TAXABILLITY OF PERSONAL GUARANTEE AND CORPORATE GUARANTEE IN GST

[Mr. M. GOVINDARAJAN]

A personal guarantee is a promise made by a person or an organization (the guarantor) to accept responsibility for some other party's debt (the debtor) if the debtor fails to pay it. In the case of a personal guarantee made by an individual on behalf of another, the person who makes the personal guarantee is usually referred to as a co-signer of a note for a loan. A guarantor can be any party, including an individual or another organization, with a credit history.   A common purpose of a personal guarantee is to allow a loan to be extended to an organization or person with either no credit history or one with a credit rating that is too poor to qualify for a loan.

A corporate guarantor is an organization that consents to assume certain responsibilities.   Corporate guarantee is also written as a “guaranty” or “corporate guaranty.” Both the debtor and the lender gain from this assurance. Because the guarantor guarantees that the money will be repaid, the lender feels more secure about the loan. Because of the guarantor’s guarantee, a debtor may be able to get a loan for which they otherwise would not have been qualified. In order to be eligible for loans, debtors with lower credit scores may require business guarantees.

Clarification by CBITC

The CBITC issued clarifications in relation to the taxability of personal/corporate guarantee under GST vide Circular No. 204/16/2023-GST, dated 27.10.2023. 

According to Explanation (a) to Section 15 of the Central Goods and Services Tax, 2017 (‘Act’ for short) the director and the company are to be treated as related persons.  The  supply of goods or services or both between related persons, when made in the course or furtherance of business, shall be treated as supply even if made without consideration according to Section 7(1)(c)  of the Act and Sl. No. 2 of the Schedule I of the Act.  Therefore the activity of providing personal guarantee by the Director to the banks/ financial institutions for securing credit facilities for their companies is to be treated as a supply of service, even when made without consideration.

Rule 28 of Central Goods and Services Tax Rules, 2017 (‘Rules’ for short) prescribes the method for determining the value of the supply of goods or services or both between related parties, other than where the supply is made through an agent.  The taxable value of such supply of service shall be the open market value of such supply.

RBI Guidelines

Vide Para 2.2.9 of Circular No. RBI/2021-22/121 dated 09.11.2021, Reserve Bank of India (‘RBI’ for short) provides that Banks should take personal guarantees of promoters, directors, other managerial personnel or major shareholders for the credit facilities granted to corporate, public or private, only when absolutely warranted after a careful examination of the circumstances of the case and not as a matter of course.   Where personal guarantees of directors are warranted, they should bear reasonable proportion to the estimated worth of the person. The system of obtaining guarantees should not be used by the directors and other managerial personnel as a source of income from the company. Banks should obtain an undertaking from the borrowing company as well as the guarantors that no consideration whether by way of commission, brokerage fees or any other form, would be paid by the former or received by the latter, directly or indirectly. This requirement should be incorporated in the bank's terms and conditions for sanctioning of credit limits.

There shall be no consideration by way of commission, brokerage fees or any other form, can be paid to the director by the company, directly or indirectly, in lieu of providing personal guarantee to the bank for borrowing credit limits.  When no consideration can be paid for the said transaction by the company to the director in any form, directly or indirectly, as per RBI mandate, there is no question of such supply/ transaction having any open market value.  The open market value of the said transaction/ supply may be treated as zero and therefore, taxable value of such supply may be treated as zero. In such a scenario, no tax is payable on such supply of service by the director to the company.

Where the corporate guarantee is provided by a company to the bank/financial institutions for providing credit facilities to the other company, where both the companies are related, the activity is to be treated as a supply of service between related parties as per provisions of Schedule I of the Act, even when made without any consideration.  Where the corporate guarantee is provided by a holding company, for its subsidiary company, those two entities also fall under the category of ‘related persons’. Hence the activity of providing corporate guarantee by a holding company to the bank/financial institutions for securing credit facilities for its subsidiary company, even when made without any consideration, is also to be treated as a supply of service by holding company to the subsidiary company, being a related person.

In respect of such supply of services by a person to another related person or by a holding company to a subsidiary company, in form of providing corporate guarantee on their behalf to a bank/ financial institution, the taxable value will be determined as per Rule 28 of  irrespective of whether full ITC is available to the recipient of services or not.  Rule 28 shall not apply in respect of the activity of providing personal guarantee by the Director to the banks/ financial institutions for securing credit facilities for their companies.

Tax rate

In M/S. STERLITE INDUSTRIES INDIA LTD. VERSUS COMMISSIONER OF GST & CENTRAL EXCISE - 2019 (2) TMI 1249 - CESTAT CHENNAI had held that the provision of only a Corporate Guarantee to an associate company is like an in-house guarantee and does not amount to providing any services.

The Supreme Court in COMMISSIONER OF CGST AND CENTRAL EXCISE VERSUS M/S EDELWEISS FINANCIAL SERVICES LTD. - 2023 (4) TMI 170 - SC ORDER held that issuance of Corporate Guarantee to a group company without consideration would not fall within banking and other financial services and was thus held to be non-taxable service.

Vide Notification No. 52/2023-Central Tax, dated 26.10.2023 Rule 28(2) was inserted.  The said Rule 28(2) provides that the value of supply of services by a supplier to a recipient who is a related person, by way of providing corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be 1% of the amount of such guarantee offered, or the actual consideration, whichever is higher.

In STERLITE POWER TRANSMISSION LIMITED & ORS. VERSUS UNION OF INDIA & ORS. - 2024 (3) TMI 1311 - DELHI HIGH COURT, the petitioner-

• seeks a declaration that the activity of the holding company providing a Corporate Guarantee to a subsidiary is not in the nature of supply of services taxable under Section 9 of Act; and
• impugns Circular dated 27.10.2023, whereby a clarification has been issued by the Central Board of Indirect Taxes & Customs pertaining to taxability of Personal Guarantee and Corporate Guarantee in GST.

The petitioner submitted the following before the High Court-

• By Notification dated 26.10.2023, Rule 28 has been amended. However, by the impugned Circular dated 27.10.2023 without amending the rule or the statute, the provision of Corporate Guarantee to associate has been made taxable and the value has been provided as 1% of the guarantee.
• The summons has been received under Section 70 of the Act, requiring the petitioner to provide all information with regard to Corporate Guarantees provided till date. He submits that in response thereto, the Officers of the petitioner have already appeared and provided the requisite information.
• The provision of Corporate Guarantee is in the nature of a contingent contract which is not enforceable till the guarantee is enforced by the entity to which the guarantee is provided. 
• The value of enforcement is not dependent on the value of the guarantee and it is only where the guarantee is enforced that the issue of service may arise.
• Fixing a value at 1% of the Corporate Guarantee provided would put onerous burden on the entity providing the Corporate Guarantee.

The High Court directed the department to file counter within six weeks from the date of order dated 28.02.2024 and rejoinder within four weeks thereafter.  The High Court also directed the Department not to take coercive action against the petitioner in case a final assessment order is passed or a demand is created.

Conclusion

The taxability of GST as stipulated in Rule 28(2) is to be decided by the Delhi High Court after filing the counter affidavit by the Department and rejoinder by the petitioner.