A corporate guarantee plays a pivotal role in the financial and business ecosystem of group entities. It represents a contractual commitment made by one company, usually a holding, subsidiary, or associate enterprise, to assure repayment of a loan or fulfillment of obligations of another related entity. Corporate guarantees are commonly extended without direct monetary consideration, primarily to enable group companies to access funds from banks and financial institutions. While this arrangement makes commercial sense, it has generated significant debate in indirect tax law, especially regarding its classification, valuation, and taxability.
The treatment of corporate guarantees has undergone a fundamental transformation from the service tax regime to the goods and services tax regime. What was once considered outside the ambit of taxation due to lack of consideration has been explicitly brought within the fold of supply under GST. The journey reflects the tax administration’s increasing focus on capturing intra-group transactions and plugging revenue leakages.
Understanding Corporate Guarantee in Commercial Context
A corporate guarantee is essentially a risk-assuming contract. When a parent company issues a guarantee on behalf of its subsidiary, it assures lenders that if the subsidiary fails to meet its obligations, the parent will step in to repay. This improves the creditworthiness of the borrowing entity and often reduces the cost of borrowing.
In practice, corporate guarantees are often issued without charging a fee. They are treated as shareholder support arrangements, given for the overall benefit of the group. The absence of direct monetary consideration, however, poses difficulties under tax laws that are structured around the principle of consideration-based supplies.
Contract of Guarantee under the Indian Contract Act, 1872
The foundation of corporate guarantees in India lies in Section 126 of the Indian Contract Act, 1872. It defines a contract of guarantee as a contract to perform the promise or discharge the liability of a third person in case of his default. The essential parties are:
- Surety: the guarantor providing the guarantee
- Principal debtor: the party whose obligation is secured
- Creditor: the person in whose favor the guarantee is given
The Act allows guarantees to be either oral or written, providing wide flexibility. This legal principle makes it possible for companies to extend enforceable guarantees without necessarily documenting them in monetary terms. While such flexibility is commercially beneficial, it creates complexities when determining taxability.
Position of Corporate Guarantees under Service Tax
During the service tax regime, taxability was confined to services provided for consideration. The critical question was whether a corporate guarantee issued free of cost could qualify as a taxable service.
The dispute culminated in the case of Commissioner of CGST and Central Excise v. Edelweiss Financial Services Ltd. in 2023. Edelweiss had provided corporate guarantees to its group companies without charging a fee. The Revenue authorities attempted to levy service tax on the ground that such guarantees constituted a service. However, both the Tribunal and the Supreme Court rejected this view, holding that in the absence of consideration, there could be no taxable service.
This ruling settled the position under service tax: issuance of corporate guarantees without consideration was not taxable. While this was a relief to businesses, it also highlighted a gap in the tax system that the government later sought to address under GST.
GST Framework and the Concept of Supply
The introduction of GST in 2017 marked a paradigm shift. Section 7 of the CGST Act defines supply in expansive terms to include all forms of supply of goods and services for consideration in the course of business. Significantly, Schedule I deems certain activities as supply even when carried out without consideration.
Among the activities covered are supplies between related persons or distinct persons, when made in the course or furtherance of business. The explanation to Section 15 of the CGST Act provides that entities under common control, such as holding and subsidiary companies, are related persons.
This change in law meant that corporate guarantees issued between related companies, even without charging a fee, would be considered as supplies. The classification of such transactions was placed under the service category of credit-granting services, which expressly includes guarantees.
Early Valuation Mechanism under Rule 28
From July 2017 until October 2023, valuation of corporate guarantees was governed by the general provisions of Rule 28 of the CGST Rules. The rule prescribed that the value of supplies between related parties should be determined based on:
- Open market value
- Value of like kind and quality
- Rule 30 or 31 methods based on cost or reasonable means
If the recipient was eligible for full input tax credit, the value declared on the invoice was deemed to be the open market value.
This approach was problematic in practice. For corporate guarantees without consideration, there was no open market benchmark, as group companies rarely charged each other fees. The cost-based approach also failed because guarantees did not involve a measurable incremental cost. This uncertainty created disputes and compliance challenges.
Introduction of Specific Rule for Corporate Guarantee in 2023
Recognizing the difficulties, the government introduced a specific provision through Notification No. 52/2023 dated 26 October 2023. Rule 28(2) was inserted to provide clarity on the valuation of corporate guarantees. It deemed the value of supply of services, by way of providing a corporate guarantee, to be one percent of the guarantee amount or the actual consideration charged, whichever was higher.
