The applicability of GST on corporate guarantees has always been a contentious issue. The first issue was whether there was any service involved in the provision of corporate guarantees.
Judicially, under the erstwhile service tax regime, the courts have indirectly indicated that there is an element of service involved in the provision of corporate guarantees. The same view has also been coming forth from the jurisprudence established under the Income Tax Act, 1961.
Thus, as there is a service, GST is leviable on the activity. However, in the case of related party supplies, corporate guarantee even without consideration is also taxable.
Thence, the next question is what should be the valuation for paying GST on such services when made without a consideration between related parties? In this regard, there was no clarity under the GST laws before October 2023.
However, in the 52nd GST Council Meeting, the Government prescribed a new Rule 28(2) in the GST Rules for prescribing a method to value services in corporate guarantee agreements made without consideration.
As per Rule 28(2) of the GST Rules, the value of corporate guarantee has been capped at 1% of the amount of borrowings or the actual consideration, whichever is higher.
Although it looks like the above amendment aimed at bringing clarity, however, this amendment has created significant challenges for industries, prompting calls for further clarification from the GST Council. This article aims to highlight these issues and the consequential need for the Council’s intervention.
Issue: – Whether the amount of 1% of the total borrowings is to be calculated on a per annum basis or once for the entire duration of the guarantee extended?
View: Since the rule does not specify that the 1% amount should be calculated on a per annum basis, the 1% value should be applied to the entire duration of the guarantee extended.
It should be noted, however, that the 1% amount is derived from the Income Tax Safe Harbour rule, where it is calculated on a per annum basis. Therefore, if the Council decides to align the GST provisions with the Income Tax provisions, it might clarify a per annum basis payment of the 1% amount, an interpretation that could have posed significant tax costs for businesses.
Moreover, it is also noteworthy that corporate guarantee does not constitute a continuous supply of services. Thus, if the Council were to adopt the per annum basis for valuation, and, for example, a corporate guarantee (CG) is extended for 3 years, the GST liability would be calculated at 3% in the year the guarantee is extended.
Issue: – Is valuation as per the above Rule mandatory even in cases wherein the recipient is not eligible to avail of ITC?
View: A plain reading of the rule suggests that the Government has not provided any relaxation in cases wherein the guarantee is extended to a related party and the recipient is not entitled to claim an input tax credit (ITC). As a result, the deeming provision of a 1% GST liability on the corporate guarantee (CG) extended has led to a significant increase in costs for sectors such as solar, power, real estate, and similar industries where ITC is not eligible.
To mitigate these issues, the Council should provide clarification and consider a lower rate of valuation for these sectors. Failure to do so could result in substantial cost escalation for the industry and may lead to prolonged disputes.
Issue: – Whether Valuation at 1% is mandatory if the recipient is entitled to full ITC or whether the benefit of the 2nd Proviso to Rule 28 of the GST Rules could be taken?
View: Rule 28(2) begins with a non-obstante clause, suggesting that suppliers cannot opt out of the 1% valuation rule. Hence, the taxpayer may not be able to take advantage of the 2nd proviso to Rule 28 of the GST Rules.
This interpretation seems illogical and inconsistent, given that, for all other supplies between related persons under GST law, the invoice value is treated as the Open Market Value (“OMV”) when the recipient is entitled to avail ITC.
Consequently, the specific rule for the valuation of Corporate Guarantees (“CG”) appears arbitrary especially since the clarification provided in Circular No. 199 accepts “Nil value” as the OMV for internally generated services, which should logically apply to CGs as well.
Thus, to avoid interpretational disputes, it is recommended that the Council clarify that the benefit of this circular should be extended to CGs or amend the rule accordingly to provide the benefit of OMV for CGs also.
Issue: – What if the benefit of the entire loan facility covered by CG has not been availed by the borrower? Whether GST would be leviable on the value of the guarantee extended or on the amount of loan borrowed?
View: It should be noted that the activity of extending Corporate Guarantee is treated as a supply of services, not the activity of availing of borrowing loan amount from the bank. Hence, in view of the author, the amount under Rule 28(2) of the GST Rules should be calculated on the value of CG extended irrespective of the amount of loan availed by the borrower from the banks or financial institutions.
Issue: -Whether this provision applicable in case CG has been extended in respect of a loan taken from VC, AIF, or similar other funds?
View: Rule 28(2) of the GST Rules provides for a valuation mechanism in case of a guarantee extended in respect of loans taken from banking companies or financial institutions. Thus, the deeming valuation mechanism may not apply to other institutions.
So, the next question that may arise is whether guarantees given w.r.t. loans from such funds are taxable.
In this regard, it is apposite to note that, although there may be a levy there is no valuation mechanism provided w.r.t. such a levy and it is a settled legal principle that if the valuation mechanism fails then the levy also would fail. As has been upheld in the landmark case of BC Srinivasa Shetty.
Thus, a view may be taken that guarantees given w.r.t loans from such funds may not be leviable to GST.
