The Gujarat High Court has upheld GST on corporate guarantees given by holding companies to their subsidiaries , but has struck down the requirement to pay tax on whichever is higher: 1% of the guarantee amount or the actual consideration.
A division bench of Justices A.S. Supehia and Vaibhavi D. Nanavati delivered the judgment on 14th August in Torrent Power Ltd v. Union of India & Ors., while hearing a batch of petitions challenging Rule 28(2) of the CGST Rules, Section 15(4) of the CGST Act and related CBIC circulars.
Torrent Power was amongst the petitioners challenging the GST treatment of corporate guarantee furnished to its subsidiaries.
What is a corporate guarantee?
A corporate guarantee is typically given by a parent company to a lender to back a loan taken by its subsidiary. Such guarantees are often given within corporate groups without the parent charging a separate fee.
The tax treatment changed under GST. Unlike the erstwhile service tax regime, where consideration or a fee was necessary for a service to be taxable, Section 7(1)(c) read with Schedule I of the CGST Act allows certain transactions between related persons to be treated as supplies even without consideration.
In October 2023, the government further introduced Rule 28(2), prescribing a deemed value of 1% of the amount of the corporate guarantee per annum. The rule was subsequently amended to provide for 1% of the guarantee amount or the actual consideration, whichever was higher.
Court upholds GST levy
The petitioner had argued that a corporate guarantee given without consideration should not be treated as a taxable supply. They also relied on the Supreme Court’s ruling in Edelweiss Financial Services, which had held under the earlier service tax regime that service tax could not be imposed on corporate guarantees where there was no consideration.
The Gujarat High Court, however, said that ruling applied to the earlier law and did not govern the GST framework.
“Unlike the Finance Act, 1994, the CGST Act… contains Section 7(1)(c) read with Schedule I to the CGST Act, a specific deeming fiction that taxes certain supplies between related persons even in the absence of consideration,” the court said.
The court therefore upheld the constitutional validity of Rule 28(2) and Section 15(4). Section 15(4) allows the government to prescribe rules for determining the value of supplies where the normal transaction value cannot be determined. The government relied on this provision to frame Rule 28(2), which sets the valuation mechanism for corporate guarantees between related parties.
The ruling brings much needed clarity for companies issuing corporate guarantees to subsidiaries, tax experts said. “The High court has upheld Rule 28(2) , holding it to be valid. In effect, the charging of GST on a corporate guarantee is a valid taxable event,” said CA Ankit Joshi, partner N.A. Shah Associates.
Court reads down ‘whichever is higher’
The court, however, found the valuation formula problematic where actual consideration is involved.
“The expression ‘whichever is higher’ is arbitrary ,” the court held, saying the provision did not give the corporate guarantor the option to pay GST on the actual commission or charge. “Actual consideration is the indispensable factor which makes the levy and Rule workable,” it said.
Rather that striking down the entire rule, the court read down the words “whichever is higher”. This means the 1% valuation mechanism survives, particularly where there is no actual consideration, but the government cannot automatically insist on the higher of the two values where an actual charge exists.
On valuation, Joshi said the 1% rule will apply where no commission is charged, while GST on guarantees carrying an actual commission will be payable on the amount charged.
No retrospective application of 1% valuation
The court held that the 1% valuation prescribed under Rule 28(2) could not be applied to periods before October 26, 2023.
The rule was introduced on October 26, 2023, while the corporate guarantees involved in the batch dated as far as 2012. The court noted that the Revenue had imposed the 1% valuation retrospectively on guarantees issued before the rule and even before the GST regime.
This is significant for companies facing demands relating to older corporate guarantees, as the new valuation mechanism cannot simply be applied to the period before the rule was introduced. “The ruling provides relief for the period before October 26, 2023, when Rule 28(2) came into force. If a guarantee continues beyond 27.10.2023, GST will apply from that date onwards,” Joshi said.
Joshi added that CBIC should issue a clarificatory circular to ensure consistent implementation and avoid further disputes.
Source: ET CFO.com
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