Deciphering GST Notification: Tax Implications of Corporate Guarantees

[Shrey Bhatnagar]

The central focus of this article is the notification within the Goods and Services Tax (GST) system, specifically addressing the taxability of corporate guarantees. The need for clarity and harmonisation in taxation and the absence of specific provisions and unambiguous definitions for terms such as 'guarantee' and 'corporate guarantee' under the GST Act has led to ambiguity in taxation. Still, these terms can be understood in the line of the definition from the Indian Contract Act 1872, which provides that a ‘contract of guarantee’ is a contract to perform the promise, or discharge the liability, of a third person in case of his default.

The Central Board of Indirect Taxes and Customs, under the Ministry of Finance, Government of India, issued Circular No. 204/16/2023-GST on 27th October, 2023. This circular addresses two key concerns:

First, the taxability of personal guarantees given by directors to banks to secure the company's credit facilities, especially if they are given without consideration. Under the CGST Act, directors and companies are considered related parties. The circular clarifies that activities offered without consideration are also considered as a supply of service under the CGST Act.

Second, the taxability of corporate guarantees issued by a company on behalf of another related company or holding company to secure credit facilities, even if they are given without consideration. In either case, the activity will be treated as supplies of service between related parties under Schedule I of the CGST Act.  Rule 28 of the CGST Rules is used to determine the taxable value; however, considering the differences in the formation of fields and the practice followed by taxpayers for determining the taxable value, a new sub-rule (2) has been inserted in Rule 28 of the CGST Rules This sub-rule, which was promulgated by this notification, lays down a standard method for determining the taxable value of such supplies between related persons. As per the rule, the value of the service rendered in the form of corporate guarantee shall be one per cent of the sanctioned loan amount subject to a maximum of twenty-five lakh rupees.

“28. Value of supply of goods or services or both between distinct or related persons, other than through an agent.-

[(1)] The value of the supply of goods or services or both between distinct persons as specified in sub-sections (4) and (5) of section 25 or where the supplier and recipient are related, other than where the supply is made through an agent, shall-

(a) be the open market value of such supply;

(b) if the open market value is not available, be the value of supply of goods or services of like kind and quality;

(c) if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order:

Provided that where the goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety per cent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person:

Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.

[(2) Notwithstanding anything contained in sub-rule (1), the value of supply of services by a supplier to a recipient who is a related person, by way of providing a corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be one per cent of the amount of such guarantee offered, or the actual consideration, whichever is higher.].”

Schedule I of the CGST Act, particularly Clause II, asserts that even if transactions occur without consideration between related persons or distinct persons during business or promotion, they must be considered taxable supplies. This provision ensures that transactions lacking consideration are included in the tax net.

The taxation of corporate guarantees has been a subject of legal scrutiny in India, with various courts delivering controversial decisions. These decisions date back to the era when the Finance Act governed the service.

1. COMMISSIONER OF CGST AND CENTRAL EXCISE VERSUS M/S EDELWEISS FINANCIAL SERVICES LTD. - 2023 (4) TMI 170 - SC ORDER : The Hon’ble Supreme Court held that the provision of a corporate guarantee without consideration is not a taxable service under the Service Tax regime. This ruling was based on the premise that there must be valuable consideration for a service to be taxable. As there was no consideration in this case, no Service tax was leviable. However, this judgment cannot be held good in the GST regime because of the existence of Schedule I of the CGST Act 2017.
2. OLAM AGRO INDIA LTD. VERSUS C.C. E-DELHI-II - 2018 (8) TMI 102 - CESTAT NEW DELHI : CESTAT Delhi ruled that corporate guarantees are taxable if they include a fee. In this case, the parent company executed a corporate guarantee to facilitate lending to the appellant, and in return, the appellant paid a fee to the parent company. The commission paid was taxed under section 65(105) of the Finance Act 1994 as a business assistance service. This case emphasises that if a corporate guarantee includes a fee, it is taxable.
3. M/S. STERLITE INDUSTRIES INDIA LTD. VERSUS COMMISSIONER OF GST & CENTRAL EXCISE - 2019 (2) TMI 1249 - CESTAT CHENNAI: Chennai CESTAT stated that the issue of corporate guarantees to subsidiaries or associates is not taxable. The court noted that corporate guarantees are issued to protect the financial position of subsidiaries and provide support, distinguishing them from bank guarantees, which are part of the bank’s regular business and for which a higher fee is charged. This decision suggests that the nature and purpose of the corporate guarantee are crucial in determining its tax liability.

Regarding the retrospective application of this rule, the circular uses the term 'henceforth' to indicate that the provisions are to be applied prospectively from the date of issue of the circular, which is 27.10.2023. This implies that past transactions that provided corporate guarantees are not affected by this change.

Accordingly, consequent to the insertion of the said sub-rule in rule 28 of CGST Rules, in all such cases of supply of services by a related person to another person or by a holding company to a subsidiary company in the form of providing corporate guarantee on their behalf to a bank/ financial institution, the taxable value of such supply of services, will subsequently be determined as per the provisions of the sub-rule (2) of Rule 28 of CGST Rules, irrespective of whether full ITC is available to the recipient of services or not.

However, under Section 168(1), read with 168A(2) of the CGST Act, the government does have the power to issue orders for uniformity in the implementation of the Act. It can have a retrospective effect on such orders under exceptional circumstances, such as war, epidemic, flood, etc., from a date not earlier than the commencement of the Act. This means that while the current notification applies prospectively, there is a provision in the law for the central government to apply rules retrospectively in certain situations. It is important to emphasise that this power is not absolute or freely exercised; it is indeed subject to the occurrence of exceptional circumstances.

The taxation of corporate guarantees could increase the cost of borrowing for subsidiary companies, as the tax cost may be factored into financing costs, potentially challenging smaller subsidiaries or related entities that rely on corporate guarantees from their holding companies in accessing credit. The taxation of corporate guarantees is expected to generate additional revenue for the government, contributing to the exchequer. It reflects a broader trend in tax policy towards broadening the tax base and standardising the treatment of transactions that were previously not taxed or subject to varied interpretations. Companies must adapt to these changes, ensuring compliance while also considering the broader implications of their financial strategies and the market at large. The impact on the exchequer and the credit market will be closely watched as companies and tax authorities adjust to this significant regulatory development. This represents a step towards greater clarity and uniformity in the taxation of corporate financial transactions under the GST framework.