CA Rohit Surana & CA Sunayna Banthia
GST ON CORPORATE GUARANTEE has come out to be one of the most burning litigations after the Hon’ble Supreme Court’s pronouncement in the case of Commissioner of CGST of Central Excise Vs Edelweiss Financial Services Ltd. [C.A. No. 001769 / 2023, Date of Judgement: 17-03-2023]. This landmark judgement stated and acknowledged the concept of “consideration” as being crucial for taxability of services under the Service Tax Act, 1994. It is pertinent to note herein that there was no ‘deemed supply’ concept under service tax unlike GST Law where Schedule I of CGST Act, 2017 provides that certain activities between related and distinct persons shall be treated as supply under GST even if made without consideration. Thus, it is palpable that question on taxability of corporate guarantee shall arise under GST laws in terms of above Schedule. Various department notices have been issued recently creating an impugned demand to corporate houses. In light of this discussion, it is pertinent to analyze the relevant legislations in GST law in view of the Apex court judgement.
To understand the taxability of corporate guarantee in GST laws, let us first go through the concept of corporate guarantee.
I. What is Corporate Guarantee?
A corporate guarantee is a contract between a corporate entity or individual and a debtor. In this contract, the guarantor takes responsibility for the debtor’s obligations, such as repaying a debt. Supposedly, if a parent company guarantees loan repayment for its subsidiary company, if the subsidiary fails to repay the loan; the parent company shall be liable to pay the loan on its behalf. These include inter-group corporate guarantees given for smooth financial functioning in a company. These are purely based on the requirements of the group and are generally given by parent company to subsidiary without any consideration.
II. Types of Corporate Guarantee
a. Upstream Guarantee: In this, the parent company receives a guarantee from a subsidiary or multiple subsidiaries; it is a financial guarantee in which the subsidiary guarantees its parent company’s debts. Such a guarantee may be required by a lender when the company’s primary asset base is its ownership in the subsidiary itself.
b. Downstream Guarantee: The parent company here, guarantees the subsidiary company’s debts. A downstream guarantee can be undertaken in order to help a subsidiary company obtain debt financing. In the event, that the borrowing entity is unable to make good its repayments, the guarantee requires the parent company to repay the loan.
c. Cross Guarantee: Cross guarantee refers to an arrangement between two or more related companies to provide a guarantee to each other’s obligations. Such a guarantee is commonly made among companies trading under the same group.
It may also be noted herein that a corporate guarantee is very different from bank guarantee. A corporate guarantee is a guarantee in which one corporate undertakes to be responsible for the financial obligations/contractual obligations by the debtor to the creditor, in case the principal debtor fails to meet its obligations or performance. Whereas, bank guarantee on the other hand, is a guarantee given on behalf of the applicant to cover a payment obligation to a third party. Corporate Guarantee are issued without any security or underlying assets whereas banks requires collateral security for providing such service.
III. Corporate Guarantee under Goods and Service Tax Act: –
Leviability of tax under the Goods & Service Tax Laws accrues when a supply takes place. Section 7 of the CGST Act, 2017 provides for scope of supply wherein it states that “supply includes all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.” Further clause (c) of sec 7 of the Act, expressly provides that “supply includes” the activities specified in Schedule I , made or agreed to be made without a consideration.
Thus, as per the definition produced supra, there are three essential elements to form a ‘supply’:
a. It should be in the nature of transfer or sale etc. of Goods or Service.
b. There must be a Consideration involved subject to Schedule I of the Act.
c. It should in the course or furtherance of business.
a. Whether providing guarantee is in the nature of a supply of service? Service” is defined under the CGST Act, 2017 as “anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;”
The definition of service is too wide to cover anything and everything that does not fall within the definition of “goods. However, the issue of whether the issuance of corporate guarantee is in itself a ‘service’ or not still remains unresolved. While dealing with the same issue under Income tax Act, the Hon’ble ITAT, Ahmedabad, in the case Micro Inks Ltd., Vapi vs.
