GST, a landmark reform in India’s post-independence history, unifies the taxation of goods and services, replacing numerous central and state taxes. By creating a seamless chain of set-offs, GST eliminates cascading effects, benefiting producers and reducing costs. It operates on a value-added tax model, ensuring that taxes are levied only on the final consumer, simplifying the tax structure and boosting economic efficiency. The inclusion of the services sector broadens the tax base, while uniform rates and procedures across the nation reduce compliance costs, making GST a transformative force in India’s tax landscape.
A corporate guarantee is essentially a legally binding contract where one party, often a corporate entity or an individual, assumes the responsibility for the obligations of another party, typically a debtor. These obligations typically involve debt repayment but can also encompass various other commitments or duties. In essence, the guarantor acts as a backup or security for the debtor, ensuring that the obligations are fulfilled, even if the debtor is unable or unwilling to do so.
Within the framework of the GST law, holding and subsidiary companies are categorised as ‘related persons,’ introducing complexities to the GST treatment of corporate guarantees. Notably, transactions between related persons, even without consideration, are deemed taxable supplies under GST. Recent amendments to the Central Goods and Services Tax Rules, 2017 (CGST Rules) address this complexity by introducing a specific valuation provision for the taxability of corporate guarantees extended by related entities.
In light of these developments, it becomes crucial to gain a comprehensive understanding of the amendments and the potential intricacies arising from them. This article aims to explore the nuances and complexities associated with corporate guarantees, particularly those extended by holding companies on behalf of their subsidiary entities, shedding light on the implications of the recent amendments to the CGST Rules.
A corporate guarantee is essentially a legally binding contract where one party, often a corporate entity or an individual, assumes the responsibility for the obligations of another party, typically a debtor. These obligations typically involve the repayment of a debt, but they can encompass various other commitments or duties as well. In essence, the guarantor acts as a backup or security for the debtor, ensuring that the obligations are fulfilled, even if the debtor is unable or unwilling to do so.
This type of arrangement is commonly used in the world of finance and business. For example, corporate guarantees come into play when a corporation guarantees the repayment of a loan taken by its subsidiary or when a parent company guarantees the performance of a contract entered into by its subsidiary. In such cases, the guarantor corporation steps in to fulfill the obligations of the debtor (subsidiary) and fail to do so. This provides confidence to lenders and other parties involved in the transaction, making it more likely for the deal to proceed.
Corporate guarantees are issued for various reasons, primarily to safeguard the financial health of associated or subsidiary enterprises. By offering a guarantee, the guarantor corporation demonstrates its commitment to supporting its affiliates and ensuring they can meet their financial and contractual obligations.
What Does Guarantee Mean?
A guarantee is a contractual arrangement wherein one party assumes liability for the current or future obligations of another party (the principal) to a third party, in addition to the principal’s own liability. It constitutes a secondary obligation and is required to be documented in writing. In the context of insolvency, a guarantee serves as an agreement between a guarantor and a creditor, stipulating that the guarantor will fulfill the debts owed by the principal debtor to the creditor, whether they are existing or prospective. To be legally valid, such agreements must be evidenced in writing and bear the signature of the guarantor.
Definition and Types of Corporate Guarantees
A corporate guarantee, also referred to as a “guaranty” or “corporate guaranty,” is a written commitment that benefits both the debtor and the lender in a financial transaction. This assurance enhances the security of the loan for the lender, as the guarantor pledges to repay the money if the debtor fails to meet their obligations. Additionally, a corporate guarantee enables debtors to qualify for loans they might not otherwise be eligible for, especially if they have lower credit scores.
Common alternative terms for a corporate guarantee include:
- Third-party guarantee
- Guaranteed loan
The key parties involved in a standard corporate guarantee are:
- Guarantor: The individual undertaking the legal obligation to assume loan payments if the debtor cannot fulfill their obligation.
- Lender: The entity to whom the debt is owed.
- Debtor: The individual receiving the money and responsible for repaying the loan.
Distinctions exist between a personal guarantor and a corporate guarantor. A personal guarantor is an individual assuming the obligations outlined in the agreement, while a corporate guarantor is a corporation taking on these responsibilities. In certain situations, a “limited guarantee” may be employed to restrict the guarantor’s obligation. For instance, the guarantor might only be obligated to repay a specific amount of the debtor’s loan rather than the entire sum. To be legally enforceable, the limits of the guarantee must be explicitly stated in the loan agreement and endorsed by the guarantor. This approach is commonly observed in mortgage agreements, where the guarantor’s responsibility is confined to a defined portion of the loan amount rather than the property’s full value.
Role of corporate guarantees in business transactions
Corporate guarantees serve as instrumental tools in business transactions, playing a pivotal role in enhancing creditworthiness and facilitating access to financing. By providing an additional layer of financial support, these guarantees instill confidence in lenders and improve the borrowing capacity of businesses, particularly those with lower credit ratings. Beyond mitigating risk for lenders, corporate guarantees also play a crucial role in building and strengthening business relationships, instilling trust among parties entering into contracts or agreements.
