In the complex landscape of taxation, the applicability of Goods and Service Tax (GST) on Corporate Guarantee has emerged as a critical point of discussion. The recent ruling by the Apex court in the case against Edelweiss Financial Services Ltd. has shed some light but also raised numerous questions about this subject. This piece aims to explore the concept of Corporate Guarantee, examine its definitions under various acts, and evaluate its taxability under the current GST regime.
Background
Recently the Apex court in the case of Commissioner of CGST and Central Excise Vs Edelweiss Financial Services Ltd., passed an order in favor of the taxpayer. While deciding the applicability of service tax on Corporate guarantee to group companies, the supreme court observed that there is concurrent finding of fact that there is no consideration and Referring to section 65B(44) of the Finance Act, it was held that there had to be valuable consideration for a service to be taxable.
Therefore, as there is no consideration, no Service tax is leviable. However the said judgment cannot be held good in GST regime, because there is existence of Schedule I. and as per Schedule I of CGST act 2017, in case of related party transaction, the same will be taxable under GST, even though there is no consideration.
So the taxability of corporate guarantee needs to be tested in the GST regime, as discussed in the below paras.
- Concept of corporate guarantee
Generally corporate guarantee/ Letter of comfort is issued by the Holding company to the Bankers of Subsidiary company / group companies. And on the basis of Corporate Guarantee /Letter of Comfort Bank extend the CC/Loans to Subsidiary company / group companies. Through this corporate guarantee/ Letter of comfort, Holding company/ Parent company, undertakes to discharge the loans / borrowings of Subsidiary company / group companies in case default made by Subsidiary company / group companies.
Since the corporate guarantee/ Letter of comfort is ultimately benefited to the Subsidiary company / group companies. It may be considered as supply flowing from Holding to Subsidiary company / group companies. And the question of taxability under GST may arise. furthermore incase Holding company is situated outside India, then this may get classified as “Import of service” and Indian Subsidiary company / group companies may be demanded for GST under RCM.
- Definition of Guarantee.
CGST Act 2017, has not provided the definition of Corporate Guarantee, therefore we need to borrow the definition of Corporate Guarantee / Guarantee from allied commercial law, prevailing as on the date.
Indian contract Act 1872 Sec 126 Provides, A ‘contract of guarantee’ is 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’.
In case, Holding Company is Surety, Subsidiary company / group companies are the Principle debtor and Bank / Financial Institution is Creditor.
Once the Concept of Corporate Guarantee is analyzed, next is to see if there is any “Supply” in between the Holding company and its subsidiary, Because the GST is applicable only if there is supply of either Goods or Supply of services.
- Corporate Guarantee is Supply of Goods or Supply of Service
Since it is mandatory to have supply for a transaction to be covered under GST Act, we shall now see that the transaction of Corporate Guarantee is a “goods’ or a “Service” ?
Now again we have to go for the definition of Goods and services, and as per the Provision of CGST Act , 2017:
Sec 2(52), “goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply;
Sec 2(102), “services” means 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;
1. Corporate Guarantee is Supply of Goods?
Definition of Goods has several Parts with inclusion and exclusions,
Exclusions,
1. Money
2. Securities
Inclusion
1. growing crops, grass
2. things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.
3. actionable claim,
Sec 2(75) Provide the definition of Money, “money” means the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value;
Sec 2(101) provides, ‘securities‘ shall have the same meaning as assigned to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 and includes:
1. shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
(ia) derivative;
(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;
(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
(id) units or any other such instrument issued to the investors under any mutual fund scheme.
Explanation. ‘For the removal of doubts, it is hereby declared that “securities” shall not include any unit linked insurance policy or scrips or any such instrument or unit, by whatever name called, which provides a combined benefit risk on the life of the persons and investment by such persons and issued by an insurer referred to in clause (9) of section 2 of the Insurance Act, 1938 (4 of 1938);
(ie) any certificate or instrument (by whatever name called), issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be;
2. Government securities;
(iia) such other instruments as may be declared by the Central Government to be securities; and
- rights or interest in securities; ;
So from the reading of the definition, we can conclude that, as the Corporate Guarantee is neither legal tender nor securities, it is not covered under the exclusion part of Goods.
Now we test the transaction in the list of inclusions,
From the plain reading of the meaning of Corporate Guarantee, It is not a growing crops, grass,
nor things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.
Further, As per 2(1) of the CGST Act, ‘actionable claim’ shall have the same meaning as assigned to it in section 3 of the Transfer of Property Act, 1882;
Section 3 of the Transfer of Property Act, 1882′, Actionable claim’ means :
- a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of moveable property, or
- to any beneficial interest in moveable property not in the possession, (either actual or constructive), of the claimant, which the Civil Courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent;
Now we need to test the Corporate Guarantee with component of definition as carved out as above.
