How GST Applies to Corporate Guarantee Transactions

Understanding/ Background:

A Corporate Guarantee is a legal promise or commitment made by one person (the guarantor) to assume responsibility for the debts, obligations, or liabilities of another (the beneficiary or principal debtor) if the principal debtor fails to meet its financial obligations. Essentially, it’s a form of financial support or assurance provided by a financially stable or creditworthy company to help secure a transaction or arrangement involving the beneficiary company.

‘Corporate Guarantees’ are quite common in trade where the holding or parent company issues a guarantee to the financial institutions as a security for extending credit facilities on behalf of its subsidiary company. Even though the terms, ‘Guarantee’ or ‘Corporate Guarantee’ are used commonly in trade transactions, the Goods and Services Tax (GST) law does not explicitly define these terms. Section 126 of the Indian Contract Act 1872, defines ‘Contract of Guarantee’ as a contract to perform the promise, or discharge a liability, of a third person in case of his default.

Example of Corporate Guarantee: 

Provisions:

The first provision of corporate guarantee:

In pursuance of the recommendation of the 53rd GST Council meeting dated June 22, 2024, the GST councils stated they are going to amend GST Rule 28.

Rule 28 talks about the Value of the supply of goods or services or both between distinct (Section 25 of CGST Act-) or related persons, other than through an agent. –

Section 25 (4) of CGST Act A person who has obtained or is required to obtain more than one registration, whether in one State or Union territory or more than one State or Union territory shall, in respect of each such registration, be treated as distinct persons for this Act.

Clarification on the valuation of corporate guarantee provided between related persons after insertion of Rule 28(2) of CGST Rules, 2017: GST Council recommended amendment of rule 28(2) of CGST Rules retrospectively with effect from 26.10.2023 and issuance of a circular to clarify various issues regarding the valuation of services of providing corporate guarantees between related parties. It is inter alia being clarified that valuation under rule 28(2) of CGST Rules would not be applicable in case of export of such services and where the recipient is eligible for full input tax credit.

 Schedule II Entry 1: Transaction between the related party will be considered at supply even if consideration is not discharged

Provisions effective till 26th Oct-2023 : Rule 28(1) was applicable :

The value of supply would be the open Market Value. As per proviso of Rule 28(1) of CGST Rule, where the recipient is eligible for full input tax credit, the value declared in the invoice shall be considered as open Market Value.

Rule 28 (2) of Central Goods and Service Tax Rules, 2017:

Please note that amendment in the above section has been vide Notification No. 12/2024 – Central Tax (clause 5) dated 10th July 2024, Circular No. 225/19/2024- GST dated 11 July 2024) effective from 26th Oct-2023

The value of the supply of services by a supplier to a recipient who is a related person [located in India],  by  way  of  providing a corporate  guarantee  to  any  banking  company  or financial institution on behalf of the said recipient, shall be deemed to be one percent of the amount of such guarantee offered [per annum], or the actual consideration, whichever is higher.]

Amendment

Sub-rule (2) of rule 28

• The phrase who is a related person located in India has now been inserted in the sub-rule, thereby narrowing its scope to guarantees provided to related parties situated within India.
• It provides the valuation norms for GST purposes to one percent of the guarantee offered per annum: The guarantee amount on an annualized basis will be the base for calculating the valuation every year to levy GST.

• A proviso has now been inserted stating that the value in the invoice will be deemed to be the value of the said supply when the ITC is eligible.

Important clarifications issued vide Circular No. 225/19/2024-GST issued on 11th July 2024

These circular addresses clarifications sought by trade and industry regarding the taxability and valuation of these services,

Issue:  Whether Corporate Guarantee issued before 26th Oct-23 liable to taxable?

Clarification: The supply of services in respect of corporate guarantee will continue to taxable supply even before 26th Oct-2024. Rule 28(2) provides only the valuation mechanism, not the taxability. The taxability of Corporate guarantee can never be disputed. It was taxable even before 26th Oct-23 by Schdule-1 entry no 2. Transaction between the related party will be considered at supply even if consideration is not discharged.

Issue:  While Corporate Guarantee is provided for an amount, whereas a loan is partially availed or not availed, then what will be the value of supply?

Clarification: The value of supply is not linked with the disbursement of the loan. The value of services providing the corporate guarantee will be linked with the value of supply for providing the corporate guarantee and not to the amount of the loan.

Further, it has also been clarified recipient of the service of providing corporate guarantee shall be eligible to avail of the ITC irrespective of the amount of loan disbursed

Issue: When the loan issued by the banking company/ financial institution is taken over by another banking company/ financial institution, whether said activity fall under the service provided for the issuance of corporate guarantee?

Clarification: The said activity of taking over the loan does not fall under the service of providing corporate guarantee to any banking company or financial institution by a supplier to a recipient unless there is issuance of fresh corporate guarantee or there is a renewal of the existing corporate guarantee.

Issue: Where corporate guarantee is provided by more than one entity / co-guarantor, what is the amount on which GST shall be payable by each co-guarantor?

Clarification: When multiple entities provide a guarantee, the valuation thereof is based on the actual consideration or 1% of the guaranteed amount, whichever is higher, each co-guarantors GST liability is proportionate to their share of the guarantee.

