold ground. It appears that corporate guarantees, being a transaction between related person without consideration will be deemed as supply and will be taxable under GST.
In absence of consideration, one aspect that merits consideration is that corporate guarantee provided to a group entity located outside India may not qualify as ‘export of service’.
- Corporate guarantee – An ‘actionable claim’?
A view is also possible that corporate guarantee falls under the definition of actionable claim and therefore such an arrangement should be outside the ambit of supply as per Schedule III to the CGST Act. It has been stated in the GST law that ‘actionable claim’ shall have the same meaning as assigned to it in section 3 of the Transfer of Property Act, 1882 (4 of 1882). Section 3 of the Transfer of Property Act, 1882 defines actionable claim to mean:
“claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent.”
To place it in a lucid manner, actionable claim represents beneficial interest in movable property that is not in possession. It is an entitlement to a debt and the holder of the actionable claim enjoys the right to demand ‘action’ against any person.
Debt in commercial parlance is understood to be something for a certain sum of money. Corporate guarantee also appears to be in the nature of an unsecured debt contingent to an event. This debt can be claimed by banks from parent company in case subsidiaries fail to pay the loan amount. Hence, it may be contended that corporate guarantee qualifies as ‘actionable claim’. However, this aspect od classification of corporate guarantee as an actionable claim’ is yet to be tested in practical scenario both in GST and service tax. The same could be analyzed better once any precedent is there in public domain.
- As per another view, it has been categorically provided vide Circular No. 34/8/2018-GST dated 01 March 2018 that the services provided by Central or State Government to any business entity including PSUs by way of guaranteeing the loan taken from financial institutions against consideration in any form including guarantee commission shall be taxable. Accordingly, as per the view laid out in the circular, corporate guarantee commission shall qualify the parameters of supply under GST.
Valuation under GST on corporate guarantee in case of absence of consideration
Rule 28 of the CGST Rules, 2017, inter alia, provides that the value of supply shall be its open market value (OMV), if available. Else, it shall be the value of supply of goods or services of like kind and quality. It is pertinent to note that transactions of providing corporate guarantees are not usually provided to unrelated parties in open market and are provided to related entities only. The issue here is the determination of the OMV of the provision of corporate guarantee. In such a scenario, OMV may not be ascertainable for corporate guarantee. However, reference may be drawn from service of ‘bank guarantee’ (BG) which appears to be of like kind and quality as the corporate guarantee. In such arrangements, banks charge a particular percentage (as a commission) of the amount of BG issued and discharge GST on said commission services. Accordingly, percentage of commission used for BG purposes may be used for valuation of corporate guarantee. However, it should be noted that commission rates applicable on BG are determined on the basis of combination of various factors such as
-
- borrowing capacity,
- credit rating,
- loan amount,
- tenure of loan etc.
Though, it may be difficult to identify these factors in corporate guarantee arrangements since the same are not usually carried out in the normal course of business of a holding entity. Accordingly, it may be challenging to adopt a particular valuation basis BG rate.
Additionally, reference may be given to valuation derived in other statues, for example – arms’ length price adopted for the purpose of Transfer Pricing provisions under Income Tax Act, 1961.
However, the second proviso to Rule 28 states that where the recipient is eligible for full input tax credit (ITC), the value declared in the invoice shall be deemed to be the open market value Thus, one may adopt a reasonable value to discharge tax on corporate guarantee transactions in cases where said proviso is applicable.
Conclusion
In view of the foregoing, it would not be out of place to mention that there are a lot of doubts pertaining to taxability and valuation of corporate guarantee arrangements. This area is full of litigations and therefore, in order to give some relief and to strengthen government’s idea of ease of doing business, the department should come up with certain clarification or guidelines in this regard.
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