This marked a significant shift. By prescribing a fixed deemed value, the government ensured that GST would apply in all cases, thereby removing ambiguity. The introduction of Rule 28(2) also reflected the intent to prevent revenue leakages from intra-group transactions.
Amendment of Rule 28(2) in 2024
The valuation mechanism was further refined through Notification No. 12/2024 dated 10 July 2024, effective retrospectively from 26 October 2023. The amendment modified the valuation to one percent per annum of the guarantee amount, or the actual consideration, whichever was higher.
This change recognized that corporate guarantees are often issued for multiple years and that taxation should correspond to the period of risk. The amendment also introduced a proviso that if the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the value of supply. This provided relief in cases where tax is revenue-neutral.
Classification of Corporate Guarantee under GST
Corporate guarantees fall under service classification code 997113, which covers credit-granting services, including guarantees and standby commitments. The classification ensures that such guarantees are consistently recognized as services under GST.
The recognition of corporate guarantees as supply under Schedule I, coupled with their classification as services, makes them fully taxable even when issued without consideration. The only remaining question then becomes the valuation mechanism, which has now been settled through Rule 28(2).
Commercial Impact on Businesses
For businesses, particularly large conglomerates, these changes have substantial financial implications. Issuing a guarantee now triggers GST liability upfront. For example, a guarantee of INR 500 crore would attract a deemed value of INR 5 crore per annum under the amended rule, on which GST would be payable.
Where the recipient has full input tax credit, the impact is mitigated, as the tax paid can be claimed as credit. However, in cases where the recipient engages in exempt supplies, such as financial services or education, input tax credit may not be available, leading to genuine cash flow outgo.
Another area of concern is the retrospective nature of the 2024 amendment, which applies with effect from October 2023. Businesses that had already complied under the earlier one-time one percent rule may now need to reassess their liability.
Comparative Evolution from Service Tax to GST
The transformation from service tax to GST highlights the progressive broadening of tax coverage.
- Under service tax, corporate guarantees without consideration were not taxable, as confirmed in the Edelweiss ruling.
- Under GST, the concept of supply and related-party provisions brought such guarantees into the tax net.
- The valuation mechanism initially created uncertainty but was later clarified by Rule 28(2).
- The 2024 amendment aligned taxation with the tenure of guarantees, ensuring consistent revenue recognition.
This trajectory underscores the policy shift toward capturing the value of intra-group transactions, even if they lack direct monetary flows.
Clarifications through Circulars
The government issued Circular No. 225/19/2024-GST to provide detailed guidance on the applicability of Rule 28(2) and its amended version. The clarifications addressed several practical questions that had arisen since the rule’s introduction in October 2023.
Applicability of Rule 28(2)
The circular clarified that Rule 28(2) applies prospectively to corporate guarantees issued or renewed on or after 26 October 2023. Guarantees issued prior to this date are not subject to the deemed valuation mechanism, though they may still be taxable under the general principles of Schedule I and Rule 28(1).
Basis of Valuation
One of the key issues was whether valuation should be based on the loan amount disbursed or the guarantee amount sanctioned. The circular confirmed that valuation is based on the guarantee amount, irrespective of how much of the loan has been availed by the borrower. This ensures uniformity but may inflate the tax base in cases where only a portion of the loan is drawn.
Takeover of Loans
The authorities clarified that where a loan is taken over by another lender without issuance of a fresh corporate guarantee, no fresh liability under GST arises. This is because the original guarantee continues, and no new supply is made.
Multiple Guarantors
In cases where multiple group entities provide guarantees for the same loan, the circular provided that GST liability is to be determined based on the consideration agreed, or in the absence of such agreement, by equally apportioning the value among guarantors. This prevents duplication of tax and ensures fair allocation.
Time of Supply
Another area of confusion was whether GST should be paid annually or upfront. The circular clarified that GST on one percent per annum of the guarantee amount must be paid upfront at the time of issuance of the guarantee. This means that even if the guarantee is valid for multiple years, the tax is discharged at the inception.
Treatment in Case of Full Input Tax Credit
If the recipient of the corporate guarantee is eligible for full input tax credit, the circular confirms that the value declared in the invoice will be accepted as the value of supply. This provision effectively neutralizes the tax impact in revenue-neutral cases, reducing unnecessary litigation.
Amendments and Retrospective Application
The amendment introduced in July 2024 applied retrospectively from October 2023, leading to compliance difficulties. Businesses that had already calculated GST on a one-time one percent basis now had to reassess their liability on a one percent per annum basis. This retrospective application, while legally valid, placed an additional burden on taxpayers who had acted in good faith based on the earlier rule.
