Introduction
GST audits are being carried out by the department and notices are being issued impetuously, as we are nearing the last date to issue show cause notice for non-fraud cases of FY 2017-18. Out of the many audit points, demanding GST on personal guarantees given by Directors is one of the burning issues.
It is a common practice by the financial institutions to obtain a personal guarantee from the Director of the Company in process of sanctioning loans to the company. No guarantee commission is paid by the companies to the Directors as per instructions of RBI. The guarantees are disclosed in the financial statements under Loans & Advances secured by the personal guarantee of Directors. Let us discuss the provisions of GST law which could be relevant for determining taxability of a guarantee transaction.
Discussion under GST:
GST is levied on supply of goods or services or both. The scope of supply is defined in section 7(1) of CGST Act to include –
“(a) all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.
…
(c) the activities specified in Schedule I, made or agreed to be made without a consideration”
Therefore, GST is levied on supply of goods or services when made or agreed to be made for a consideration. Only the activities specified in schedule I are taxed even without consideration.
In Schedule I, para 2, the supply of goods or services or both between related persons even without consideration, is deemed as “supply” when made in the course or furtherance of business.
The term “related persons” is defined in explanation to section 15 of CGST Act to include officers or directors of one another’s business. Therefore, a director of the company, and the company, are related persons under GST law.
Accordingly, as per para 2 of Schedule I, supply of goods or services by a director to the company, even without consideration, when made in the course or furtherance of business, would be deemed to be “supply”.
However, supply of services by employee to employer in the course of or in relation to employment is neither supply of goods nor services, accordingly, not liable to GST as per para 1 of Schedule III of CGST Act, 2017.
Services provided by Director of company, to the company, other than in the course of employment, is taxable in the hands of company under reverse charge (RCM) as per entry no. 6 in Notification no. 13/2017-CT (Rate) reproduced below.
| Sl.No. | Category of Supply of Services | Supplier of Service | Recipient of Service |
| 6 | Services supplied by a director of a company or a body corporate to the said company or the body corporate. | A director of a company or a body corporate | The company or a body corporate located in the taxable territory. |
We would now discuss whether the activity of giving personal guarantee by director amounts to supply under GST.
Discussion on personal guarantee given by Director:
A contract of guarantee is defined under section 126 of Indian Contract Act, 1872 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”.
In the instant case, the financial institution/bank giving the loan is the creditor. The Director giving personal guarantee is the surety. The borrower company is the principal debtor.
Section 127 of Indian Contract Act, 1872 provides for consideration in a guarantee contract as “anything done, or any promise made, for the benefit of the principal debtor, may be a sufficient consideration to the surety for giving the guarantee.” Illustration: B requests A to sell and deliver to him goods on credit. A agrees to do so, provided C will guarantee the payment of the price of the goods. C promises to guarantee the payment in consideration of A’s promise to deliver the goods. This is a sufficient consideration for C’s promise.
Therefore, the contract of guarantee is between the financial institution (bank) and the surety (Director). The bank giving loan to the principal debtor (company) is the consideration for the Director in providing guarantee service to the bank. Therefore, it could be inferred from above discussion that the recipient of service given by the Director is the bank. There is no supply between the surety (Director) and the principal debtor (company).
Further, RBI Circular No. RBI/2009-10/70 DBOD. No. Dir. BC. 14 /13.03.00/2009-10 July 1, 2009 stated that the personal guarantee is obligatory in nature. The director is not having any choice to reject the personal guarantee when the lending bank insists for guarantee by the directors of the company. From the detailed guidelines, it is clear that the directors are obligated to give personal guarantee as per the requirement of the lending bank.
Further, even assuming without admitting that giving of personal guarantee by Director is a service to the company, it is beyond the scope of their employment as Directors in the company. The Director having provided his personal guarantee has acted beyond the call of duty as employee of the company. Similarly held in the case of Controls & Switchgear Contactors Limited vs. DCIT [2014 (6) TMI 46 – Delhi High Court] that the act of the directors in providing their personal guarantees and undertaking the attendant risks is clearly beyond the scope of their services as employees of the company. Therefore, in view of the author, even assuming director is providing service to the company, the same is in his personal capacity which is not covered under para 2 of Schedule I of the CGST Act, 2017.
Similarly, it is clarified in the CBIC Circular no. 201/13/2023-GST dt. 01.08.2023 that services supplied by a director of the company, to the company, in his private or personal capacity, are not taxable under reverse charge in entry no. 6 of Notification no. 13/2017-CT (Rate) as cited supra.
Circular no. 201/13/2023-GST is clarificatory in nature and is applicable retrospectively from 01.07.2017. Further, the circular of the Board is binding on all GST officers. GST departmental officers cannot raise contention contrary to binding circular by Board. When a circular remains in operation, the Revenue is bound by it and cannot be allowed to plea that it is not valid nor that it is contrary to the terms of statute. Similarly held in a catena of cases including Collector of CEx., Vadodara v. Dhiren Chemical Industries cited 2002 (139) E.L.T. 3 (S.C.), Commissioner v. Indian Oil Corporation Ltd. – 2005 (186) E.L.T. A119 (S.C.) and many more.
Alternatively, erring on caution and to avoid disputes, the company may enter into an employment agreement with the Managing/Whole-Time/Executive Directors with clear duties defined. Accordingly, services provided by way of giving personal guarantee would get covered under services provided by employee to employer in para 1 of Schedule III.
Therefore, personal guarantee provided by Director to the company is neither supply of goods nor services. Accordingly, for all the reasons listed above, in view of the author, GST is not payable by the company in reverse charge. Also, when service itself is not taxable, the question of valuation does not arise.
GST Law is new and developing with grey areas, it may take 8-9 years until these matters are decided by the Apex Court. It is advisable to intimate understanding on taxability of transactions to the Jurisdictional range by written letter and seek confirmation of understanding about taxability of the transaction to ensure that there can be no sustainable demands for extended periods. Views of author are strictly personal. For feedback or clarifications author can be reached at vini@hnaindia.com
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