Background
The GST Council, in its 52nd GST Council meeting, had recommended taxing Corporate Guarantees which was accepted by the Government.
The taxability of corporate guarantees within the framework of the Goods and Services Tax (GST) has been a matter of ongoing debate since the inception of the GST regime. This persistent discussion was primarily fuelled by the absence of explicit provisions specifically addressing the tax treatment of corporate guarantees.
The ambiguity existed as neither the term 'guarantee' nor 'corporate guarantee' is defined under the GST law. In a general sense, a corporate guarantee entails a corporate entity pledging to ensure the performance of another corporate entity under a contract or the discharge of the latter's liabilities in the event of default. Here it is important to note that the concept of guarantee is present in the Indian Contract Act, 1872 which defines a 'contract of guarantee' as an agreement to fulfil the promise or discharge the liability of a third party in case of default.
Though a contract of guarantee would always have a consideration, this is not true in the case of Corporate Guarantees. Corporate Guarantees, typically offered by parent or holding companies on behalf of their subsidiaries or joint ventures to secure loans from financial institutions, often transpire without any monetary consideration changing hands as they are more of a necessity rather than a commercial transaction.
As there was no consideration flowing Corporate Guarantees were considered to be non-taxable. In the erstwhile regime (Service Tax) the courts had given clear findings that this transaction is not taxable. Recently, the Hon'ble Supreme Court in Commissioner of CGST and Central Excise v. Edelweiss Financial Services Ltd., (2023) 5 Centax 58 (S.C.) has upheld this view.
Interestingly, Schedule I of the Central Goods and Service Tax Act, 2017 provides for transactions that would be considered as supply even without there being a consideration. Entry 2 of this Schedule covers supplies between related persons. The GST law categorizes holding and subsidiary companies as 'related persons'. Thus, this classification introduces a layer of complexity in the GST treatment of corporate guarantees, as transactions between related persons, even in the absence of consideration, are deemed taxable supplies under GST.
Addressing this intricacy, a recent amendment to the Central Goods and Services Tax Rules, 2017 (CGST Rules) has been introduced in the form of Rule 28(2). This sub-rule provides that the value of supply of services to a related person, by way of providing a corporate guarantee to any banking company or financial institution on behalf of the said related person, is to be deemed to be the higher of the following amounts:
- 1% of the amount of such guarantee offered, or
- Actual consideration.
The Central Board of Indirect Taxes and Customs vide its Circular No. 204/16/2023-GST dated 27.10.2023 has issued clarifications on this issue. It has been clarified that the activity of providing a corporate guarantee to the bank/financial institutions for providing credit facility to the other company, where both the companies are related, is to be treated as a supply of service. In case where no consideration is involved then also it is to be treated as a taxable supply of service as per provisions of Schedule I of the CGST Act.
Impact on the Infrastructure Companies
Infrastructure companies generally operate through Special Purpose Vehicles (SPVs). under the SPVs it is imperative for the primary entity to provide guarantees to financial institutions in order to secure funding for SPVs. Contrary to the notion that this guarantee is a discretionary benefit extended by the primary entity to its SPVs, it is a fundamental necessity for the SPVs to maintain operational viability.
The necessity to give guarantees stems from the intricacies of accounting and other regulatory requirements mandating separate Profit and Loss (P&L) statements for each project. Consequently, creating distinct entities for individual projects becomes not just a practical choice but a legal requirement to comply with regulatory frameworks. This segregation allows entities to adhere to legal obligations, ensuring transparency and accountability in project-specific financial reporting.
However, a significant challenge arises when these separate entities, established for legal compliance, seek to raise funds from financial institutions. The inherent newness of these entities poses a hurdle in convincing banks to extend funding. Consequently, the industry argues that the provision of guarantees from an Indian holding company becomes not merely a choice but a preferred and often necessary approach to overcome the funding challenge. In essence, the guarantee is viewed as a strategic measure to facilitate project financing rather than an optional benefit provided by the holding company to its SPVs.
In light of the recent amendments, the holding company is liable to pay 18% GST on the 1% of the amount of the guarantee it gives for getting the funding for its SPV as there will be no consideration flowing from the SPV to the holding company.
Retrospective demands
Rule 28(2) of the CGST Rules has been introduced vide Notification No. 52/2023-CT dated 26.10.2023. As per this Notification the rules, introduced/ amended, shall come into force on the date of the publication of the notification. Therefore, Rule 28(2) of the CGST Rules came into being only on 26.10.2023 and there was no valuation mechanism for valuing the deemed service of Corporate Guarantee.
In view of the above, no GST should be levied for the period prior to the insertion of Rule 28(2) of the CGST Rules as no levy of tax is sustainable without a valuation mechanism.
In recent times, there have been many media reports suggesting that the GST authorities have issued show-cause notices to many infrastructure companies proposing a levy of the GST even for the period prior to 26.10.2023.
Even though the Revenue may argue that the transaction of Corporate Guarantee was always taxable in view of Entry 2 of Schedule I of the CGST Act, however, they cannot ignore the fact that there was no valuation mechanism till 26.10.2023. Therefore, the levy of GST prior to 26.10.2023 is bound to fail.
Arbitrary valuation
Vide Rule 28(2) of the CGST Rules, the Government has stated that the companies will have to pay 18% GST on a minimum of 1% of the value of the Corporate Guarantee. There is absolutely no rationale behind fixing the minimum percentage as 1%. Therefore, manifest arbitrariness is a strong ground on which this rule could be challenged.
There can be other grounds on which the levy of GST on the Corporate Guarantee can be challenged depending on the allegations raised in the show cause notices issued by the GST department.
Conclusion
A provision such as Rule 28(2) of the CGST Rules is always susceptible to challenges for being arbitrary and unreasonable. It will be hard for the Government to defend the levy of GST on a minimum of 1% of the guaranteed amount. Though the levy of GST on Corporate Guarantee per se might not be held illegal. However, if the valuation provision, i.e., Rule 28(2) of the CGST Rules, is held to be arbitrary then the Revenue will have to either amend the provision or introduce a new one. Till then, it will be difficult for the Government to levy GST on the Corporate Guarantees.
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