Applicability of GST on Corporate Guarantee

Introduction

A Corporate Guarantee is a guarantee in which any corporation agrees to be responsible for the financial obligations of the principal debtor to the creditor. These transactions usually include inter-group Corporate guarantees, which are given to facilitate smoother financial functioning for the related persons. For example, A holding or parent company issues a corporate guarantee to Banks or Financial Institutions as collateral security for the credit facilities availed by its subsidiaries.

As the GST is applicable on the supply of goods or supply of services, hence the question arises whether GST is applicable on such credit facility in the form of corporate guarantee provided by the holding company to its subsidiaries as no consideration is charged by the holding company in this regard from their subsidiaries or other related parties.

Applicable provisions

Section 7 of CGST Act 2017 states that Supply includes all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business. Hence the involvement of consideration is the primary element for a transaction to be considered as supply.

As, no consideration is charged by the holding company for providing the corporate guarantee in respect of financial assistance obtained by the subsidiaries, hence it should not be covered under the scope of supply. However, it is important to know that Schedule I of the CGST Act, 2017 specifies the list of activities which would be considered as supply even if no consideration is involved. Accordingly, if any transaction is covered under Schedule I, then it would be treated as supply even if there is no consideration.

Let us discuss the para 2 of schedule I of CGST Act 2017 which states that-

“Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business”.

As per para 2 of said schedule, the supply of goods or services between related persons would be considered as supply, even if made without consideration.

Now, the question arises what is the definition of related persons and distinct persons for the purpose of GST. Section 2 of CGST Act 2017 contains the list of definitions, but the related person and distinct persons are not defined in section 2, the related person is defined in clause (a) of explanation of section 15 of CGST Act and distinct persons are defined in sub section 4 of section 25 of CGST Act 2017. The Explanation (a) of section 15 of CGST Act 2017 defines the related persons as follows;

“Explanation: For the purposes of this Act,

(a) persons shall be deemed to be "related persons" if

(i) such persons are officers or directors of one another’s businesses

(ii) such persons are legally recognised partners in business

(iii) such persons are employer and employee

(iv) any person directly or indirectly owns, controls or holds twenty-five per cent or more of the outstanding voting stock or shares of both of them

(v) one of them directly or indirectly controls the other

(vi) both of them are directly or indirectly controlled by a third person

(vii) together they directly or indirectly control a third person; or they are members of the same family”

As per the above definition of related person it is clear that the holding company & their all subsidiary companies would be considered as related persons for the purpose of GST and any transaction between them would be considered as supply even if made without consideration by virtue of para-2 of schedule I.

Let us understand the meaning of distinct persons as per sub-section 4 of section 25 of CGST Act 2017 which states that a person who has obtained or is required to obtain more than one registration, whether in one State or Union territory or more than one State or Union territory shall, in respect of each such registration, be treated as distinct persons for the purpose of this Act. Hence, the person registered in two different states on the basis of same PAN would be treated as distinct person. For example, if a company has a head office registered in Delhi and has branches registered in Haryana & UP under the same PAN. For the purpose of GST such head office and branches would be considered as distinct persons. Accordingly, any transaction between these head office and branches would be considered as supply irrespective of the fact whether any consideration is involved or not. If consideration is involved then it would be a supply by virtue of section 7 and if consideration is not involved then it would be treated as supply by virtue of schedule I. Hence it is clear that the services provided by way of corporate guarantee by separately registered head office to the separately registered branches on the same PAN would be considered as supply of services even if made without consideration.

Now the next question arise that what would be the value of such service since no consideration is involved in such transaction. Section 15(1) of CGST Act 2017 states that the value of a supply of goods or services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply. For the valuation purpose of corporate guarantee, we can not apply the provisions of Section 15(1) as such transaction is with related parties and the price is not the sole consideration. To handle such kind of situations the valuation rules are given under GST, which prescribes method of valuation for different scenarios. The attention is invited to sub rule 2 of rule 28 of CGST Rules 2017 which states that-

“(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 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”. Hence as per rule 28(2), the value of such service would be the higher of (i) one per cent of the amount of such guarantee offered or (ii) the actual consideration.

To bring more clarity regarding the taxability of Corporate Guarantee, the CBIC has also issued Circular No. 204/16/2023. Para 1 of said circular states that 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 but the open market value of the said transaction may be treated as zero, because as per RBI Mandate, no consideration can be paid for the said transaction by the company to the director in any form, directly or indirectly 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. However, there may be a cases where the director, who had provided the guarantee, is no longer connected with the management but continuance of his guarantee is considered essential because the new management's guarantee is either not available or is found inadequate or there may be other exceptional cases where the promoters, existing directors, other managerial personnel and shareholders of borrowing concerns are paid remuneration/consideration in any manner, directly or indirectly. In all these cases, the taxable value of such supply of service shall be the remuneration/consideration provided to such a person/ guarantor by the company directly or indirectly.

Para 2 of said circular states that 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 CGST Act, even when made without any consideration. Similarly, where the corporate guarantee is provided by the holding company, for its subsidiary company, these 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 the holding company to the subsidiary company, being a related person, as per provisions of schedule I of CGST Act.

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(2) of CGST Rules.

As different practices were being followed by the field formations and taxpayers in determining such taxable value, to provide uniformity in practices and ease of implementation, sub-rule (2) has been inserted in rule 28 of CGST Rules vide Notification No. 52/2023 dated 26.10.2023, for determining the taxable value of such supply of services between related persons in respect of providing corporate guarantee. 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 henceforth 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, as per the judgement of Punjab & Haryana High Court in case of Acme Clean tech Solutions Private Limited [2024(05)LCX0016] the effect and operation of Circular No. 204/16/2023-GST dated 27.10.2023 relating to taxability of corporate guarantee by a person on behalf of another related person or by the holding company for sanction of credit facilities to its subsidiary company, to the bank/ financial institutions even when made without any consideration, shall remain stayed.

Conclusion

From the above detailed discussion, it is clear that providing a corporate guarantee by the holding company to their subsidiaries or providing a corporate guarantee by the one company to another company which are separately registered under GST under the same PAN would be considered as supply of service and accordingly GST would be applicable on the value determined as per Rule 28(2) of CGST Rules 2017 i.e., higher of 1% of the amount of corporate guarantee or consideration received. It is also important to keep in mind that a   judgement of Punjab & Haryana High Court in case of Acme Clean tech Solutions Private Limited [2024(05)LCX0016] has stayed the para-2 of the circular relating to taxability of  corporate guarantee by a person on behalf of another related person or by the holding company for sanction of credit facilities to its subsidiary company, to the bank/ financial institutions even when made without any consideration. 
 

Disclaimer: The information given in this article is solely for purpose of understanding the law. It is completely based on the interpretation of the author and cannot be constituted as a legal advise, the author of this article and Lawcrux team is not responsible for any legal issues if arises on the basis of the interpretation given above.