GST on Personal and Corporate Guarantee Provided by Related Persons

Understand the implications of GST on Personal and Corporate Guarantees, including treatment under CGST Act, related person provisions, Rule 28(2), and key CBIC circulars. A simple guide to GST on personal and corporate guarantee transactions.

Why Personal and Corporate Guarantee Is Chargeable to Tax – GST Council’s Decision

Many times, a director, partner, or proprietor gives a personal guarantee to the bank or financial institution when the business applies for a loan. This means the person promises to repay the loan if the business cannot. In most of these cases, the person does not charge any fee or commission for giving the guarantee. This raised a question: Is GST applicable on such personal guarantees given without any payment?

To address this confusion, the issue was discussed in the 52nd GST Council Meeting held on 7th October 2023. The Council observed that there was no uniform practice across the country, and some tax officers were issuing notices demanding GST even when no money was paid for such guarantees.

To solve this, the Council recommended that a detailed clarification should be issued by CBIC. The Council also approved a new provision to be added in the rules — Rule 28(2) — to determine the value of corporate guarantees between related parties. The idea was to ensure clear treatment under GST law for both personal and corporate guarantees.

Following this meeting, the Government issued Circular No. 204/16/2023-GST dated 27th October 2023, which clarified when GST would apply on personal guarantees and how the value would be determined. The same circular also explained how GST will apply on corporate guarantees, even if no fee is paid.

Definition of Supply under GST in relation to Personal and Corporate Guarantee

To understand why GST may apply to a personal or corporate guarantee, we first need to understand the meaning of the word “supply” under the GST law.

The term “supply” is very important in GST. If something is considered a supply, then GST may be charged on it. The definition of supply is given in Section 7 of the CGST Act, 2017. It includes all forms of supply of goods or services such as sale, transfer, barter, exchange, license, rental, lease, or disposal made or agreed to be made for a consideration in the course or furtherance of business.

But that’s not all. The law also says that even if there is no consideration (i.e., no payment), some transactions may still be treated as supply. This is covered under Section 7(1)(c), which refers to Schedule I of the Act.

Below is the verbatim provision from Schedule I:

Schedule I – Activities to be treated as supply even if made without consideration

 Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business:

 Provided that gifts not exceeding fifty thousand rupees in value in a financial year by an employer to an employee shall not be treated as supply of goods or services or both.

This means that if two related persons carry out a transaction in the course of business, it will be treated as a taxable supply even if no money is paid. So, when a director gives a personal guarantee to a company’s bank without charging any fee, the law may still treat it as a supply because they are related persons.

In summary, the definition of supply under GST is very wide and includes free services between related persons, which is why personal and corporate guarantees can fall under GST, even when no fee is charged.

Definition of Related Persons under GST

Now that we understand the definition of supply, let’s look at who are considered related persons under GST. This is important because, as we saw in the last section, transactions between related persons are treated as supply, even if there is no consideration (no payment involved).

The definition of “related persons” is given in the Explanation to Section 15 of the CGST Act, 2017. Below is the exact wording from the law:

Explanation.– For the purposes of this Act,–

 (a) persons shall be deemed to be “related persons” if–

 (i) such persons are officers or directors of one another’s businesses;

(ii) such persons are legally recognised partners in business;

(iii) such persons are employer and employee;

(iv) any person directly or indirectly owns, controls or holds twenty-five per cent. or more of the outstanding voting stock or shares of both of them;

(v) one of them directly or indirectly controls the other;

(vi) both of them are directly or indirectly controlled by a third person;

(vii) together they directly or indirectly control a third person; or

(viii) they are members of the same family;

(b) the term “person” also includes legal persons;

 (c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, however described, of the other, shall be deemed to be related.

This means that a director and the company, or partners of an LLP or firm, or a holding company and its subsidiary, all fall under the definition of related persons.

So, if one related person provides a service to another — like giving a personal or corporate guarantee — it is treated as a supply, even if no fee is charged. This is why the relationship between the parties is key when determining whether GST applies.

Personal Guarantee by Proprietor / Partner / Director to the Firm / LLP / Company

In many businesses, especially in MSMEs and closely-held companies, the owners or key persons often give personal guarantees to help the business get loans or credit facilities. These personal guarantees are usually given by:

• A proprietor, for a proprietorship firm (though in law, they are the same person).
• A partner, for a partnership firm or LLP.
• A director, for a private or public limited company.

