Exploring Corporate Guarantee Matters within the Framework of GST

1. Position under the Service Tax Regime

Under the service tax regime, taxability was intricately tied to the definition of "services" as an activity carried out by one person for another for consideration. Receipt of consideration was a prerequisite triggering the tax levy.

In many corporate guarantee arrangements, Reserve Bank of India (RBI) guidelines restrict or govern guarantee commission payments. Banks often obtain undertakings confirming no direct or indirect consideration is involved.

The landmark Supreme Court judgment in Edelweiss Financial Services Limited [2023 (4) TMI 170] affirmed that consideration is a prerequisite for imposing service tax on a corporate guarantee. In the absence of consideration, service tax liability was negated due to the lack of a deemed valuation mechanism. However, the court did not rule out that corporate guarantees constitute an "activity" or "service" in principle.

2. Position under the GST Regime

Under GST, tax liability is triggered by a "supply". The standard parameters of supply require goods/services, consideration, and furtherance of business. However, Schedule I of the CGST Act introduces a deeming fiction where supplies between related persons without consideration qualify as a supply. Consequently, the Supreme Court’s ruling in Edelweiss Financial holds no application under GST.

While government loan guarantees to PSUs were clarified as exempt vide Circular No. 154/10/2021-GST, corporate guarantees between related entities remained complex regarding valuation.

Following recommendations from the 52nd GST Council meeting, the CBIC issued Circular No. 204/16/2023-GST on 27.10.2023, affirming that providing a corporate guarantee is a "supply of service" even without consideration and is subject to GST.

3. Valuation Framework: Pre vs. Post Amendment

A. Valuation Prior to 26 October 2023

Prior to the amendment, valuation of services between related persons was governed by Rule 28 of the CGST Rules:

• Open Market Value (OMV) of the service.
• Value of supply of services of like kind and quality, if OMV is unavailable.
• 110% of the cost of provision of services or best judgment method.

Under the second proviso to Rule 28, where the recipient is eligible for full Input Tax Credit (ITC), the value declared in the invoice is deemed to be the OMV. However, where full ITC is unavailable to the recipient, valuation posed significant challenges.

B. Valuation Effective from 26 October 2023

Rule 28(2) was inserted vide Notification No. 52/2023-CT effective 26.10.2023. It mandates that the value of supply of a corporate guarantee to a related person shall be the higher of:

4. Key Challenges & Open Issues

Valuation Base: Guarantee Offered vs. Credit Utilized

Rule 28(2) specifies valuation as 1% of the guarantee offered. If a parent company provides a guarantee of ₹100 crore, but the subsidiary avails a credit facility of only ₹20 crore, a strict legal interpretation imposes GST on 1% of the full ₹100 crore, exceeding the actual economic benefit derived.

Taxable Event & Periodicity

It remains ambiguous whether the liability to pay GST arises as a one-time event upon execution/annual renewal or on a recurring monthly/quarterly basis. The CBIC clarification indicates that issuing a guarantee is a single event, with tax liability triggered primarily at execution or annual renewal.

Continuation of Pre-GST Guarantees

Long-term guarantees executed under the Service Tax regime without consideration were non-taxable at inception. Applying GST to continuing pre-existing guarantees contradicts the legal principle that tax cannot be imposed subsequently if the levy did not exist when the service was initiated.

Bank Guarantee Benchmark vs. Corporate Guarantee

Divergent judicial views exist on whether bank guarantee rates serve as a benchmark for corporate guarantee valuation:

• CESTAT Delhi (M/s Olam Agro India Ltd [2018]) & CESTAT Mumbai (Hindustan Construction Co [2023]): Treated corporate guarantees as similar to bank guarantees.
• CESTAT Chennai (M/s Sterlite Industries India Ltd [2019]): Held that bank guarantees and corporate guarantees are distinct instruments. Bank guarantees are regular commercial services offered to the public, whereas corporate guarantees are in-house financial supports to group entities.

Letter of Comfort / Intent vs. Corporate Guarantee

Letters of Comfort or Intent provide financial assurance without creating a direct binding obligation to discharge liability upon default under Section 126 of the Contract Act. Under Insolvency and Bankruptcy Code (IBC) jurisprudence, classification depends on the specific terms and intent rather than nomenclature.

Transfer Pricing & Global Perspectives

While Transfer Pricing regulations and judicial precedents commonly accept a 0.5% guarantee commission, the 1% GST valuation standard creates a regulatory mismatch. Globally, countries such as Australia and Canada categorize corporate guarantees under financial services and exempt them from indirect tax laws.

Conclusion

While Rule 28(2) brings standardization to corporate guarantee valuations under GST, unresolved issues—such as the legal challenge to Rule 28(2) before the Delhi High Court—require definitive clarification from the GST Council to promote tax certainty and a business-friendly regime.