Corporate structures in India often involve parent companies supporting their subsidiaries through financial backing. One of the most common tools used in such support arrangements is a corporate guarantee. While these guarantees may not involve direct monetary exchanges between the holding company and the subsidiary, they play a pivotal role in enabling subsidiaries to secure funding and credit facilities from banks or financial institutions. The complexity arises when such arrangements are brought under the scope of indirect taxation, particularly the Goods and Services Tax regime. To understand the treatment of corporate guarantees under GST, it is important to first explore the underlying legal framework of guarantees under Indian law, their role in corporate finance, and how the tax position has evolved from the Service Tax regime to GST.
Meaning of Guarantee under the Indian Contracts Act
Guarantee as a legal concept is not defined in the GST law. Therefore, reference is taken from the Indian Contracts Act, 1872. According to Section 126 of the Indian Contracts Act, a contract of guarantee is a promise made by one person to discharge the liability or obligation of a third person in case of default. It involves three distinct parties, each playing a significant role in the arrangement.
- The guarantor is the person who gives the guarantee.
- The principal debtor is the person on whose behalf the guarantee is given.
- The creditor is the person in whose favor the guarantee is extended.
This tripartite relationship is fundamental to every guarantee arrangement. The creditor places reliance on the guarantor to secure repayment or performance of the obligation of the principal debtor. By definition, a guarantee ensures that the creditor is not left without recourse in case of default.
Nature and Purpose of Corporate Guarantee
A corporate guarantee is a form of contractual commitment given by a company, generally a holding or parent company, to a bank or financial institution on behalf of its subsidiary. In such an arrangement, the parent company assures the lender that in case the subsidiary fails to meet its obligations, the parent will step in to discharge those liabilities.
The purpose of corporate guarantees lies in building confidence for lenders. Financial institutions often require additional comfort before extending credit facilities to subsidiaries, particularly when the subsidiary is newly incorporated or does not have sufficient independent financial strength. By issuing a guarantee, the parent company effectively leverages its financial standing to secure credit for its subsidiary.
Corporate guarantees are typically issued without charging any fee or consideration from the subsidiary. They are seen as part of the responsibility of the parent company to support the group’s overall business objectives. However, while they may not involve monetary transactions between related companies, the commercial value they provide is significant.
Differences between Personal Guarantees and Corporate Guarantees
While both personal and corporate guarantees serve the purpose of securing obligations, their nature and implications differ considerably.
- A personal guarantee is given by an individual, often a director or promoter, to secure the borrowings of a business entity. The liability is personal and may extend to the individual’s personal assets.
- A corporate guarantee, on the other hand, is given by a company. The liability is undertaken by a legal entity rather than an individual. The guarantee leverages the corporate balance sheet rather than personal assets.
The corporate guarantee is thus an institutional form of assurance and is commonly used in complex corporate structures where group entities support each other to access external funding.
Role of Corporate Guarantees in Corporate Finance
Corporate guarantees are crucial in enabling subsidiaries and group entities to obtain financing at favorable terms. Without such guarantees, banks may either decline to extend credit or may charge higher interest rates reflecting the higher perceived risk. By providing a guarantee, the parent company allows its subsidiary to gain access to funds at terms similar to what the parent itself could have obtained.
In some cases, a corporate guarantee may be the only way for a subsidiary to access credit facilities at all. For instance, a newly incorporated company may not have the financial history or creditworthiness to secure a loan. The parent company, with its established credit profile, bridges this gap by providing a guarantee.
Treatment of Corporate Guarantees under the Service Tax Regime
Under the earlier Service Tax framework, corporate guarantees provided without consideration were generally not subjected to service tax. The key reason was the absence of a taxable service element when no fee or commission was charged for the issuance of the guarantee.
Some taxpayers argued that corporate guarantees should be classified as actionable claims. Actionable claims are excluded from the definition of supply under the GST framework and were similarly excluded from the scope of service tax.
According to this view, since the guarantee merely created a contingent right enforceable upon default, it should not be regarded as a service. This interpretation found acceptance among many businesses, and as a result, corporate guarantees without consideration were largely outside the scope of taxation in the pre-GST era.
Transition into the GST Era
The introduction of GST in July 2017 brought in a comprehensive tax regime that subsumed various indirect taxes, including service tax. GST introduced a broad definition of supply, which covered all forms of provision of goods or services made for a consideration in the course of business. It also contained deeming provisions under Schedule I, which treated certain supplies between related persons as taxable even if made without consideration.
