[Esha Rathi is a final year B.B.A. LL.B. (Hons.) student at Jindal Global Law School]
Parent companies extending corporate guarantees for their subsidiaries is a common practice but has been a subject of debate on whether it can be construed as a taxable service.
In July 2023, the Directorate General of Goods and Services Tax Intelligence issued tax demand notices to numerous local corporate houses for corporate guarantees extended on behalf of their subsidiaries, as well as to multinational corporations that had provided such guarantees for their Indian units. The concerned officials justified this move by categorizing the practice as a “service” subject to taxation under Goods and Services Tax (“GST”). Consequently, companies that received these notices raised objections, contending that the GST law should not be extended to encompass shareholder functions within its purview, and asserting that corporate guarantees do not inherently entail any element of service or taxability.
In a clarification issued on October 7, 2023, during the 52nd GST Council Meeting, it was recommended that GST will be applicable at a rate of 18 percent on one percent of the corporate guarantee provided by the parent company to its subsidiary company for a bank loan.
The Background for Clarifying GST on Corporate Guarantees
The current law does not define the term “support services”. The definition of “support services” under the erstwhile service tax regime in India was primarily governed by Section 65B(104b) of the Finance Act, 1994, as amended by Section 143(C) of the Finance Act, 2012. This definition encompassed a broad range of services, such as infrastructural, operational, administrative, logistic, marketing, or any other form of support, aimed at sustaining and advancing an entity.
The expansive scope of this term in the previous tax regime and the extensive interpretations under the GST regime had given rise to a growing number of uncertainties and disputes concerning the taxation and valuation of support services. One of the focal points in this context was the taxation of a corporate guarantee provided in favour of related parties.
Corporate Guarantees as Supply
In the erstwhile tax regime, the provision of corporate guarantee in the absence of a consideration was not taxable. Furthermore, in Commissioner of CGST & Central Excise Mumbai East v. Edelweiss Financial Services Ltd., the Supreme Court had ruled that issuance of a corporate guarantee in favour of a subsidiary company will not attract service tax in the absence of a consideration. However, this principle has not been carried over into the current GST regime.
Under Section 2(102) of the Central Goods and Services Tax Act, 2017 (“CGST Act”), “service” means anything others than goods, money, and securities. Furthermore, under Schedule I, Clause 2 of the CGST Act, supply of goods or services between related persons in the course of, or in furtherance of business without consideration qualifies as “supply”. Relying on these provisions, tax authorities assert that under the GST law, services provided to related parties for the purpose of advancing business objectives are considered taxable supplies, even when provided without any explicit consideration. These provisions are particularly relevant in cases involving corporate guarantees provided by a parent company to its subsidiary company.
Explanation (a) under Section 15 of the CGST Act, defines the criteria for establishing related parties. Explanation (a)(iv) and (v) stipulate that for parties to be deemed related, one person must directly or indirectly own, control, or hold 25 percent or more of the outstanding voting stock or shares of both entities, or one entity must directly or indirectly control the other. Consequently, these clauses are instrumental in establishing a parent and subsidiary company as related parties.
Further, when parent companies extend guarantees for bank loans obtained by their subsidiary companies, they ultimately optimize their returns on investments in these subsidiary entities through the activities funded by the loan amount. As a result, the parent companies hold a vested interest as they indirectly benefit from supporting the subsidiary’s business. In light of this, providing a corporate guarantee that furthers business of both the subsidiary and the parent company is regarded as a service a subject to taxation, even in the absence of consideration.
Corporate Guarantees as Actionable Claims?
The question of whether issuing a corporate guarantee can be categorized as an actionable claim, thereby falling outside the scope of supply as per Schedule III of the CGST Act, introduces another layer of debate.
Schedule III of the CGST Act enumerates a list of activities or transactions that fall outside the scope of the definition of supply and are exempt from GST. One such exclusion found in Schedule III pertains to the supply of actionable claims. In the context of a corporate guarantee, the entity providing the guarantee commits to paying a debt or fulfilling an obligation on behalf of another entity in the event of a default. Therefore, it could be argued that a corporate guarantee, which involves a contingent liability or a future obligation, qualifies as an actionable claim. If it is established that the issuance of a corporate guarantee indeed involves the transfer of an actionable claim, then such a transaction would not be subject to GST.
Based on the notices issued by tax authorities and the recommendations from the GST Council, it is evident that this interpretation lacks sufficient backing. To avoid potential legal disputes on this matter, it is crucial for the Government to provide clarification regarding why corporate guarantees are not classified as actionable claims. In the interim, we can operate under the assumption that corporate guarantees may not be actionable claims because they are contingent, secondary obligations that depend on the failure of a primary debtor. While they involve legal agreements and can be enforced through legal means, they do not represent independent rights to payment or performance like traditional actionable claims. Instead, they serve as a form of financial security and assurance in various business transactions.
Value of Supply
In the realm of GST, the valuation of a supply is typically established based on the transaction value, which is the actual price paid or payable for the supply, as stipulated in Section 15 of the CGST Act. However, when it comes to corporate guarantees provided without charges, determining the appropriate value for GST assessment becomes challenging, as there is no straightforward monetary consideration available.
To address these challenges, it becomes crucial to explore alternative valuation methods, as outlined in Rule 30 or Rule 31 of the CGST Rules, 2017 (“CGST Rules“). Rule 30 of the CGST Rules specifies that the value of a service should be set at 110 percent of the cost of providing the service. Nevertheless, this rule is not applicable in the case of corporate guarantees because there are no direct costs associated with providing such guarantees.
In such instances, the only viable option is to apply Rule 31 of the CGST Rules, which mandates that valuation should be determined using reasonable means, in alignment with the principles and general provisions laid out in Section 15 of the CGST Act.
Following this discretionary principle, the GST Council has recommended a tax rate of 18 percent on one percent of the value of corporate guarantees. This discretionary approach to determining what constitutes “reasonable means” and subsequently arriving at the valuation can potentially lead to disputes between the two parties involved. Hence, it is imperative to establish transparency regarding the factors and deliberations that guided the GST Council in adopting this particular valuation approach. This will help prevent challenges to the valuation on the basis of ambiguity.
Conclusion
In this evolving landscape of GST, one thing is clear: striking the right balance between tax collection and fostering a conducive business environment remains a formidable challenge. The recent recommendation of an 18 percent GST rate on a portion of corporate guarantee values is a step towards clarity, but it is far from the final word on the matter.
Corporate guarantees play a crucial role in business operations, facilitating trade, and enhancing creditworthiness. They are complex financial instruments that can have a substantial impact on the financial health of companies. As we move forward, it is imperative for policymakers, legal experts, and businesses to engage in a constructive dialogue to address the intricate nature of these guarantees. This dialogue should aim to create a framework that addresses the taxability of corporate guarantees by considering the myriad of unanswered or ambiguous questions surrounding them within the tax framework, including the questions regarding the inclusion of corporate within the scope of supply, the potential classification of guarantees as actionable claims, and the intricacies involved in valuing these guarantees.
– Esha Rathi