The quandary regarding the GST implications on corporate guarantees has once again been aggravated by the insertion of sub-rule (2) in Rule 28 of the Central Goods and Services Tax Rules, 2017 vide Notification No. 52/2023 – Central Tax dated 26.10.2023 pursuant to the recommendations of the 52nd Goods and Services Tax Council meeting held on 07.10.2023 which prescribes the value of corporate guarantees to be 1% of the guarantee amount or actual consideration, whichever is higher. This has opened another pandora’s box inciting a lot of debates and controversy.
Circular No. 204/16/2023-GST dated 27.10.2023 issued by the Central Board of Indirect Taxes and Customs, further clarified that the new valuation methodology will be applicable to such transactions, irrespective of whether full ITC is available to the recipient of services or not.
This article is an attempt to highlight the constitutional validity of levy of GST on Corporate Guarantees, valuation difficulties, the unresolved issues and challenges and the possible way out.
Page Contents
- What is a Corporate Guarantee ?
- Corporate Guarantee vs Bank Guarantee
- Position under erstwhile service tax regime
- Does provision of a corporate guarantee constitute a supply of service ?
- The Conundrum on Valuation
- Interest rate differential method:
- Discounted cash flow analysis (expected value)
- Position prior to 26th October 2023
- Time of supply
- Corporate Guarantee by Indian Holding Company to Foreign Subsidiary Company
- Corporate Guarantee by Foreign Holding Company to Indian Subsidiary Company
- Way forward
What is a Corporate Guarantee ?
The term “Corporate Guarantee” encompasses a wide range of different types of guarantees provided amongst corporate entities.
A Corporate Guarantee is a guarantee, in which a corporate, agrees to be responsible for the financial obligations of, or the performance of contractual obligations by the principal debtor to the creditor, in the event the principal debtor fails to discharge his obligation to the creditor. These transactions usually include intra-group corporate guarantees amongst related parties in a group entity.
Rule 28(2) inserted by Notification No. 52/2023 – Central Tax dated 26.10.2023 and Circular No. 204/16/2023-GST dated 27.10.2023 cover only the case of corporate guarantee provided by a company to a bank /financial institution for providing credit facilities to another company where both the companies are related. It specifically covers the cases of provision of corporate guarantee by a holding company to a bank / financial institution for securing credit facilities for its subsidiary company.
This type of guarantee is generally referred to as a financial guarantee contract in accounting terms.
A financial guarantee contract is a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due, in accordance with the original or modified terms of the debt instrument.
Thus, any other type of corporate guarantee which is not a financial guarantee contract is not covered within the ambit of Rule 28(2) for the purposes of valuation.
To illustrate, a credit related guarantee which requires payments to be made if there is a change in a specified credit rating of the party is not a financial guarantee contract but a derivative instrument. Similarly, a comfort letter provided by the guarantor may not be a financial guarantee, if the guarantor is not required to make specified payments to reimburse the holder for a loss it incurs because the debtor fails to make payment.
Corporate Guarantees without consideration are quite generic transactions among companies wherein holding or parent companies issues corporate guarantee to various banks or other financial institutions as a collateral security for the credit facilities availed by its subsidiaries. In multiple cases, corporate guarantees are unsecured, implying that they are not tied to any specific asset of the surety. Corporate guarantee to related parties without consideration are based on the business needs to facilitate smooth financial functioning and for group synergy.
Corporate Guarantee vs Bank Guarantee
Bank guarantee is a guarantee given by a bank on behalf of the applicant to cover a payment obligation to a third party. In the case of Micro Inks Ltd vs ACIT, the Ahmedabad ITAT while comparing bank guarantees and corporate guarantees held that:-
Corporate guarantees are issued without any security or underlying assets. When these guarantees are invoked, there is no occasion for the guarantor to seek recourse to any assets of the guaranteed entity for recovering payment of defaulted guarantees.
The guarantees are not based on the credit assessment of the entity, in respect of which the guarantees are issued, but are based on the business needs of the entity in question. Even in a situation in which the group entity is sure that the beneficiary of guarantee has no financial means to reimburse it for the defaulted guarantee amounts, when invoked, the group entity will issue the guarantee nevertheless because these are compulsions of his group synergy rather than the assurance that his future obligations will be met.