Now, let’s understand how these personal guarantees are treated under GST:

Personal Guarantee by Proprietor for his Firm

In the case of a proprietorship, the proprietor and the business are not separate legal entities. Therefore, when a proprietor gives a personal guarantee for his own business, it is not a transaction between two persons. Hence, it is not considered a supply under GST, and no GST is applicable.

Personal Guarantee by Partner for his Firm or LLP

In an LLP or partnership firm, the partner and the firm are legally separate. As per GST law, a partner and the LLP are related persons. So, if a partner gives a personal guarantee to the bank for a loan taken by the LLP or partnership firm, it is considered a supply between related persons under Schedule I of the CGST Act.

Personal Guarantee by Director or Shareholder for his Company

In the case of a company, the director and the company are also treated as related persons under GST. So, when a director gives a personal guarantee for a company loan, this too is a supply between related persons, even if done without payment.

All these transactions — whether a guarantee is given by a partner to a firm, a director to a company, or even a corporate entity to another related company — fall under the definition of “supply” as per Section 7 read with Schedule I of the CGST Act. This is because they involve related persons and are made in the course or furtherance of business. However, the main question is not whether GST applies, but rather — on what value should GST be paid? This is where the valuation rules, RBI guidelines, and CBIC circulars come into play, which we will now discuss in the next sections.

Rule 28(2) of the GST Rules – Valuation of Guarantees between related persons

To decide the value on which GST should be charged when a service is provided between related persons (like a corporate guarantee by a holding company to its subsidiary), the law refers to Rule 28 of the CGST Rules, 2017. This rule tells us how to calculate the value of supply when the supplier and the recipient are related, and no open market price is available.

Here is the verbatim text of Rule 28(2), which was inserted specifically to deal with corporate guarantees:

“(2) Notwithstanding anything contained in sub-rule (1), the value of supply of services by a supplier to a recipient who is a related person, by way of providing corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be one per cent of the amount of such guarantee offered per annum, or the actual consideration, whichever is higher:

Provided that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the value of said supply of services.”*

This means that even if no fee is charged, the value of a corporate guarantee between related companies will be 1% of the guaranteed amount per year or the actual amount received — whichever is more. This provision applies even if the receiving company can claim full input tax credit.

It is important to note that this sub-rule applies only to corporate guarantees and not to personal guarantees given by directors, partners, or promoters — which are covered under the CBIC circular and valued differently.

CBIC Circular No 204/16/2023 dated 27-10-2023 – Clarifying the GST Treatment

To remove confusion among taxpayers and tax officers, the Central Board of Indirect Taxes and Customs (CBIC) issued a detailed clarification through Circular No. 204/16/2023-GST dated 27th October 2023. This circular clearly explains how GST applies to personal guarantees and corporate guarantees, especially when they are given between related persons.

Personal Guarantee by Director

The circular confirms that when a director gives a personal guarantee to a bank or financial institution for a company’s loan, it is treated as a supply of service under GST. This is because the director and company are related persons under the law. However, the circular also explains that if no fee, commission, or benefit is received by the director for giving such a guarantee, then:

• The transaction has no open market value, and
• The taxable value of the supply is treated as zero.

So, no GST is payable in such cases.

The circular also refers to RBI guidelines that say no payment should be made to the director for giving a personal guarantee. This supports the view that such transactions have no value for GST purposes.

What If the Director Is Paid?

The circular clarifies that if the director receives any payment — whether directly or indirectly — for giving the guarantee, then GST will apply. In such cases, the taxable value will be the actual consideration received by the director.

Corporate Guarantees

The circular also covers cases where a holding company or any related company provides a corporate guarantee for a loan taken by another company. It confirms that such guarantees are also treated as supply of service between related persons. However, the valuation of these transactions is governed by a special rule — Rule 28(2) of the CGST Rules, which we will discuss in further in next section of this article.

In summary, the CBIC circular makes it clear: Personal guarantees without any payment are not taxable under GST, but if any amount is received, GST is payable on that value. For corporate guarantees, special valuation rules apply even if no fee is charged.

RBI Guidelines and Rules – Their Role in GST Treatment

When it comes to personal guarantees given by directors or promoters for loans taken by a company, the Reserve Bank of India (RBI) has issued clear instructions to banks. These guidelines play an important role in determining whether any consideration (payment) is involved in such guarantees — which is the key point in deciding GST applicability.

