Every Company in order to do its business gets finance from various entities including that of Banks and Financial Institutions as well as Non-Banking Financial Companies. To obtain the finances from these entities as per the mandate of The Reserve Bank of India, a personal guarantee is taken from the Promoters of the Company who are also the Directors of the Company. This Guarantee is given by him in his personal capacity to act as Guarantor in case the Company fails to pay its debt to these Banks/Financial Institutions.
These guarantees are mandatorily required in terms of provisions of the Reserve Bank of India Circular No. RBI/2009-10/70 DBOD. No. Dir. BC. 14 /13.03.00/2009-10 dated July 1, 2009 wherein it is specifically stated that the Directors cannot take any Guarantee Commission from the company to which they stood as guarantors. The relevant portion of the said circular at Para 2.2.9.1 is reproduced herewith for your kind consideration: –
2.2.9.1 Personal guarantees of directors
Banks should take personal guarantees of directors for the credit facilities, etc. granted to corporates, public or private, only, when absolutely warranted after a careful examination of the circumstances of the case and not, as a matter of course. In order to identify the circumstances under which the guarantee may or may not be considered necessary, banks should be guided by the following broad considerations:
C. Worth of the guarantors, payment of guarantee commission, etc.
Where personal guarantees of directors are warranted, they should bear reasonable proportion to the estimated worth of the person. The system of obtaining guarantees should not be used by the directors and other managerial personnel as a source of income from the company. Banks should obtain an undertaking from the borrowing company as well as the guarantors that no consideration whether by way of commission, brokerage fees or any other form, would be paid by the former or received by the latter, directly or indirectly. This requirement should be incorporated in the bank’s terms and conditions for sanctioning of credit limits. During the periodic inspections, the bank’s inspectors should verify that this stipulation has been complied with.
This circular makes it absolutely clear that the director cannot take any remuneration from the company to whom he stood as the guarantor and in the presence of such absolute mandate no value could be attributed to the alleged service being provided by the Director. In fact, there is no service which has been provided by the director.
A service is a concept of willingness wherein a person provides certain facility to another person willingly. In order to constitute a transaction as a service there must be a willingness by the service provider. In the instant case the guarantee is necessarily to be provided by the Director even though he is not willing as it is mandated by the Reserve Bank of India Circular therefore it is not something which is provided or agreed to be provided by the Directors of the Company to the Company.
Without prejudice to the discussion made hereinbefore, it must be understood that the guarantee is taken from the directors who are actually involved in the day to day working of the business, who are actually the employees of the company, and they provide such guarantee in their capacity as the employee. It is manifest that the directors are not into the business of giving the guarantees. It is merely for the purpose of this Company that they have given guarantee and that too without any business intention in the mind. They are employees of the Company only and are not doing any business of their own therefore they are not making supply as a supply as per Section 7(1) has to be done in the course of furtherance of business, but the directors are not doing any business activity here in this case.
The moot question herein is that when the personal guarantee is given not as a matter of choice but as a matter of regulatory requirement without which the company would not be able to avail credit facilities, can this at all be termed as an activity in the course or furtherance of business by the director. A director has no choice but to give the guarantee.
It is further submitted that that Section 7(2)(a) specifies that the activities listed in Schedule-III of the CGST Act, 2017 would not be considered as a ‘supply’. This Schedule contains a list of activities that have been excluded from the scope of supply. Entry-1 thereof lists services done by an employee to the employer ‘in the course of or in relation to his employment’ as one of the services that would not be considered as a ‘supply’ as per the definition. Thus, if the personal guarantee is given during the employment as per the terms of employment, then the same can be said to be in the course of employment and qualifies under Schedule-III as an activity that shall not be treated as a supply under the definition of supply under Section 7 of the CGST Act, 2017. Therefore, the personal guarantee executed by the director for term loan or cash credit facilities enjoyed by the Company shall not be chargeable to GST, if it is in the nature of a service provided by an employee to an employer in the course of or in relation to the employment. Therefore, in this case there is no tax payable under Reverse Charge Mechanism by the company.
Your attention is further invited to the Circular No. 140/10/2020 – GST dated 10.06.2020 wherein it is categorically stated that the services which are provided by the directors in their capacity as the employees of the company, Reverse Charge is not required to be paid.
Further, Audit Team generally considering a valuation of 3% of the total amount of loan taken by the Company that is value of Guarantee Commission by the director without any basis. The valuation in case of related parties is required to be done as per the provisions of Rule 28 of the CGST Rules, 2017 which requires the valuation to be done at Open Market Value. Open Market Value has been defined as under explanation to the Chapter IV beneath Rule 35 which reads as follows:
a. “Open market value of a supply of goods or services or both means the full value in money, excluding the integrated tax, central tax, State tax, Union territory tax and the cess payable by a person in a transaction, where the supplier and the recipient of the supply are not related and the price is the sole consideration, to obtain such supply at the same time when the supply being valued is made;”
However, in this case, the Open Market Value is not available therefore in case if Open Market Value is not available then the valuation is supposed to be taken up based on the supply of goods or services of like kind and quality. The said terms are also defined as follows:
“(b) ―supply of goods or services or both of like kind and quality means any other supply of goods or services or both made under similar circumstances that, in respect of the characteristics, quality, quantity, functional components, materials, and the reputation of the goods or services or both first mentioned, is the same as, or closely or substantially resembles, that supply of goods or services or both.”
Under this valuation method (Rule 28(b) of the CGST Rules, 2017) the Audit Team have purported to value the alleged services provided by the directors of the Company. To fall under this Rule, one need to satisfy the following conditions as per the Rule:
1. The transaction must be in similar circumstances;
2. There must be similarity as to quality;
3. There must be similarity as to Reputation of goods or services;
4. There must be similarity as to other functional components.
However, the observation does not showcase any such similarity in the present case of the and the one which are provided by the Banks. There are following differences:
Banks are a very reputed entities having a large experience in the field of extending the Guarantee. Their reputation is absolutely different then the directors of the Company.
Banks give large quantity guarantees and charge premium as per their wish looking at the circumstances of the borrower.
None of the circumstances of the Banks and that of the director of the Company are similar as Banks exploit guarantees as their professional ventures while the directors are gist doing it in their absolute mandate.
Therefore, in any case it cannot be stated that the directors and the Banks are equally placed. Also, the Audit Teams generally mot providing single document/evidence to support their view therefore the valuation is absolutely.
In the case of Micro Ink Limited vs. Additional Commissioner of Income Tax, Vapi Range (27.11.2015 – ITAT Ahmedabad) it was held by ITAT that –
“In view of the above discussions, OECD Guidelines, as a matter of fact, strengthen the claim of the assessee that the corporate guarantees issued by the assessee were in the nature of quasi capital or shareholder activity and, for this reason alone, the issuance of these guarantees should be excluded from the scope of services and thus from the scope of ‘international transactions’ under section 92B.”
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on the same matter ( RCM on Personal guarantee by director ) can you provide any case law under gst ?