Assessee I.T.A. No. 2873/Ahd/10 has observed that “……. it is also to be clear that when the corporate guarantees are issued for the purpose of subsidiaries raising funds for acquisitions by such subsidiaries, these guarantees will be deemed to be services to the subsidiaries, and, as a corollary thereto, when corporate guarantees are issued for the subsidiaries to raise funds for their own needs, the corporate guarantees are to be treated as shareholder activity. The use of borrowed funds for own use is a reasonable presumption as it is a matter of course rather than exception.”
Thus, as observed by Hon’ble ITAT, usage of funds needs to checked while determining whether guarantee tantamount to shareholder activity or supply of service.
It is also argued that a transaction of corporate guarantee is akin to quasi-capital or shareholder activity such as capital investment, buy-back of shares, venture capital etc., which are performed by the group entities to cover the financial exposure of the entity as a whole, and can be classified as transaction in money. Pertinent to note herein that transaction in money has been explicitly excluded from the scope of goods and service and therefore, no question of GST shall arise on such transaction.
However, it is crucial to note herein that the CBIC vide Circular No. 34/8/2018-GST dated 01-03-2018 had clarified that 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 shall be taxable. Hence, the circular clearly supports the view that the transaction of guaranteeing the loan against consideration is in the nature of supply.
Further, it is noteworthy herein that as per entry 5(e) of the Schedule II of the CGST Act, 2017 “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” shall be treated as supply of service. Thus, the act of the corporate person (guarantor) if at all considered as a service, it is likely to fall under the instant entry of Schedule II “agreeing to the obligation……. to do an act.”
Moreover, before drawing any conclusion, let us delve into the other elements of supply to analyze whether the activity of issuance of corporate guarantee qualifies as a ‘supply leviable to GST’.
b. Consideration: –
Schedule I of the CGST Act, 2017 read with sec 7 (1) (c) of the CGST Act, 2017 forms an exception to the clause of “consideration” to be present in a transaction for supply to take place. Schedule I enlists transactions between related and distinct persons in the course or furtherance of business, to be considered as supply under GST even if made without any consideration.
With regards to a related party, the explanation under section 15 of the CGST Act has been provided where holding and subsidiary company or Directors/employees are treated as related parties; as reproduced below:
(a) persons shall be deemed to be “related persons” if-
i. such persons are officers or directors of one another’s business
ii. such persons are legally recognized partners
iii. such persons are employer and employee
iv. any person directly or indirectly owns, controls or holds twenty-five percent or more of the outstanding voting stock or shares of both of them
v. one of them directly or indirectly controls the other
vi. both of them are directly or indirectly controlled by a third person
vii. together they directly or indirectly control a third person or
viii. they are members of the same family.
(b) the term “person” also includes legal persons
(c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.
Further, sec 25(4) of the CGST Act, 2017 defines ‘distinct person’ which is read as “a person who has obtained or is required to obtain more than one registration, whether in one State or Union Territory or more than one State or Union Territory shall, in respect of each such registration, be treated as distinct persons.”
A corporate guarantee is an activity without consideration between related persons as defined above, and therefore is squarely covered under deemed supply as per Schedule I.
c. In the course or furtherance of Business:
Since, “in the course or furtherance of business” being a mandatory element in the definition of supply under GST, it becomes utmost important to analyse whether the service in question has been provided in the course or furtherance of business or not. It’s noteworthy herein that the phrase “in the course or furtherance of business” has not been defined in the Act; however, the word business has been defined in the Act, which is reproduced below: –
(a) “any trade, commerce, manufacture, profession, vocation, adventure, wager or any other similar activity, whether or not it is for a pecuniary benefit;
(b) any activity or transaction in connection with or incident ancillary to sub-clause(a);
(c) any activity or transaction in the nature of sub-clause (a), whether or not there is volume, frequency, continuity or regularity of such transaction;
(d) supply or acquisition of goods including capital goods and services in connection with commencement or closure of business;
(e) provision by a club, association, society, or any such body (for a subscription or any other consideration) of the facilities or benefits to its members;
(f) admission, for a consideration, of persons to any premises;
(g) services supplied by a person as the holder of an office which has been accepted by him in the course or furtherance of his trade, profession or vocation;
(h) activities of a race club including by way of totalisator or a license to book maker or activities of a licensed book maker in such club; and
(i) any activity or transaction undertaken by the Central Government, a State Government or any local authority in which they are engaged as public authorities;”
Evidently, the definition of business is inclusive in nature and quite broad in scope. Business includes any activity carried out by a person which is related to his/its trade, commerce, etc. whether or not, there is volume, frequency, continuity or regularity of such transaction. It means a single transaction of supply also is considered business. Also, occasional trade or even one-time trade constitutes business.
