GST on Corporate Guarantee (including Continuing Corporate Guarantee)

The Goods and Services Tax (GST) has altered India’s indirect tax system and opened a pandora’s box of problems. The impact of GST on corporate guarantees is one such topic that has been gaining popularity in recent times.

A corporate guarantee is a business’s agreement to pay another entity’s debts if the other party cannot do so. Obtaining loans or credit facilities is a typical reason for such arrangements in company operations. The taxability and the value of such guarantees are significant concerns raised by the GST Department recently, with frivolous notices that paved the way for several CBIC explanations.

Through this article, the Author explores the intricacies of GST treatment of corporate guarantees (including continuing corporate guarantees).

Before getting into the discussion on the taxability of CG, it is equally important to understand the terms Guarantee, Corporate Guarantee, and Continuing Corporate Guarantee.

The terms Guarantee, Corporate Guarantee, and Continuing Corporate Guarantee were not defined in GST. When words are not defined in the GST Law, we can rely upon the dictionary meanings {Star Paper Mills Ltd vs C.C.Ex [1998 (43) E.L.T. 178 (S.C.)]} and definitions given under other acts, status, etc.

Guarantee

• Black’s Law Dictionary defines Guarantee as follows
  • To assume a suretyship obligation to agree to answer for a debt or default
  • To promise that a contract or legal act will be duly carried out
  • To give security to.
• 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.

Corporate Guarantee

In common parlance, Corporate Guarantee meaning guarantee given by the Corporate is called corporate Guarantee. But the term Corporate means to a corporation, as a corporate name; incorporated, as a corporate body.  The term corporation/body corporate is defined in the Companies Act, 2013 as under

Section 2(11) – ‘body corporate’ or ‘corporation’ includes a company incorporated outside India, but does not include –

i) a co-operative society registered under any law relating to co-operative societies; and

ii) any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification, specify in this behalf;

Ex: Guarantee by the holding company to the bank or financial institutions for sanction of credit facilities to its subsidiary company.

Continuing Corporate Guarantee (CCG)

• Black’s Law Dictionary defines CCG as a guarantee that governs a course of dealing for an indefinite time or by a succession of credits. It is also called an open guarantee.
• Section 129 of the Indian Contract Act, 1872 defines CCG as a guarantee which extends to a series of transactions and is called a continuing guarantee.

Let us take an illustration to move forward:

Y Ltd (located in India) is the wholly owned subsidiary of X Ltd (located outside India). X Ltd issued a corporate guarantee to the Bank for the provision of loan facilities to its subsidiary company. Hereon, the Author elucidates the taxability and the valuation of CCG, When CCG is given in the following scenarios

a. April 2017

b. April 2023

c. April 2024

Before examining taxability and value of supply, the Author would like to put forward the following GST matters:

Discussion of taxability:

A. When CG is given in April 2017:

(The date of CG is April 2017 which is of service tax. Hence the taxability of CG in the service tax regime is as follows.)

For the period from 1.7.2012, Service tax shifted to a negative list regime, where all activities forming part of the definition of “service” are liable to service tax other than those mentioned in the negative list.

Accordingly, the term “service” was defined in Section 65B(44) of the Finance Act, 1994 as follows:

“(44) “Service” means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include-

a. …

b. …

c. …”

Thus, from the above definition, it is clear that to treat a transaction to be a “service”, there has to be a consideration being paid by one person to another. The term “consideration” has not been defined in Section 65B of the Finance Act, 1994, the section which defines various terms for service tax.

However, in Section 67, which pertains to valuation of taxable services for charging service tax, the meaning of “consideration” is given in the explanation (a) and is extracted below:

(a) “consideration” includes-

a. any amount that is payable for the taxable services provided or to be provided;

b. …

c. …

Going by the above definition read with the definition of service in Section 65B(44), it could be said that for an activity to be service, there has to be a “consideration”, which is any amount payable for taxable services provided or to be provided.

a. If CG is issued with consideration:

When the CG is issued for consideration, it satisfies the definition of Service under the ST Regime. Hence, CG is taxable under ST and the consideration paid by Y Ltd shall be treated value of supply. However, the rate of tax and the person responsible for discharging taxes needs to be examined.

b. If CG is issued without any consideration:

Let’s assume, there is an absence of consideration payable by Y Ltd to X Ltd.  In this regard, It is pertinent to note the Supreme Court judgment in the case of CIT Vs B. C. Srinivasa Setty [(1981) 128 ITR 294 (SC)] wherein it was held that the charging section and the computation provisions together constitute an integrated code; when there is a case to which the computation provision cannot apply at all, it is evident that such a case was not intended to fall within the charging section. Thus, when valuation fails, the levy fails.