Example: A and B have provided a corporate guarantee jointly to a banking/ financial institution on behalf of a related recipient C for Rs 1 crore, A provides a guarantee for 60% of the guarantee amount and B provides a guarantee for the remaining 40% of the guaranteed amount, then GST shall be payable by A and B proportionately i.e 60 L and 40L.

Issue: In the case of inter-corporate guarantee, whether GST would be applicable under RCM or forward?

Clarification: Where the domestic Company issues the corporate guarantee, GST would be applicable under forward, and where the foreign Company issues the Corporate guarantee, GST would be applicable on RCM and to be discharged by the recipient in India.

Issue: Whether the discharge of tax liability on corporate guarantee @ 1% of such guarantee offered to be done one time yearly or monthly and when issued for a fixed term of say, five years or ten years as per tenure of the loan?

Clarification: Guarantees extending over multiple years (at the time of issue itself): GST is payable upfront on the valuation arrived at, by multiplying 1% of the guaranteed amount by the number of years & extends to or the actual consideration, whichever is higher.

Guarantees are renewed annually: GST is payable annually at 1% of the guaranteed offer per annum or the actual consideration, whichever is higher

Guarantees issued for periods shorter than a year: GST is calculated proportionately for the part of the year

Issue: Whether valuation specified under rule 28(2) of CGST Rule apply to the export of Services?

Clarification:  Provisions of Rule 28(2) do not apply where the recipient is located outside India. Hence not applicable to the export of services.

Section 2(6) of IGST Act, 2017 specifies the definition of  “export of services” means the supply of any service when-

(i) the supplier of service is located in India;

(ii) the recipient of service is located outside India;

(iii) the place of supply of service is outside India;

(iv) the payment for such service has been received by the supplier of service in convertible foreign exchange 1[or in Indian rupees wherever permitted by the Reserve Bank of India]; and

(v) the supplier of service and the recipient of service are not merely establishments of a distinct person by Explanation 1 in section 8;

Issue: Whether the benefit of the second proviso of Rule 28(2) is applicable in all instances?

Clarification: The safe harbor nude for restricting the value to the declared value in the invoice when the ITC is fully eligible has now been extended to corporate guarantee transactions.

Determination of the Value of Corporate Guarantee for Related Parties

1. Deemed Value of Corporate Guarantee as per Rule 28(2)

Under Rule 28(2) of the CGST Rules, if no fee is charged, the deemed value of a corporate guarantee is calculated as 1% per annum of the guarantee amount. This method applies when both the guarantor and the recipient are located within India, and the recipient is not eligible for full input tax credit (ITC).

Example: If a parent company provides a corporate guarantee for its subsidiary worth ₹20 lakh without charging a fee, GST on the corporate guarantee would be calculated on ₹20,000 (1% of ₹20 lakh).

2. Declared Value of Corporate Guarantee as per Invoice

Following a recent amendment in July, the declared invoice value can now take precedence over the deemed value for GST on corporate guarantee purposes. This change, effective for guarantees issued or renewed after October 26, 2023, is significant for entities eligible for full ITC, allowing them to claim the actual fee as the basis for GST calculation. 

IMPACT OF CORPORATE GUARANTEE ON THE RENEWABLE SECTOR 

Key Characteristics of the RE Sector

Before highlighting the pain areas on the introduction of taxability on Corporate Guarantee, we have discussed the key contours for setting up of RE Project. 

Creating Special Purpose Vehicle (SPV)

It is pertinent to highlight that, the RE sector operates through the creation of special purpose vehicle(s) (SPV) for each project wherein the main (parent) entity provides a guarantee to financial institutions to extend the funding to these SPVs. The requirement for separate entities / SPVs stems from regulatory, funding, and related requirements to maintain separate P&L for each project.

Debt Equity Ratio

As per the financing norms for RE Projects issued by REC Limited, the Debt Equity Ratio proposed for private sector borrowers is 70:30 (https://recindia.nic.in/download/Financing_Norms.pdf). Accordingly, the SPV will have to borrow 70% of its capex requirement from lenders which makes corporate guarantees an essential tool to facilitate credit for project development.

GST-Related Challenges for the renewable sector

  With this backdrop, we have highlighted the key pain areas and suggested remedial measures below:

GST Burden on an Exempt Sector

The RE sector, where electricity generation is GST-exempt, already faces significant cost burdens due to the inability to claim Input Tax Credit (ITC). With GST on plant and machinery ranging from 14% to 15% and now additional GST on corporate guarantees, the sector is struggling with mounting financial challenges. The tax cost cannot be passed on or offset, unlike other sectors where ITC is available.

This creates an inequitable situation, imposing an unfair financial burden on the sector compared to industries that are not similarly constrained. Consequently, these increased costs must be factored into the final price of electricity, thereby inflating the tariffs for end consumers.

Unjustified Valuation of Corporate Guarantees:

The valuation determined at the rate of 1% per annum of the corporate guarantee offered is quite steep that too without any basis poses a challenge to the RE industry. 

The GST offices’ rationale of 1% per annum can be ascertained from the demand notices issued to many corporates. The relevant extract of the rationale is reproduced below: