GST Crisis or Solution? Govt Steps In To Fix Valuation of Corporate Guarantees Amid Cash Flow Woes

GST Crisis or Solution? Govt Steps In To Fix Valuation of Corporate Guarantees Amid Cash Flow Woes​

The government is reportedly planning a significant review of the GST valuation mechanism applied to corporate guarantees. The Central Board of Indirect Taxes and Customs (CBIC) officials are anticipated to issue a circular in the near future aiming to provide relief to industries currently grappling with cash-flow constraints linked to these financial commitments.

Businesses across various sectors are facing severe difficulties because they cannot utilize input tax credit (ITC) against the 18 percent GST paid on corporate guarantees. This predicament is acutely felt by companies whose business models involve supplies that are exempt from GST, rendering the paid tax a non-recoverable cost.

Understanding Corporate Guarantees and Tax Mandates​

A corporate guarantee involves a parent company committing to back its subsidiary’s financial obligations in the event of default. This backing allows the borrowing entity to secure substantial loans and achieve favorable interest rates.

Under Indian law, GST is levied at 18 percent on these specific transactions. Even if the parent provides this assurance free, tax authorities mandate a fixed "deemed valuation" of 1 percent of the total guaranteed amount. Consequently, the company faces a mandatory 18 percent tax calculation on that prescribed 1 percent value.

The Core Cash Flow Dilemma for Exempt Suppliers​

For most sectors where ITC is available, the GST paid on corporate guarantees can be recovered by the company. However, in certain business models, this credit cannot be claimed, meaning the tax transforms from a credit into an actual cash cost.

Businesses in renewable energy, healthcare, education, and financial services are particularly affected as they produce goods and services exempt from GST. Brijesh Kothary, Partner at Khaitan &Co., explained that "It becomes an actual cash cost rather than a pass-through credit." This points to the debate going beyond whether corporate guarantees are taxable.

The Deemed Valuation Mechanism Explained​

The legal position dictates that a guarantee provided by a director or related person is treated as a supply under GST law. A specific valuation mechanism was therefore prescribed through rules, mandating 1 percent of the guaranteed amount as the value for levying GST.

One government official stated that this 1 percent valuation is a standard methodology intended to ensure "certainty and uniformity in determining the taxable value." However, officials have also acknowledged concerns that the current deemed valuation may be excessively high for certain taxpayers unable to fully utilize ITC.

Broader Impact on Inverted Duty Structures​

Tax experts indicate that similar financial difficulties exist for businesses operating under an inverted duty structure. Rahul Shekhar, Partner - Indirect Tax at Nangia Global, noted that such entities struggle to utilize the input tax credit (ITC) from the GST paid on corporate guarantees.

While the government offers refunds for GST paid on 'inputs' in these scenarios, he added, "refunds of GST paid on 'input services' are not available." This accumulation of non-recoverable taxes leads directly to working capital blockage for affected businesses.