Despite the broad sweep of GST, corporate guarantees were not explicitly defined or addressed in the law. This created uncertainty. Companies questioned whether a corporate guarantee without consideration would amount to a supply under Schedule I. They also raised the issue of valuation, since GST required every taxable supply to be valued, but there was no clear method to value a corporate guarantee issued without consideration.
Ambiguities and Interpretational Challenges
Several ambiguities arose during the initial years of GST implementation with respect to corporate guarantees.
- Whether corporate guarantees constituted supply of goods or services under GST.
- Whether guarantees without consideration fell within the deeming provisions of Schedule I as supplies between related persons.
- If taxable, what should be the value of such a supply when no consideration was charged.
- Whether such guarantees could be classified as actionable claims and therefore be outside the scope of GST.
Taxpayers favored the interpretation that corporate guarantees were not supplied under GST, particularly when issued without consideration. The absence of a valuation mechanism was a strong basis for this view.
The GST department, however, viewed corporate guarantees as services provided by the guarantor to the debtor, creating a supply event. This difference of interpretation created compliance risks and uncertainty for businesses.
Preliminary Departmental Approach
Although no formal rule existed in the early years of GST, departmental officers occasionally questioned the taxability of corporate guarantees, particularly in group structures. The argument was that even if no consideration was charged, a corporate guarantee provided by a parent to its subsidiary represented a service rendered to a related person.
Some field officers attempted to apply the general valuation rules to estimate a taxable value. Others demanded GST on a notional basis. These interpretations were not uniform, leading to confusion and potential disputes.
Industry Concerns
Industry groups and tax professionals repeatedly highlighted the uncertainty in the law. They pointed out that guarantees were often provided as part of group financial management and did not involve any revenue for the parent company. Treating such arrangements as taxable without a clear valuation mechanism would create unnecessary compliance burdens and distort group financial structures.
The lack of clarity also made it difficult for companies to account for potential GST liabilities in their financial planning. Businesses were concerned about retrospective demands and litigation risks if departmental interpretations prevailed.
Need for Clarity
The absence of a specific provision for corporate guarantees under GST created a pressing need for administrative clarity. Without a uniform approach, businesses were left exposed to differing departmental interpretations. To address these concerns, the GST Council and the central authorities eventually moved to issue a circular and amend the valuation rules to specifically address corporate guarantees.
The Regulatory Gap Prior to 2023
Before the issuance of the circular and notification, the GST framework left taxpayers uncertain about the treatment of corporate guarantees. Schedule I of the CGST Act mandated that supplies between related persons would be treated as taxable supplies even if made without consideration. However, the law did not specifically define what constituted a service in the context of guarantees.
While the department sometimes took the position that corporate guarantees were services rendered by the guarantor to the subsidiary, taxpayers countered that such guarantees were not supplies at all. Some businesses argued that guarantees were actionable claims, excluded under Schedule III of the Act.
The absence of a valuation rule further compounded the issue. Without a prescribed method, businesses found it unreasonable to assign a taxable value to a guarantee provided without monetary consideration. This vacuum led to varied departmental practices, uncertainty for businesses, and a growing need for administrative clarity.
Circular No. 204/16/2023-GST
On 27th October 2023, the Central Board of Indirect Taxes and Customs issued Circular No. 204/16/2023-GST. This circular clarified the taxability of corporate guarantees under GST. Its purpose was to establish uniformity in the implementation of the law and remove interpretational inconsistencies across field formations.
The circular explicitly stated that when a holding company provides a corporate guarantee to a bank or financial institution on behalf of its subsidiary, it constitutes a supply of service from the holding company to the subsidiary. The reasoning rests on two key provisions of GST law:
- The transaction is between related persons, and under Schedule I, such supplies are taxable even when made without consideration.
- The guarantee benefits the subsidiary by enabling it to obtain credit facilities. Thus, it has an identifiable recipient of the service.
The circular further clarified that the recipient of service in such cases is the subsidiary company, not the bank or financial institution. The bank merely accepts the guarantee, while the subsidiary derives the benefit by accessing credit.
Notification No. 52/2023 and the Insertion of Rule 28(2)
Alongside the circular, the government issued Notification No. 52/2023 – Central Tax on 26th October 2023. This notification inserted sub-rule (2) into Rule 28 of the CGST Rules, 2017, specifically to address the valuation of corporate guarantees.
The text of Rule 28(2) is as follows:
“Notwithstanding anything contained in sub-rule (1), the value of supply of services by a supplier to a recipient who is a related person, by way of providing corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be one per cent of the amount of such guarantee offered, or the actual consideration, whichever is higher.”
This provision settled two critical questions:
- Corporate guarantees are taxable supplies of services when provided between related persons.