We see no meeting ground in these two types of guarantees, so far, their economic triggers and business considerations are concerned, and just because these instruments share a common surname, i.e., ‘guarantee’, these instruments cannot be said to belong to the same economic genus.
Of course, there can be situations in which there may be economic similarities, in this respect, may be present, but these are more of an exception than the rule. In general, therefore, bank guarantees are not comparable with corporate guarantees.
Position under erstwhile service tax regime
Under the service tax law, two elements, i.e., ‘activity’ and ‘consideration’ were necessary to classify a transaction as a ‘service’ and there was no deeming fiction for related party transactions. The same has been considered by the Hon’ble Supreme Court (SC) in the case of Commissioner of CGST & Central Excise vs Edelweiss Financial Services Limited where it was has held that service tax is not leviable on Corporate Guarantees in the absence of any consideration. The Supreme court stated that consideration is a must for levying service tax and thereby, upheld the order of CESTAT, Mumbai on the said matter. The ruling sets a binding precedent in other similar cases that would aid in resolving long-drawn litigations on the issue under the erstwhile service tax regime.
Does provision of a corporate guarantee constitute a supply of service ?
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. However, an exemption was later provided in respect of such services supplied by Central /State /UT Government to their undertakings or PSUs vide S. No. 34A of Notification No. 12/2017 – Central Tax (Rate) dated 28.06.2017.
Thus, by the corollary, this raises an issue that only aforementioned services by way of guaranteeing the loans taken by such undertakings or PSUs from banking companies and financial institutions is exempt and all other services of similar nature would be taxable.
As per section 7(1)(c) read with Para 2 of Schedule I to the CGST Act, 2017, any services between related persons or distinct persons in the course or furtherance of business qualifies as a ‘supply’ leviable to GST even in the absence of consideration.
Explanation to Section 15 provides that persons are deemed to be “related persons” if inter alia, any person directly /indirectly owns, controls, or holds 25% or more of the outstanding voting stock /shares of both of them, if one of them directly /indirectly controls the other, or if both of them are directly /indirectly controlled by a third person.
Consequently, the revenue department interprets the provision of corporate guarantee by a parent or holding company as a taxable supply even when there is no consideration for the same.
The most significant question that needs to be answered before determining the taxability of a corporate guarantee arrangement is whether there is a contract between the guarantor (holding company) and the principal debtor (subsidiary company) in such cases in the first place for it to constitute a supply.
A contract of guarantee is a tripartite agreement between principal debtor, creditor and surety. There are in effect, three contracts.
i. A principal contract between the principal debtor and the creditor.
ii. A secondary contract between the creditor and the surety.
iii. An implied contract between the surety and the principal debtor whereby principal debtor is under an obligation to indemnify the surety, if the surety is made to pay or perform.
The principal debtor is a third person in a contract of guarantee. The contract of guarantee is primarily between the surety and the creditor. The contract of guarantee is not a contract between the surety and the principal debtor.
Section 140 of the Indian Contract Act, 1872 provides for the right of subrogation, which states that once the guarantor has paid off the debt of the principal debtor, he steps into the shoes of the creditor and is possessed of all the rights that a creditor has against the principal debtor.
Section 126 of the Indian Contract Act, 1872 defines a “contract of guarantee” as a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the “surety”; the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called the “creditor”. A guarantee may be either oral or written.
Section 127 provides that anything done, or any promise made, for the benefit of the principal debtor, may be a sufficient consideration to the surety for giving the guarantee.
On an analysis of Section 126 and Section 127 of the Indian Contract Act, it is evident that any act done or promise made for the benefit of the principal debtor (for instance, to provide a loan to the principal debtor) performed by the creditor (a bank or a financial institution), acts as sufficient consideration to the surety (guarantor) for providing the guarantee to the creditor.
Section 127 makes it clear beyond doubt that consideration to guarantor (surety) for providing the guarantee to the creditor, flows from the creditor (promisor) by way of accepting to advance loan to the borrower /principal debtor (promisee) who otherwise would not be eligible for the loan.
Consideration to guarantor (surety) does not flow from the principal debtor in any manner. Schedule I provides that absence of consideration flowing between related persons will not come in the way of incidence of tax.