Further, Hon’ble ITAT-Ahmedabad in the matter of Micro Ink Limited v. ACIT (I.T.A. No.: 2873/AHD/10) held that “When the legislature itself does not group ‘guarantees’ in the ‘provision for services’ and includes it in the ‘capital financing’, it is reasonable to proceed on the basis that issuance of guarantees is not to be treated as within the scope of normal connotations of expression ‘provision for services’.

Recently, Hon’ble Supreme Court in Commissioner of CGST and Central Excise Vs Edelweiss Financial Services Ltd [(2023) 5 Centax 57 (Tri.-Bom)] wherein it was pronounced that no service tax should be imposed on corporate guarantees provided by parent companies to its subsidiaries when there is no consideration involved.

Hence, the Provision of CG does not amount to Service and is also not taxable under ST when the consideration is absent.

B. When CG is given in the April 2023:

(The date of CG is April 2023 which is related to the GST regime.)

As of the date of the CG, there is an ambiguity under the law relating to taxability and value of supply. On 26.10.2023, a specific valuation mechanism was inserted [i.e., Rule 28(2)] to determine the value of supply for the services provided by way of corporate guarantee. However, by way of Circular 225/16/2024-GST w.e.f. 26.10.2023, it was clarified that Rule 28(2) will be applicable only to those guarantees issued/renewed after 26.10.2023. Further it is also clarified that the value of supply for the guarantee issued/renewed before 26.10.2023 needs to be determined as per Rule 28(1).

Hence from the above, we can take a stand that, there is no requirement to pay taxes since there is an ambiguity regarding the value of supply. However, if Y Ltd wants to pay taxes under reverse charge to mitigate the litigation, the following discussion would be relevant.

Thus, it appears that corporate guarantees, being a transaction between related persons without consideration, will be deemed as supply under Schedule I and will be taxable under GST. The same was clarified by way of Circular 204/16/2023 para 2.

Valuation of CG:

CG was issued in April 2023 and there is no renewal of the said CCG has taken place. It was clarified by way of Para 1 of Circular 225/16/2024-GST that the value of supply of services by way of providing corporate guarantee issued or renewed before 26.10.2023, needs to be determined under Rule 28 as it exists during that time.

Hence, the Value of CG shall be

i) Open Market Value

ii) Value of supply of like kind and quality

iii) Value determined under Rule 30

However, if the recipient is eligible for full ITC, the value declared in the invoice shall be deemed to be the open market value of goods or services.

Rule 28(1) shall be applied irrespective of the consideration, because Section 15(1) (which deals with value of supply) states that transaction value shall be deemed to be the value of supply when supplier and recipient are unrelated and the price is sole consideration. Since X Ltd and Y Ltd are related, we cannot apply Section 15(1).

Case 1: Y Ltd is eligible for full ITC

If Y Ltd is eligible for full ITC, then the 2^nd proviso to Rule 28(1) will apply and the value declared in the invoice shall be deemed to be the OMV.

Case 2: Y Ltd is not eligible for full ITC

When Y Ltd is not eligible for full ITC, then the 2^nd Proviso to Rule 28(1) will not apply. Hence, we need to determine the value as per Rule 28(1).

It is required to note that corporate guarantees, unlike bank guarantees, are specific to a particular corporate group or company, and therefore external third-party comparisons may not be available or relatable.

As the OMV and value of like kind and quality are not available, Rule 30/31 can be applied. Rule 30 of the CGST Rules, prescribes the value of supply of goods or services shall be 110% of the cost of provision of services when it is not determinable by any of the preceding rules.

Cost of the provision of services includes costs incurred for executing the guarantee such as legal charges, documentation charges, etc. This could be determined in terms of CAS-4 and certified by a cost accountant. Hence, Y Ltd can discharge taxes on the costs incurred for providing CCG at the rate of 18%.

