Positive decision of Apex Court on Corporate Guarantee under Service Tax regime has negative implications under GST !

[Kapil Mahani]

Introduction:

The introduction of the GST regime brought various and drastic changes to the applicability of taxation norms that were being followed in the pre-GST era. It brings a plethora of transactions in the purview of GST, which was not liable for taxation in the pre-GST era, the same has been done by introducing and enacting wider, more inclusive definitions of the term ‘supply’ and ‘business’  in  Schedule I of the CGST Act, 2017.

A Corporate Guarantee simply means a contract between a corporate entity or individual and a debtor. In this, the guarantor agrees to take responsibility for the debtor's obligations, such as repaying a debt, in case the debtor fails to do so. For example, If a company guarantees repayment of a loan granted to one of its subsidiaries if the subsidiary defaults to pay the loan, the guarantor (Parent company in this case), who agreed to guarantees would be liable to repay the loan on behalf of its subsidiaries.

By means of this article, we have made an effort to examine one such transaction “the applicability of GST on Corporate Guarantee” without consideration. We have relied and opined upon the recent judgment delivered by the Hon’ble Supreme Court in the case of Edelweiss Financial Services Ltd. in relation to “the applicability of Service Tax” on the Corporate guarantee provided to the subsidiary company without consideration.

Brief Summary of the Case:

• In this case, the Assessee provided a corporate guarantee to banks or financial institutions lending to their subsidiary or related companies without consideration. The revenue issued an SCN to the assessee and imposed the demand of tax on service along with interest and penalty to allege that he had provided a Banking and financial service as a ‘corporate guarantee’ on the behalf of its subsidiary company located within or outside India   similar to a ‘Bank guarantee’. As on 1^st July 2012, such transaction of giving a Corporate guarantee is considered to be a ‘Service’ under section 65B (44) of the Finance Act 1994. Hence, such service was subject to be charged with appropriate service tax as may be prescribed by the government.
• Aggrieved by the order of the Adjudicating authority, the assessee filed an appeal before Commissioner of Appeals and the same was accepted , further, the demand imposed by the adjudicating authority was dropped. Relevant paragraph from the judgement is iterated as is below for ease of reference-

“Further, the consideration can be of two types viz., monetary consideration and nonmonetary consideration. In the present case, the Assessee has argued that they have not received any consideration. In such case, it’s for the department to prove that the Assessee’s claim is wrong. It is observed that nowhere in the Show Cause Notice, attempt has been made to prove that the Assessee received either monetary or non-monetary consideration in any form. It is not alleged or proved in the Show Cause Notice as to how the Assessee got any benefit from their 3 subsidiaries in monetary or non-monetary terms for the Corporate Guarantees issued. Missing this vital point, valuation of the consideration using provisions of Section 67(1) of the Finance Act, 1994 become a futile exercise”.

• Being aggrieved by the order of the Commissioner of Appeals, the revenue department filed an appeal before the Hon’ble CESTAT, Mumbai Bench which was dismissed by them.. Relevant paragraph from the judgement is iterated as is below for ease of reference-

“8. The criticality of ‘consideration’ for determination of service, as defined in section 65B (44) of the Finance Act, 1994, for the disputed period after the introduction of the ‘negative list’ regime of taxation has been rightly construed by the adjudicating authority. Any activity must, for the purpose of taxability under the Finance Act, 1994, not only, in relation to another, reveal a ‘provider’, but also the flow of ‘consideration’ for the rendering of the service. In the absence of any of these two elements, taxability under Section 66B of the Finance Act, 1994 will not arise. It is clear that there is no consideration insofar as ‘corporate guarantee’ issued by respondent on behalf of their subsidiary companies is concerned.

9. The reliance placed by Learned Authorised Representative on the ‘non-monetary benefits’ which may, if at all, be of relevance for the determination of assessable value under section 67 of Finance Act, 1994 does not extend to the ascertainment of ‘service’ as defined in section 65B (44) of Finance Act, 1994. ‘Consideration’ is the recompense for the ‘contractual’ undertaking that authorizes levy while ‘assessable value’ is 4 a determination for computing the measure of the levy and the latter must follow the former.”

• Revenue Department being aggrieved by the order of the Hon’ble CESTAT filed an appeal before Hon’ble Supreme Court by contending that this matter is similar to the DLF case which has already been dealt by this   Hon’ble  Court.