In a contract of guarantee, consideration DOES NOT flow between related persons (Surety and creditor are not related persons). Under corporate guarantee arrangements, only the surety and the principal debtor are related. Consideration flows to the guarantor (surety) from the creditor who is unrelated to the guarantor.
Only the benefit of the contract of guarantee accrues with the principal debtor (by way of eligibility to obtain loan or reduced finance costs). Equating accrual of benefit to consideration is not at all provided in law. Just because, benefit accrues to the principal debtor, on account of the guarantee provided by the surety to the creditor, it does not imply that consideration for the contract is paid by the principal debtor to the surety. When the contract law clearly defines the payer and payee of the consideration in respect of contract of guarantees, any attempt to deviate from the same is perverse in law.
Consideration to guarantor (surety) flows from the creditor for advancing loan to the principal debtor. One who pays the consideration is the recipient. Supplier is one who collects the consideration.
Section 2(d) of the Indian Contract Act, 1872 defines consideration in a contract.
When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise;
As per Section 2(c) of the Indian Contract Act, 1872, the person making the proposal is called the “promisor”, and the person accepting the proposal is called the “promisee”;
In a contract of guarantee, the creditor is the promisor who agrees to advance loan to the borrower and the principal debtor is the promisee who pays the consideration by way of interest on loan to obtain the creditor’s promise. The principal debtor pays interest on loan at the desire of the promisor (creditor) and consequently the interest paid tantamounts to consideration within the ambit of section 2(d) for the loan contract.
The Guarantee provided by the surety to the creditor (promisor) is a remedy to the promisor for recovery of money lent. The guarantee provided is not a consideration to contract with the principal debtor (promisee). The surety is not the promisor. The guarantee is provided by the surety to the creditor at the desire of the creditor (promisor) and therefore there is no consideration between the surety and the principal debtor.
In the absence of consideration, there is no establishment of contractual relations between the guarantor and the principal debtor. Section 25 of the Indian Contract Act, provides that an agreement made without consideration is void. Disclosure of contingent liability in the financial statements of guarantor, is no indicator of contractual relationship as enunciated above. Privity of contract in a contract of guarantee is between the guarantor and the creditor.
Whether or not the principal debtor pays a fee to the surety, the principal debtor has no rights under the guarantee, and does not acquire any interest in the guarantee. Surety does not make a supply of an interest in a guarantee to the principal debtor. It does, however, make a supply of such an interest to the creditor, wherein the consideration that the creditor provides is their agreement to enter into the credit arrangement with the principal debtor.
In the absence of consideration and contractual relationship between the surety and the principal debtor, no question of supply arises between the both and consequently no tax can be levied.
Benefit accruing to principal debtor/ borrower (by securing loan based on guarantee) is not a supply in itself. Benefits flowing to distinct or related persons does imply existence of supply. Deemed supply under Schedule I does not tantamount to imputed supply. Tax is levied on supply and the surety supplies nothing to the principal debtor for him to be foisted with the liability to discharge tax.
Pure transactions in money are neither supply of goods nor supply of services [Sec 2(52) of CGST Act, 2017]. Guarantee becomes void if there is no performance due. Guarantee becomes a loan on default by principal debtor. Performance by surety leads to an enforceable loan against the principal debtor. Everywhere, the only benefit is the loan (and interest accrued thereon) and the same is not taxable under GST.
Therefore, corporate guarantee arrangements cannot qualify as a supply of services by the surety to the principal debtor (holding /parent company to subsidiary company) and accordingly, GST, being a contract-based levy between supplier and recipient, cannot be levied on such arrangements.
In the case of Micro Ink Ltd vs ACIT, the Hon’ble ITAT held that corporate guarantees are prima facie in the nature of a ‘shareholder activity’ as it is to provide, or compensate for lack of, core strength for raising finances from banks. The Tribunal further held that it is impossible to consider corporate guarantees as ‘provision of service’ and not shareholders activity which are mutually exclusive in nature. The same view has been adopted in the case of Suzlon Energy Limited v. DCIT. Though judgements under the Income Tax Law do not constitute binding precedents under the GST law, they do have a persuasive value.
Considering the legal propositions, the levy of GST on corporate guarantee arrangements seems unsustainable and is yet to be time tested and challenged before higher judicial forums.
