– By Shivam Mehta, Rohini Mukherjee, and Divya Bhardwaj
Since the introduction of Goods and Services Tax (“GST”) law, there has been uncertainty clouding over the application of GST to certain transactions, particularly corporate guarantee transactions. Recently, the GST council recognized that many taxpayers are encountering challenges in determining the GST applicability on such transactions along with valuation issues. In light of the same, the GST council in its 53rd meeting proposed a retrospective amendment to Rule 28(2) of the Central Goods and Services Tax Rules, 2017 (“CGST Rules”), addressing these concerns. It recommended that the mandatory valuation under this rule which fixed the value to be equal to 1% of the corporate guarantee or actual consideration whichever is higher, would not apply in cases of export of services or when the recipient can claim full Input Tax Credit (“ITC”). Additionally, the GST council suggested issuing a circular to clarify various aspects related to corporate guarantees.
This move by the GST council has raised hopes among taxpayers who have been under scrutiny regarding the GST taxability of corporate guarantee transactions.
Earlier, the taxpayers were expecting to get clarity or relief from authorities in a manner of declaring corporate guarantee transactions outside GST ambit or otherwise declaring nil value for payment of GST. However, on October 26, 2023, the Central Board of Indirect Taxes and Customs (CBIC) amended Rule 28 of the CGST Rules, 2017. This amendment fixed the value of services by way of furnishing corporate guarantee on behalf of related parties to a bank at 1% of the value of the corporate guarantee provided or the agreed consideration, whichever is higher. This change caused significant concern among taxpayers.
Subsequently, challenges against this valuation method and the GST levy on corporate guarantee transactions were brought before various High Courts. Following the recommendations in the 53rd GST council meeting, it remains to be seen whether these companies will continue to pursue their legal actions or opt to withdraw their writ petitions. The proposal of the GST Council to address other issues related to corporate guarantees through clarifications adds further importance to resolving other matters concerning these transactions.
Taxability of corporate guarantee transactions under the GST law
A related party offers a corporate guarantee to safeguard its investment in another related company enabling the latter to secure funding and enhance its creditworthiness, as the borrowing entity may lack the financial strength to borrow independently. Further, it is provided on request of the bank only. Typically, no fee is levied by the guarantor for providing the corporate guarantee. In fact, in some instances, the Guarantee Deed with the financial institution explicitly states that no fee can be imposed by the guarantor as long as the guaranteed obligations persist. In light of this, deeming a transaction where the supplier is not undertaking the activity voluntarily and is obligated not to charge any consideration as “supply” seems unjust. In the absence of one party willingly undertaking such activity of furnishing the corporate guarantee, an argument is possible that it is not a service in itself.
Previously, Rule 28 of the CGST Rules, 2017 prescribed a valuation method for such transactions without clarifying the taxability. It is crucial to determine whether history will repeat itself or if the GST Council, in conjunction with forthcoming clarifications, will provide clear guidelines on the taxability of these transactions, supported by appropriate rationale
In the absence of consideration whether the exception as recommended by the GST council will be available.
The GST Council has recommended that the mandatory valuation of 1% or the agreed consideration whichever is higher will not be applicable in case where the transaction qualifies as “export of services” or where the recipient is eligible for full ITC. Under the GST law, any service qualifies as “export of services” only when certain conditions are fulfilled. One of such conditions required to be fulfilled is that the payment should be received in foreign convertible exchange.
In scenarios where Indian entities provide corporate guarantees to foreign entities without charging any consideration, no payment is received by the Indian entities. It remains to be seen whether the exception recommended by the GST Council in case of “export of services” will be extended to taxpayers in such situations or not.
Thus, it is important to await further clarification to understand if and how these recommendations will apply to taxpayers involved in providing corporate guarantees to foreign entities without charging any fees.
Other unresolved issues
It is worth noting that Rule 28 of the CGST Rules provides that the value of services by way of furnishing corporate guarantee will be 1% of the corporate guarantee or agreed consideration whichever is higher. However, in the absence of any clarification on the manner of calculation, doubts arise as to whether for the purpose of calculating 1% value, the value of sanction amount is required to be considered or the value of loan disbursed should be considered.
In cases where the exceptions i.e., export of services or full ITC is not available, assigning a high value i.e., either 1% of the corporate guarantee or agreed consideration whichever is higher, is unreasonable. It will have huge financial impact on the taxpayers. Assigning such an unreasonable value as a mandatory deemed value to such services appears to be unjustified when taxpayers have the option to determine the value reasonably under Rule 31 of the CGST Rules.
Additionally, corporate guarantees are provided while obtaining a loan from a bank, which can be in the form of a term loan or working capital loan. Since working capital loans are typically spread over years, questions regarding when tax payments are due to arise. It raises doubts whether the tax is required to be paid at the time of furnishing the corporate guarantee only i.e., only once at the time of sanctioning the credit facility by the bank or it is required to be paid on an annual basis when the credit limit is revised by the Bank.
Moreover, in many instances, related parties issue letters of comfort to banks on behalf of other related parties at the time of loan sanction. It remains unclear whether such transactions also qualify as corporate guarantee services and thus, will attract GST at the value prescribed under Rule 28 of the CGST Rules, 2017.
These uncertainties underscore the need for clearer guidelines from the GST Council to address these practical issues and provide clarity on the applicability, time of supply along with valuation to be adopted for GST payments related to corporate guarantee transactions.
Impact on taxpayers who being law abiding citizens of India adopted valuation as per Rule 28(2)
During the time period in which Rule 28(2) is applicable even in cases where the recipient is eligible for full ITC, many taxpayers have adopted the valuation mechanism and have discharged tax considering 1% of the corporate guarantee value as the consideration. In case where full ITC is available, the companies already having accumulated ITC, have made payment of tax at 1% of the corporate guarantee which has led to additional accumulation of ITC in their electronic credit ledger. It is worthwhile to see if any refund mechanism or an option to amend such transactions in returns will be provided for such taxpayers as they have paid excess tax which otherwise they were not obligated to pay.
Given these developments and unresolved issues, businesses can only hope that the government will take steps to address all concerns pertaining to taxability of corporate guarantee effectively.
(Shivam Mehta is the Executive Partner; Rohini Mukherjee is the Partner; and Divya Bhardwaj is the Principal Associate at Lakshmikumaran & Sridharan Attorneys.)
(Disclaimer: Views expressed are personal and do not reflect the official position or policy of Financial Express Online. Reproducing this content without permission is prohibited.)