The Hon’ble Supreme Court held that in this case, the assessee in this case had not received any consideration while providing the service of a corporate guarantee to its Subsidiary company. The present appeal filed by the revenue department was dismissed. The l  assessee contended and argued via the way of an appeal by stating that there is no reason to admit this case basis on the pending Appeal as it has not been proved beyond reasonable doubt that the facts of the pending case filed by the revenue are identical or similar to the present case.

Since such transactions do not show their effect In the books of accounts of any business, it is reasonable to say that the financial statements are not altered by it,  as such transactions are done without consideration. So, it is essential to examine the applicability of GST on such transactions. Hence examination of the supply & taxability of corporate guarantee transactions under GST is most relevant for companies in a similar business and day-to-day activity of providing corporate guarantee.

The way forward under GST:

Whether GST is applicable on Corporate Guarantee or not?

1. Under GST Section 7 of CGST Act, 2017 provide all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.  Further, entry no 2 of schedule I provides that the supply of goods or services or both between related persons or between distinct persons as specified in section 25 when made in the course or furtherance of business will be treated as supply even if made without consideration.
2. With regards to a related party, the explanation under section 15 of CGST Act, 2017 has been provided where holding and subsidiary company or directors or its employee are treated as related parties. The relevant provision is reproduced below:

Explanation. - For the purposes of this Act, -

(a) persons shall be deemed to be "related persons" if-

(i) such persons are officers or directors of one another's businesses;

(ii) such persons are legally recognized partners in business;

(iii) such persons are employer and employee;

(iv) any person directly or indirectly owns, controls or holds twenty-five percent. or more of the outstanding voting stock or shares of both of them;

(v) one of them directly or indirectly controls the other;

(vi) both of them are directly or indirectly controlled by a third person;

(vii) together they directly or indirectly control a third person; or

(viii) they are members of the same family;

(b) the term "person" also includes legal persons;

(c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.

Basis the above, a corporate Guarantee provided by the director or its holding company is covered under the scope of supply even made without consideration and GST is required to be paid on such transactions.

Comparative Analysis of Position under Service tax and GST

S.no.	Chapter V of Finance Act, 1994	CGST Act, 2017
	As per section 65B (44) of this act "Service" means any activity carried out by a person for another for consideration and includes a declared service and exclude a negative list of service.	Section 7 of CGST Act, 2017 “Scope of supply” all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.
	There is no deeming provision for transactions between a related party regarding consideration	Entry 2 of Schedule I of CGST Act, 2017 provide deeming provision for transaction between related party even if made without consideration. The related party has been explained under section 15 of the CGST Act, 2017. Basis the same, director, holding company, subsidiary company and employee of the company is covered under related parties.
	The Hon’ble Supreme Court does not hold that Corporate Guarantee is not a Service. It held that tax is not payable in the absence of consideration.	Considering the deeming provision under GST for transactions between related parties, GST will be levied on the corporate guarantee provided by a related party to the company even if made without consideration. Regarding consideration, Rule 28 of CGST Rules, 2017 will apply. Tax is a Service and tax is leviable even if there is no consideration, the same will be considered as a deemed consideration.

Conclusion:

We would like to conclude on the note that, a corporate guarantee is a supply of service and is accordingly liable under the current GST regime. The lack of consideration may not be accepted as an excuse for not paying GST, in as much as the provision of Schedule I, clearly specify that consideration is not required in respect of transaction between related persons. Further, it will not even fall under the category of an “Actionable Claim” as issuance of corporate guarantee is not covered under the Schedule III of the CGST Act which are neither treated as a supply of goods nor services. Hence issuance of corporate guarantee without consideration is a taxable supply under the GST regime.

Therefore, it cannot be said that corporate guarantees are issued without consideration and are not liable for tax under GST due to the aforesaid entry in Schedule I of the CGST Act, 2017. Thus, it appears that corporate guarantees are transactions between related persons without consideration and will be deemed to be a  supply under Schedule I and shall be taxable.

Considering the same, the taxpayer is required to evaluate carefully the position taken with respect of the corporate Guarantee before the issuance of notice from the department. In case the department issues a notice for recovery of GST on such transactions then input tax credit cannot be availed as the same shall be blocked under section 17(5) of the CGST Act.