Nevertheless, until the controversy on the matter is put to rest by the Hon’ble Supreme Court, the challenges would have to be addressed.
The Conundrum on Valuation
The next important question to be addressed is the methodology to be adopted for valuing such corporate guarantee transactions for the purposes of determination of quantum of GST liability to be discharged.
Rule 28 of the CGST Rules, 2017 deals with the valuation of supplies between distinct or related persons.
Rule 28(1)(a) provides for open market value as the value of supply in such cases.
Open Market Value means the full value of money excluding taxes under GST laws, payable by a person to obtain such supply at the time when supply being valued is made, provided such supply is between unrelated persons and price is the sole consideration for such supply.
The term “open market value” is often confused with “fair value.”
Fair value refers to the true worth of an asset or liability, which is derived fundamentally and is not determined by the market forces of demand and supply, while market value is solely determined by the factors of demand and supply.
Fair value often remains the same, and does not fluctuate frequently unlike market value.
Fair value is a globally accepted method of valuation as per International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) unlike market value which is not universally recognized.
Indian Accounting Standards (Ind AS 109) require financial guarantee contracts to be recorded at fair value. Financial guarantee contracts between related parties may not be at arm’s length and therefore the fair value would have to be determined. As elucidated above, GST law makes reference to market value and not fair value for the purposes of valuation. Accordingly, fair value recorded in books of account cannot be a base for valuation for GST purposes.
Fair value of a financial guarantee contract need not always be equal to the open market value.
Fair value of a financial guarantee contract is dependent on the credit risk of the entity in whose favour the guarantee is issued. Consequently, it is not always easy to find a perfect comparable in the open market especially in cases of intra-group related party transactions. In rare occasions, it may be possible to identify market prices for similar guarantees, the open market price of which would require an adjustment to reflect differences in terms of liquidity, credit rating, tenure, and the amount of the guarantee. Correspondingly, only such value arrived at after making adjustments from open market prices have to be considered for GST purposes.
Valuation based on value of identical or similar goods is most prominent under customs law. GST law, has to an extent borrowed this concept from Customs (Determination of Value of Imported Goods) Rules, 2007.
It is an established principle under customs law that price of identical goods should be compared at same commercial level and in substantially the same quantity of goods. If not, suitable amendments are to be made to account for the difference. But it should be on demonstrated evidence which clearly establishes the reasonableness and accuracy of the adjustments. Same concept ought to be followed in GST while arriving at the open market value or value of like kind and quality.
The intangible nature of services makes it difficult to arrive at any sort of comparison.
In case there is no perfect comparable transaction in the open market, resort to Rule 28(1)(b) is made which requires the valuation to be made based on the value of supply of services of like kind and quality.
Supply of like kind & quality means any other supply made under similar circumstances, that is same or closely resembles in respect of characteristics, quality, quantity, functionality, reputation to the supply being valued.
In practical scenarios, in case of financial guarantee contracts, supply of services of like kind and quality may not be available, because financial guarantee contracts are exclusive tailor-made contracts based on entity specific attributes. Accordingly, valuation under Rule 28(1)(b) may not be possible.
Consequently, Rule 28(1)(c) requires value to be determined by application of rule 30 or 31 in that order. Rule 31 provides that where the value of supply of goods or services or both cannot be determined under rules 27 to 30 (rule 28), the same shall be determined using ‘reasonable means’ consistent with the principles and the general provisions of Section 15 and the provisions of Chapter V of the CGST Rules. Further, it explicitly provides that in the case of supply of services, the supplier may opt for rule 31, ignoring rule 30.
The following methods of valuation of financial guarantees can be construed to be “reasonable means consistent with the principles and the general provisions of section 15 and the provisions of valuation rules.”
Interest rate differential method:
Under this method, the difference between the present value of interest charged on the guaranteed loan and what would have been charged if the loan had not been guaranteed, over the period of guarantee, may represent the fair value of the guarantee.
