Corporate Guarantee under GST or whether to supply

In the realm of GST, understanding corporate guarantee under GST or in supply scenarios is crucial. A corporate guarantee involves one company assuring to meet the obligations of another if it falls short. Whether this assurance qualifies as a supply under GST can be complex. It’s pivotal to grasp its implications, whether it triggers GST or not. Exploring this ensures clarity on tax implications, aiding businesses in navigating the nuances of GST and financial agreements.

Definition of Corporate Guarantee-

A corporate guarantee is a contract between a corporation or individual and a debtor. In this arrangement, the guarantor agrees to accept responsibility for the debtor’s responsibilities, such as repaying debt. When a corporation guarantees repayment of a loan issued to one of its subsidiaries, if the subsidiary fails on the loan, the individual who signed the agreement guarantees that the debt will be paid back.

Corporate guarantee under companies act, 2013, is given under Section 185 which applies to both private and public corporations, prevents holding companies from providing corporate guarantees as security to banks for loans to subsidiaries. The company cannot make loans, including those represented by a book debt, to its directors or other interested parties, nor guarantee or provide security for loans taken by them or others. 

Related party and Corporate guarantees-

Related party transactions are always presumed to be not at arm’s length, therefore tax regulations require that the transactions be conducted at market value and on customary corporate conditions, as if they were with a third party. Transactions involving related parties are always scrutinized and must demonstrate that they are motivated by commercial understanding. The GST regime also specifies the definition of related individuals and the application of valuation criteria in transactions involving related parties. 

According to Section 15 of the Central GST Act, the value of a supply of goods or services is regarded to be the actual amount paid or payable for taxation purposes when the transaction is not between related parties and price is the sole consideration for supply. If products or services are supplied between related people, the value of such supplies must be established in accordance with the valuation standards. 

Valuation of Corporate guarantee under GST- 

Rule 2 of the Determination of Value of Supply Rules, provides for determining the value of supply of goods and/ or services between distinct or related persons, other than through agent. The rule prescribes that the value of the supply between related persons shall be:  the open market value of such supply; where open market value of such supply is not available, it shall be the value of supply of like kind and quality; and where the value cannot be determined by the mechanisms stated in (a) and (b) above, it shall be determined by application of Rule 4 or Rule 5 of the above-mentioned rules. 

Corporate guarantee under GST is granted by holding to a subsidiary or similar transactions between related people are regarded a delivery of service for GST purposes, and no guarantee commission is normally imposed. So, in the case of guarantees supplied by related parties, the valuation standards apply.

Valuation of Corporate guarantee-

While there are various sophisticated ways of pricing guarantees, the two most typical techniques of pricing a corporate guarantee are presented below:  

The value of the corporate guarantee is the difference between the value of the uncovered transaction and the value of the covered transaction. The primary goal is to price the transaction based on the difference in loan value with and without the guarantee. Assume a lending institution requested a 10% interest rate on a loan received through the guarantee. Because of the presence of a guarantee, the interest rate has dropped to 8%. In this scenario, the guarantee’s value should be calculated using 2% of the loan amount.  

The second strategy is based on the predicted loss from the exposure. The guarantee commission should cover the estimated losses. 

Here, 

Expected loss = Loss given default * likelihood. Loss provided default = amount for which the assurance is granted * (1-recovery rate).

Relevant Legal Precedents- Hindustan Construction Company Limited vs. Commissioner of Service Tax (CESTAT Mumbai)- 

In the case of Hindustan Construction Company Ltd. vs. Commissioner of Service Tax (CESTAT Mumbai), the question of service tax on ‘corporate guarantee’ and ‘credit protection fee’ is at stake. The appellant, Hindustan Construction Company Ltd., challenged the duty demand and penalties imposed by Section 73(2) of the Finance Act of 1994 for issuing a ‘company guarantee’ to M/s Lavasa Corporation Ltd. against loans secured from banking institutions.

The Tribunal emphasized that, while there are practical distinctions, the essential aim of ‘corporation guarantee’ and ‘bank guarantee’ is the same: to provide assurances to beneficiaries. It was found that while the statutory language did not clearly include ‘corporate guarantee,’ legislative meaning suggested exclusion. The Tribunal also dismissed the appellant’s claim that they were not a ‘body corporate.

In the matter of Everest Kento Cylinders Ltd1 and Manugraph India Ltd, the Bombay High Court ruled that a corporate guarantee cost of 0.50% was reasonable based on the facts of the case. However, in the matter of Redington (India) Limited, the Madras High Court ruled that, based on the facts, a corporate guarantee charge of 0.85% was arm’s length. There have been numerous decisions from various Income Tax Appellate Tribunals sustaining the corporation guarantee cost at 0.50%.

Currently, the litigation around corporate guarantee is focused on arm’s length pricing. A general observation from the various tribunal decisions is that a corporate guarantee commission fee between 0.5% to 0.85% has been considered to be at arm’s length.

Conclusion: 

Given the above reasoning, it appears that corporate guarantee under GST is granted without consideration because, under the GST regime, the value of the service cannot be treated as zero. As a result, issuing guarantees becomes more expensive, discouraging businesses from doing so. However, deciding on the applicability of GST in the case of such consideration, less corporate guarantees, would require clarification from the tax authorities themselves or perhaps another court order.