Pertinent to note herein that under the erstwhile VAT laws also, the term ‘Business’ has been defined in the same manner as the present definition under GST law. The jurisprudence of erstwhile decisions would be of help in understanding the meaning and scope of business and to address the question – whether proving guarantee by a director or another group company would tantamount to business or not.
In the case of Commissioner of Sales Tax vs. Sai Publication Fund (Civil Appeal No. 1716 of 1999), the Hon’ble Supreme Court vide para 11 has held— “No doubt, the definition of “business” given in section 2(5A) of the Act even without profit- motive is wide enough to include any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture and any transaction in connection with or incidental or ancillary to the commencement or closure of such trade, commerce, manufacture, adventure or concern. If the main activity is not business, then any transaction incidental or ancillary would not normally amount to “business” unless an independent intention to carry on “business” in the incidental or ancillary activity is established.
Thus, going by the Rule laid down by the Hon’ble Apex Court, the activity of providing guarantee must be related to the main activity in order to render the same as falling under the term ‘business’ under GST.
Further, dictionary meaning of the term “furtherance” implies advancement, promotion of scheme, etc. Therefore, furtherance of business would imply advancement or promotion of business. Any activity carried on with a purpose to achieve business objectives, business continuity and stability would per se amount to an activity in course or furtherance of business.
Thus, a provision of service should only be treated as supply under GST when it has been made with a view to achieve its business objective. The instant criterion is very subjective as the same service may or may not be for the purpose of advancement of business objectives depending upon the person who has provided such guarantee. Further, it has also been pointed out BY Hon’ble ITAT, Ahmedabad in the case of Micro Inks Ltd., Vapi vs. Assessee I.T.A. No. 2873/Ahd/10, “it is not really possible to hold that the corporate guarantees issued by the ass essee were in the nature of ‘provision for service’ and not a shareholder activity which are mutually exclusive in nature.”
IV. Our analysis on “taxability of corporate guarantee under GST”: – The Hon’ble Supreme Court in the case of Edelweiss Financial Services Pvt. Ltd., under Service Tax Regime, held that Service Tax cannot be levied on services not involving any consideration. Thus, this judgement has cleared the air that no tax shall be payable under the service tax regime when no consideration is involved in the transaction.
It is crucial to note that judgement of the Hon’ble Supreme Court Edelweiss case is based upon the fact that that no deeming consideration provision was there in Service Tax laws unlike GST Law where Schedule I provides for concept of Deemed Supply which lists the activities to be treated as supply even if made without consideration. Thus, the basis on which the Hon’ble Apex court held that no Service Tax shall be levied on such transactions i.e. not involving any consideration is per se not applicable under GST. However, one more basic difference between service tax and GST laws which merit our attention is “in the course or furtherance of the business”. There was no such element like “in the course or furtherance of the business” under Service tax. Hence, it cannot be concluded merely on the basis of this judgement that guarantee services are taxable under GST, because as aforesaid, the criterion of “Deemed supply” and “in the course or furtherance of the business” needs to critically examined before levying GST on such transactions.