To illustrate, if the subsidiary can obtain a loan of Rs.1 crore from a bank at 11% per annum for 3 years based on its standalone financial position and the same subsidiary can obtain the same amount of loan from the same bank at 8% per annum if the loan was guaranteed by the parent, the value of guarantee would be determined as the difference between the present value of cash outflows (interest payments) at 11% p.a and the present value of cash outflows (interest payments) at 8% p.a.
|
Particulars |
Year 1 | Year 2 | Year 3 |
Total |
| Cash flows based on Interest Rate of 11% – (A) |
₹ 11,00,000 |
₹ 11,00,000 | ₹ 11,00,000 |
₹ 33,00,000 |
| Cash flows based on Interest Rate of 8% – (B) |
₹ 8,00,000 |
₹ 8,00,000 | ₹ 8,00,000 |
₹ 24,00,000 |
| Interest Rate Differential (A) – (B) |
₹ 3,00,000 |
₹ 3,00,000 | ₹ 3,00,000 |
₹ 9,00,000 |
| Discount factor @ 11% |
0.901 |
0.812 | 0.731 | |
| Interest rate differential discounted at 11% |
₹ 2,70,300 |
₹ 2,43,600 | ₹ 2,19,300 |
₹ 7,33,200 |
| Fair value of Financial Guarantee Contract |
₹ 7,33,200 |
The logic is that the interest that the bank is willing to forgo represents a price that it is willing to pay for the guarantee. Valuation under this method considering the interest rate differential as the price actually paid or payable for the guarantee, is consistent with the principles of section 15.
This method may not always be suitable, for example, in the case of a new subsidiary without significant equity, many banks may not provide a loan, in the first place, if the parent had not given a guarantee. Determining the interest rate differential will require determining the credit rating of the subsidiary in isolation, because the subsidiary’s credit rating will benefit from being a member of a particular group. The same may prove to be challenging and might involve the aid of different financial models and assumptions.
Discounted cash flow analysis (expected value)
The price that the guarantor would demand for accepting the guarantee obligation may provide evidence of a fair value, and can be estimated using a probability-adjusted discounted cash flow. Valuation under this method considering the price that the guarantor would demand, as the price actually paid or payable for the guarantee, is consistent with the principles of section 15.
For example, a parent has guaranteed INR 5 crore of 10-year debt obtained by subsidiary. The probability of default by subsidiary is estimated at 0.05% (based on historical default rates amongst companies with the same credit rating as the subsidiary), and the loss in the event of default is estimated at 25% (based on subsidiary’s asset base and other collateral available to the bank). So, the expected value of the liability (its fair value) would be INR 6,250. (Rs. 5 crore x 0.05% x 25%)
This method may pose practical challenges to estimate the probability of default and the loss in the event of default.
The phrase “reasonable means” is too vague and open ended to confine it to any particular method. What shall constitute “reasonable means” is a core area of conflict & litigation.
Where full ITC is available to the recipient (i.e., principal debtor), the valuation has not been contentious since any value declared in the invoice can be deemed to be the open market value of the supply in such cases, in terms of the second proviso to Rule 28(1).
The newly introduced sub-rule (2) of Rule 28 provides that notwithstanding anything contained in sub-rule (1) of Rule 28, the value of supply of services by a supplier to a recipient who is a related person, by way of providing corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be 1% of the amount of such guarantee offered, or the actual consideration, whichever is higher.
Further, Circular No. 204/16/2023-GST dated 27.10.2023 inter alia clarifies that the valuation prescribed in Rule 28(2) will be applicable, irrespective of whether full ITC is available to the recipient of services or not.
A general observation from various tribunal decisions is that corporate guarantee fee between 0.5% to 0.85% has been considered to be at arm’s length. Further, for provision of corporate guarantee, Rule 10TD of the Indian Income Tax Rules, 1962, provide a rate of 1% of the guaranteed amount as the safe harbour rate. Safe harbour is defined as circumstances in which the tax authority shall accept the transfer price declared by the taxpayer to be at arm’s length.
There are several judicial precedents where the Court of law has accepted a lower value of corporate guarantee like the decision in the case of Commissioner of Income Tax vs Everest Kanto Cylinders Ltd., wherein the assessee computed the corporate guarantee commission at 0.5% of the loan amount and the department rejected and argued that the corporate guarantee commission shall be determined by considering the commission rates charged by banks for giving bank guarantee. The Hon’ble Bombay High Court held that the bank guarantees are different from corporate guarantees and rejected the contentions of department. The rate of guarantee commission at 0.5% of the loan amount was thus accepted.
