The Central Board of Indirect Taxes and Customs (CBIC) is likely to issue a circular in the coming months to clarify or change the “valuation” mechanism (methodology) for taxing corporate guarantees in a bid to provide relief to the industry, Moneycontrol has learnt from two government officials.
Many businesses across sectors, not all, are currently facing cash-flow issues because the 18 percent GST paid on these guarantees cannot be recovered via input tax credit (ITC) due to the nature of their business models – where the goods and services they supply are exempt from GST.
“Many companies have raised such concerns – which is limited to some business models. We’re working on it, and a circular will be issued soon,” an official from CBIC told Moneycontrol. The official didn’t clearly say what changes in the methodology will be made for taxing exempt supplies, but the attempt is to ensure no businesses are treated in “an unfair manner”.
Under the GST regime, businesses cannot claim ITC on goods or services used to make exempt supplies. And since there is no output tax to collect, they can’t claim ITC. As a result, the tax that some businesses pay on corporate guarantee is a pure cost for them.
Businesses engaged in renewable energy, healthcare, education, financial services are grappling with this issue at present – as a wide range of goods and services they produce are exempt from GST.
Corporate guarantee and tax rate
A corporate guarantee is a commitment, where a parent company steps in to back its subsidiary’s financial obligations, promising lenders to repay the debt if the subsidiary defaults. This corporate backing allows the subsidiary to secure large loans easily and lock in lower rates.
Under Indian law, GST is levied at 18 percent on these transactions. Even if the parent company provides this support for free, tax authorities mandate a fixed “deemed valuation” of 1 percent of the total guaranteed amount. This means, the company faces a mandatory 18 percent tax on that 1 percent value (say on Rs 100 of a Rs 10,000 guaranteed amount).
For most sectors, where ITC is available, the GST paid on corporate guarantee is recovered by the company. However, in some business models, where full ITC can’t be claimed, the GST paid on the deemed guarantee value is not fully recoverable.
“It becomes an actual cash cost rather than a pass-through credit. That’s why the debate goes well beyond whether corporate guarantees are taxable,” an tax expert explained. “The issue is whether a notional, non-cash, intra-group support arrangement should be assigned a statutory value that results in a genuine indirect tax cost for businesses with restricted ITC,” he added.
‘Some taxpayers are paying high cost’
The legal position is that a corporate guarantee provided by a director or a related person is treated as a supply under the GST law. “Since the issue was how such a supply should be valued for the purpose of levying GST. That is why a specific valuation mechanism was prescribed through the rules, under which 1 percent has been specified as the value of the supply,” explained the second government official.
The 1 percent valuation is a standard methodology, which was prescribed so that there is “certainty and uniformity in determining the taxable value”, the official explained.
“However, one argument being made is that the current deemed valuation of 1 percent may be on the higher side for certain taxpayers, particularly where the recipient is not in a position to fully utilise the input tax credit (ITC). In such cases, the GST paid on corporate guarantees can translate into an additional tax cost,” said the second official.
Tax experts say similar concerns also arise for businesses operating under an inverted duty structure. “Such businesses are unable to fully utilise the ITC of the GST paid on corporate guarantees, leading to accumulation of ITC and consequent working capital blockage,” another tax expert said.
“Although the government provides refunds of GST paid on ‘inputs’ for businesses operating under an inverted duty structure, refunds of GST paid on ‘input services’ are not available,” he added.
