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In the inaugural episode of our new podcast series on ‘Indirect Tax Insights’, we explore the taxation aspect of corporate guarantees and demystify GST provisions on this topic. Featuring our Indirect Tax Partners Jayashree Parthasarathy and TR Venkateswaran, the podcast unravels the evolving tax landscape around corporate guarantees. Together, they explore the history of this tax provision, discuss key clarifications from the government, and impact on businesses. Tune in for relevant insights on how GST is transforming corporate guarantees and what lies ahead for taxpayers.
Corporate guarantees between related parties are now taxable under GST, with a 1% valuation rule for non-creditable transactions.
The 1% GST levy on corporate guarantees applies annually but is not required to be paid for businesses with full input tax credit.
Outbound corporate guarantees from India may qualify as exports, exempting them from the 1% GST valuation provision.
It is important to understand the risk assumed when valuing corporate guarantees, as a one-size-fits-all approach does not align with transfer pricing principles.
TR Venkateswaran
Partner, Indirect Tax, EY India
For your convenience, a full text transcript of this podcast is available on the link below:
Jayashree Parthasarathy: Welcome all to the premiere of the ‘Indirect Tax Insights’ series on EY India Insights podcast. My name is Jayashree Parthasarathy, and I am your host for the day. Today, we will explore the taxation of corporate guarantees and try to demystify GST provisions on this particular topic with our guest.
Our guest today is TR Venkateswaran, a partner with EY’s Bangalore Indirect Tax practice. TRV, as we call him, joined EY six months ago, and I have had the privilege of being associated with him for over 10 years now. Welcome to our podcast today, TRV.
TR Venkateswaran: Thank you, Jayashree.
Jayashree Parthasarathy: There has been a lot of buzz around the GST levy on corporate guarantee. My understanding of corporate guarantee is that it is a guarantee, or an undertaking typically provided by one related party – usually a parent (company) or an affiliate – on behalf of a subsidiary to a bank or financial institution to assume responsibility of repayment of any borrowings the subsidiary may have.
Now, my understanding is that these types of guarantees have been around for a long time, even pre-GST. But why this sudden buzz? Why are we hearing so much about corporate guarantees being taxed when they have always been there, perhaps as a service offering, if we wanted to consider them as one?
So, when, how, why and where did this start? More importantly, is issuance of a corporate guarantee really a service that should be taxed under GST, given it has remained untaxed till now?
TR Venkateswaran: Thank you, Jayashree. It is always a pleasure to engage in our technical discussion and especially on an exciting topic like corporate guarantee. As you rightly said, this topic has existed for a long time. Let us take a step back. Even under the service tax law, this issue was widely debated.
In service tax, there were two eras – the positive list era and the negative list era, which began in July 2012. Going back to the positive list, there were cases that said there was no classification for the particular service of corporate guarantee, and hence, service tax should not apply.
But if we were to look at the issue, for anything to qualify as a service under the service tax regime, there needs to be a service in existence, and, for a consideration. There were debates around whether the act of extending a corporate guarantee fit into any of the common services which were defined under the positive list review of service tax.
The litigation focused on whether this activity fit under a particular type of service or not. Once the negative list came into the picture, the issue shifted, with everyone agreeing that there was some element of service present because it was not specifically excluded or exempted. However, between related parties, there was no consideration, and due to this lack of consideration, the condition for qualifying as a service was not getting fulfilled.
Under the service tax era, the issue was that without consideration, there was no service, and hence no taxability. But when GST came in, even between related parties, any service without consideration was also deemed to be a service. This led to the issue of how to tax this particular transaction.
That was the starting point. With GST commencing from July 2017, the question became what value should be charged to corporate guarantees between related parties. Whether it is a service or not, was a question that remained. On top of that, valuation became a key concern, with different authorities and companies making different interpretations. This led to the need for the government to come up with a standardized approach to resolve this issue.
Jayashree Parthasarathy: Very interesting to hear the history. In summary, the act of providing a guarantee has always been a service, but it went untaxed until now because there was typically no consideration agreed upon between the parties. Now, as we all know, the government has provided a valuation mechanism where 1% of the guaranteed amount is supposed to be offered to an 18% tax.
Could you tell us how this impacts some of our taxpayers, and whether these valuation rules, when they were introduced, were aligned to the basic principles of GST taxation and what has happened since then?