- The valuation of such services is standardized at one per cent of the guarantee amount or actual consideration, whichever is higher.
Purpose and Intent of Rule 28(2)
The government introduced Rule 28(2) to provide certainty and consistency. Without a clear valuation mechanism, corporate guarantees had been a grey area under GST. By prescribing a standard method, the government ensured that:
- Taxpayers would have clarity on how to value such supplies.
- Revenue authorities could uniformly apply the law across jurisdictions.
- Disputes and litigation over arbitrary or varied valuation methods would be minimized.
The rule also reflects a policy decision that the provision of a corporate guarantee has measurable value, even when no consideration changes hands. The deemed valuation of one per cent is meant to capture the economic benefit conferred by the holding company on the subsidiary.
Key Features of the Valuation Rule
The valuation rule for corporate guarantees has several notable features.
- It applies only when the guarantor and the recipient are related persons. In practice, this covers holding-subsidiary arrangements.
- The value of the guarantee is calculated as one per cent of the total guaranteed amount. For example, if a parent company guarantees a loan of Rs. 50 crore for its subsidiary, the deemed taxable value of the service will be Rs. 50 lakh.
- If the parent company charges an actual fee for the guarantee, the higher of the actual fee or one per cent of the guarantee value will be considered for GST.
- The rule applies prospectively from 26th October 2023, meaning guarantees issued before this date are not affected.
Identification of the Service Recipient
One of the key clarifications provided by the circular is the identification of the recipient of service. When a holding company issues a guarantee, the bank or financial institution is not considered the recipient, as it merely accepts the assurance. Instead, the subsidiary company is identified as the recipient, because it is the party that gains the benefit of access to credit.
This clarification aligns the treatment of corporate guarantees with the conceptual framework of GST, which taxes supplies of goods and services where there is a supplier and a recipient. By establishing the subsidiary as the recipient, the law ensures that the transaction fits within the GST structure.
Applicability to Existing Guarantees
The valuation rule applies prospectively. Guarantees issued before 26th October 2023 are not subject to the new valuation provisions. Since the service of issuing a guarantee is rendered at the time of issuance, past guarantees are considered completed supplies. Therefore, GST will not be levied on a prorated basis for continuing guarantees executed prior to the notification.
This prospective application is significant for businesses, as it prevents retrospective liabilities and litigation. Companies with longstanding guarantees issued before October 2023 are not required to revisit those arrangements for GST compliance.
Practical Scenarios
To better understand the application of the valuation rule, consider the following examples.
- A parent company issues a corporate guarantee of Rs. 100 crore to a bank for its subsidiary without charging any fee. Under Rule 28(2), the taxable value of the service is deemed to be Rs. 1 crore, being one per cent of the guaranteed amount. GST at the applicable rate must be paid on this value.
- A holding company charges its subsidiary Rs. 20 lakh as a fee for providing a corporate guarantee of Rs. 50 crore. Under Rule 28(2), the deemed value would be Rs. 50 lakh, being one per cent of the guarantee amount. Since the rule requires the higher of the actual fee or one per cent, the taxable value will be Rs. 50 lakh.
- If a corporate guarantee of Rs. 30 crore was issued in 2021, no GST applies retrospectively under the new rule. The rule applies only to guarantees issued after 26th October 2023.
Implications for Group Companies
The introduction of Rule 28(2) has significant implications for corporate groups.
- Parent companies providing guarantees to support their subsidiaries must now account for GST liability.
- Subsidiaries receiving guarantees are considered recipients of services and may be eligible to claim input tax credit, subject to conditions.
- Corporate groups must assess the financial impact of the deemed valuation, as large guarantees can result in substantial GST outflows.
The change also necessitates adjustments in accounting practices, internal documentation, and contractual arrangements to ensure compliance.
Interaction with Schedule I and Related Party Transactions
Schedule I of the CGST Act plays a crucial role in the treatment of corporate guarantees. It specifies that supplies between related persons are taxable even when made without consideration. Holding and subsidiary companies fall within the definition of related persons under GST law.
Thus, even if the parent company issues the guarantee without charging a fee, the transaction is still deemed to be a taxable supply. Rule 28(2) provides the valuation mechanism to operationalize this principle. Together, Schedule I and Rule 28(2) establish the framework for taxing corporate guarantees.
Industry Response
The industry has expressed mixed reactions to the new provisions. On one hand, the certainty provided by Rule 28(2) and the circular is welcome, as it eliminates ambiguity and reduces the risk of arbitrary departmental actions. On the other hand, the deemed valuation of one per cent is considered by many to be on the higher side, especially for large guarantees where the actual risk undertaken by the parent may not justify such a valuation.