Companies are now compelled to reissue invoices, recalculate liability, and potentially pay additional tax along with interest. While input tax credit may be available in some cases, entities engaged in exempt supplies are at a disadvantage, as they cannot fully utilize the credit.
Input Tax Credit Eligibility
One of the important aspects of corporate guarantees under GST is the eligibility of input tax credit for the recipient entity.
Where the recipient is engaged in taxable supplies, the GST paid on the guarantee can be availed as credit, thereby nullifying the financial impact. However, where the recipient is engaged in exempt supplies such as education, healthcare, or certain financial services, the credit is restricted, resulting in actual cash outflow.
The circulars attempted to balance this by allowing invoice value as the supply value in full ITC cases, but this relief does not extend to exempt businesses.
Import of Corporate Guarantee
Import of services under GST arises when the supplier is located outside India, the recipient is in India, and the place of supply is in India.
Where a foreign parent company provides a corporate guarantee to an Indian subsidiary, it qualifies as an import of service. Under Section 5 of the IGST Act, the liability to pay GST arises under the reverse charge mechanism. The valuation of such guarantees follows the same principle as Rule 28, with the recipient company in India required to calculate the deemed value at one percent per annum of the guarantee amount or the actual consideration, whichever is higher.
This creates practical difficulties for multinational groups, as the foreign parent may not charge any fee for providing the guarantee. The Indian subsidiary, however, is obligated to self-assess and pay GST under reverse charge. While input tax credit may be available in some cases, the cash flow burden cannot be ignored.
Export of Corporate Guarantee
When an Indian company issues a corporate guarantee in favor of a foreign subsidiary or group entity, the question arises whether it qualifies as an export of service.
Section 2(6) of the IGST Act defines export of services to mean a supply of service where the supplier is located in India, the recipient is located outside India, the place of supply is outside India, and payment is received in convertible foreign exchange.
In cases where these conditions are met, the issuance of a corporate guarantee to a foreign group entity may qualify as an export of service. Such transactions are treated as zero-rated supplies, allowing refund of accumulated input tax credit. Importantly, Rule 28(2) does not apply to exports, and valuation is determined under Rule 28(1) based on open market value or invoice value.
This distinction creates complexities for businesses operating in multiple jurisdictions, as different valuation rules apply depending on whether the guarantee is domestic or cross-border.
Time of Supply Issues
Determining the time of supply for corporate guarantees is another challenge. Where consideration is not involved, Section 13(5) of the CGST Act provides that the time of supply is the earlier of the date of filing the return or the date of payment of tax. This effectively gives flexibility to taxpayers but also creates room for disputes.
For guarantees with a specified tenure, businesses must ensure timely discharge of GST at the time of issuance, even if the liability is calculated on a per annum basis. Any revision in guarantee amount or extension of tenure requires additional compliance, including issuance of revised invoices and payment of incremental tax.
Practical Challenges in Compliance
The taxation of corporate guarantees under GST has given rise to several practical challenges for businesses.
- Determining valuation: Even with the deemed value mechanism, questions remain on applicability in cases of partial loans, rolling guarantees, or guarantees backed by collateral.
- Accounting complexities: Businesses must create new systems to recognize guarantees as taxable supplies, issue invoices, and account for GST liability, even when no consideration is charged.
- Cash flow concerns: In cases where the recipient cannot avail input tax credit, GST becomes a real cost, adding to the burden of financing.
- Retrospective amendment issues: Companies that complied under the earlier rule now face additional liabilities due to the retrospective effect of the 2024 amendment.
- Cross-border inconsistencies: Import and export of guarantees are treated differently, creating scope for interpretational disputes in multinational operations.
Ongoing Disputes and Judicial Review
Despite the circulars, litigation continues in various High Courts. In the case of Sterlite Power Transmission Ltd. v. Union of India, the Delhi High Court granted interim stay, holding that a corporate guarantee is a contingent contract that becomes enforceable only when invoked. The Court observed that taxing such guarantees at the time of issuance may not align with the principles of contract law.
In another matter, Acme Cleantech Solutions Pvt. Ltd. challenged the circulars before the Punjab and Haryana High Court, arguing that administrative clarifications cannot override statutory provisions. The Court granted interim relief, indicating that judicial clarity on the scope and timing of taxability is awaited.
These cases highlight the tension between administrative intent and judicial interpretation. Businesses must navigate carefully, balancing compliance with the possibility of future relief through courts.
