GST on Corporate Guarantees: 1% Deemed Valuation Struck Down as Mandatory Ceiling

Gujarat HC Upholds GST on Corporate Guarantees, Reads Down 1% Valuation Rule

Summary: The Gujarat High Court Division Bench in Torrent Power Ltd v. Union of India & Ors. examined GST liability on intra-group corporate guarantees under Schedule I, Section 7 and Rule 28(2) of the CGST Rules. The Court held that such guarantees constitute taxable supplies of services between related persons even without consideration, rejected their treatment as actionable claims, and held that a guarantee supporting a subsidiary’s credit facilities is an activity connected with or ancillary to business. However, it read down Rule 28(2) by removing the mandatory effect of “whichever is higher”: where actual, ascertainable consideration exists, including below 1%, GST applies to that actual consideration; the 1% deemed value applies where the guarantee is gratuitous or its value cannot be determined. The Court held valuation should be based on the subsisting guarantee balance disclosed annually, not the original sanctioned amount, and rejected classification as a continuous supply of services. It further held Rule 28(2) cannot operate retrospectively for periods before October 26, 2023, and set aside Section 74 notices concerning past periods.

The legal debate over the taxation of intra-group corporate guarantees under India’s Goods and Services Tax (GST) regime reached a pivotal milestone with the judgment delivered by the Division Bench of the High Court of Gujarat in Torrent Power Ltd v. Union of India & Ors. (R/Special Civil Application No. 12175 of 2024 with connected matters, Neutral Citation: 2026:GUJHC:51510-DB, CAV Judgment pronounced on August 14, 2026). This judgment systematically dissects corporate law, contract law, accounting standards, and constitutional principles to balance legislative taxing power with taxpayer safeguards.

Factual and Legislative Background

When a subsidiary company seeks project financing or working capital from financial institutions, lending banks frequently require the parent/holding company to stand as a guarantor. Historically, parent companies provided these corporate guarantees without charging any guarantee commission or consideration from their subsidiaries.

The Statutory Framework and Changes

I. Schedule I (Entry 2) of the CGST Act, 2017: Treats supplies between “related persons” as taxable events even when made without consideration.

II. Rule 28(2) of the CGST Rules, 2017: Inserted via Notification No. 52/2023-CT (w.e.f. October 26, 2023) and subsequently amended via Notification No. 12/2024-CT (w.e.f. October 26, 2023). It mandated that the taxable value of an intra-group corporate guarantee extended to a bank on behalf of a related recipient in India shall be deemed to be 1% of the amount of such guarantee offered per annum, or the actual consideration, whichever is higher.

III. CBIC Circulars: Clarifications issued vide Circular No. 204/16/2023-GST (dated October 27, 2023) and Circular No. 225/19/2024-GST (dated July 11, 2024).

A batch of corporate taxpayers, led by Torrent Power Ltd., approached the High Court challenging the constitutional validity of Rule 28(2), Section 15(4), the associated circulars, and the show-cause notices issued under Section 74 covering periods both before and after the introduction of the rule.

Core Legal Terms and Their Judicial Interpretation

The judgment extensively unpacks several key statutory terms and concepts across interrelated enactments:

Supply and Deemed Consideration under Sections 7 and 15

I. Petitioners’ Argument: Under general jurisprudence, a supply requires a two-way transaction of giving and taking with an economic quid pro quo. A gratuitous, contingent promise involves no actual cost, performance, or consideration.

II. Court’s Interpretation: Relying on the Supreme Court’s rulings in Union of India v. Mohit Minerals Pvt. Ltd., (2022) 10 SCC 70 and Directorate General of Goods and Services Tax Intelligence (HQS) v. Gameskraft Technologies (P.) Ltd., [2026] 186 taxmann.com 1232 (SC), the Court held that the GST framework departs from the old “sale-centric” model to a “supply-centric” architecture. Section 7(1)(c) read with Schedule I dispenses with the requirement of actual consideration for related-party transactions.

In the Course or Furtherance of Business

I. Petitioners’ Argument: Holding companies are engaged in power generation, manufacturing, etc., not in the business of banking, money lending, or credit enhancement. Providing a guarantee is a shareholder investment activity, not a business activity.

II. Court’s Interpretation: Section 2(17) contains an expansive and inclusive definition encompassing not just core trade, but any transaction “in connection with or incidental or ancillary” to it, regardless of volume, frequency, continuity, or profit motive. Following State of Tamil Nadu & Anr. v. Board of Trustees of the Port of Madras, (1999) 4 SCC 630, facilitating credit for a subsidiary preserves and strengthens the group’s economic operations, making it an ancillary business activity.

Agreeing to the Obligation to Do an Act

I. Petitioners’ Argument: Entry 5(e) corresponds to negative covenants (like non-compete agreements) requiring reciprocal bargaining.