TR Venkateswaran: As we discussed, the problem was how to tax it and what value it should be taxed at. The government solved that by putting in an amendment in October 2023, which said that the value of a corporate guarantee for taxation purposes would be 1%, and this was made applicable to all types of businesses.
The problem was, even for related party transactions where people were eligible to take full credit, there always existed a law that the invoice value would be deemed to be the open market value. But even in those cases, only for corporate guarantee, the specific valuation of 1% came into the picture. So, the lack of distinction between those eligible for full credit and those not eligible created a dichotomy.
In the 53rd council meeting, the government clarified that the amendment to Rule 28(2) of the CGST Rules, 2017, specifies that the 1% valuation is applicable only for applicants or recipients located in India. Furthermore, this 1% valuation is to be assessed on a per annum basis. The earlier question of when this charge would be applicable—at the time the guarantee is issued or annually—has been clarified: the 1% must be paid annually. More importantly, they created an exception to say that this 1% will not apply for people who are able to avail full credit of it. Thus, whatever value they charge in their invoice for the service will be deemed the valuation for corporate guarantee purposes.
To some extent, the clarity has emerged that 1% is applicable only for assesses who do not have the ability to take full credit, and the periodicity at which this 1% will be levied.
Jayashree Parthasarathy: Thank you for clarifying that. It is good to know the government seems to have stepped in quite swiftly to clarify and provide relief to the extent that we have businesses who are eligible for full input tax credit. What you are saying is that the 1% does not really apply; it can probably even be a nil value if there is really no charge for the corporate guarantee.
While we have spoken about how this levy has evolved in India, can you throw some on how this type of taxation in India compares to the tax treatment of guarantees across the rest of the world?
TR Venkateswaran: The concept of corporate guarantee has been in existence. Because it is between related parties, we need to rely on the transfer pricing loss, which is where the actual origin of this particular levy comes into picture. We all know that in transfer pricing, if it is an international transaction, there has to be an arm's length value at which the charges are determined.
Traditionally, the litigation and transfer pricing laws have also been that this does not qualify as an international transaction at all and, hence, it should be outside the purview of the arm's length benchmarking exercise. Subsequently, the transfer pricing laws recommended to specifically include guarantees as part of international transactions, and hence the aspect of taxing them at an arm's length value originated.
But traditionally across the tribunals in India, the law has evolved over a period of time to assess the risk that the guarantor undertakes or the potential loss that the guarantor undertakes for the purpose of determining the arm's length value of the cross charge. So, the important element is how does one values this risk, depending on what risk the person assumes, which becomes an important basis for valuing this transaction.
Even internationally, the disputes in VAT laws have not centered around what the value should be, but rather whether a corporate guarantee is liable to VAT or not. However, assuming people agree that it is liable to VAT, they have always accepted the value determined under the transfer pricing laws to be the value on which VAT will also be applied.
Unfortunately, in India, in the GST regime, this 1% basis of valuation has come about, but we are not sure how this 1% was determined. One has to appreciate the risk that the guarantor or the guaranteeing entity undertakes in order to derive the valuation. A disconnected value, which is a deeming value, and represents some sort of a one-size-fits-all approach, does not seem to align well with the underlying principles already present in the transfer pricing setup.
Jayashree Parthasarathy: Absolutely. I have also seen that in many cases the guarantee amount is as low as 0.2-0.6%. It is rarely 1%. We also see a lot of different types of guarantees or letters being provided between related parties, such as of holding companies and subsidiaries. Some of them call it a guarantee, letter of comfort, assurance of liquidity, and so on. From your standpoint, should all of these be treated as corporate guarantees? Or is this 1% levy that we are discussing today restricted to a certain type of corporate guarantee and not just any assurance that is given?
TR Venkateswaran: The present law makes it applicable only on guarantees given to a financial institution or to a bank. From that perspective, if a guarantee is given for any other purpose, it is safe to assume that such a guarantee is not covered, and only those given for a loan taken from a financial institution or a bank are covered.
But all of this goes back to the contract law and what contract for a guarantee entails. It is primarily a contract to assure someone that the borrower will repay the loan, or that the person giving the guarantee will step into the shoes of the borrower and cover the loss in case of a default by the borrower. Technically, my view is that only those who qualify under a contract of guarantee should be covered under this particular aspect of taxation.
