GST on Corporate Guarantees: Decoding the Recent Rulings

GST on Corporate Guarantees: Decoding the Recent Rulings and Valuation Rules#

The Core Dispute#

In the corporate world, it is standard practice for a parent (holding) company to provide a Corporate Guarantee to a bank on behalf of its subsidiary. This guarantee helps the subsidiary secure loans at lower interest rates. Typically, the holding company does not charge the subsidiary any fee or commission for providing this guarantee. The GST department recently stirred up a massive hornet's nest by asserting that providing a corporate guarantee is a "supply of service" between related parties. Under Schedule I of the CGST Act, supplies between related persons are subject to GST even if made without consideration (free of cost).

Introduction of Rule 28(2)#

To standardize how this "free" service should be valued for taxation, the government introduced Rule 28(2). This rule dictates that the value of supply of a corporate guarantee provided by a holding company to its subsidiary shall be deemed to be:- 1% of the amount of the guarantee offered, OR- The actual consideration charged, whichever is higher.

This means if a holding company provides a Rs. 100 Crore guarantee to a bank for its subsidiary, the GST department will assume the holding company provided a service worth Rs. 1 Crore, and will demand 18% GST (Rs. 18 Lakhs) on it, even if no money actually changed hands.

The Legal Pushback and High Court Rulings#

Corporate India heavily contested this rule, leading to a flood of writ petitions. The debate centers on two main arguments:

1. Is it a Service? A corporate guarantee is fundamentally an actionable claim or a transaction in money, neither of which qualifies as a 'service' under GST. Furthermore, the holding company provides the guarantee to protect its own equity investment in the subsidiary, not to provide a distinct service to the subsidiary.2. Arbitrary Valuation: Applying a blanket 1% valuation is arbitrary and ignores the commercial realities and credit ratings of different subsidiaries.

Recent rulings from various High Courts, including the Bombay and Punjab & Haryana High Courts, have provided mixed relief, often granting stays on coercive recovery actions by the GST department until the Supreme Court can provide a final, binding constitutional interpretation.

Navigating the Compliance Maze#

While the legal battles rage on, companies must protect themselves against massive, unexpected tax demands:

• Cross-Charge with ITC: If the subsidiary is engaged in fully taxable business (not exempt supplies), the holding company can choose to pay the GST and issue a tax invoice. The subsidiary can then claim the full Input Tax Credit (ITC), making the transaction revenue-neutral (a pure cash flow exercise).
• Valuation Under Rule 28(1): For companies choosing to litigate, it is critical to rely on the second proviso to Rule 28(1), which states that if the recipient (subsidiary) is eligible for full ITC, the value declared in the invoice (even if it is Nil) shall be deemed to be the open market value.

Who Is Affected#

This issue matters to any group where a parent company stands behind a subsidiary's borrowing: manufacturing groups, infrastructure companies, and businesses where the parent's balance sheet is what persuades the bank to lend. Note that Rule 28(2), as described above, applies to guarantees given by a holding company to its subsidiary, so the first task is to identify exactly which guarantees fall into that relationship.

How the Valuation Works: A Worked Example#

Using the figures already in this article: suppose the holding company gives a Rs. 100 Crore guarantee and charges the subsidiary nothing. Under Rule 28(2), the value is 1% of the amount, which is Rs. 1 Crore, and GST at 18% comes to Rs. 18 Lakhs. If instead the holding company charges a guarantee fee that is higher than 1% of the amount, the actual consideration is the value. The rule takes whichever is higher.

If the subsidiary can claim full Input Tax Credit, the Rs. 18 Lakhs paid by the holding company comes back to the subsidiary as credit, so the net cash cost across the group is nil, apart from the timing gap and compliance effort. If the subsidiary makes exempt supplies, the credit position is different, and that is where the exposure becomes real.

Two Ways Groups Are Responding#

Practitioners and companies do not all take the same position, and the matter is being litigated.

• Pay and cross-charge. Some groups treat the guarantee as taxable, issue an invoice, and let the subsidiary claim credit. This reduces the risk of a notice, at the cost of conceding the point.
• Contest. Others rely on the arguments above (that a guarantee is not a service, or that the valuation is arbitrary) and the High Court stays, and defend any demand in litigation.

Which route fits depends on the group's risk appetite, the subsidiary's ITC position, and the size of the guarantees. Neither route is universally correct while the final position is awaited.

Step-by-Step: Reviewing Your Group's Position#

1. List every guarantee given by any group company on behalf of another, including bank guarantees, corporate guarantees and letters of comfort. Record the amount, the beneficiary, the lender and the period.
2. Classify the relationship. Identify which guarantees are from a holding company to a subsidiary, and which are between other related parties.
3. Check consideration. Note whether any fee has been charged, and how it was accounted for.
4. Check the subsidiary's ITC eligibility. Confirm whether it makes fully taxable supplies.
5. Model the cash flow. Estimate the GST payable and the credit recoverable, month by month.
6. Decide the approach (pay and cross-charge, or contest) and document the reasoning.
7. Review notices and replies. If a notice has been received, record deadlines and consult a professional immediately.

Common Mistakes to Avoid#

• Assuming that because no money changed hands, no GST question arises. The law on related-party supplies described above is not limited to paid transactions.
• Ignoring guarantees that were given years ago and are still outstanding. Confirm with a professional how the rule applies to older guarantees.
• Issuing an invoice without checking whether the subsidiary can actually use the credit.
• Relying on a High Court stay as if it were a final ruling. A stay on coercive recovery, as this article notes, is temporary relief.
• Failing to keep a written record of why the group took its chosen position.

Practical Checklist#

• Register of all corporate and bank guarantees across the group.
• Related-party mapping for each.
• Subsidiary ITC eligibility confirmed.
• GST cash flow model prepared.
• Decision (pay or contest) documented and approved by the board or CFO.
• Litigation status of relevant High Court matters monitored.

Because this area is unsettled and depends on the facts of each group, consult a Chartered Accountant or GST advocate before deciding how to treat any specific guarantee.

Group CFOs must immediately map all outstanding corporate and bank guarantees across their entities and model the potential GST cash flow impact to avoid surprise notices.