A Division Bench of the Bombay High Court (‘High Court’) in M/S. DP Jain & Co Infrastructure Private Limited v Union of India (‘DP Jain case’) ruled that corporate guarantee, not accompanied by consideration, cannot be subjected to GST. And set aside the Revenue’s show cause notice issued to M/S DP Jain. The High Court’s primary reason was that M/S DP Jain had not received any money for providing corporate guarantee and in the absence of a consideration there cannot be a valid case for levying GST. The High Court relied on Supreme Court’s decision in Commissioner of CGST & Central Excise v Edelweiss Financial Services Ltd (‘Edelweiss Financial Services case’) wherein the Supreme Court had ruled that issuance of corporate guarantees without consideration was not a taxable service.
The High Court in relying on Edelweiss Financial Services case overlooked three crucial points: first, that the Edelweiss Financial Services case was decided in the context of service tax; second, that under the Central Goods and Services Act, 2017 (‘CGST Act, 2017’) certain supplies between related persons, even if without consideration, are taxable. Third, while the High Court – in its judgment – reproduces two of the Central Board of Indirect Taxes Circulars (‘CBIC Circulars’) relating to corporate guarantee, it does not examine them adequately. The Revenue invoked the CBIC Circulars to fortify its tax demand. However, the High Court did not give the CBIC Circulars or relevant provisions of the CGST Act, 2017 proper attention. I conclude that while the High Court’s judgment alleviates tax liability of M/S DP Jain, its reasoning does not withstand a considered scrutiny. And the judgment should be overturned in appeal.
Brief Facts and Arguments
M/S DP Jain was engaged in the business of construction of national and state highways through its various affiliated and subsidiary companies. Between 2020-2022, M/S DP Jain executed three corporate guarantees for the purpose of securing loans of its subsidiary companies. In each of the three deeds of corporate guarantees it was clearly stated that M/S DP Jain had not received and shall not receive any security, fee, commission or any other consideration from the borrower for providing a guarantee. Further, the legal charges incurred by M/S DP Jain for extending the corporate guarantees were shown in its account’s ledger.
The Revenue sent show cause notice to M/S DP Jain alleging that providing corporate guarantees was a taxable service under CGST Act, 2017. The Revenue inter alia relied on the CBIC Circular issued on 23 October 2023 which clearly mentioned that a holding company providing corporate guarantee to its subsidiary company for sanction of credit facilities to the latter – even if made without consideration – will be treated as supply of services. The value of such services was to be determined as per Rule 28(c) or Rule 28(2), CGST Rules, 2017 depending on the date on which the corporate guarantee was executed. While M/S DP Jain claimed that activity of providing corporate guarantee is not supply of goods and the Revenue has not examining relevant legal provisions of the CGST Act, 2017. M/S DP Jain alleged that the Revenue by ‘its own assumption’ has declared that providing corporate guarantee is a taxable supply of service. Also, M/S DP Jain argued that the notification of CBIC Circulars and Rule 28(2) be set aside for being ultra vires to the CGST Act, 2017.
Bombay High Court Misses a Beat
The High Court held that it is evident that M/S DP Jain is not in the business of providing corporate guarantee on a regular basis. And the three corporate guarantees were extended only to secure the loan of its subsidiary companies. The aim of corporate guarantees was to safeguard the financial health of its associate companies and provide them financial support. And M/S DP Jain does not extend corporate guarantees to its customers but only provides in-house support to its companies. The High Court though helpfully clarified that the Revenue is not making the case that the M/S DP Jain was in the business of extending corporate guarantees on a regular basis. However, the High Court did not agree with the Revenue’s contention that corporate guarantees extended without consideration can be subjected to GST. And the value of services can be determined as per Rule 28(c), CGST Rules, 2017.
The High Court cited Edelweiss Financial Services case which involved a similar issue. But overlooked that the case was decided under Finance Act, 1994 and involved levy of service tax. The issue in Edelweiss Financial Services case was whether extension of corporate guarantee without consideration amounted to banking and other financial service and was a taxable service. The Supreme Court endorsed the Commissioner’s and the CESAT findings which held that the entity extending corporate guarantee must receive either a monetary or a non-monetary consideration. And that there must be real provider of service in question for a service to constitute a taxable service. The Supreme Court added that consideration is a ‘recompense’ for the contractual undertaking that authorizes levy of service tax and that:
The above would suggest that this was a case where the assessee had not received any consideration while providing corporate guarantee to its group companies. No effort was made on behalf of the Revenue to assail the above finding or to demonstrate that issuance of corporate guarantee to group companies without consideration would be a taxable service. (para 7)
The Supreme Court in Edelweiss Financial Services case was right in insisting on presence of consideration and a real provider of service. So how and why did the High Court miss a beat in adjudicating the DP Jain case?