In aspects like letters of guarantee, while the nomenclature may differ, we must always circle back to see the underlying principles that originate from it, and whether it is given to a particular bank or a financial institution, and then read the taxability according.
What is also interesting is how the financial treatment is done in the books of accounts. As per my understanding, Indian Accounting Standards (IndAS) and International Financial Reporting Standards (IFRS) recognize the need to value of the guarantee in the books of accounts, and this issue also originated under the GST law. When a corporate guarantee is given, because it is an off-balance sheet item, the risk has to be computed and captured in the balance sheet. Therefore, it is always a good practice to compute it and report it in the financial statements.
How the value of the guarantee is computed, the risk assumed is determined, and the investment created in the books reflect, along with the liability that arises as an obligation. On a year-on-year basis, this investment is reduced, and a notional income is recognized in the profit and loss account.
That notional income acted as a trigger for the GST department to say that there is an income that is recognized in the books, but no GST has been registered. That is how this whole issue started. So, now the important point is that we need to go back to the contract law and determine whether something qualifies as a contract for guarantee, and then apply these principles of taxability to it. Anything falling outside this scope, in my view, should be kept outside the purview of tax.
Jayashree Parthasarathy: Great point! A good starting point for all of us is also to see how these statutory auditors are treating the accounting for some of these arrangements. Are they going to be essentially treated as guarantees or not?
You spoke about the fact that the government was swift to clarify many aspects surrounding the taxation of corporate guarantees in a timely manner. However, even after these amendments and clarifications, do you believe there are still some open issues? What would be your advice to our listeners who are dealing with some of these open issues with respect to corporate guarantees?
TR Venkateswaran: Certainly, there are a few issues. For example, the amendment to the rule only talked about the value applying on a per annum basis. But the time when this particular 1% has to be paid was not clarified in the rules. Although, the circular went ahead and clarified that the time of supply will be when the guarantee is given, and it should be for the entire term of the guarantee, right from the start.
This raises another issue related to different types of corporate guarantees. For instance, one could be a perpetual guarantee, where there is no definite time period mentioned in the contract. How do you treat those transactions? From a value perspective, I may determine that 1%, but what is the time of supply? How many years should I compute this value?
One practical way of dealing with it is to say, “I will pay 1% every year,” but whether that will be accepted by the department, we do not know. That particular aspect has to be tested.
There are certain guarantees which can have no monetary limits. It can say that whatever is the default, I will make good that loss, but there is no monetary value attached to it. Then, how would I value that 1%? On what value that 1% will be applied? Should I assume that this means the levy fails, and therefore, the taxability fails in those transactions? Again, this could become a topic for litigation.
More importantly, the circular does not consider instances where certain loans and guarantee arrangements are pre-closed. I may start off with a loan at 10% for ten years, but let us say, I pre-close the loan after two years. The circular states that I need to value that 1% for 10 years and pay the 1% at the beginning of the tenure itself. But after two years, once I pre-close the loan, will I have the ability to do a raise a credit note for the unexpired term, or can I get a refund for the amount that I already paid? Those aspects are not clear.
Sometimes, it may also happen that the purpose of the loan changes. For example, in the current scenario, if I am in a situation where I cannot take full credit, I pay the 1% upfront. Let us take an example of a construction or an infrastructure company. I take a term loan for construction purposes. However, two years down the line, once the construction is complete and the property is ready for lease or generating revenue, I may approach the bank to refinance the term loan into an operating loan and repay the original loan.
So, now the loan is converted from construction-related loan to an operational loan. Can I then say that the part of the GST which I paid on the entire amount is eligible for credit? That situation is not clear. There are such unique use cases depending on the industry. Similarly, there are sectors where the creation of the statute comes into play—such as infrastructure companies and real estate investment trusts—which are structured based on statutory policies. These entities derive their structure from the statute itself.
Jayashree Parthasarathy: And also, in these structures, rather than the holding company giving the guarantees, it is vice versa.