In complex projects or large-scale transactions, corporate guarantees are often essential, providing security for funding and assuring stakeholders that financial obligations will be met. Moreover, these guarantees find application in structured financing arrangements, meeting legal and regulatory compliance requirements in certain transactions. The use of corporate guarantees can also contribute to investor confidence, signaling a commitment to financial stability and responsible business practices.
In a recent legal development, the Supreme Court ruled in favour of the taxpayer in the case of Commissioner of CGST and Central Excise v. Edelweiss Financial Services Ltd.The case revolved around the question of whether service tax should be imposed on corporate guarantees provided to group companies. The Supreme Court’s decision hinged on the absence of consideration, and it referred to section 65B(44) of the Finance Act, which stipulates that there must be valuable consideration for a service to be subject to taxation. Given the absence of consideration, the court concluded that no service tax should be levied.
However, it’s important to note that this judgment may not hold in the context of the Goods and Services Tax (GST) regime. The reason for this lies in the existence of Schedule I under the CGST Act of 2017. According to Schedule I, in the case of transactions involving related parties, they can be subject to GST even when no consideration is involved. Therefore, the taxability of corporate guarantees needs to be reevaluated in the context of the GST regime, taking into account the provisions of Schedule I.
Balancing Profit Motive and Economic Viability in Taxation of Corporate Guarantees
Corporate guarantees’ taxability faces scrutiny regarding the fundamental purpose behind providing such guarantees. When a parent company issues a guarantee, its primary objective is not to generate income or profit through charges for offering the guarantee. Typically, the core intention behind providing a corporate guarantee is the subsidiary’s contribution to the broader objectives of the group. The parent company offers operational support to help the subsidiary overcome financial challenges, enabling it to refocus on the group’s overarching goals. In this context, the provision of a corporate guarantee isn’t viewed as a supply to the subsidiaries but rather as a means for the parent company to advance its group objectives.
Assessing Corporate Guarantees as “Actionable Claims”
The question revolves around whether a corporate guarantee can be considered a claim of debt. The definition of “debt” encompasses a sum of money owed by one party to another, including amounts payable in the future arising from present obligations. When a parent company issues a corporate guarantee, it effectively commits to indemnify banks or financial institutions in case of default by the subsidiary or a group company. This commitment represents a claim of debt, albeit one contingent on a future event—specifically, the default by the principal debtor.
It’s crucial to note that this claim isn’t secured by a mortgage of immovable property or by the subsidiary’s hypothecation or pledge of movable property. When a parent company provides a corporate guarantee, it doesn’t establish cross-security on the subsidiary’s property or create a hypothecation on the subsidiary’s immovable property. From the perspective of the subsidiary, this debt remains entirely unsecured. Hence, a corporate guarantee can be classified as an “actionable claim.”
GST on Corporate Guarantees: Business Course and Furtherance of Business
Assessing the taxability of corporate guarantees, we can conclude that they constitute a supply of goods. However, for GST on corporate guarantees to be applicable, such a supply must be in the course of business or aimed at furthering a business objective.
In the financial services industry, bank guarantees are a standard offering, and services are provided as part of regular business operations. However, beyond the financial services sector, offering guarantees typically does not align with activities in the course of business or furtherance of business objectives. Therefore, it’s challenging to categorise these transactions as supplies in the course of business or in furtherance of business.
Introduction of Regulation of GST on Corporate Guarantees Involving Related Entities
During its 52nd meeting on October 7, the GST Council clarified the government’s stance on the applicability of GST on corporate guarantees, particularly those issued by a parent company to its subsidiary. This decision introduces a nuanced perspective on the GST implications of corporate guarantees, eliciting a varied response from tax experts.
With the GST Council’s recent clarification, the previously held belief by litigating parties that considered a corporate guarantee as a shareholder function facilitating related party operations, and thus not subject to GST, is no longer valid. In response, the GST Council proposed an amendment, suggesting the insertion of sub-rule 2 into Rule 28 of the CGST Rules, 2017.
According to this proposed sub-rule, the taxable value of a corporate guarantee provided between related parties is set at 1% of the guarantee amount or the actual consideration, whichever is higher. Notably, this valuation applies universally, regardless of whether the recipient (subsidiary company) can avail input tax credit. This move aims to establish a clear framework for the treatment of GST on corporate guarantees within related entities.
The Central Board of Indirect Taxes and Customs (CBIC) has introduced a new regulation for the application of GST on corporate guarantees involving related entities, such as parent companies and subsidiaries. This regulation came into effect on Thursday, October 26th, 2023 following the decision made by the GST Council on October 8th, 2023. It’s important to note that the CBIC has implemented this rule prospectively, which means it will not have any retroactive impact on transactions conducted before October 26th.
According to the notification, an 18% of GST on corporate guarantees will be applicable between parent companies, subsidiaries, and other related parties. The GST will be based on either the financial consideration charged by the guarantor for providing this service or 1% of the value of the guarantee, whichever amount is higher.
