Embarking on an adventurous pursuit to tax Corporate Guarantees!

***Written from the perspective of a related party transactions

Following a perplexing action pertaining to the Gaming Industry, another urgent matter arose necessitating the issuance of a circular by the Central Board of Indirect Taxes and Customs (CBIC), This matter concerns the imposition of GST on Corporate guarantees.

A number of local corporate entities that provided corporate guarantees on behalf of their subsidiaries, as well as MNCs that provided similar guarantees for their Indian subsidiaries, have received GST demand notices from the Directorate General of Goods and Services Tax Intelligence (DGGI).

At least 14 companies, including automakers, FMCG, and electronic goods companies, have received these notices, according to information obtained.

The DGGI, in a notice, stated that providing corporate guarantees is considered a taxable ‘service’ under GST, as it is a strategic action taken by parent companies to maximize returns on investment in their subsidiaries. In the case of multinational companies, under the reverse charge mechanism, tax authorities are expecting GST payments from the local units.

Let's delve deeper into the matter at hand..

In a recent legal case titled "Commissioner Of CGST And Central Excise Versus M/S Edelweiss Financial Services Ltd." (2023 LiveLaw (SC) 281), the division bench comprising Justice Hrishikesh Roy and Justice Manoj Misra made an observation. The bench concluded that, since no consideration is involved, the provision of corporate guarantees by a parent company to its subsidiaries would not be subject to assessment for service tax.

In order to provide a comprehensive understanding of the subject matter, it is essential to provide a brief background!

1. The department has lodged a challenge against the dismissal of proceedings initiated against M/s Edelweiss Financial Services Ltd., concerning their provision of 'corporate guarantees' on behalf of their subsidiaries located within and outside India.
2. The department is contesting the non-payment of tax liabilities as a provider of 'banking and other financial services' for the period preceding and following June 30, 2012.
3. The show cause notice issued proposed the recovery of an amount totaling Rs. 97,956,437. This amount comprised guarantees provided to overseas companies, for which consideration had been received, as well as guarantees offered free of charge to their Indian subsidiaries, in connection with the provision of taxable services under Section 65(105)(zm) of the Finance Act, 1994, until June 30, 2012.
4. Furthermore, it covered services as defined in Section 65B(44) for the period thereafter, until March 15, 2015.
5. The adjudicating authority had reached the conclusion that the receipt of commission from overseas companies, as consideration for the export of services, was not subject to taxation.
6. Regarding domestic facilitation, the definition provided in Section 65(12) of the Finance Act, 1994, did not encompass corporate guarantees. Unlike 'bank guarantees', corporate guarantees were not specifically listed as 'other financial services' until June 20, 2012.
7. Additionally, for the period following that date, the absence of 'consideration' for facilitating a corporate guarantee led to the exclusion of such activities from falling under the definition of 'service' as outlined in Section 65B(44) of the Finance Act, 1994.

CESTAT View

1. The CESTAT held that 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.
2. For the purposes of taxability under the Finance Act of 1994, any activity must reveal not only a 'provider' in relation to another but also the flow of 'consideration' for the rendering of the service.
3. In the absence of either of these two elements, taxability under Section 66B of the Finance Act of 1994 will not arise. It is clear that there is no consideration insofar as the ‘corporate guarantee’ issued by respondents on behalf of their subsidiary companies is concerned.

The department challenged CESTAT’s order before the Supreme Court, which ultimately rejected Revenue's plea.

Applicability of the Judgment in the GST Era

1. The law does not define the term ‘support services’. The erstwhile tax regime defined it as infrastructural, operational, administrative, logistic marketing, or any other kind of support.
2. Schedule I of the Central Goods and Services Tax (CGST) Act, 2017, supply of goods or services between related persons in the course of, or in furtherance of a business without consideration qualifies as ‘supply’.
3. Valuation of the Supplies between related parties can be done through Rule 28.
4. The transfer pricing guidelines of the Organisation for Economic Co-operation and Development (OECD), inter alia, state that activity performed by a parent company for its subsidiary to govern its business is basically an exercise of control function and cannot be considered a ‘service’.?
5. Now, the Issuance of corporate guarantee on behalf of its subsidiary company is in nature of quasi capital or shareholder activity and not in nature of ‘provision for services and, therefore, said the transaction is to be excluded from the scope of ‘international transaction’
6. If not, then as per Section 15(5), the Central government has also the power to introduce certain rules to determine the valuation of the supplies.

But, this issue requires immediate attention!

If you are currently undergoing any departmental proceedings concerning this matter, please do not hesitate to contact me at [email protected] or on +91 9953357999.