A Critical Analysis on Corporate Guarantees under Service Tax and GST

Dayita Kanodia, Executive | finserv@vinodkothari.com

“The Supreme Court’s only armour is the cloak of public trust; its sole ammunition, the collective hopes of our society.” – Irving R. Kaufman

Background

The Supreme Court has ruled that service tax will not be levied on corporate guarantees by a parent company to its subsidiaries where there is no consideration involved.

This article discusses the impact of this ruling on companies which issue corporate guarantees without consideration.

Corporate guarantee and Bank guarantees

Before proceeding with the above ruling let us first have a look at the concept of corporate guarantee and bank guarantee. A Corporate Guarantee is a guarantee in which one corporate undertakes to be responsible for the financial obligations or the performance or of any other contractual obligations by the principal debtor to the creditor, in case the principal debtor fails to to meet its obligations or meet the predetermined performance parameters. Such type of guarantees are quite common among group entities which are often without any consideration and are intended towards group synergy.

On the other hand a bank guarantee is a guarantee given by the bank on behalf of the applicant to cover a payment obligation to a third party.

In Micro Inks Ltd., Vapi v. Assessee, I.T.A. No.: 2873/Ahd/10, while comparing bank guarantees and corporate guarantees, the ITAT held that :-

“The (corporate) guarantees are issued without any security or underlying assets. When these guarantees are invoked, there is no occasion for the guarantor to seek recourse to any assets of the guaranteed entity for recovering payment of defaulted guarantees. The guarantees are not based on the credit assessment of the entity, in respect of which the guarantees are issued, but are based on the business needs of the entity in question. Even in a situation in which the group entity is sure that the beneficiary of guarantee has no financial means to reimburse it for the defaulted guarantee amounts, when invoked, the group entity will issue the guarantee nevertheless because these are compulsions of his group synergy rather than the assurance that his future obligations will be met. We see no meeting ground in these two types of guarantees, so far their economic triggers and business considerations are concerned, and just because these instruments share a common surname, i.e. ‘guarantee’, these instruments cannot be said to be belong to the same economic genus. Of course, there can be situations in which there may be economic similarities, in this respect, may be present, but these are more of an exception than the rule. In general, therefore, bank guarantees are not comparable with corporate guarantees.”

It is to be noted that section 65(12) of the Finance Act 1994 states that Banking and other financial services shall inter alia include, bank guarantee provided by the bank.

However, a corporate guarantee cannot be construed to be a bank guarantee, which was also held by the Supreme Court in the current ruling.

Service tax on corporate guarantees issued without consideration

Service, as defined under section 65B(44) of the Income Tax Act, 1994 means-”means any activity carried out by a person for another for consideration, and includes a declared service …”

Now the question is how this ruling of the Supreme Court will affect the companies which provide corporate guarantees without consideration to their group companies? 

In the case of COMMISSIONER OF CGST AND CENTRAL EXCISE V. M/S EDELWEISS FINANCIAL SERVICES LTD it was argued before the Court that issuance of corporate guarantee to a group company without consideration would not fall under the definition of service as given under section 65B(44) of the Finance Act 1994 the definition of service would indicate that it relates to only such service which is rendered for valuable consideration Further, considering that corporate guarantees are distinct from bank guarantees, the same shall also not be covered under section 65(12) of the Finance Act 1994 w.r.t. Banking and other financial services which include bank guarantee.

In the case stated above the assessee had got relief at the stage of original adjudication, however, revenue appealed before the apex court which was dismissed at the admission stage itself on the premise that in the service tax regime for a service to be taxable there must be a consideration.

However, consideration includes monetary as well as non-mone

Situation under the GST Regime

However the GST regime regarding related party transactions is totally different. Schedule I of CGST act states that Supply of goods or services or both between related persons or between distinct persons when made in the course or furtherance of business shall be treated as supply even if made without consideration. In view of the above it is to be noted that distinct persons are persons with different GSTINs belonging to one legal entity situated within the same state or in two different states.

Therefore as per the current CGST Act corporate guarantees between related parties would be liable to tax under GST even if they are made without consideration. We can say that here, the relationship is itself the consideration.

Corporate guarantees as a service

The question which still remains is if we can actually consider corporate guarantee as a service as the same is provided for maximization of gains for the recipient entity and thus the group as a whole. Another view is possible that there is no service activity undertaken and the company issues the guarantee in its capacity as a shareholder to protect its investment in securities. The same was observed in the case of Micro Ink Limited (supra) where the ITAT stated –

“it is not really possible to hold that the corporate guarantees issued by the assessee were in the nature of ‘provision for service’ and not a shareholder activity which are mutually exclusive in nature.”

Lastly, companies should be careful as there is a lot of ambiguity as to how far this ruling on service tax will apply to the GST regime.

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Additional Resources:

1. GST on Financial Services: Frequently Asked Questions