Corporate guarantees are common in business, where a parent or holding company offers a guarantee to financial institutions on behalf of its subsidiary.
These guarantees are covered under the Indian Contract Act, RBI guidelines, and the Companies Act. However, GST law does not define ‘corporate guarantee’.
Section 126 of the Indian Contract Act defines a contract of guarantee as one where a party promises to fulfill the obligation of a third person in case of default.
Taxability under the Service Tax Regime
Under the earlier service tax regime, tax was levied only if a service was provided for consideration.
In the case of corporate guarantees without consideration, the Supreme Court (in Edelweiss Financial Services Ltd.) ruled that service tax was not applicable, as no consideration was received.
The SC emphasized that ‘consideration’ is a pre-condition for service tax, though it did not say that a corporate guarantee isn’t a service.
GST Framework and Key Changes
Unlike service tax, GST law treats certain supplies between related parties as taxable even without consideration. Schedule I of the CGST Act deems such supplies as taxable when done in the course or furtherance of business. Thus, the Edelweiss ruling is not relevant under GST.
Initially, the CBIC clarified via a circular that guarantees given by governments to PSUs are taxable, but later exempted such guarantees. These early circulars didn’t address the core issue in corporate guarantees—valuation when there’s no consideration involved.
Major Shift Post October 2023
To address valuation concerns, the GST Council, in its 52nd meeting, clarified taxability and introduced new valuation rules.
CBIC Circular No. 204/16/2023-GST (dated 27 Oct 2023) confirmed that corporate guarantees are taxable even without consideration. A new sub-rule under Rule 28 was introduced from 26 October 2023.
Valuation Before the Amendment
Earlier, valuation between related parties followed Rule 28, which prescribed using the open market value (OMV), or if unavailable, the value of similar services, or 110% of cost.
Since corporate guarantees are not standard transactions, finding OMV is difficult. A proviso under Rule 28 allowed using invoice value if the recipient could claim full ITC. But where ITC wasn’t available, valuation remained unclear.
Valuation After the Amendment
After the 2023 amendment, Rule 28(2) prescribes that the value of a corporate guarantee is the higher of 1% of the guarantee amount or the actual consideration received.
This standardizes valuation but has sparked debate. For example, if a ₹100 crore guarantee is issued for a ₹20 crore loan, GST is still levied on ₹100 crore, which may not reflect the real benefit.
Determining the Taxable Event
A key concern is whether GST on corporate guarantees should be charged annually, monthly, or otherwise.
Based on CBIC’s clarifications, tax liability seems to arise when the guarantee is first extended or renewed, usually annually—not on a recurring basis. Further clarification may still be required.
Transitional Guarantees from the Service Tax Era
There are concerns about guarantees issued before GST but continuing into the GST era. Under the principle that no tax can be levied retroactively if there was no existing levy at the time, GST may not apply to such guarantees. Courts have followed this principle in other cases.
Bank Guarantee as Benchmark?
Some have argued that bank guarantee commission rates could be used to value corporate guarantees. While some CESTAT benches supported this comparison, others rejected it, saying corporate guarantees are not issued in the ordinary course of business and are not comparable to bank guarantees issued by banks.
Letters of Comfort and Similar Instruments
Letters of comfort, intent, or commitment are similar to corporate guarantees but carry different legal weight. They usually provide moral assurance rather than legal obligation.
Courts have held that such instruments can only be treated as guarantees if they meet the criteria under Section 126 of the Contract Act. Their classification depends on the content and intent, not merely their title.
Global Perspective and Conflicts with Transfer Pricing
Internationally, countries like Australia and Canada treat corporate guarantees as exempt financial services under their indirect tax laws. This contrasts with India’s approach.
There’s also potential conflict with transfer pricing practices, where a 0.5% guarantee commission is accepted. The 1% GST valuation under Rule 28(2) may contradict these norms.
Conclusion
While Rule 28(2) offers some clarity, several practical and legal issues remain unresolved. The matter is now before the Delhi High Court, and its ruling could shape the future of corporate guarantee taxation under GST.
Businesses await further clarification to avoid litigation and ensure consistent tax treatment.