Taxability of continuing corporate guarantee:

Let’s assume, X Ltd provides a continuing corporate guarantee without any consideration to Y Ltd. At the time of the provision of CCG, Y Ltd is liable to pay taxes to the Government under reverse charge on the value as discussed above.

Further, the option of renewal is not available with a continuing corporate guarantee. The only option available to X Ltd to increase the value of CG is an amendment (which is being followed by the industry). Author discussed the taxability and valuation mechanism of the amendment made to CCG in the following paras.

Summary of Para 1 of Circular 225/16/2024-GST which clarifies the valuation mechanism for the corporate guarantee is given below:

In this instance facts of the case, CCG was issued before 26.10.2023, and there is no subsequent renewal happened neither before 26.10.2023 nor after 26.10.2023. Hence in the author’s view, tax on continuing corporate guarantee amendment needs is not leviable because neither a fresh issue of guarantee nor renewal of guarantee is happening, It is merely an amendment of the initial guarantee and not covered under any of the above criteria.

If, Y Ltd wants to pay taxes on an amendment to avoid litigation, then can pay taxes on value determined as per Rule 28(1) (i.e., cost incurred for executing the amendment to the guarantee plus 10% markup) and take a certificate from the cost accountant as discussed above to certify the cost incurred.

Note: The above mechanism i.e., Payment of taxes on cost + 10% is applies on those amendments carried out before 26.10.2023. Valuation for the amendment carried out after 26.10.2023 is discussed further.

C. When CG is given in the April 2024:

As per Circular 225/16/2024-GST, the applicable valuation mechanism for the CG issued on or after 26.10.2023 is Rule 28(2). An extract of Rule 28(2) is given below for reference.

Rule 28(2): Value of the supply of services by a supplier to a recipient who is a related person located in India by way of providing corporate guarantees to any banking company or financial institution on behalf of the said recipient shall be corporate guarantees as 1% per annum of guarantee offered or actual consideration, whichever is higher.

Provided that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the value of said supply of services

In other words, the value of the supply of CG shall be (if full ITC is not available)

a. 1% of CG offered; or

b. Actual consideration,

whichever is higher (WIH).

a. Value of supply in the instance case:

i) If full ITC is available to Y Ltd: The value declared in the invoice shall be deemed to the open market value.

ii) If full ITC is not available to Y Ltd: 1% p.a. of CG offered or Consideration WIH.

• If Consideration is charged: 1% p.a. of CG offered or Consideration WIH.
• If consideration is not charged: 1% p.a. of CG offer.

b. Discussion on the period of guarantee:

It was clarified by the CBIC that if a CG is issued for a particular number of years then the value of supply shall be 1% of CG offered multiplied by the number of years for which the said guarantee is offered.

Taxability of continuing corporate guarantee:

Let’s assume, X Ltd gave a guarantee which is a continuing one. In other words, there is no fixed time for the expiry of the guarantee. Now the question may arise, what should be the period of guarantee?

Since the period is not expressed clearly, we are unable to determine the period. However, a cue can be taken that if the guarantee is given for a specific loan then the period of the loan is deemed to be the period of guarantee because there is no requirement of a guarantee in the absence of a loan. However if X Ltd gave a general guarantee which is not specifically linked to the a specific loan, then it is difficult to determine the time period.

Further, the amendment carried out after 26.10.2023 might be contended by the department stating that the amendment of the guaranteed amount in the contract leads to a significant fundamental change to CG, thus it creates a new contract, as a result, Rule 28(2) will apply for determining the value of supply.

Hence, to avoid the above hindrances, the author suggests initially to pay taxes considering the life as 1Year. After completions of 1 year, if the guarantee is still alive pay for one more, and so on. Further, if any upward revision happens, pay taxes proportionately for a year. To illustrate

Let ‘n’ be the number of months present till the next succeeding April Month.

There is an ambiguity in determining the value of supply when the CG value is revised/amended downwards in the middle of the year.

Let’s summarise the above discussion:

Views expressed in this article are personal and must not be construed as a legal opinion.

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Suggestions or feedback can be sent to the author at vltanguturi1110@gmail.com