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Taxability and Valuation of Corporate Guarantee – Need for a Re-Evaluation

Article by Smita Singh and Manpreet Kaur

Typically, a corporate guarantee is an arrangement within the group companies wherein an associate entity agrees to act as a guarantor for its group entity while securing finance/ loans/ debts from a financial institution. These arrangements are executed either without any consideration or with a nominal commission on the total loan amount.

The taxability of corporate guarantee has been an issue of tussle for a long time, however the issue of valuation arising has become complex due to amendment in Rule 28(2) of the CGST Rules[1] prescribing the deemed valuation of the service by way of issuance of corporate guarantee.

Till date, the companies were fighting the battle of non-taxability of corporate guarantee on the argument that there is no underlying service involved in the issuance of corporate guarantee, however, the Government jumped off the issue and directly notified the deemed valuation rules for the service of issuance of corporate guarantee. Making it clear that there was never an intention to not tax the corporate guarantee and the missing piece of the puzzle at least from the exchequers point of view was not identification of underlying supply but the valuation of service only.

However, it is pertinent to note that under direct tax laws and OECD[2] guidelines, issuance of corporate guarantee is treated as a ‘shareholders’ activities’ or ‘quasi-capital activity’[3] and not in the nature of ‘provision of services’; thus, qualifying the issuance of corporate guarantee as ‘provision of service’ under the GST law is not in consonance with the Income tax provisions. Such different positions in different tax legislations indeed creates more confusion in the industry.

On the recommendations made in the 52nd GST Council Meeting, the Government vide the Notification[4] notified Rule 28(2) of the CGST Rules in terms of which value of supply by way of issuance of corporate guarantee is deemed to be 1% of the amount of such guarantee offered or the actual consideration, whichever is higher. Moreover, vide the Circular[5], it was also clarified that such valuation rule shall apply even when the corporate guarantees are issued without consideration.

Thus, the intention of the Government is amply clear to tax the corporate guarantee irrespective of the consideration involvement. However, apart from the issue of taxability, there are other inter-connected issues such as ‘time of supply’, ‘value of the guarantee offered’, and ‘periodicity of payments’ which are propelling to take off.

While providing for the deemed valuation in Rule 28(2) of the CGST Act, it has been mentioned that the value of service by way of providing corporate guarantee is 1% of the ‘guarantee offered’. Now, as an industry practice, guarantee does not only include the principal amount of the loan granted, but may also include interest, penalty (if any), other charges etc. Since the meaning of ‘guarantee offered’ has not been defined in the GST laws there seems to exist anomaly, whether in finalising the amount of ‘guarantee offered’ will include only the principal amount or include other charges such as interest, penalty, and other charges as well.

It is further important to note that a blanket valuation of 1% of guarantee offered may not be feasible in some cases. For example, in a scenario wherein loan is sanctioned for INR 100 crore and equivalent guarantee is provided by the related entity. However, the company ends up in utilising only INR 50 crores of the total sanctioned amount and the balance INR 50 crores is never disbursed. In such a case, applying the deemed valuation on the whole sum of sanction amount of loan i.e., INR 100 crore might not be justifiable as the same was never disbursed to the company and hence, corporate guarantee for such amount would never get triggered. With these ambiguities around the scope of ‘guarantee offered’ in place, the tussle between the government and taxpayer is imminent since there are likely chances that the revenue authorities may consider the meaning of ‘guarantee offered’ to include maximum amount to increase the valuation and hence, the taxes. Undoubtedly, by leaving the definition of ‘guarantee offered’ open-ended with uncapped amount, the Government has paved way for an impending litigation revolving around valuation of ‘corporate guarantee’.

Another issue in line is related to the taxability of the additional corporate guarantee offered by the company to the same bank or financial institution. Generally, companies’ top-up their existing loans with additional amount and subsequently, their related entity also provides additional corporate guarantee for such additional amount including the ongoing loan. In such cases, whether the definition of ‘guarantee offered’ will include only the additional amount covered or the whole amount of corporate guarantee. Ideally, it should be only the additional amount, however, in absence of clarity, the interpretation adopted by taxpayers and revenue authorities may vary.

Determination of the time of supply is another pertinent issue which needs to be addressed while making the tax payment on the service of issuance of corporate guarantee. As contracts for corporate guarantee are continuous contract, i.e., guarantee is triggered at the time of payment of instalment. The question that arises here is whether the time of supply of corporate guarantee will be the effective date of the agreement entered or the time period as and when the corporate guarantee is triggered i.e. the due of payment of instalment. With this uncertainty in place with respect to time of supply, the time of payment of tax is a critical issue that needs immediate attention.

Thus, it is apparent that the Government has notified the valuation rule in a haste to settle the issue pertaining to taxability of corporate guarantee without considering the practical implications on the industry. In fact, it will not be wrong to say that in the urge of settling one issue related to taxability of corporate guarantee by way of notifying valuation rule, the Government has sown the seed for many issues which will crop into litigation in no time if not clarified at the earliest.

[1] The Central Goods and Services Tax Rules, 2017
[2] Organisation for Economic Co-operation and Development
[3] Micro Ink Limited Vs. ACIT (ITA No. 2873/Ahd/10)
[4] Notification No. 52/2023- CT, dated October 26, 2023
[5] Circular No. 204/16/2023-GST dated October 27, 2023
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