Gujarat HC upholds levy of GST on corporate guarantee while reads down mandatory 1% valuation where actual consideration is lower

 This Tax Alert summarizes a recent ruling of the Gujarat High Court (HC)1 on the taxability of corporate guarantee provided by the Petitioners on behalf of their related party located in India and the constitutional validity of Rule 28(2) of the Central Goods and Services Tax Rules, 2017 (CGST Rules).

The key observations of the HC are:

• A corporate guarantee given by a holding company to a bank or financial institution for its subsidiary’s credit facilities constitutes a supply of service between related persons under Section 7(1)(c) read with Schedule I of the CGST Act, even without consideration.
• Such guarantee is neither an actionable claim nor a shareholder activity and accordingly cannot be excluded from the scope of supply.
• Rule 28(2) of the CGST Rules and Section 15(4) of the CGST Act are constitutionally valid. However, the expression “whichever is higher”, which requires valuation at the higher of 1% of the guarantee amount or the actual consideration charged, is arbitrary and liable to be read down as it denies the corporate guarantor the option to pay GST on the actual charge.
• The collection of tax for the period prior to introduction of Rule 28(2) i.e. 26 October 2023, will be hit by the doctrine of unjust enrichment, since the revenue had no legal basis or authority to levy GST on corporate guarantee, which were executed prior to the date of introduction. However, GST may be leviable prospectively where guarantees continue beyond that date.

Basis above, HC allowed the writ petitions in part, by upholding the levy of GST on corporate guarantees and constitutional validity of Rule 28(2) but reading down the expression ”whichever is higher”.

Comments:

• The findings of the HC may have wider implications for valuation disputes involving deemed valuation mechanisms under GST or other laws, particularly where actual consideration is identifiable but differs from statutorily prescribed deeming values.
• The implications of the ruling may need to be assessed based on the facts of each corporate guarantee arrangement, including whether the guarantee was issued before the introduction of Rule 28(2) and its continuation thereafter, the key aspect of consideration and whether the arrangement involves periodic payment obligations.
• While HC has analyzed the time of supply implications for domestic transactions, businesses may need to separately evaluate the position for import of services, considering the distinct time of supply provisions applicable under the reverse charge mechanism.
• Similar challenges relating to the taxability and valuation of corporate guarantees are currently pending consideration before other HCs [Punjab & Haryana HC - CWP 10249 of 2024; Bombay HC - WP No 4519 of 2024, and Delhi HC - WP (C) 2966 of 2024] Accordingly, the jurisprudence on these issues is still evolving, and taxpayers may closely monitor further judicial developments.
• Considering the significance of the issue, Revenue is likely to challenge the ruling before the SC.