Judicial Challenges to Taxability
The Core Question
At the heart of ongoing disputes is whether a corporate guarantee represents a taxable supply at the time of issuance or only when invoked. Tax authorities consider issuance itself to be a service since it creates a commercial advantage for the borrower. Businesses, however, contend that guarantees are contingent liabilities under the Contract Act and do not involve any present service until triggered.
Sterlite Power Transmission Ltd. v. Union of India
In this case before the Delhi High Court, the petitioner argued that a corporate guarantee is a contingent contract and cannot be equated with an immediate supply of service. The Court observed that guarantees are enforceable only upon default of the principal debtor, raising doubts on whether they should be taxed at inception. An interim stay was granted against coercive action, highlighting judicial reluctance to accept the administrative stance without deeper examination.
Acme Cleantech Solutions Pvt. Ltd. v. Union of India
The Punjab and Haryana High Court considered a challenge to the circular that clarified valuation and applicability of Rule 28(2). The petitioner contended that the circular overstepped its authority by creating new obligations not supported by the Act. The Court granted interim relief, restraining the authorities from enforcing demands based on the disputed interpretation. This case emphasizes the tension between legislative intent and administrative circulars.
Other Emerging Petitions
Several other companies across sectors such as infrastructure, renewable energy, and finance have approached High Courts, seeking relief against demands raised for guarantees issued prior to the introduction of Rule 28(2). These cases collectively represent a broader industry pushback against retrospective taxation and expanded interpretation of supply.
Doctrinal Conflicts
Contract Law versus GST Law
Under the Indian Contract Act, a contract of guarantee is defined as a promise to discharge the liability of a third person in case of default. The obligation of the guarantor is contingent upon the failure of the principal debtor. Businesses rely on this principle to argue that until the default occurs, there is no actionable service provided.
GST law, however, takes a wider view of supply. Section 7 includes transactions between related parties even without consideration. Authorities argue that issuance of a guarantee creates a measurable benefit for the borrower, improving its creditworthiness, and therefore qualifies as a supply at inception. This doctrinal conflict is central to the ongoing disputes.
The Nature of Consideration
Another point of debate is whether notional benefits, such as enhanced credit rating or reduced borrowing costs, can be treated as consideration under GST. While authorities emphasize the economic value derived, companies argue that without actual payment or enforceable obligation, such notional benefits do not amount to consideration under law.
Retrospective Application of Valuation Rules
The retrospective amendment to Rule 28(2), changing the valuation from one percent one-time to one percent per annum, has added another layer of conflict. Businesses contend that retrospective application violates principles of certainty and fairness, while authorities justify it as a clarification of existing intent. Courts are yet to deliver definitive rulings on this aspect.
Industry-Specific Impact
Financial Services Sector
Banks and financial institutions are heavily impacted, as corporate guarantees are widely used within group structures to secure credit. The requirement to discharge GST upfront on one percent per annum of large guarantee amounts creates significant cash flow pressures. Additionally, entities engaged in exempt supplies, such as insurance or financial services, face real costs due to blocked input tax credit.
Infrastructure and Power Sector
Companies in infrastructure and power projects often rely on guarantees from group entities to meet financing conditions imposed by lenders. The taxability of such guarantees, even when provided without consideration, adds to project costs and complicates financial structuring. Ongoing litigation in this sector underscores the materiality of the issue.
Multinational Corporations
For multinational groups, cross-border guarantees are common. When a foreign parent provides a guarantee for its Indian subsidiary, the subsidiary is liable to pay GST under reverse charge. Even if full input tax credit is available, the compliance burden is significant. Moreover, valuation based on the entire guarantee amount, irrespective of loan utilization, creates disproportionate liabilities.
Small and Medium Enterprises
Although SMEs may not frequently issue large guarantees, group structures with related companies often depend on them to access credit. For smaller businesses with limited working capital, the upfront payment of GST on guarantees becomes a considerable challenge.
Administrative Concerns
Valuation Mechanism Enforcement
The deemed valuation of one percent per annum has been criticized as arbitrary and disconnected from commercial reality. Tax officers face difficulties in enforcing this rule, particularly when guarantees are revised, extended, or partially discharged. Questions also arise when guarantees are supported by collateral or when multiple guarantors are involved.
Input Tax Credit Verification
Authorities must also verify whether the recipient of the guarantee is eligible for full input tax credit. Where the recipient engages in mixed supplies, allocation of credit becomes complex, leading to disputes.
Time of Supply Tracking
Determining the correct time of supply in cases of revisions or renewals of guarantees presents compliance challenges. Businesses often struggle to maintain accurate records, while authorities scrutinize returns for discrepancies.