Whether Corporate Guarantee is a claim of any debt?
The term “Debt” includes a sum of money due by one person to another and which includes A sum of money which becomes payable in future due to present obligations will be considered as a Debt.
At the time of giving of Corporate guarantee, the parent company undertakes to indemnify the Bankers / Financial Institution in case of default by the subsidiary / group company. It can be considered as a claim of debt which is contingent and payable upon the future event, default by principal debtor.
Whether the same is secured by mortgage of immovable property or by hypothecation or pledge of moveable property. or to any beneficial interest in moveable property not in the possession, (either actual or constructive), of the claimant.
No, it is not secured by a mortgage of immovable property or by hypothecation or pledge of moveable property of the subsidiary. Because at the time of giving Corporate Guarantee by the Holding company, no Cross security is created on the property of neither Subsidiary nor any hypothecation is created on immovable property of subsidiary.
From the subsidiary point of view it is completely unsecured debt. And so Corporate Guarantee can be considered as “Actionable claim”
Now since the Corporate Guarantee is now classified as Goods, it will not be classified as supply of services. As the definition of service specifically provides, “services” means anything other than goods,—–.
Taxability of Corporate guarantee.
From the above discussion, conclusion can be drawn, Corporate Guarantee is supply of Goods, however to levy the GST, such supply should be in the course of Business or furtherance to the business.
Generally, the banking / Financial services industry has Bank guarantee in their product list and the services are provided by this industries in a regular course of business. Apart from the financial services sector, providing Guarantee neither activity in the course of business nor it fall under furtherance of business. Therefore, the same cannot be considered as Supply in the course of business or furtherance of business.
3. Scope of GST on Actionable claim.
CGST Act 2017, provides the various schedules to the act. One of the schedules is Schedule III, and it is providing the list of activities which are neither supply of goods nor supply of services. Entry 6 of the said schedule provides,
Actionable claims, other than lottery, betting and gambling.
Therefore, Lottery, betting and gambling are only the actionable claims which are considered as supply of goods under GST and taxable under GST, any other actional claims are covered under Schedule III and hence, the same will not be considered as supply for levy of GST.
4. Valuation related challenges
Rule 27 to 31 provides the various valuation rules in case of no monetary consideration is received /consideration is not fully received in money. However these valuation rules cannot be applied , because of below limitations.
- Since the parent company is not engaged in the business of Providing Guarantee, monetary valuation on the basis of open market value cannot be determined, as per rule 27 and Rule 28.
- There is no principal agent relationship between Parent company and Subsidiary / group company, Rule 29 cannot be applied for valuation.
- There is no monetary cost of Parent company is involved at the time of Providing Guarantee cost + 10% as per Rule 30 will not be applicable. Even if one decide to valutate on the basis of Bank charges paid, it would be very nominal for valuation.
- There is no residual method for this kind of issue.
Therefore as on the date there is a valuation mechanism that has been made available. And since the mechanism failed, levy also failed.
5. Profit Objective vs Economic Operational feasibility.
Taxability of Corporate guarantee is also challenged on the ground of the basic objective of providing Guarantee. Whenever the parent company provides Guarantee, there is no objective of the parent company to earn income / profit by way of charges for providing Guarantee.
Generally, the main intention behind the Corporate guarantee is provided because the subsidiary is also contributing to the ultimate goal of the group. And for the said reason, the parent company is providing operation support. As soon as the subsidiary comes out of financial difficulties, it can focus on the group objectives. And therefore through Corporate Guarantee, the parent company is not making any supply to subsidiaries but helping themselves in achievement of the group objectives.
Conclusion:
From the above discussion we can conclude that, there is no supply component in the corporate guarantee, however after the Apex court decision and various interpretations taxman may face the notices from Department.
Even recently after the judgment DGGI[i] has started sending the notices for recovery of taxes and soon dispute will start under GST. And considering the complexities in interpretation of law, clarification is expected from Finance ministry in this regards.
Further, proviso II to Rule 28, provide the relaxation for valuation related provision in case of related parties’ transaction, in case full ITC is available to the recipient. Therefore by the time matter is get settled / clarified, it is advisable to mutually decide the valuation and discharge the GST, and same time claim the whole ITC on recipient end.
[i] https://economictimes.indiatimes.com/news/economy/policy/gst-directorate-seeks-tax-on-corporate-guarantees/articleshow/101806010.cms?from=mdr
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