Navigating GST impact on Financial Transactions beyond Corporate Guarantees

The primary confusion that persists is whether it constitutes a supply of service when a corporate guarantee is provided by a related party against a loan facility. In this regard, Circular No. 204/16/2023-GST (“Circular 204”) was issued which clarified that a corporate guarantee provided by a company for credit facilities availed by another company, where both the companies are related, is to be treated as supply of services.

However, writ petitions have been filed before the Hon’ble Delhi High Court and the Punjab and Haryana High Court with respect to the issue of corporate guarantee.  In the case of M/s Sterlite Power Transmission Limited v. Union of India, interim protection has been granted to the petitioner against any coercive steps in case any demand is created on the supply of corporate guarantee. Further, in Acme Cleantech Solutions (P) Ltd. v. Union of India, the Court has stayed the effect of Circular 204 to the extent it clarified that the provision of corporate guarantee to a related party shall be treated as a supply even when made without consideration. The Court was of the view that the appellate authority shall be free to decide the issue without being influenced by the clarification provided.

Further, the government through the amendment vide Notification No. 52/2023 - Central Tax (“Notification 52”), inserted sub rule (2) of Rule 28, with an aim to provide clarity over the valuation of such transactions. Rule 28(2) provides that the value of supply of services by a supplier to a recipient who is a related person, by way of providing a corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be 1 per cent of the amount of such bank guarantee offered or actual consideration, whichever is higher.

Though issued with an aim to provide clarity to the taxpayers, the Notification and its pursuant Circular have arguably raised more doubts than before in the minds of taxpayers.

Taxpayers are troubled by issues such as whether the provision of a corporate guarantee is a one-time supply or a continuous supply, and whether the one per cent fee should be calculated solely on the loan amount or whether it should include interest as well. Further, the valuation of supply of a corporate guarantee executed prior to the insertion of Rule 28(2) has also been a cause of concern for the taxpayers.

However, an issue which is being overlooked but could potentially emerge as a major issue down the line is GST implications on financial assurances or support agreements. Such support agreements need to be thoroughly analysed on the touchstone of corporate guarantee for the purpose of GST laws.

Financial Assurances

As a general industry practice, banks or other financial institutions seek financial assurances in various forms. Some of the examples of such assurances are: a letter of comfort, a sponsor undertaking, and a pledge agreement, amongst others. A few of such agreements have been detailed below:

1. Letter of Comfort

   A letter of comfort is an instrument which provides certain assurance that an obligation would be met. An example of the same in the present context could be the holding company agreeing not to dilute its share in the subsidiary as a condition for the lender extending a loan facility. Another example could be a promise by the holding company to inject sufficient funds into the subsidiary to enable timely payment by the subsidiary. Notably, the Bombay High Court ruled in a case that a letter of comfort may indeed amount to a guarantee. Not every letter of comfort is, ipso facto, a guarantee. The nomenclature is unimportant, as is the absence of the word 'guarantee'.

2. Sponsor Undertakings

   A Sponsor Undertaking is a contractual agreement among the lender, sponsor and borrower, in which the sponsor commits to specific obligations related to the loan. These obligations can differ based on the lender’s needs. In some instances, the lender may request assurances like maintaining a minimum balance for the debt service ratio, supporting in case of cost overruns, or providing pre-payment support.

3. Security Trustee Agreements (‘STA’)

   STA is a contractual arrangement between the borrower, lenders and the security trustee wherein the borrower settles in a trust.  The security trustee is appointed as an independent entity to represent the group of investors, holding the charge on their behalf until the agreement is fulfilled. In such cases, if a mortgage or guarantee is executed in pursuance of the credit facility, such mortgage or guarantee is provided to the security trustee acting on behalf of the lenders/ debenture holders. 

   In many of the cases, the Security Trustee is neither a banking company nor a financial institution. A question which may logically follow is whether the guarantee extended under this arrangement will fall under the ambit of Rule 28(2) or not as the provision requires the provision of a guarantee to a banking company or a financial institution.

   Take an example wherein a guarantee is issued to the Debenture Trustee against the debentures issued by the Real Estate Investment Trust (‘REIT’). Here, the applicability of Rule 28(2) poses a significant issue, especially where only some of the debenture holders are banking companies or financial institutions.

4. Collateral Agreements

   A bank or financial institution may, for securing the loan, ask the holding company to extend securities as collateral for the credit facility. The collateral may be in the form of stocks, debentures, mutual funds, land and buildings or any other assets. Here, the holding company agrees that in case of default by the subsidiary, the lender may realise such assets and fulfil the borrower’s obligations.  In some cases, it could be in addition to a corporate guarantee agreement which gives rise to questions such as the nature of supply as a composite or mixed supply, applicability of Rule 28(2), valuation of supply and so on.

The list of above agreements is far from being exhaustive and financial assurances may be extended by the holding company to the lender in many other ways. These support agreements may provide varied levels of cushion to the banks/ creditors. However, questions such as whether such agreements would qualify as a supply under GST and whether it could be said that such agreements are in the nature of corporate guarantee remain a grey area.

Unravelling the confusion

Post the insertion of Rule 28(2), a question which naturally follows is whether the abovementioned supports would also fall under the purview of corporate guarantee and be liable to be taxed accordingly.

The definition of guarantee has been provided under Section 126 of the Indian Contract Act, 2017 which states that a ‘contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default.’ Here, it becomes imperative to note that one of the essentials to constitute a contract of guarantee is that the performance of promise or discharge of liability shall only be on the occurrence of default by a third person.

The permutations and combinations of questions which may emerge on a careful perusal of the existing agreements in the industry are endless. However, the moot question which is required to be answered is whether the arrangement between the parties would constitute a contract of guarantee or not.

In case the arrangement qualifies to be that of a guarantee extended by one group company for another group company to a banking company or financial institution, the same shall be treated in accordance with Rule 28(2).

However, if the same is not the case, another array of questions emerge - such as whether such support extended by the group entity is taxable or not. Further, in case such support is taxable but does not form a corporate guarantee, deciding the valuation of such supply becomes another challenging avenue.

Conclusion

Whether support agreements qualify as corporate guarantees or not largely hinges upon the specific facts and circumstances of each agreement. In this scenario, the taxpayers are faced with a myriad of questions and uncertainties surrounding the taxability of such agreements.

Here, it becomes imperative for the government to provide clear and comprehensive guidance to mitigate confusion and ensure the uniform interpretation and application of the provisions.