- Torrent Power ruling upholds GST levy on corporate guarantees but reads down “whichever is higher” under Rule 28(2)
- Pre-October 26, 2023 guarantees get crucial relief as Court holds 1% valuation cannot be imposed retrospectively
- Verdict could reshape GST exposure for infrastructure, real estate and utilities companies while setting the stage for a Supreme Court battle
NE LAW & BUSINESS BUREAU
AHMEDABAD, AUG 26
A corporate guarantee may never be called upon, may carry no fee and may simply be a parent company standing behind its subsidiary — but under GST, that assurance can still become a taxable event. The Gujarat High Court has now drawn an important line: the levy survives, but the taxman cannot mechanically impose a 1% valuation floor in every case or travel backwards to tax guarantees furnished before the rule came into force.
In a significant ruling with potentially wide ramifications for corporate groups, the Gujarat High Court, in its August 14 judgment in Torrent Power Ltd. v. Union of India, upheld the constitutional validity of the GST framework governing corporate guarantees while simultaneously reading down a crucial part of Rule 28(2) of the CGST Rules.
The Court held that furnishing a corporate guarantee between related parties can constitute a taxable supply of service under the GST regime, even where no consideration is charged. At the same time, it found the expression “whichever is higher” in Rule 28(2) arbitrary and read it down, thereby providing an important opening for businesses where actual consideration is lower than the prescribed 1% benchmark.
For businesses that had furnished corporate guarantees before October 26, 2023, the ruling carries an even more significant consequence: the Gujarat High Court held that the 1% levy under Rule 28(2) cannot be imposed retrospectively for the pre-rule period.
A mixed verdict for corporate India
Ranjeet Mahtani, Partner, Dhruva Advisors, described the judgment as a “mixed bag of outcomes”, noting that the challenge had enabled the Court to undertake an extensive examination involving contract law, transfer-pricing principles and constitutional questions.
“The challenge to the provisions concerning levy of GST and valuation of corporate guarantees before the Gujarat High Court enabled it to undertake a deep-dive analysis covering branches of contract law, transfer pricing principles and the Constitutional aspects. The resultant judgment in Torrent Power is a mixed bag of outcomes.”
The first major takeaway, according to Mahtani, is that the Court rebuffed the challenge to taxability, holding that corporate guarantees constitute a taxable supply of service under GST, with the borrowing subsidiary or group entity treated as the recipient.
The Court distinguished the Supreme Court’s ruling in Edelweiss Financial Services, which dealt with the pre-GST service-tax regime, by pointing to the GST law’s deeming mechanism for specified related-party transactions even in the absence of consideration. The Gujarat High Court also declined to apply OECD transfer-pricing principles concerning shareholder activities, holding that providing corporate guarantees could be regarded as an activity undertaken in the course or furtherance of business.
The constitutional challenge to Section 15(4) and Rule 28(2) was consequently rejected, subject to the Court’s important qualification on valuation.
The 1% rule gets a judicial haircut
This is where the judgment provides a significant silver lining for taxpayers.
Under Rule 28(2), the value of the supply involving a corporate guarantee had been pegged at 1% of the amount of the guarantee per annum or the actual consideration, whichever is higher.
The Court upheld the basic valuation mechanism but found the expression “whichever is higher” problematic and read it down. This means the mandatory application of the higher of actual consideration or 1% cannot survive in its original form.
Mahtani said this could give businesses an important basis for benchmarking their transactions and charging actual consideration where the benchmarked amount is below the 1% prescribed figure.
“The first silver lining for the taxpayer is that the Court, by applying the Wipro principle, read down Rule 28(2)’s mandatory 1% floor value, wherever actual consideration exists. This creates the plank for businesses to benchmark transactions and charge actual consideration, where such benchmark value is lower than the 1% prescribed in law.”
The judgment also recognised that the corporate-guarantee valuation mechanism operates on a continuing basis. The Court observed that where a guarantee continues across financial years, valuation is linked to the amount of the guarantee subsisting in each year rather than treating the entire multi-year guarantee as a single lump-sum taxable event.
October 26, 2023 becomes the crucial date
For companies facing demands relating to guarantees issued before the introduction of Rule 28(2), the ruling could prove particularly consequential.
Rule 28(2) was introduced with effect from October 26, 2023. The Gujarat High Court held that the 1% valuation mechanism cannot be retrospectively applied to corporate guarantees furnished before that date. However, where a guarantee continues beyond October 26, 2023, the levy can become applicable from that date in accordance with the Court’s interpretation.
“It is equally crucial that Rule 28(2) is declared as prospective in nature; this implies GST demands on corporate guarantees given prior to October 26, 2023, are legally unsustainable, at this point in time.”
The Court’s conclusion specifically held that the levy under Rule 28(2) on corporate guarantees furnished prior to October 26, 2023 violates Articles 14 and 19(1)(g), while allowing the levy to operate from October 26, 2023 where such guarantees continue.
Why corporate India will be watching the next move
The ramifications extend well beyond the parties before the Court.
Corporate guarantees are widely used by parent companies to facilitate financing for subsidiaries, particularly across infrastructure, power, utilities, real estate and other capital-intensive sectors. The Gujarat ruling therefore has the potential to influence tax positions, compliance strategies and ongoing litigation across multiple industries.
The decision also leaves several larger questions open for consideration at the next judicial level, particularly because similar disputes have surfaced before courts in different jurisdictions.
Mahtani expects the battle to move further.
“This battle will likely move to the Supreme Court, given the footprint of this topic across India as also variety of sectors it covers, pending writ petitions in various High Courts, and the verdict from the Bombay High Court in D.P. Jain’s case.”
For taxpayers, however, the immediate outcome offers some breathing space.
“Nonetheless, taxpayers, especially in the infrastructure, real estate, utilities space will heave a sigh of relief with the pair of favourable outcomes.”
The Gujarat High Court’s judgment therefore does not dismantle GST on corporate guarantees. Instead, it creates a more nuanced framework: taxability survives, the automatic 1% higher-value rule does not, and the clock cannot be turned back to impose Rule 28(2) on pre-October 26, 2023 guarantees.
For corporate India, the next question is no longer simply whether a guarantee is taxable.
It is how much can legitimately be taxed — and from when?