The relevant RBI instruction is given in Para 2.2.9 of Circular No. RBI/2021-22/121 dated 9th November 2021. It deals with how and when banks can take personal guarantees from promoters, directors, and managerial personnel. The key portion is quoted verbatim below:

“Where personal guarantees of directors are warranted, they should bear reasonable proportion to the estimated worth of the person. The system of obtaining guarantees should not be used by the directors and other managerial personnel as a source of income from the company. Banks should obtain an undertaking from the borrowing company as well as the guarantors that no consideration whether by way of commission, brokerage fees or any other form, would be paid by the former or received by the latter, directly or indirectly.”

This means that banks must ensure that directors do not receive any payment — either directly or indirectly — for giving personal guarantees. The borrowing company must also give an undertaking confirming this.

Because of this RBI rule, the CBIC circular rightly concludes that where no consideration is permitted under RBI’s own guidelines, there is no open market value for such a transaction under GST either. Hence, in such cases, the value of the guarantee is treated as zero, and no GST is payable.

However, in exceptional cases — like when a director is no longer associated with the company but continues the guarantee, or if the director receives any fee or benefit — then GST will apply, and the taxable value will be based on the amount received.

In summary, the RBI’s restriction on payment for personal guarantees supports the GST position that such guarantees — when given without consideration — should not attract tax, since the taxable value is nil.

GST on Inter-Corporate Guarantees

In the business world, it is common for one company — usually a holding company — to provide a corporate guarantee to the bank for a loan taken by its subsidiary or another related company. Even though no money may be exchanged between the two companies, this kind of arrangement is now clearly taxable under GST.

As per the CBIC Circular No. 204/16/2023-GST dated 27th October 2023., when one related company gives a corporate guarantee to a bank or financial institution for another related company, it is considered a supply of service under GST. This is because both companies fall under the definition of related persons as per Section 15 of the CGST Act.

Earlier, there was confusion on how to value such services when no fee was paid. To address this, the government introduced a new rule — Rule 28(2) of the CGST Rules, inserted via Notification No. 52/2023-Central Tax dated 26th October 2023. This rule sets a minimum taxable value for such corporate guarantees, even if they are given free of cost.

Rule 28(2) – the Valuation of Inter Corporate Guratantee for GST Purpose

As per rule 28(2);

“… the value of supply of services by way of providing corporate guarantee shall be deemed to be one per cent of the amount of such guarantee offered per annum, or the actual consideration, whichever is higher.”

So, for example, if a holding company gives a guarantee of ₹10 crore for its subsidiary, then GST will be payable on at least ₹10 lakh (1% of ₹10 crore) per year — even if the subsidiary does not pay anything to the holding company.

It is important to note that this rule does not apply to personal guarantees given by directors or partners. It is only applicable to corporate guarantees given between related companies or group entities.

Thus inter-corporate guarantees are always taxable under GST, and the value is calculated using the 1% rule under Rule 28(2), even when no fee is charged. Businesses must keep this in mind while structuring loans and financial guarantees within group companies.

Importance of Proviso to Rule 28(2)

While Rule 28(2) sets a deemed value of 1% of the guaranteed amount per annum (or the actual consideration, whichever is higher) for corporate guarantees between related persons, there is also an important proviso added to the rule. This proviso offers some relief to taxpayers in certain cases. It reads as follows:

 “Provided that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the value of said supply of services.”

This means that if the company receiving the guarantee can claim full input tax credit (ITC), then the value declared on the invoice — even if it is lower than 1% — will be accepted as the taxable value under GST. This is a beneficial provision, as it gives flexibility to related parties to charge a lower value for GST purposes, as long as there is no loss to the government (since the recipient will fully offset the tax through ITC).

However, if no invoice is issued, or the recipient is not eligible for full ITC, then the 1% valuation rule will apply strictly. Hence, companies should ensure proper documentation and invoicing if they wish to take benefit of this proviso.

CBIC Circular No 225/19/2024 dated 11-07-2024– Additional Clarifications on Corporate Guarantees

The CBIC has also issued Circular No. 225/19/2024-GST dated 11th July 2024, which provides further clarifications on various practical situations involving corporate guarantees, such as valuation in case of partial disbursement, treatment of loan takeovers, co-guarantor arrangements, and more. Readers may refer to this circular for a more detailed understanding of how GST applies in different scenarios relating to corporate guarantees.

To Sum Up

The GST law clearly brings both personal and corporate guarantees within the scope of “supply” when given between related persons. However, the tax treatment depends on whether any consideration is involved and the nature of the guarantee. While personal guarantees given without payment are not taxable, corporate guarantees between related companies are taxable even if given free of cost, based on a deemed value. With the latest CBIC circular and changes in Rule 28(2), businesses must now carefully evaluate their guarantee arrangements to ensure proper compliance with GST provisions.