Some businesses argue that the provision effectively imposes a tax burden on intra-group financial support mechanisms, which could discourage parent companies from extending guarantees freely. Others see it as a necessary step to bring transparency and uniformity to the tax treatment of these arrangements.
Compliance Challenges under GST
Determination of Taxable Value
The valuation mechanism introduced under Rule 28(2) prescribes one per cent of the guarantee amount or actual consideration, whichever is higher. While this offers clarity, it poses compliance challenges for large corporate groups. For example, a parent company providing a guarantee of Rs. 500 crore will face a deemed taxable value of Rs. 5 crore, irrespective of whether any fee was actually charged. The holding company must calculate GST on this value and discharge the tax liability.
Identification of Time of Supply
Another compliance issue is determining the time of supply. Under GST, the time of supply of services generally depends on the earlier of the issuance of invoice or receipt of payment. However, in the case of a corporate guarantee issued without consideration, the question arises as to when the supply is considered to have occurred. The issuance date of the guarantee is treated as the time of supply, which requires holding companies to monitor guarantee issuance dates closely and ensure timely compliance.
Documentation and Record Keeping
Since corporate guarantees are often provided without separate agreements or monetary consideration, documentation becomes a critical challenge. Companies must maintain clear records of guarantee agreements, board approvals, and related communications to establish the occurrence of the transaction and its treatment under GST. Proper documentation is essential both for tax compliance and for defending positions in case of departmental scrutiny.
Accounting and Financial Reporting Considerations
Recognition of Liability
From an accounting perspective, the issuance of a corporate guarantee creates a contingent liability in the books of the guarantor. With the introduction of GST liability on such guarantees, companies must also recognize the tax outflow. This affects both the profit and loss account and the cash flows of the guarantor entity.
Input Tax Credit
While the holding company is liable to discharge GST on the deemed value of the corporate guarantee, the subsidiary company may be eligible to claim input tax credit, subject to fulfillment of conditions. This ensures that the overall tax cost within the group is neutralized to some extent. However, companies must ensure that proper documentation is in place to enable the subsidiary to claim the credit.
Impact on Financial Ratios
The additional GST liability arising from corporate guarantees can influence financial ratios, particularly in groups with significant inter-company support structures. For instance, the recognition of GST expenses and related receivables may impact debt-to-equity ratios, net profit margins, and liquidity indicators, thereby affecting the group’s financial analysis and investor perception.
Industry Concerns
High Valuation Percentage
One of the key concerns raised by industry stakeholders is the deemed valuation of one per cent of the guarantee amount. For large corporations, the guaranteed sums can run into thousands of crores, making the GST liability disproportionately high compared to the actual economic value of the service. Businesses argue that the one per cent valuation does not reflect market realities, as guarantees are often issued as a matter of group policy without a direct cost or risk assessment.
Impact on Business Flexibility
Corporate guarantees have traditionally been a tool for group companies to facilitate financing and ensure business growth. The imposition of GST on such arrangements may discourage parent companies from freely extending guarantees, thereby impacting the ability of subsidiaries to access credit facilities. Some companies may shift towards alternative arrangements such as charging guarantee fees or restructuring financing to reduce tax exposure.
Double Taxation Concerns
In certain cases, banks or financial institutions may also levy charges for processing guarantees, which are subject to GST. Businesses fear that the imposition of GST on both the guarantee processing fees and the corporate guarantee itself may result in a cascading effect, although input tax credit mechanisms aim to mitigate this.
Interpretational Issues
Scope of Application
Although the circular and Rule 28(2) clearly apply to guarantees provided by related persons, questions remain about guarantees issued in other contexts. For example, if a group company issues a guarantee for a fellow subsidiary, or if an associate company provides a guarantee, interpretational issues arise regarding whether such transactions fall under the scope of related persons as defined under GST law.
Renewal or Modification of Guarantees
Another area of debate concerns the renewal or modification of existing guarantees. If a guarantee issued prior to 26th October 2023 is subsequently renewed or its terms modified, does the new valuation rule apply? The law is not explicit, and businesses must carefully evaluate such situations to determine tax implications.
Multiple Guarantees for the Same Facility
Where multiple holding entities provide joint guarantees for the same subsidiary loan, questions arise about how the one per cent valuation should be applied. Should each guarantor calculate GST on the full guaranteed amount, or only on their respective share? Clarification on this point is still awaited.
