Goods & Service Tax (GST) on Corporate Guarantee

Introduction

The question of GST on corporate guarantees has been a topic of ongoing debate. This uncertainty primarily arises due to the absence of explicit definitions of "corporate guarantee" within the GST regulations. The Indian Contract Act of 1872 defines a "contract of guarantee" as an agreement to fulfil a promise or absolve a third party from liability in case of default. This legally binding agreement, signed by a guarantor on behalf of a borrower, involves the following parties:

1.    Principal Debtor: The borrower who is responsible for payment and for whom a guarantee is provided in case of default.

2.    Creditor: The entity to whom a valuable item has been entrusted for borrowing, entitled to payment, and granted a guarantee.

3.    Guarantor: The person who pledges to pay if the principal debtor defaults.

A corporate guarantee typically involves a company acting as the guarantor for a loan taken by a creditor, usually related to the company as its subsidiary, associate company, or a company where the directors of the guarantor company hold influential positions. This arrangement ensures that if the borrower defaults, the guarantor will cover the lender's credit exposure.

The 52nd GST Council meeting recommended levying GST on corporate guarantees, which the GST department accepted through notification 52/2023-CT dated October 26, 2023.

The applicability of GST on corporate guarantees has been challenged before the Delhi High Court. The challenge is based on the premise that issuing such a guarantee to an associate company constitutes an in-house guarantee and does not qualify as a supply of services under the GST framework. This article aims to summarize the applicability of GST on corporate guarantees, provide an update on the current status of litigation, and outline important steps that corporations should take to avoid penalties.

Goods & Service Tax on Corporate Guarantee

Chargeability

Corporate guarantees are often provided by holding or group companies without any charges or consideration. The primary objective of these guarantees is to facilitate the smooth operations of subsidiary or group companies.

Schedule I of the CGST Act, 2017, addresses transactions or activities that are treated as supplies even if made without consideration. According to Clause 2 of this Schedule, the supply of goods or services (or both) between related parties or distinct persons, as specified in Section 25, made in the course or furtherance of business, is subject to GST even if no consideration is involved. Therefore, under Schedule I, corporate guarantees are also covered within the scope of supply and are liable to tax.

Value of Services

Now, the question arises as to the value on which GST should be levied for corporate guarantees. Rule 28(2) of the CGST Rules vide notification 52/2023-CT dated 26th October 2023 provides guidance on this matter. It stipulates that the value of the supply of services to a related person, by providing a corporate guarantee to any banking company or financial institution on behalf of the said related person, is to be deemed the higher of 1% of the amount of the guarantee offered or the actual consideration.

Rate of Goods & Service Tax

The GST rate on corporate guarantees is 18%, classified under the HSN code 999799.

Supreme Court’s (SC) decision on the Corporate Guarantee in the case of Edelweiss Financial under the Service Tax regime

On 17th March 2023, the Supreme Court, in the case of Commissioner of CGST and Central Excise vs. M/s Edelweiss Financial Services Limited, held that no Service Tax is applicable on corporate guarantees. The brief facts of the case are as follows:

Appellant View:

M/s Edelweiss Financial Services Ltd provides corporate guarantees to banks and financial institutions lending to its subsidiaries and related companies.

Revenue Department Allegations:

The Revenue Department alleged that M/s Edelweiss Financial Services Ltd had provided "banking or financial services," arguing that a corporate guarantee is similar to a bank guarantee and can be considered a "service" under section 65B(44) of the Finance Act. Consequently, they raised a demand of over Rs. 97 crores, along with interest and penalties, for the "services" provided by the appellant both internationally and domestically.

Supreme Court Decision:

The Hon'ble Supreme Court dismissed the appeal filed by the department. The Court held that for an activity to be taxable under the Finance Act, 1994, it must not only involve a 'provider' but also a flow of 'consideration' for the rendering of the service. In the absence of either of these elements, taxability under section 66B of the Finance Act, 1994 does not arise. The Court found that there was no consideration for the corporate guarantees issued by the respondent on behalf of their subsidiary companies. Hence, the Revenue's appeal was dismissed.

Goods & Service Tax on Corporate Guarantee challenged before Delhi High Court

Facts of the Case

1.    Sterlite Power Transmission Limited (“company”) challenged the applicability of GST on the corporate guarantee to a subsidiary company, arguing that it does not fall within the ambit of the supply of services. The petitioner has also contested the Central Board of Indirect Taxes and Customs (CBIC) Circular No. 204/16/2023-GST dated 27 October 2023, which clarified the taxability of corporate guarantees.

Key Submissions

2.    The company stated that the Customs, Excise, and Service Tax Appellate Tribunal (CESTAT) in Chennai, in the case of its own group company, M/s. Sterlite Industries India Limited had held that providing a corporate guarantee to an associate company is akin to an in-house guarantee to protect the company’s own investment. Therefore, it would not amount to providing taxable services. They also referenced the Supreme Court’s decision on the corporate guarantee in the case of Edelweiss Financial Services under the Service Tax regime, which supported their position.

3.    The company further argued that a corporate guarantee is a contingent contract, becoming enforceable only at the instance of a bank or financial institution in the event of a default. Consequently, extrapolating the value of enforcement with the value of the guarantee and fixing a value of 1% of the corporate guarantee imposes an onerous burden on the entity providing such a guarantee.
Delhi High Court

4.    The Delhi High Court issued a notice and directed that no coercive action be taken until the final assessment is completed and liability is determined by the department.

Conclusion

In light of the recent amendments in the GST framework regarding corporate guarantees and the absence of clear decisions from high courts, companies may encounter the following challenges:

1.    The GST department may argue that tax is leviable on corporate guarantees from the implementation date of GST, i.e., 1st July 2017, under Entry 2 of Schedule I of the CGST Act, 2017. However, the rules for determining the value of such guarantees were introduced only on 26th October 2023.

2.    Determining the value on which GST is applicable remains uncertain because a corporate guarantee is contingent, becoming enforceable only if a bank or financial institution demands it due to a default.

3.    There are no specific valuation criteria provided for cases where corporate guarantees provided to government entities, individuals, or by foreign holding companies.

It is advisable that companies carefully negotiate the terms of corporate guarantees with financial institutions, considering the potential applicability of Goods and Services Tax. For further clarification, please contact us at office@indialawoffices.com.