New CBIC Circular: Is the Ministry of Finance Taxing a Hypothetical Risk?

As per the recommendations of the 52nd Goods and Services Tax (GST) Council, Rule 28(2) of the Central Goods and Services Tax Rules, 2017¹ (hereinafter “CGST Rules”) vide Notification No. 52/2023-Central Tax dated 26-10-2023² has been inserted to provide for a specific clause for valuation of supply of services of providing corporate guarantee to any banking company or financial institution by an entity on behalf of a related person. Besides, Circular No. 204/16/2023-GST dated 27-10-2023³ was also issued as per the recommendations of the GST Council, to provide clarifications regarding the applicability of the said sub-rule. Subsequently, based on the recommendations of the GST Council, Rule 28(2) of the CGST Rules has been amended retrospectively with effect from 26-10-2023 vide Notification No. 12/2024 dated 10-7-2024⁴. The second Circular i.e. Circular No. 225/19/2024-GST dated 11-7-2024⁵ has been issued in response to the various representations that were received from trade and industry post the issue of the first Circular. Two recent notifications followed by two Circulars have been floated by the Ministry of Finance thereby transforming the GST landscape. These notifications have provided for a levy of Goods and Services Tax on all related party corporate guarantee transactions, that means, that when a corporate guarantee is provided by a related party company to a bank/financial institution for providing credit facilities to the other related party, then this activity will be a supply of service and will come under the ambit of Schedule 1 of the Central Goods and Services Tax (CGST) Act, 2017⁶ regardless of whether a consideration has been paid or not.

This post aims to assess whether this move by the Central Board of Indirect Taxes and Customs (hereinafter “CBIC”) of taxing related party corporate guarantee transaction a milestone or an overarching step?

Retrospectivity of the provision stands in contra to the position of law

The new Circular affirmatively addresses whether sub-rule (2) of Rule 28 of the CGST Rules applies to corporate guarantee transactions executed prior to its issuance. According to the Circular⁷:

It is to be clarified that the supply of service of providing corporate guarantee to any banking company or financial institution by a supplier to a related recipient, on behalf of the said recipient, was taxable even before the insertion of sub-rule (2) in Rule 28 of the CGST Rules with effect from 26-10-2023.

This clarification thus suggests that recent circulars merely offer an alternative calculation method rather than imposing a new levy on corporate guaranteed transactions.

However, this position is inherently contradictory, and challenges established legal precedent. The Supreme Court in CCE & CGST v. Edelweiss Financial Services Ltd.⁸, alongside the Chennai Customs, Excise & Service Tax Appellate Tribunal (CESTAT) in Sterlite Industries (India) Ltd. v. Commr. of Customs⁹, unequivocally held that corporate guarantees are not liable to tax in the absence of prescribed consideration. Therefore, the prevailing legal stance has been that only the explicitly mentioned supplies of goods or services are taxable, with no tax liability arising from related party transactions involving corporate governance.

This new Circular, in attempting to retroactively impose tax obligations on such transactions, not only disregards these judicial pronouncements but also disrupts the settled legal framework. It undermines the principle that tax laws should be applied prospectively, ensuring predictability and fairness in tax administration. By asserting that the supply of related party corporate guarantees was always taxable, the Circular effectively rewrites the legal landscape, creating uncertainty and potential disputes.

Taxing a hypothetical risk

Another critical issue that the industry has raised concerns about is the valuation of the supply of corporate guarantees in scenarios where the guaranteed amount is provided, but the loan is either partly availed or not availed at all by the recipient. The CBIC has addressed this in its Circular¹⁰, stating:

The activity of supply of the service of providing a corporate guarantee is not linked with the actual disbursal of the loan. The service that is provided by the guarantor to the guarantee is that of taking on the risk of default. Therefore, it is clarified that the value of supply of the service of providing a corporate guarantee will be calculated based on the amount guaranteed and will not be based on the amount of loan actually, disbursed to the recipient of the corporate guarantee.