To begin with, the High Court did not even underline that the Edelweiss Financial Services case was adjudicated under the Finance Act, 1994 in relation to service tax. While the DP Jain case involved determining the levy of GST. And it is not a distinction without a difference as the relevant provisions of both legislations are different and scope of taxability is different. For example, Schedule I of the CGST Act, 2017 enlists activities that are to be treated as supply even if made without consideration. And Entry 2, Schedule I includes supply of goods or service made between related or distinct persons in the course or furtherance of business. Thus, Schedule I read with Section 7 certainly leads to the conclusion that providing corporate guarantees to subsidiary companies even without consideration amounts to supply.
Equally, the CBIC Circular issued in October 2023 explicitly covers the exact situation of a holding company providing corporate guarantee to a related company and mentions that:
Hence the activity of providing corporate guarantee by a holding company to the bank/financial institutions for securing credit facilities for its subsidiary company, even when made without any consideration, is also to be treated as a supply of service by holding company to the subsidiary company, being a related person, as per provisions of Schedule I of CGST Act. (para 2)
Prima facie the CBIC Circular is not ultra vires CGST Act, 2017. The High Court failed to properly scrutinize validity of the CBIC Circular or its contents. The para cited above clearly establishes that the corporate guarantees in question were subjected to GST. Only way to treat them beyond the scope of GST was to hold the Circular to be ultra vires. Instead, the High Court cited Edelweiss Financial Services case which did not apply provisions of the CGST Act, 2017.
We can argue that if extending corporate guarantees should be subjected to GST since it is a commonplace intra-group transaction and not a provision for service. But that is a policy issue and subject of a separate debate. In so far the law as it currently exists, Section 7 of the CGST Act, 2017 with Schedule I is clear that supply includes transactions between related persons, even if without consideration. However, the High Court’s narrow focus on Section 7 and Edelweiss Financial Services case did not permit it to consider that some supplies, even if without consideration, can be subjected to GST. And in this respect the provisions of CGST Act, 2017 may differ from Finance Act, 1994.
Finally, Rule 28(c) provided for valuation of all corporate guarantees and was applicable for all such transactions before 26 October 2023. CBIC Circular issued in July 2024 clarified that Rule 28(2) was applicable from 26 October 2023 onwards. The Revenue insisted on levying GST on 1% of the amount guaranteed as per Rule 28(c) while M/S DP Jain challenged the validity of Rule 28(2). Since the High Court held that providing a corporate guarantee was not a supply of service, the question of value of supply was rendered moot. But the High Court nonetheless refused accept M/S DP Jains’ plea that Rule 28(2) is ultra vires CGST Act, 2017. The High Court relied on the familiar doctrine of wide latitude to the legislature in taxation statutes and correctly rejected the challenge to Rule 28(2).
Conclusion
The High Court’s verdict in DP Jain case is an example of the bench putting on blinders and focusing on only one aspect of the issue. The lack of consideration in the transaction and one Supreme Court decision was enough to seal the fate of Revenue’s tax demand. All other aspects were duly cited but there was no meaningful engagement. For example, the judgment cites the relevant CBIC Circulars, ingredients of supply under Section 7, and Schedule I without meaningfully analyzing their scope and impact. Given the paucity of analysis in DP Jain case, the High Court’s verdict is unlikely to be – and ideally should not be – the last word on the issue. Levy of GST on corporate guarantees have been the subject of uncertainty and discomfort amongst taxpayers. And the policy of subjecting them to GST is questionable. DP Jain case adds another layer of contestation by deciding in favor of the taxpayer but by using weak and inchoate reasoning. It is worth noting that the judgments pronounced in service tax regime are not alien to GST, and I’ve made an argument elsewhere that service law jurisprudence can usefully inform the GST jurisprudence. But it requires nuanced appreciation of the distinct legal provisions of both legal regimes and not a blind reliance on judicial precedents without examining the underlying provisions.