It can be observed that the valuation mechanism prescribed under Rule 28(2) does not consider the settled precedents from Income-tax law. Though judgements under the Income Tax Law do not constitute binding precedents under the GST law, they do have a persuasive value.
When the taxability of corporate guarantee arrangements is itself contentious, Rule 28(2) seems to exceed its scope beyond what is conferred upon the rule making authority under Section 9 of the CGST Act, which is the charging section. Therefore, if such arrangements do not pass the test of taxability in the first place, Rule 28(2) may arguably be ultra vires the enabling Act and consequently be struck down.
Prescribing a uniform rate of 1% for valuation without any reasonable basis when there are other means available to determine the fair value, may be arbitrary and prejudicial to several taxpayers.
The Gujarat High Court in the case of Munjaal Manish Bhatt vs. Union of India held that where a delegated legislation is challenged as being ultra vires the provisions of the CGST Act as well as violating Article 14 of the Constitution, the same cannot be defended merely on the ground of Government’s competence to issue such delegated piece of legislation.
The validity of the rule is yet to be subjected to judicial scrutiny.
Position prior to 26th October 2023
The taxability of Corporate Guarantees has been under dispute by GST authorities since introduction of GST and divergent views were adopted to arrive at taxable value and in most cases, they continue to remain under dispute. On the extreme, in the absence of any specific valuation mechanism prior to 26.10.2023, it can be argued that levy itself fails and consequently no tax is payable. Lex Prospicit, Non Respicit.
Alternatively, because the sub-rule is inserted specifically under Rule 28 with prospective effect, one can argue that the revenue department should accept any value (even if it is ‘Nil’) as transaction value in terms of Rule 28 for periods prior to 26th October 2023, if the recipient is eligible for full ITC. This view is supported by CBIC Circular No. 199/11/2023-GSTwhich clarifies regarding the taxability of services provided between Head Office and Branch Offices of the same organisation, where the same valuation provisions, as applicable to related persons, apply. In case the recipient is not eligible for full ITC, the valuation mechanisms as enumerated above in the previous paragraphs can be resorted to.
Time of supply
Neither the Circular nor the Notification provide any clarity on the aspect of time of supply for levy of tax liability.
Ambiguity revolves around the following areas:-
i. In case of outward supplies of providing corporate guarantee, what would be date of provision of service ?
ii. What should be the frequency of paying tax on such transactions i.e., monthly, quarterly, half early, annually, or once for the entire period of guarantee ?
iii. In case of inward supplies of receiving corporate guarantee, where the recipient is eligible for ITC, what would be the date of receipt of service for availing ITC ?
Where there is no actual consideration involved and GST is being paid on notional valuation basis, once the guarantee deed is executed by the guarantor, the activity of provision of guarantee is crystalized. It is only the operation of the guarantee that is continuous over a period. Thus, provision of corporate guarantee cannot be construed to be a continuous supply of service within the meaning of Section 2(33) of the CGST Act, 2017. The point of transfer of service is the point at which the surety binds himself to the creditor.
The entire scheme of point of taxation (or) time of supply provisions under the GST law rests on the pillar that the supplier must discharge tax liability when the recipient avails the benefit of the services rendered. Inseparability is an exclusive service characteristic that renders it essentially impossible to divorce the supply or production of service from its consumption. Services, being intangible in nature cannot be stored prior to their consumption. Consumption of service implies obtaining the benefit from the service.
In almost all cases, it is based on the guarantee of the surety that the loan is sanctioned to the principal debtor i.e., the principal debtor obtains the benefit of having the loan sanctioned (or obtaining loan at reduced interest rates) from the creditor, solely based on the guarantee provided by the surety. The same can be evidentially proven considering the credit characteristics of the principal debtor. Thus, the benefit of the guarantee accrues to the principal debtor at the time of execution of the contract of guarantee by the surety with the creditor. Accordingly, the date of accrual of the benefit of the guarantee to the principal debtor and the date of execution of the contract of guarantee by the surety with the creditor would always be the same. Consequently, in such corporate guarantee arrangements, the date of execution of the contract of guarantee would be the date of provision of service and as a result the time of supply would be the date of execution of the contract of guarantee.