Issue: – Whether CG extended by Indian Holding Company to the foreign subsidiary company covered under this Rule? Further, whether such services be treated as export of services as the entire amount of 1% might not be recoverable from a foreign subsidiary?
View: In view of the author, the place of supply of such services is the location of the recipient and thus there should not be any GST liability as GST law cannot be extended to territory outside India.
There could be a contrary argument that exclusion from GST levy in case of internal service transaction can be claimed only if the services fall within the term “export of services” where one of the conditions is the recipient of consideration for services in convertible foreign exchange.
In view of the author, this condition can also be said to be fulfilled in this case even if the full 1% amount is not received from the foreign company on account of below reasons:
(i) The requirement of receipt of consideration in foreign currency can be made applicable only in cases where there is commercial consideration in the transaction. In case of transaction covered under Schedule I where deeming levy and valuation provision is made even though there is no actual commercial consideration, the condition of realization in convertible foreign exchange for the transaction without consideration cannot be imposed.
(ii) Rule 37 provides that there is no need for reversal of ITC even if payment is not made in case of transactions falling within Schedule I or where valuation is added under section 15 (2) (b). The same logic should be made applicable for the fulfillment of a condition of export of services.
Thus, while the author is of the view that there is no GST liability in such cases, nevertheless it would be beneficial for the industry if the Government either excluded the applicability of this provision to CG extended by Indian Companies to foreign related parties or to specifically clarify that the condition of realization in convertible foreign exchange shall be deemed to have been fulfilled in such cases.
Moreover, in this case, the taxpayer may also need to understand the interplay of valuation with transfer pricing provisions.
Issue: – if A Ltd and B Ltd are co-guarantors for loans procured by C Ltd from a bank, then there are two supplies provided by two different suppliers (A Ltd & B Ltd) to one single recipient (C Ltd). Whether valuation rule @ 1% would apply to both guarantors jointly or separately?
View: The issue arises here as to what is “guarantee offered” for A Ltd & B Ltd. Here, it would be relevant to consider Section 146 of the Contract Act. In this regard, let us consider the following 2 scenarios:
a) When the proportion of guarantee offered is defined in the contract:
In this case, each guarantor is aware of the proportion of the debt which it is required to pay in case of default of the principal debtor. Thus, the guarantee offered would be to a pre-defined extent only. Thus, the valuation of 1% of the “guarantee offered” would be 1% of the proportionate value of the loan as defined in the contract. For example, A Ltd & B Ltd are joint guarantors for a loan of Rs. 10 Crores obtained by C Ltd from a bank. A Ltd & B Ltd agree to provide a guarantee for 60% and 40% of the loan amount respectively.
In this case, assuming there is no actual consideration paid to A Ltd as guarantee commission, the valuation should be 1% of Rs. 6 Crores i.e., Rs. 6 Lakhs, on which GST is to be charged by A Ltd. The valuation for B Ltd would be 1% of Rs. 4 Crores, i.e., 4 Lakhs, on which GST is to be charged by B Ltd.
b) When the proportion of guarantee offered is NOT defined in the contract:
In this case, concerning Section 146 of the Contract Act, when the proportion of guarantee is not defined in the contract, then it is deemed to be divided equally. The GST valuation under Rule 28(2) may also be done accordingly. For example, A Ltd & B Ltd are joint guarantors for a loan of Rs. 10 Crores obtained by C Ltd from a bank. The agreement does not specify any proportion for the guarantee offered by A Ltd and B Ltd. Thus, it is deemed that A Ltd & B Ltd would be liable for payment of Rs. 5 Crores each in case of default of payment by C Ltd.
In this case, assuming there is no actual consideration paid to A Ltd & B Ltd as a guarantee commission, the valuation shall be 1% of Rs. 5 Crores each for A Ltd & B Ltd. This also ensures there is no double taxation of guarantee services on the same loan transaction.
It is expected that the Council gives suitable clarifications on such cases to avoid interpretational ambiguities.
Issue: – Whether new valuation rules can be applied retrospectively?
View: Insertion of the new rule itself establishes that there was no specific provision for the determination of valuation of such services in the past. In the absence of any valuation provision for the past period, the application of this rule retrospectively cannot be sustained.
Even if the department takes a view that there is GST liability for the past period, in view of the author, the benefit of Circular 199 can be taken for the past period and the Nil value can be considered as the open market value where the recipient is entitled to take ITC.
Where the recipient is not entitled to take ITC for the past period, it is recommended to dispute the matter on the grounds that the levy did not exist earlier owing to the absence of a valuation mechanism.
It is advisable for the government to explicitly clarify that the new rule is not applicable for past periods to avoid unnecessary disputes.
Conclusion
The GST Council is urged to address these ambiguities promptly to ensure compliance and prevent disputes. Clear guidelines will aid industries in adapting to the new rule without incurring substantial financial or operational disruptions. The Council’s clarification and appropriate amendments are essential to mitigate the challenges faced by the industry and ensure a smooth transition under the new GST provisions for corporate guarantees.
Inputs and feedback are welcomed at ashish@hnaindia.com or poojajajwani@hnaidia.com.
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