The notification states, “The value of services supplied by a supplier to a related person, involving the issuance of a corporate guarantee to a banking company or financial institution on behalf of the said related person, shall be considered as one per cent of the amount of such guarantee offered, or the actual consideration, whichever is greater.”
Furthermore, the order clarifies that in cases where a corporate guarantee is issued to a bank by a director against loans granted to a company and where no fee is paid to the director for this service, no GST on corporate guarantees will be applicable.
Clarity on GST Refunds for Supplies to Special Economic Zones (SEZ)
A recent notification has brought clarity to the issue of claiming GST refunds for supplies made to Special Economic Zones (SEZ). This notification allows suppliers to SEZ developers or SEZ units to request a refund for the GST they have paid on their supplies. The notification specifies that all goods or services, with the exception of items like pan masala, tobacco, and gutkha, are eligible for export with integrated tax payment, and the suppliers of these goods or services can subsequently claim a refund on the tax paid.
This notification further clarifies that suppliers to SEZ Developers or units involved in authorized operations can provide goods or services, excluding items like pan masala, tobacco, and gutkha, while paying integrated tax. These suppliers are then entitled to claim a refund for the tax paid. This development removes any ambiguity regarding the ability to seek GST refunds on supplies made by domestic suppliers to SEZ, and experts believe it will help mitigate potential working capital concerns for domestic industries engaged in SEZ supplies.
In conclusion, the Finance Ministry’s notification imposing an 18% of GST on corporate guarantees represents a significant development in the taxation of such transactions. This move is aligned with the GST regime’s goal of streamlining and standardizing taxation across various economic activities. While it may introduce taxation on a previously untaxed aspect of business, it ensures that corporate guarantees involving related entities, such as parent companies and subsidiaries, are subject to a consistent tax rate, simplifying compliance and fostering uniformity in the tax system. This notification has implications for businesses and financial transactions, especially within the corporate sector, and it underscores the importance of understanding the specific tax treatment i.e., treatment of GST on corporate guarantees.
Frequently Asked Questions (FAQs)
The GST council has clarified that corporate guarantees given by a parent company to its subsidiary will be subject to goods and services tax (GST) i.e., 18% of GST on corporate guarantees. This decision has implications for holding companies that have extended guarantees to their subsidiaries in India.
A corporate guarantee is not typically considered a service. Instead, it is a financial arrangement or instrument that falls under the broader financial services or transactions category. A corporate guarantee is a commitment made by one company (the guarantor) to take responsibility for the financial obligations of another company (the debtor) if the debtor fails to fulfil its obligations.
A bank issues a bank guarantee to assure a beneficiary in trade transactions. In contrast, a corporate guarantee involves one company within a corporate group providing assurance for another affiliated company’s financial obligations. Bank guarantees are more independent, while the overall financial health of the corporate group influences corporate guarantees.
A corporate guarantee can be either secured or unsecured. In a secured corporate guarantee, specific assets are pledged as collateral, providing security for the guarantee. Conversely, an unsecured corporate guarantee relies on the overall creditworthiness of the guarantor without the pledge of specific assets. The choice between secured and unsecured depends on negotiations and the parties’ preferences.
The notification by the Finance Ministry specifies the imposition of an 18% of GST on corporate guarantees provided by companies to their subsidiaries and related entities.
No, the notification ensures that this GST on corporate guarantees applies prospectively, which means it won’t affect transactions conducted before the notification came into effect.
The notification outlines that the taxable value for GST on corporate guarantees is determined as either 1% of the guaranteed amount or the actual consideration, depending on the specific circumstances of the transaction.
Corporate guarantees are typically issued to safeguard the financial health of related enterprises and provide support. They are a means of ensuring the fulfillment of a debtor’s obligations to a lender, especially when the debtor is unable to meet the terms of the lending agreement.
Another notification in the same context allows suppliers to SEZ developers or units to claim refunds on GST paid, except for certain excluded goods like pan masala and tobacco. This notification aims to address issues related to GST refunds in SEZ transactions.
Schedule I of the CGST Act 2017 outlines that in the case of related party transactions, even if there is no consideration involved, they can still be subject to GST. This provision affects the taxability of corporate guarantees, especially in cases involving related parties.
The Supreme Court ruling in the case of Commissioner of CGST and Central Excise Vs Edelweiss Financial Services Ltd. highlights the importance of understanding the applicability of service tax on corporate guarantees. However, it’s essential to consider the implications of Schedule I of the CGST Act in the GST context.
Typically, providing guarantees within the banking and financial services sector is part of regular business activities and is subject to GST. However, outside this sector, providing guarantees may not be categorised as a supply in the course of business or furtherance of business, making them less likely to be subject to GST.
GST essentially taxes the final consumer and aims to eliminate the cascading effects of tax-on-tax, thus reducing production costs. It introduces a uniform tax structure, making compliance more straightforward.
To determine the tax treatment of corporate guarantees in the GST regime, businesses need to consider factors such as the specific circumstances of the guarantee, the relationship between the parties involved, and the provisions of Schedule I of the CGST Act. It’s advisable to seek professional tax advice when necessary.
Read Our Article: GST on Advertising Services