Invocation of the contract of guarantee where the surety makes payment to the creditor, when the principal debtor makes a default, is only a discharge of the supplier’s side (guarantor) of the bargain which he has already agreed to. Taxation is at the time of accrual of the right to the recipient (creditor) to call upon the guarantor to make payment in the event of default by the principal debtor. Such a right accrues at the time of execution of the contract and consequently making of payments only signifies a discharge of the contractual obligation. Thus, no tax is required to be paid at the time when the surety makes payment to the creditor.
From the above principles, the questions can be answered as follows:-
i. In case of outward supplies of providing corporate guarantee, date of provision of service would be the date of execution of the contract of guarantee.
ii. Tax liability must be discharged on such corporate guarantee arrangements only once, at the time of execution of the contract of guarantee.
iii. In case of inward supply of receiving corporate guarantee, where the recipient is eligible for ITC, the date of receipt of service for availing ITC would be the date of execution of the contract of guarantee.
Corporate Guarantee by Indian Holding Company to Foreign Subsidiary Company
Provision of Corporate Guarantee by Indian Holding Company to Foreign Subsidiary Company may be treated as “export of services” subject to satisfaction of all conditions provided therein.
Section 2(6) of IGST Act, 2017 defines “export of services” as the supply of any service when :-
(i) the supplier of service is located in India;
(ii) the recipient of service is located outside India;
(iii) the place of supply of service is outside India;
(iv) the payment for such service has been received by the supplier of service in convertible foreign exchange or in Indian rupees wherever permitted by the Reserve Bank of India and
(v) the supplier of service and the recipient of service are not merely establishments of a distinct person in accordance with Explanation 1 in section 8
Explanation 1 to section 8 provides that, for the purposes of this Act, where a person has,-
(i) an establishment in India and any other establishment outside India;
(ii) an establishment in a State or Union territory and any other establishment outside that State or Union territory; or
(iii) an establishment in a State or Union territory and any other establishment registered within that State or Union territory,
then such establishments shall be treated as establishments of distinct persons.
Explanation 2. – A person carrying on a business through a branch or an agency or a representational office in any territory shall be treated as having an establishment in that territory.
Circular No. 161/17/2021-GST clarifies that a company incorporated in India (Holding company) and a body corporate incorporated by or under the laws of a country outside India (Subsidiary Company) are separate persons under the CGST Act, and thus are separate legal entities. Accordingly, these two separate persons would not be considered as “merely establishments of a distinct person in accordance with Explanation 1 in section 8”.
Supply from a company incorporated in India to its related establishments outside India, which are incorporated under the laws outside India, would not be treated as supply to merely establishments of distinct person under Explanation 1 of section 8 of IGST Act 2017. Such supplies, therefore, would qualify as ‘export of services’, subject to fulfilment of other conditions as provided under sub-section (6) of section 2 of IGST Act.
Where no consideration is charged or partial consideration is charged from foreign subsidiaries, for corporate guarantees issued prior to 26.10.2023, valuation would be based on the principles enshrined in Rule 28(1) and for corporate guarantees issued post 26.10.2023, Rule 28(2) would be applicable. In either of the cases, consideration should flow to the Indian Holding Company (for the full amount of valuation) for the same to satisfy the stipulation of Section 2(6)(iv). Unless the subsidiary located outside India remits the full value of consideration, the transaction would be challenged by the revenue department as taxable in India.
Where all the aforementioned conditions are satisfied, the corporate guarantee arrangement with the foreign subsidiary would qualify as an export of service.
Corporate Guarantee by Foreign Holding Company to Indian Subsidiary Company
Where the guarantee is given by the parent entity located outside India for a borrowing by its subsidiary in India, the transaction will qualify as ‘import of services’ under GST. In case of import of services, Notification No. 10/2017- Integrated Tax (Rate) requires the person located in taxable territory to discharge tax liability on the same on reverse charge basis. If the subsidiary entities in India were not discharging GST under reverse charge on such guarantees till 26.10.2023, it would be essential to revisit the position and compute the value in terms of rule 28(1) and discharge GST under reverse charge. For all transactions post 26.10.2023, valuation would be as per rule 28(2) and tax liability would have to be discharged on reverse charge basis.
In case of import of services of corporate guarantee, time of supply would differ from the previous propositions discussed since tax is to be discharged on reverse charge basis.