Practical Implications for Businesses
Strategic Review of Guarantees
The new GST rules require corporate groups to reassess their approach to guarantees. Parent companies may reconsider whether to issue guarantees without charging a fee or to restructure the arrangement by levying an explicit charge on subsidiaries. By charging a fee aligned with the one per cent valuation, companies may improve transparency and avoid disputes.
Need for Stronger Documentation
Companies must ensure that guarantee arrangements are backed by proper documentation. Guarantee agreements, board resolutions, and communications with financial institutions must be carefully maintained to establish the nature of the transaction and to facilitate accurate GST compliance.
Collaboration Between Tax and Treasury Functions
The issuance of guarantees often falls under the purview of a company’s treasury function, while GST compliance is managed by the tax team. With the new rules, closer collaboration between these functions is essential. Treasury teams must inform tax teams of new guarantees promptly to ensure timely GST payment and reporting.
Comparative Perspective
International Treatment of Guarantees
In several international jurisdictions, corporate guarantees are treated differently from India’s approach under GST. For example, in some countries, guarantees provided without consideration are not taxed, recognizing that they are primarily risk-mitigation tools rather than commercial supplies of services. By contrast, India’s deemed valuation approach imposes a tangible tax liability even in the absence of consideration, reflecting a stricter interpretation.
Learning from Other Tax Regimes
Comparing India’s approach with international practices highlights the need for a balance between revenue considerations and ease of doing business. While the uniform valuation rule provides clarity, the high deemed rate of one per cent may require reconsideration in the future to align with global norms and reduce the compliance burden on businesses.
Way Forward for Businesses
Internal Policy Revisions
Corporate groups must revisit their internal policies on issuing guarantees. Establishing formal policies on when and how guarantees are extended, how fees are charged, and how GST implications are handled will help ensure consistent and compliant practices.
Training and Awareness
Given the technical nature of the new provisions, training programs for finance, treasury, and tax teams are crucial. Awareness about the valuation rule, documentation requirements, and input tax credit eligibility will enable smoother implementation.
Engaging with Regulators
Industry associations and businesses may continue to engage with regulators to seek clarifications on unresolved interpretational issues, advocate for more practical valuation mechanisms, and ensure that compliance requirements do not stifle business growth.
Conclusion
The introduction of GST provisions relating to corporate guarantees marks a significant turning point in how intra‑group financial support is treated under indirect tax law. For years, businesses relied on the assumption that corporate guarantees issued without consideration were outside the ambit of service taxation. With the insertion of Rule 28(2) and the clarifications in Circular No. 204/16/2023, the government has put an end to this ambiguity by bringing such guarantees firmly within the GST framework.
The new rules have brought both clarity and complexity. On the one hand, there is now a prescribed valuation mechanism, ensuring uniformity and reducing disputes over how to measure the taxable value of guarantees. On the other hand, the deemed valuation of one per cent of the guaranteed amount has raised concerns of excessive tax liability, particularly for large conglomerates where the guaranteed sums can be massive. Businesses must therefore balance compliance with strategic decision‑making, weighing whether to continue issuing guarantees without charge or to realign their internal policies by levying guarantee fees.
From a compliance standpoint, corporate groups must strengthen documentation, align treasury and tax functions, and ensure timely reporting of guarantees as taxable supplies. From an accounting perspective, the recognition of GST liability on guarantees adds another layer of complexity to financial reporting and may impact group cash flows and key financial ratios. At the same time, subsidiaries can generally avail input tax credit, which may mitigate the overall tax cost within the group, provided proper compliance protocols are followed.
Industry stakeholders have voiced concerns about the rigidity of the valuation rule, especially in scenarios where guarantees are extended purely as a matter of business necessity without any direct benefit to the guarantor. Questions also remain about renewals, modifications, and multiple guarantees, leaving scope for further clarifications. A careful balance must be struck between the government’s objective of broadening the tax base and the need to maintain business ease and competitiveness.
Looking ahead, businesses must adopt a proactive approach. Internal policies on issuance of guarantees, proper contractual arrangements, clear inter‑company agreements, and a robust compliance framework are essential. Training and cross‑functional collaboration will be vital in ensuring smooth compliance with the new rules. Engagement between industry and regulators will also play a crucial role in refining the framework and addressing unresolved interpretational issues.
In essence, the treatment of corporate guarantees under GST exemplifies the evolving nature of indirect taxation in India. While the law has moved toward greater clarity and consistency, it has also introduced new responsibilities and costs for businesses. Corporate groups that adapt early, align their practices with the new framework, and anticipate the financial and operational implications will be better placed to manage risks and leverage opportunities in the changing regulatory environment.