Further, there are many other transactions also between related parties (such as Holding-subsidiary, Company and its directors etc.) where leviability of GST can be questioned. One important among those is pledging of shares of a group company (say, holding company) for the loan taken by another group company (say, subsidiary). For e.g. promoters pledge their shares to facilitate the borrowing of subsidiaries and meeting their various financial objectives. Loans are lent by the banks by keeping shares pledged by promotors as collateral. Generally, promotors don’t charge anything for such services made by them. Here, the question arises – Does such pledging of shares by promotors for the benefit of subsidiaries fall under the definition of service?
As already discussed, the definition of service under GST is too wide to cover anything and everything that does not fall within the definition of “goods. Further, by pledging their shares, promotors agree to make good the losses of the bank in case off non-payment of the same by subsidiaries. One view in this regard is that the act of the promotor is most likely in the nature of “agreeing to the obligation……… to do an act” as per Schedule II of the CGST Act, 2017 and thus falls under supply of service.
However, a second school of thought is that such pledging of shares are purely shareholder activity as observed by the Hon’ble ITAT, Ahmedabad, in the case of Micro Inks Ltd., Vapi vs. Assessee I.T.A. No. 2873/Ahd/10.
V. Valuation of Corporate Guarantee services under GST: –
Rule 28 of the CGST Rules, 2017 deals with valuation of supplies between related or distinct person. Rule 28 provides for open market value or value of supplies of like kind and quality, if open market value is unavailable. Otherwise, Rule 30 or Rule 31 can be resorted to. Important to note herein that 2nd proviso to Rule 28 provides that “where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services”. Further, it has also been clarified that Circular No. 199/11/2023-GST, dated 17th July 2023 that if a tax invoice has not issued by Head Office (H.O) to the Branch Office (B.O) in respect of any particular services, the value of such services may be deemed to be declared as Nil, and may be deemed as open market value in terms of second proviso to rule 28 of CGST Rules.
Hence, from valuation point of view, where recipient is eligible for full ITC there may not be any issue as any amount declared in Tax Invoice shall be accepted as taxable value in terms of 2nd proviso to Rule 28. However, problem arises when recipient is not eligible for ITC and thus 2nd proviso to Rule 28 is not applicable. Further, in many cases it has been that Department has issued notice demanding tax on full amount of loan which is quite absurd and not as per the Valuation Rules. For e.g. against a guarantee for a loan amounting to Rs. 30 Lakhs, instead of taking any commission amount (say 2% of loan amount) entire 30 Lakhs has been considered as taxable value on GST is demanded on the same.
Furthermore, where open market value or value of supplies of like kind and quality is not available, Rule 30/31 can be applied. Rule 31 provides that where the value of supply of goods or services or both cannot be determined under rules 27 to 30, the same shall be determined using reasonable means consistent with the principles and the general provisions of section 15. Further, it explicitly provides that in the case of supply of services, the supplier may opt for this rule, ignoring rule 30.
VI. Conclusion:
As far as taxability of the corporate guarantee under GST is concerned, it depends on assessment – whether the said service is in the nature of pure shareholder activity or the same should be construed as supply of service. As pointed out by the Hon’ble Hon’ble ITAT, Ahmedabad that “it is not really possible to hold that the corporate guarantees issued by the assessee were in the nature of ‘provision for service’ and not a shareholder activity which are mutually exclusive in nature.”, in our professional view, provision of corporate guarantee should be classified in the same manner as other capital investment activities and hence should not be treated as supply of service.
However, it may also be noted that the Department’s view is quite clear that such services are taxable under GST as clarified by the CBIC vide Circular No. 34/8/2018-GST dated 01-03-2018 wherein it was clarified that transaction of guaranteeing the loan of PSUs by Central/State Government against
consideration, is in the nature of supply. However, regarding taxability of corporate guarantee provided by group companies without consideration under the GST regime, the entire business fraternity eagerly awaits any such clarification.
Thus, the taxability of Corporate Guarantee under GST will be a matter of interpretation and could be a potential area for litigation. Interference of clarifications from the Council is the need of the hour for the businesses to understand taxability of this transaction.
Disclaimer: The views expressed by the Author are personal and should not be treated as legal opinion.
Author Bio
Thank you sir, This is very informative.