2nd proviso to Section 13(3) provides that in case of supply by associated enterprises, where the supplier of service is located outside India, the time of supply shall be the date of entry in the books of account of the recipient of supply or the date of payment, whichever is earlier. Where there is no consideration involved, the time of supply would be the date of entry in the books of account of the recipient (Indian subsidiary).
Associated enterprises shall have the same meaning as defined in Section 92A of the Income Tax Act, 1961.
Two enterprises shall be deemed to be associated enterprises inter-alia if, at any time during the previous year, one enterprise holds, directly or indirectly, shares carrying not less than 26 % of the voting power in the other enterprise;
Ind AS 109 requires the subsidiary to recognize the guarantee at fair value upon initial recognition. Initial recognition would technically be the date on which the guarantee contract is executed by the foreign parent. Thus, time of supply being the date of entry in books of account would effectively be the date of execution of guarantee.
Way forward
The following conclusions are noteworthy:-
If the guarantor executes the contract of guarantee without consideration, in the erstwhile service tax regime and the period of guarantee spills over into the GST regime, no tax is required to be paid under both the regimes. No service tax is payable in light of the judgement of the Supreme Court in the case of Commissioner of CGST & Central Excise vs Edelweiss Financial Services Limited. No GST is payable if the guarantee is invoked under the GST regime, as the point of taxation is the time of execution of the contract, which was in the service tax period when it was not taxable.
If the guarantor executes the contract of guarantee without consideration, in the GST regime prior to 26.10.2023, for the benefit of a related party, GST would be payable on the basis of the valuation mechanisms as enunciated in the previous paragraphs as per Rule 28(1) at the time of execution of the contract. Where such contract is for the benefit of a third party (without consideration), GST would be payable on the basis of valuation mechanism as prescribed by Rule 27 at the time of execution of the contract.
If the guarantor executes the contract of guarantee without consideration, for the benefit of a related party in the GST regime post 26.10.2023, GST would be payable on the basis of valuation mechanism introduced by Rule 28(2) i.e., 1% of guarantee amount at the time of execution of the contract. Where such contract is for the benefit of a third party (without consideration), GST would be payable on the basis of valuation mechanism as prescribed by Rule 27 at the time of execution of the contract.
If the guarantor executes the contract of guarantee with consideration in the erstwhile service tax regime and the period of guarantee spills over into the GST regime, tax is ideally required to be paid under the service tax regime at the time of execution of the contract and no tax is payable under the GST regime. But there is a controversy with respect to payment of service tax. Divergent views have been taken by different benches of CESTAT in such cases. In the case of M/s Olam Agro India Ltd., Delhi CESTAT upheld the demand of service tax on the Corporate Guarantee commission and pronounced that 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. The, said matter is pending for disposal before the apex court. On the other hand, Chennai CESTAT held in favour of taxpayer in the case of M/s Sterlite Industries India Ltd. The bench took a view that 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 with support and thus are not equivalent to bank guarantees and consequently are not taxable. Such conflicting decisions have created doubts about the taxability of corporate guarantees in those cases where consideration exists in the erstwhile regime. The matter is yet to be adjudicated upon by the Hon’ble Supreme Court.
If the guarantor executes the contract of guarantee with consideration, in the GST regime prior to 26.10.2023, for the benefit of a related party, GST would still be payable on the basis of the valuation mechanisms as per Rule 28(1) as enunciated in the previous paragraphs at the time of execution of the contract. Transaction value cannot be taken as basis for valuation, as transaction value under section 15(1) is permissible only where the supplier and the recipient are not related. Where such contract is for the benefit of a third party (with consideration), GST would be payable on the basis of transaction value as per section 15 at the time of execution of the contract.
If the guarantor executes the contract of guarantee with consideration, in the GST regime post 26.10.2023, for the benefit of a related party, GST would be payable on the basis of valuation mechanism introduced by Rule 28(2) i.e., 1% of guarantee amount or actual consideration, whichever is higher at the time of execution of the contract. Where such contract is for the benefit of a third party (with consideration), GST would be payable on the basis of transaction value as per section 15 at the time of execution of the contract.
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Excellent. Very well explained.
Appreciate your time and effort in collating this.