Litigation Risks and Future Scenarios
Expanding Disputes
The growing number of High Court cases indicates that the issue is likely to reach the Supreme Court in the near future. Judicial clarity will be critical in settling the fundamental question of whether issuance of a corporate guarantee qualifies as supply at inception.
Potential Outcomes
There are three possible judicial directions:
- Courts may uphold the validity of Rule 28(2) and the administrative circulars, endorsing the taxability of guarantees at issuance.
- Courts may hold that guarantees are contingent and become taxable only upon invocation.
- Courts may strike a balance by recognizing guarantees as supply but limiting valuation to actual economic benefit or consideration charged.
Each outcome will have far-reaching consequences for industries and compliance practices.
Risk of Retrospective Demands
If judicial rulings favor the authorities, companies may face retrospective demands for past guarantees issued without paying GST. This could result in significant liabilities, particularly for large corporations with multiple group entities.
Industry Response
Representations to Authorities
Industry bodies have made representations to the government, seeking either withdrawal of the valuation rule or relaxation in its application. Proposals include restricting taxability to guarantees involving explicit consideration or exempting guarantees within wholly-owned group structures.
Contractual Adjustments
Companies are revisiting their internal policies to restructure financial arrangements. Some are introducing formal agreements to document nominal consideration for guarantees, thereby aligning with GST requirements and minimizing disputes.
Litigation as Strategy
In the absence of legislative relief, many companies are choosing to litigate. Interim stays by High Courts provide temporary protection, though final outcomes remain uncertain. The litigation trend reflects industry unwillingness to absorb the compliance and financial burden without judicial resolution.
Comparative Global Practices
European Union
In the EU, financial guarantees are often exempt from value-added tax when issued by financial institutions. However, guarantees within corporate groups may be treated differently depending on member state regulations.
United States
The US does not have a national GST system, but under state-level sales taxes, corporate guarantees are generally not considered taxable supplies. Instead, they are treated as financial instruments.
Other Jurisdictions
In several countries with VAT systems, guarantees issued without consideration are either excluded from the scope of supply or taxed only when consideration is charged. India’s approach of taxing deemed value at issuance is relatively unique and may be considered aggressive in comparison.
Conclusion
The treatment of corporate guarantees under GST represents one of the most complex intersections of contract law, fiscal policy, and business practice. What began as a compliance clarification has now evolved into a contentious area, marked by divergent views between taxpayers and authorities. The journey from the service tax era, where guarantees without consideration were not taxable, to the GST regime, which treats them as deemed supplies between related parties, highlights the expanding scope of indirect taxation in India.
The introduction of Rule 28(2) and its subsequent amendment to impose a one percent per annum valuation standard was intended to resolve ambiguity. Instead, it triggered further disputes by raising questions about legislative competence, retrospective effect, and the true nature of consideration. Judicial proceedings in multiple High Courts demonstrate that the matter is far from settled, with companies challenging both the basis of taxability and the method of valuation.
From an industry perspective, the implications are significant. Financial services, infrastructure, power, and multinational corporations face material liabilities, compliance burdens, and uncertainty in structuring their financing arrangements. Even where input tax credit is available, the timing of cash flows and risk of retrospective demands create pressure. Smaller enterprises, though less exposed, are not immune from the challenges of navigating guarantees in group structures.
At a doctrinal level, the debate underscores a larger policy question: should GST extend to contingent commitments that do not involve immediate transfer of goods or services? Authorities emphasize the economic benefit derived at issuance, while businesses stress the contingent nature of obligations under the Contract Act. Until resolved by the judiciary, this conflict will remain a source of compliance complexity and litigation.
Globally, India’s approach stands out as relatively aggressive, as many jurisdictions either exempt such guarantees or tax them only when consideration is explicitly charged. This divergence adds another dimension for multinational groups, which must reconcile Indian requirements with global practices.
The way forward will likely be shaped by judicial clarity and possible legislative refinement. Courts may either uphold the current framework, restrict taxability to guarantees with actual consideration, or evolve a balanced approach reflecting economic reality. Meanwhile, industries will continue to seek relief through representations and litigation, while simultaneously adapting contractual and compliance strategies.
Ultimately, the resolution of this issue will set an important precedent for how GST law interprets and taxes financial commitments that are not easily categorized as conventional supplies. It will determine whether corporate guarantees are treated as genuine business arrangements or as deemed taxable services, thereby influencing the broader trajectory of GST jurisprudence in India.