This position raises significant concerns about the broader impact on the ease of doing business. By severing the link between the availment of the loan and the provision of the corporate guarantee, the Circular effectively broadens the tax base to include all possible corporate guaranteed transactions. This interpretation is not only overreaching but also fundamentally flawed. It taxes the mere promise to provide a guarantee as a service, regardless of whether the actual service — covering the guarantee in case of loan non-repayment — takes place. This interpretation is alarming, as it disincentivises related party companies from offering guarantees due to the substantial tax burden placed on the holding company (the guarantor)¹¹.

The CBIC’s approach is counterproductive as it fails to recognise the practical realities of corporate guarantees, where the actual risk and subsequent financial implications may never materialise. By imposing taxes on hypothetical risks, the Circular undermines the very essence of business facilitation and risk management. This draconian measure could stifle corporate support mechanisms, where holding companies are naturally positioned to provide financial assurances for their subsidiaries or related entities.

Furthermore, this stance contradicts the principle of fair taxation, which should be based on actual economic benefits received. Taxing potential and unrealised risks is an unreasonable extension of tax liability, deterring corporate entities from engaging in standard financial practices essential for operational flexibility and financial health. The CBIC’s interpretation is not just a misstep but a significant threat to the business ecosystem.

Regulatory inconsistency between the GST Notification and RBI Circular

The taxable value of supply for calculating the levy of GST in a related party transaction is determined as per Rule 28 of the CGST Rules. To standardise the tax calculation in corporate guaranteed transactions, sub-rule (2) has been added to Rule 28. This sub-rule stipulates that the transaction value for guarantees extended to related persons is now “the higher of 1% of the guaranteed amount or the actual consideration charged, if any”.

This provision stands in stark contradiction to the RBI Circular (RBI/2023-24/04 DOR.STR.REC.5/13.07.010/2023-24)¹², which explicitly prohibits related parties from charging any consideration. The Reserve Bank of India (RBI) Circular unequivocally states that no security driven by consideration can be accepted, essentially prohibiting guarantee commissions. This position was upheld in IIFL Holding Ltd. v. CGST & CCE¹³, wherein para 3 affirms:

Thus, RBI prohibits the collection of any consideration for providing a corporate guarantee. In the absence of payment of consideration, the learned Commissioner concluded that it cannot be said that the service has been provided by the assessee-appellants to its group companies/subsidiary companies.

The Commissioner thus considered the RBI Circular that specifically prohibits the collection of any consideration for providing corporate guarantees to subsidiary companies.

Given this legal framework, the RBI Circular effectively eliminates one of the two options for corporate guarantors. Consequently, the only remaining option is to pay 1% of the guaranteed amount, which can amount to crores of rupees in the industry. While it may be argued that this superficially appears to bolster government revenue, this approach poses a severe threat to market investments.

The Government’s insistence on taxing corporate guarantees at 1% of the guaranteed amount, despite the RBI’s prohibition on charging consideration, is an overreach that undermines established legal principles and economic logic. It penalises companies for offering financial support to their subsidiaries, a standard business practice aimed at ensuring financial stability and growth. This tax burden is not justifiable as it ignores the reality that no actual economic benefit is derived in the absence of consideration and deters companies from engaging in legitimate financial transactions. It sends a conflicting message to the corporate sector, where compliance with one regulatory body (RBI) puts them at odds with another (GST authorities). This lack of coherence between regulatory frameworks not only complicates compliance but also prioritises short-term revenue gains over long-term economic stability and growth.

Conclusion

CBIC Circulars and Notifications serve as critical inputs in shaping business decisions, providing clarity and guidance on tax obligations and compliance requirements. These circulars influence how companies strategise their financial operations, including tax planning, risk management, and corporate structuring. A well-defined and predictable tax framework allows businesses to make informed decisions, ensuring operational stability and fostering investor confidence.

However, the recent CBIC Circulars, by broadening the scope of taxation on corporate guarantees, have introduced an element of unpredictability and financial burden that impacts investment decisions. By taxing the mere promise of a guarantee as a service, irrespective of actual economic benefit, these circulars create a disincentive for companies to offer guarantees to their own holding companies. This overarching tax approach not only strains corporate financial support mechanisms but also deters investors from engaging in standard financial practices essential for operational flexibility and growth.