Gujarat High Court’s Ruling On GST Treatment Of Corporate Guarantees Between Related Persons

The recent Gujarat High Court ruling in Torrent Power Ltd. v. Union of India & Ors.¹ is a significant development on the Goods and Services Tax (GST) treatment of corporate guarantees between related persons.

In its ruling, the Court upheld the constitutional validity of Rule 28(2) of the CGST Rules, 2017, while reading down the phrase "whichever is higher" contained in Rule 28(2). The Court further held that Rule 28(2), introduced with effect from 26 October 2023, cannot be applied to levy GST for any period prior thereto. However, where a corporate guarantee remains in force beyond October 26, 2023, GST implications would arise from such date onwards.

Set out below is our detailed alert on the ruling.

Relevant Provisions and Circulars

Rule 28(2) of the CGST Rules, 2017

Rule 28(2), inserted w.e.f. October 26, 2023, prescribes that value of corporate guarantee services provided between related persons shall be deemed to be 1% of the guaranteed amount per annum, or the actual consideration charged, whichever is higher.

Circular No. 204/16/2023-GST Dated October 27, 2023

The Central Board of Indirect Taxes and Customs (CBIC) Circular clarified that corporate guarantees furnished between related persons constitute a taxable supply even where no consideration is charged. Additionally, it stated that following the introduction of Rule 28(2), the valuation of such services would be governed by the said provision.

Circular No. 225/19/2024-GST Dated July 11, 2024

CBIC Circular provided additional clarifications on the taxability and valuation of corporate guarantee services. In particular it clarified that: corporate guarantee services were taxable even prior to the introduction of Rule 28(2); guarantees issued or renewed before October 26, 2023, would be valued under Rule 28 as applicable at the relevant time; guarantees issued or renewed on or after October 26, 2023, would be valued under Rule 28(2); and valuation is to be determined with reference to the amount guaranteed and not the amount of loan disbursed.

Brief Background of the Case

The petitioners challenged the constitutional validity of Rule 28(2), Section 15(4), and the above CBIC Circulars, contending that:

• Corporate guarantees furnished without consideration do not constitute a taxable supply,
• The prescribed 1% valuation methodology is arbitrary,
• GST cannot be levied applying Rule 28(2) on corporate guarantees furnished prior to October 26, 2023, as that would amount to an impermissible retrospective tax burden.

The Revenue contended that

• Corporate guarantees provided between related persons constitute a supply of services under Section 7 read with Schedule I to the CGST Act, irrespective of consideration, and
• Rule 28(2) merely prescribes a valuation mechanism for such supplies and does not tantamount to a retrospective levy.

Key Findings of the Gujarat High Court

Corporate Guarantees Are Taxable Supplies Under GST

• A corporate guarantee given by a holding company for the benefit of its subsidiary constitutes a supply of service, even if no separate fee is charged.

Rule 28(2) Remains Valid

• The Court upheld the validity of Rule 28(2) (introduced from October 26, 2023) and Section 15(4) of the CGST Act.

Relief on the 1% Valuation Formula

• The Court "read down" the words "whichever is higher" in Rule 28(2).
• Tax authorities cannot automatically insist on GST being paid on 1% of the guaranteed amount merely because it is higher than the actual consideration charged.

No Retrospective Application Prior to October 26, 2023

• Rule 28(2) cannot be used to levy GST for the period before October 26, 2023.
• However, if a guarantee issued before that date continued thereafter, GST implications may arise from October 26, 2023, onward.

Section 74 Protection

• Mere non-payment of GST based on a bona fide interpretation of law does not automatically amount to fraud or suppression of facts.
• The Court quashed the Section 74 proceedings involved in the case.

Circulars Partly Set Aside

• CBIC Circulars dated October 26, 2023, and July 11, 2024, have been set aside to the extent they conflict with the Court's ruling.
• The Revenue may issue fresh guidance aligned with the judgment. The directions contained in the judgment directed to be implemented within three months.

Refund of Excess GST Paid

• Any excess GST deposited by the petitioners be refunded or allowed for adjustment as mutually agreed between the parties.

Key Implications for Businesses

Major Relief for Pre-October 26, 2023, Guarantees

Authorities cannot apply the Rule 28(2) and invoke 1% valuation mechanism retrospectively.

Post-October 26, 2023, Guarantees Require Review

Taxpayers should reassess valuation methodology in light of the Court's interpretation and undertake a guarantee-wise review.

Potential Refund Opportunities

Taxpayers who paid GST on corporate guarantees for the pre-October 26, 2023, period may evaluate refund or adjustment claims.

Litigation risk remains

The Revenue may challenge the judgment before the Supreme Court, so taxpayers should monitor further developments before taking irreversible positions.

Our Takeaways 

The judgment provides substantial relief for historical corporate guarantees and limits the Revenue's ability to retrospectively apply the Rule 28(2) valuation mechanism. However, the Court has upheld the levy of GST on corporate guarantees and businesses should carefully reassess their valuation and compliance position for guarantees continuing or issued from October 26, 2023, onwards. For the periods prior to October 26, 2023, valuation of corporate guarantees may continue be litigious as the Court has not expressly addressed the manner of valuation applicable to such periods.

Given the significance of the issue, the Revenue may consider challenging the judgment before the Hon'ble Supreme Court. Accordingly, taxpayers should evaluate any consequential actions with due caution and monitor future developments.
 

^{Disclaimer: This piece is based on publicly available information, market analysis, and the authors’ professional experience. For questions regarding the underlying sources or analytical methodologies, please reach out to the author directly. The analysis reflects market trends and observations and is intended for general informational purposes only. It does not constitute investment, legal, or financial advice.}