II. Court’s Interpretation: The Court analyzed the word obligation (vinculum juris or a legal tie). The holding company binds itself to a legal duty to step in upon default. Once a supply is established under Section 7(1)(c), Entry 5(e) of Schedule II classifies this undertaking to fulfill the debtor’s liability as a “supply of service”.

Recipient of Service

I. Petitioners’ Argument: The guarantee is executed directly in favor of the lender bank, meaning the bank is the beneficiary/recipient, not the subsidiary.

II. Court’s Interpretation: Under Section 2(93)(c), when no consideration is payable, the recipient is the person to whom the service is rendered. Because the guarantee is triggered at the request of the subsidiary to secure credit facility approval, the ultimate economic accrual terminates with the subsidiary, making it the statutory recipient.

Corporate Guarantee and Actionable Claim

I. Petitioners’ Argument: Under Article 366(8) of the Constitution and the Insolvency and Bankruptcy Code, 2016 (IBC), a guarantee is recognized as a “debt”. Therefore, a contingent claim to debt constitutes an “actionable claim” under Section 3 of the Transfer of Property Act, 1882, which is excluded from GST under Schedule III.

II. Court’s Interpretation: The definitions under Article 366(8) and the IBC cannot be imported to redefine the Transfer of Property Act for GST purposes. An actionable claim represents a direct, primary right to an unsecured debt that is freely transferable/assignable under Section 130 of the Transfer of Property Act, 1882. A corporate guarantee is an unassignable, secondary, tripartite contingent obligation, not an actionable claim.

Pledge of Shares vs. Guarantee

I. Petitioners’ Argument: Pledging parent shares to back a loan involves “securities,” which are expressly excluded from the definitions of both goods (Section 2(52)) and services (Section 2(102)).

II. Court’s Interpretation: While shares themselves are securities, executing a pledge agreement where the parent covenants to surrender assets upon subsidiary default serves the same functional purpose as a contract of guarantee under Section 126. GST is concerned with the core supply of credit support, not the specific asset mechanism through which that promise is secured.

Corporate Guarantee and Continuous Supply of Services

I. Court’s Interpretation: The Court rejected the Revenue’s attempt to classify corporate guarantees as a “continuous supply of services”. Section 2(33) mandates “periodic payment obligations”. Because gratuitous intra-group guarantees lack periodic payments, they are one-time executions with a continuing legal obligation, not a statutory continuous supply.

Analysis of Precedents Cited by Both Sides

The judgment undertakes an analysis of numerous domestic and international authorities, drawing clear boundaries of applicability.

Precedents Distinguished or Held Inapplicable

a. Commissioner of CGST & Central Excise v. Edelweiss Financial Services Ltd., MANU/SC/0648/2023 : (2023) SCC OnLine SC 425 (Supreme Court, decided on 17.03.2023): Rendered under the erstwhile Service Tax regime (Section 65B(44), Finance Act, 1994), where consideration was an indispensable statutory prerequisite. Held inapplicable to the CGST Act due to the explicit insertion of Schedule I deeming fictions.

b. M/s D.P. Jain & Co. Infrastructure Private Limited v. Union of India & Ors., Writ Petition No. 2087 of 2025 (Bombay High Court, decided on 06.05.2026): The Gujarat High Court respectfully disagreed with the Bombay High Court to the extent that it relied on Edelweiss to negate taxability under GST.

c. Micro Ink Ltd. v. Assistant Commissioner of Income Tax, (2016) 176 TTJ 8 (ITAT Ahmedabad) & OECD Transfer Pricing Guidelines: Direct tax concepts of “shareholder activity” and arm’s-length principles cannot override the specific statutory architecture enacted by Parliament under the CGST Act.

d. Centel Communications Co. v. Commissioner of Internal Revenue, 920 F.2d 1335 (US 7th Cir. 1990, decided on 17.12.1990) & Australian GST Ruling (GSTR 2006/1): Foreign tax determinations concerning stock options or foreign VAT policies cannot control domestic GST statutes.

e. Phoenix ARC Private Limited v. Ketulbhai Ramubhai Patel, (2021) 2 SCC 799 (Supreme Court, decided on 03.02.2021) and Maitreya Doshi v. Anand Rathi Global Finance Ltd., (2023) 17 SCC 606 (Supreme Court, decided on 14.11.2022): Addressed pledge vs. guarantee in the distinct context of financial debt under the IBC, which cannot be imported into GST.

