Gujarat High Court Declares Pre-October 2023 GST Levy On Related Persons' Corporate Guarantees Unconstitutional

The Gujarat High Court has declared unconstitutional the levy of GST on corporate guarantees furnished by one related company on behalf of another before October 26, 2023, holding that the retrospective levy violates fundamental rights.

However, the court held that GST can be levied from that date where such corporate guarantees continue.

While upholding the constitutionality of Rule 28(2) of the CGST Rules read it down by removing the expression “whichever is higher” from the prescribed valuation mechanism.

A Division Bench comprising Justice A.S. Supehia and Justice Vaibhavi D. Nanavati held that the retrospective levy was harsh and unfair to taxpayers who had arranged their financial affairs under the law prevailing when the guarantees were furnished.

The court ruled, “The levy of GST on the corporate guarantee furnished prior 26th October, 2023 under Rule 28(2) is declared violative of Article 14 and 19(1)(g) of the Constitution of India, however, levy gets attracted from this date in case the guarantees continue.”

The batch of petitions was filed by holding companies that had furnished corporate guarantees in favour of their subsidiaries. The guarantees in the cases had been furnished before October 26, 2023, when the valuation rule at issue came into force.

The petitioners challenged the levy of GST on such guarantees, along with the relevant provisions of the Central Goods and Services Tax Act, the valuation rule and CBIC circulars dated October 27, 2023 and July 11, 2024.

The petitioners argued that corporate guarantees furnished without consideration did not constitute taxable supplies. They also challenged the 1% valuation mechanism, contending that it could result in GST being imposed on a value higher than the actual charge or commission. They further opposed the Revenue's attempt to apply the valuation mechanism to guarantees furnished before it came into force.

The court rejected the challenge to the basic taxability of corporate guarantees. It held that the GST framework treats corporate guarantees between related persons as taxable supplies even where no consideration is received. The court noted that this was different from the earlier service tax regime, under which the absence of consideration meant that corporate guarantees escaped the levy.

The petitioners had also challenged Section 15(4) of the GST Acts, which provides the framework for determining the value of supplies between related persons. The court upheld the provision as constitutionally valid. This means the statutory basis for valuing related-party transactions remains in place, even though the court has separately read down part of the valuation mechanism applicable to corporate guarantees.

On the retrospective levy, however, the court found that the valuation mechanism was being applied to a period when no such levy existed under the law. It held that taxpayers had arranged their financial affairs according to the law prevailing when the guarantees were furnished.

"Rule 28(2) imposes a retrospective levy of a new tax for the period during which no levy existed as per the law. The taxable event as previously discussed resulting into in levy travels back to pre-GST era. The retroactive effect impinges the fundamental rights under Article 14 and 19(1)(g), since the levy is unduly harsh and unfair, as taxpayers arrange their financial affairs based on the prevailing law. It imposes an unexpected financial burden without any fault on the assessee, disrupts settled legal and financial implication, more particularly when the corporate guarantee, may stretch for long period of time. Thus, the imposition of levy of GST on 1% valuation per annum to the corporate guarantee prior to the introduction of Rule 28(2) of the CGST Rules w.e.f 26.10.2023 is harsh and unfair to the tax payers. The collection of tax for the period prior to introduction of Rule 28(2), will also be hit by the doctrine of unjust enrichment, since the revenue had no legal basis or authority to levy GST on corporate guarantee, which were executed prior to the date of introduction. However, the levy is permissible, if the period crosses the date of introduction of Rule 28(2), as the taxable event occurs every years as previously discussed", it ruled.

The court nevertheless clarified that where a corporate guarantee continued beyond October 26, 2023, the GST levy would apply from that date. The court treated the taxable event as recurring in relation to guarantees that continued after the rule came into force.

The court separately examined the valuation mechanism, which prescribed 1% of the guarantee amount or the actual consideration, whichever was higher. It noted that the actual charge or commission on corporate guarantees in the cases before it ranged from 0.25% to 0.3%.

The court held that the expression “whichever is higher” was arbitrary and contrary to Articles 14 and 19(1)(g). It did not strike down the entire rule. Instead, it read down those words, holding that the valuation could be determined on the basis of actual consideration or 1%.

The court also considered the Revenue's action under Section 74 of the Central Goods and Services Tax Act. Section 74 provides for recovery of tax where the department alleges fraud, willful misstatement, or suppression of facts with an intention to evade tax.

The court quashed the impugned action taken against the petitioners and directed that any excess GST deposited be refunded. It also permitted the parties to adjust the amount if they so desired.

In the case of Torrent Power, the court examined a corporate guarantee accompanied by an agreement pledging shares. It found that the pledge secured the subsidiary's obligations and permitted appropriation of the pledged shares upon default. The court held that the arrangement satisfied the relevant provisions of the Contract Act and constituted a supply of services attracting GST under the valuation rule.

The court observed, “Thus, the execution of the recitals of the agreement of pledging of shares along with the corporate guarantee is a supply of services attracting levy of 1% of valuation under Rule 28(2) of the CGST Rules.”

The court further set aside the CBIC circulars dated October 27, 2023 and July 11, 2024 to the extent that they ran contrary to its findings. It permitted the Revenue to issue fresh circulars or administrative instructions in accordance with the judgment and directed that its directions be implemented within three months.

For Petitioners: Senior Advocates and Advocates appearing for the respective petitioners, including Dhaval Shah and Dhinal Shah

For Revenue: N. Venkatraman, Additional Solicitor General, with Ankit Shah, Utkarsh R. Sharma, Tirth Nayak, Shashvat Shukla, Hetal Patel,.Hetvi Sancheti and Mr. Deepak Khanchandani, Senior Standing Counsel; along with other advocates for the respective respondents