Having said the same, it is important that the company should structure the transactions of levy of the GST on the corporate guarantee considering the fact that compliance has to be done under the CGST Act, 2017 for the purpose of charging of the GST from the supplier of corporate guarantee to the recipient without actual payment of the consideration. Further, any transaction which should be done in the current date will have implications on the point of taxation.

Questionnaires:

Q1. Whether Corporate Guarantee is a Service under a Pre-GST regime or post GST Regime?

Ans. Yes, Corporate Guarantee is a service under both, the GST regime as well as Pre GST regime (Negative list regime)

Q2. Whether Corporate Guarantee without consideration provided by related parties covered under the definition of service?

Ans. Yes, it is covered under the definition of service while provided by related parties.

Q3. Whether the concept of deemed Consideration is applicable under the pre-GST regime?

Ans. No, the concept of deemed consideration is applicable under the GST regime and was  not applicable during the Negative list regime.

Q4. Whether in the books of accounts affected if the Corporate Guarantee issue without Consideration?

Ans. Corporate Guarantee issue without Consideration has not been recorded in the books of account. However, the same is reported under contingent liabilities notes under the financial statements of a company.

Q5. Whether Corporate Guarantee without consideration provided by related parties is liable for tax under the service tax regime and the GST regime?

Ans. Corporate Guarantee without consideration is not taxable under the service tax regime as there is no concept of deemed Consideration. However, under the GST regime, the Corporate Guarantee provided by a related party is taxable even without consideration by considering the concept of deemed consideration which is covered under Schedule I of the CGST Act, 2017.

Q6. Authority may issue notice for recovery of tax on Corporate Guarantee without consideration provided by the related party after the recent Judgement of the Hon’ble Supreme Court on Service tax. Now assessee has required to be examined by for applicability of tax after the GST regime? If no, then what are the possibilities of risk on the part of the assessee especially after the recent judgment of the Hon’ble Supreme Court on Service tax?

Ans. After the recent Judgment  of the Hon’ble Supreme Court in the matter of Edelweiss Financial Services Ltd. the department is now more vigilant and may issue notice to the assessee who are still providing the corporate guarantee under the GST regime.

Now the companies need to structure the transaction on the following aspects:

1 Whether the implications of corporate guarantee will apply similarly to the Directors Guarantee? If yes, then whether the GST shall be payable under reverse charge by the company who is receiving the directors guarantee.

2 Since the corporate guarantee is recurring transaction, so, whether the liability needs to be discharged for the period involved under GST for each year.

3 Whether the credit of the GST charged shall be eligible in the current period? For instance, if the company decide to pay the GST on the corporate guarantee which is given every year to the banks, then whether the GST should be computed on each year and whether cumulative / separate invoice issued for the past period can be issued including eligibility of the credit of the same in current period?

4 What should be the valuation which should be used for the purpose of computing the service value for the corporate guarantee considering the transaction of levy of the GST is tax neutral for the service recipient? Whether any market benchmarking needs to be taken for the purpose of valuation of the service value of the transaction on corporate guarantee given to the service recipient from the GST stand point

5 Whether the department may allege that point of taxation of the service for the past period is due on the completion of the said period instead of current month, then whether the company can take stand that completion of service is being done in the current month on the ground that service has been completed in previous period but the milestone for the billing is being due in the current month for the purpose of issuing of the service invoice?

6 In case the company decides the issue the invoice for the valuation basis the valuation rules, then whether the commercial transaction of the payment for the notional value of the consideration should be paid to the service provider? If yes, whether then the same have implications under Income tax under the head of prior period expenses? And if No, then whether the transaction should be done only for the tax portion between the supplier and recipient without actual consideration being paid by the recipient of the service to the supplier of the service

Discussions to this article

[Jalpesh Vora]

Thanks, Kapil ji, for nice and in depth analysis of Supreme court Judgement and applicability under GST. Is it possible to take a view that Financial Corporate Guarantee is Derivative under section 2(ac) of SCRA, 1956 read with IND AS 109 (MCA)?

[Govind TK]

Dear Sir, whether corporate guarantee issue to foreign subsidiaries with commission is chargeable under GST?

[Narasimha MurthyR]

Sir
One important aspect that is not discussed is that whether corporate guarantee to a group company can be considered to be in the course of business or in furtherance of business. If there are no direct business deals between group companies, it would be incorrect to hold that such guarantee is in the course of business or furtherance of business