Precedents Followed

a. Union of India & Anr. v. Mohit Minerals Pvt. Ltd., (2022) 10 SCC 70 (Supreme Court, decided on 19.05.2022) and Directorate General of Goods and Services Tax Intelligence (HQS) v. Gameskraft Technologies (P.) Ltd., [2026] 186 taxmann.com 1232 (SC): Affirmed that “supply” must be construed broadly and that specialized valuation mechanisms under Section 15(5) and Section 164 are within legislative competence.

b. State of Tamil Nadu & Anr. v. Board of Trustees of the Port of Madras, (1999) 4 SCC 630 (Supreme Court, decided on 29.04.1999): Established that activities incidental or ancillary to the main establishment fall squarely within the definition of “business”.

c. Wipro Ltd. v. Assistant Collector of Customs, (2015) 14 SCC 161 (Supreme Court, decided on 16.04.2015): The Supreme Court held that a mandatory uniform deeming valuation (such as 1% handling charges) is arbitrary and invalid if applied where the actual transaction value is ascertainable. Deeming fictions can only operate as fallbacks when actual figures cannot be ascertained.

d. Munjaal Manishbhai Bhatt v. Union of India, Special Civil Application No. 1350 of 2021, 2022 (5) TMI 397 (Gujarat High Court, decided on 06.05.2022): Applied Wipro to read down the mandatory 1/3rd land deduction notification under GST, making it optional where actual land value is ascertainable.

e. Authorised Officer, Central Bank of India v. Shanmugavelu, (2024) 6 SCC 641 (Supreme Court, decided on 02.02.2024) and B.R. Enterprises v. State of U.P. & Ors., (1999) 9 SCC 700 (Supreme Court, decided on 07.05.1999): Laid down that courts must adopt the rule of “reading down” to salvage a statutory provision from constitutional invalidity rather than striking it down entirely.

Detailed Judicial Findings and Key Nuances

Time of Supply and Annual Valuation Base

Addressing when and on what amount GST is payable, the Court established two rules:

I. Trigger Date (Section 13(2)(c): The time of supply occurs annually on the date when the subsidiary discloses the subsisting guarantee commitment in its books of accounts / annual financial statements pursuant to statutory accounting standards (Ind AS 24, Clause 18(b)).

II. Subsisting Balance (Not Sanctioned Amount): The 1% valuation applies only to the outstanding/subsisting amount of the guarantee in that specific financial year, and not on the gross total amount originally sanctioned. If a loan of ₹100 Crore is reduced to ₹90 Crore in Year 2, GST is leviable on ₹90 Crore; if prepaid in Year 7, no GST applies for Years 8–10.

Reading Down Rule 28(2): “Whichever is Higher”

The central relief granted by the Court targets the arbitrary nature of the mandatory 1% benchmark:

I. Under the Safe Harbour Rules of Income Tax (Rule 10TD of Income-tax Rules, 1962), 1% is an optional safe harbor, not a compulsory floor.

II. The GST Council recognized that actual bank commissions vary widely between 0.5% and 3%, with intra-group arrangements often costing around 0.25% to 0.3%.

III. Imposing a mandatory 1% deemed value when the taxpayer has an actual, ascertainable consideration lower than 1% violates Article 14 (arbitrariness) and Article 19(1)(g) (freedom of business).

IV. The Remedy: Applying the doctrine of reading down, the Court removed the mandatory effect of the phrase “whichever is higher”.

a. If an actual, ascertainable consideration or commission exists (even if lower than 1%), tax is payable on that actual consideration.

b. The 1% legal fiction applies only where the corporate guarantee is provided purely gratuitously (without consideration) or where the actual value cannot be determined.

Invalidation of Retrospective Demands and Section 74 Notices

I. Prospective Operation: Rule 28(2) was inserted into the CGST Rules on October 26, 2023. The Court held that substantive valuation machinery cannot be applied retrospectively to transactions executed prior to this date.

II. Quashing of Penal Notices: Show Cause Notices issued under Section 74 (alleging fraud, willful misstatement, or suppression of facts) for past periods were set aside, as taxpayers acted under a bona fide legal interpretation in the absence of explicit valuation machinery.

Comparative Summary

Practical Implications for Industry

a. Reassessment of Ongoing Guarantees: Corporate groups must align their GST computations with the subsisting loan balances recorded annually under Ind AS 24 rather than the cumulative sanctioned guarantee limits.

b. Structuring Intra-Group Commissions: Where parent entities charge an actual, arm’s-length guarantee fee supported by transfer pricing or commercial documentation (even if below 1%, e.g., 0.25%–0.5%), GST can be discharged on that actual fee rather than the rigid 1% deemed rate.

c. Relief for Historical Audits: Taxpayers facing show-cause notices under Section 74 for periods prior to October 26, 2023, receive direct judicial support against retrospective demands and allegations of suppression.

Author: Mihirkumar V. Patel is an independent Advocate practicing before the High Court of Gujarat, Debts Recovery Tribunal-1 and 2 at Ahmedabad, Debts Recovery Appellate Tribunal at Mumbai, and the City Civil Court at Ahmedabad. He specializes in Writ Petitions (Article 226), Direct and Indirect Tax Litigation, Commercial Litigation, Land disputes, RERA, Banking, SARFAESI Act, RDB Act, and Recovery Disputes.