Taxability of Corporate Guarantee under GST: Gujarat HC Ruling
Case Background
The Gujarat High Court has delivered an important judgment concerning the GST liability and valuation of corporate guarantees furnished by holding companies to banks/financial institutions for their subsidiaries.
The Court upheld the levy of GST on corporate guarantees furnished without consideration between related persons, holding that such guarantees constitute a taxable supply under Section 7(1)(a) read with Schedule I of the CGST Act. The subsidiary was held to be the recipient of the service, and furnishing the guarantee was considered an activity undertaken in the course or furtherance of business.
However, the Court provided substantial relief to taxpayers on the valuation mechanism under Rule 28(2). While the Court upheld the validity of Rule 28(2) and the 1% benchmark valuation, it held the expression "whichever is higher" to be arbitrary and unconstitutional and directed that the expression be read down. Consequently, valuation cannot automatically be determined at the higher of 1% of the guarantee amount or actual consideration.
Key Findings
A corporate guarantee furnished by a holding company to secure the borrowings of its subsidiary, even without consideration, constitutes a supply between related persons under Schedule I.
The Court held that safeguarding the financial interests of a subsidiary is an activity incidental or ancillary to the business of the holding company. Profit motive, frequency or continuity of the activity is not essential.
The prescription of 1% as a benchmark valuation was not struck down. However, the words "whichever is higher" were held to be arbitrary and violative of Articles 14 and 19(1)(g) of the Constitution.
The Court held that GST under Rule 28(2) of CGST Rules 2017 cannot be imposed for the period prior to 26 October 2023, when Rule 28(2) of CGST Rules 2017 was introduced. Such retrospective levy was held to be harsh and unfair and violative of Articles 14 and 19(1)(g). Where the guarantee continued beyond 26 October 2023, however, GST liability could arise from that date.
The Court noted that Circular No. 225/19/2024-GST governs the valuation and excludes application of the deemed valuation mechanism under Rule 28(2) of CGST Rules 2017.
Where a corporate guarantee was accompanied by a pledge of shares, the Court held that the pledge merely secured performance of the guarantee. The corporate guarantee remained taxable.
Time of supply — the Court held that corporate guarantees are not a continuous supply of services merely because Rule 28(2) of CGST Rules 2017 provides for 1% valuation "per annum". The time of supply arises annually under Section 13(2)(c), when the recipient recognises receipt of the service in its books.
Circulars Nos. 204/16/2023-GST and 225/19/2024-GST were set aside to the extent they were inconsistent with the Court's interpretation. The Revenue was given liberty to issue fresh instructions consistent with the judgment.
The Court held that mere non-declaration of the corporate guarantee, in circumstances involving a genuine interpretational dispute and where the relevant facts were known to the Revenue, did not establish wilful suppression with intent to evade tax. Accordingly, proceedings under Section 74 of CGST Act 2017 were quashed.
Final Ruling
The Court ultimately directed that:
Rule 28(2) is intra vires, except the words "whichever is higher", which are to be read down;
GST under Rule 28(2) cannot be levied for corporate guarantees prior to 26 October 2023;
GST can apply from 26 October 2023 onwards where the guarantee continues;
Section 15(4) of CGST Act is held by the court to be valid;
The impugned Section 74 proceedings were quashed;
Excess GST deposited, if any, is to be refunded, subject to adjustment by the parties;
The contrary portions of the impugned CBIC Circulars were set aside; and
The directions were to be implemented within three months from date of pronouncement of this order.
Taxpayer Impact
The judgment is therefore a mixed ruling, but materially favourable on valuation and retrospective demands. The basic GST liability on corporate guarantees has been upheld. However, taxpayers receive significant protection against:
GST demands for periods prior to 26.10.2023,
Automatic application of the higher-of-1%-or-actual-consideration formula, and
Invocation of Section 74 merely on the basis of non-disclosure where there is no established wilful suppression or intent to evade tax.
Practical Takeaway
Companies should review all corporate guarantees furnished to subsidiaries, identify guarantees continuing beyond 26 October 2023, examine the actual consideration/commission involved, and separately review any historical GST demands raised for the pre-26 October 2023 period.