(First published on Linkedin)
Corporate guarantees play a crucial role in intra-group financial arrangements, helping subsidiaries and group companies secure credit facilities. However, a GST circular classifying these guarantees as taxable supplies, despite the lack of monetary consideration, has created complexities, particularly in valuation. The recent stay by the Bombay High Court on this circular brings a welcome relief.
While corporate guarantees have garnered sufficient attention from a GST perspective, the implications stretch far beyond GST; income Tax, the Companies Act, SEBI, FEMA, IndAS, and IBC also bring different perspectives to how corporate guarantees are treated.
Key Takeaways:
1. Income Tax:
– Domestic Taxation: Can corporate guarantees be treated as a non-monetary benefit under Section 28(iv) and taxed on a notional basis in the hands of the beneficiary company? Although reliance on corporate guarantees could be considered ‘in the course of business,’ it should not be construed as ‘arising from business,’ which is a key requirement for triggering Section 28(iv). Therefore, notional benefits from corporate guarantees should ideally fall outside the scope of taxation.
– Transfer Pricing: However, in case of cross-border transactions, guarantees so provided fall under the ambit of Section 92B and must be benchmarked at arm’s length. The valuation could include considerations like implicit credit rating differentials or market rates for guarantee commissions.
2. FEMA: For guarantees provided by an Indian company to overseas subsidiaries, the Indian company must have ‘control,’ defined as at least 10% voting rights in the subsidiary. Additionally, such guarantees are counted toward the 400% net worth cap. Corporate guarantees may also be issued in favor of overseas lenders or security trustees for ECBs availed by Indian borrowers.
3. Companies Act, 2013: Under Section 186, the provision of guarantees is subject to limits and requires prior approval of the board and, in certain cases, shareholders.
4. SEBI LODR Regulations: Corporate guarantees, being financial transactions involving the transfer of obligations without monetary consideration, may qualify as related party transactions. This necessitates board and audit committee approvals, and if materiality thresholds are breached, shareholder approval. Disclosures under R. 30 would also be necessitated.
5. IndAS: IndAS 109 classifies corporate guarantees as financial guarantees, requiring fair value recognition in the books of the issuing company. Changes in credit risk or recoverability may lead to re-measurement and corresponding adjustments in the P&L.
6. IBC Implications: Once the corporate guarantee is invoked, the guarantor would step into the shoes of the borrower, and therefore, be subject to recovery under the IBC proceedings, if so invoked by the creditors.