TR Venkateswaran: Exactly. The point remains is that, on one hand, the law governing both require me to create special purpose vehicles (SPVs), and because SPVs do not have a significant balance sheet of their own, they have to rely on the corporate or the main entity for raising loans. This means it is a creation of the law, per se. But on the other hand, there is a deeming provision which requires me to pay GST on the corporate guarantee. These issues recreate a lot of challenges from a sector-specific viewpoint, and hence this subclass has many areas that still need to be addressed.
Jayashree Parthasarathy: I am guessing for some of these sectors where credit is also a challenge, the 1% becomes a huge cost effectively, or the GST on that 1% becomes a cost. We spoke a lot about maybe inbound guarantees till now where, a subsidiary in India needs to determine or a company in India needs to determine whether there is a GST applicable on the provision of the guarantee and then it takes a call to either pay business 1% or take a position that nil value is acceptable because they are eligible for full input tax credit.
But let me flip the scenario on the question to you. If we are looking at an outbound company, where the corporate offices in India and it has subsidiaries, or affiliates outside India and headquartered in India. Should the head office in India, or the parent in India, provide a corporate guarantee to its affiliate subsidiaries in other countries? Do these valuation provisions cover that? They need to pay the 1%. Can they claim an export status? What is the scenario there?
TR Venkateswaran: This particular provision specifically clarifies that the deeming provision does not apply for outbound transactions; it applies only for recipients of guarantees in India. This means this provision will apply for inter-company transactions within India and inbound guarantees. However, it is entirely viable, and possibly feasible, to take an export position. We need to understand that there has to be a charge under the seat of consideration for that.
We all know that for something to qualify as an export, it must qualify as a supply. But that supply should also be realized in cash to be considered. So, in the scenario where an outbound guarantee is given, and a specific charge is raised by the Indian entity on the overseas entity, provided that the money is remitted back to India, an export position should be feasible. In the absence of a remittance coming into India, the question of satisfying the export condition does not arise.
To that extent, I think there will not be a charge at all because I am not raising an invoice. There is no requirement for me to adopt any deeming valuation provisions because it is specifically excluded.
Jayashree Parthasarathy: There is some merit to say that outbound guarantees should not be taxable, ideally. Let us see how that progresses. Thank you for these great insights. You mentioned that there are quite a few open issues notwithstanding the clarifications that have come in. How and when do you see these issues getting resolved, and what should our listeners to get to a resolution?
TR Venkateswaran: There are two ways in which this issue will likely be settled in due course. One obvious way is through the court of law. We already know that there are quite a few writ petitions before the Delhi High Court, the Telangana High Court, and the Punjab and Haryana High Court, where the aspect of the levy of GST on corporate guarantees has been teste. The courts have held the operation of this circular should not apply to specific assessees, directing the assessing authority to evaluate these transactions without considering the clarifications in the circular.
Having said that, even the new circular that we talked about, there can be certain areas which can go beyond the operation of the rule that is existing today. On that aspect, the circular can also be tested. One of the aspects which we talked about was whether the circular is right in specifying the time of supply to be the time when the guarantee is given itself, that too for the entire tenure of the guarantee - that is one aspect which can definitely be tested in the court of law.
The other aspect is the validity of this 1% levy itself, whether it qualifies as a rational valuation, can be questioned. In the Gujarat High Court, a similar question was raised about the construction sector - whether the deeming deduction of one third of the value of the land, deeming it to be the value of land, is it a viable or a rational deeming fiction This aspect was questioned, and the Gujarat High Court said it may not be the correct way of determining the deduction.
Similarly, what is the basis for arriving at a 1% valuation is open to interpretation and can be questioned in the court of law. But having said that, I believe that advocacy is also a good road to probably engage with the stakeholders across the government and the state governments to highlight to them how this issue has different connotations across industries, and it is important for the industry players to raise these issues at their respective forums, so that the government is also made aware of some of the nuances which are specific to particular sectors and represent to the government to create certain exceptions for those sectors. That is another way in which some of these issues can be resolved.
Jayashree Parthasarathy: Thank you, TRV for the extremely insightful and valuable perspectives. There are so many takeaways for all listeners tuned into today's podcast. We look forward to more such nuggets from you in the future.
Thank you to all our listeners. Stay tuned for more captivating discussions and insightful sessions as part of this EY India Insights podcast series. Please do not forget to subscribe for the latest updates. Until next time, this is your host, Jayshree Parthasarathy, signing off.
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