Corporate Guarantees Under GST: Taxability Survives, Arbitrary Valuation Does Not

A Long Judgment With a Clear Commercial Impact

The Gujarat High Court judgment in Torrent Power Ltd Versus Union Of India & Ors. - 2026 (8) TMI 990 - GUJARAT HIGH COURT, is among the most significant GST rulings on corporate guarantees. As reported in VIL, the judgment runs to 141 pages, including headnotes, while the original judgment copy runs to 148 pages. The length itself reflects the depth of the controversy. The Court had to examine the nature of a corporate guarantee, the scope of supply under GST, the role of related-party deeming provisions, the valuation machinery under Rule 28(2), the validity of a retroactive levy, and the use of Section 74 in a highly debatable interpretative matter.

The issue was not confined to one company or one notice. It affected a large number of corporate groups where holding companies issue guarantees to banks or financial institutions for loans taken by subsidiaries. In ordinary commercial language, such guarantees are often seen as group support or shareholder comfort. In GST law, however, the question becomes more technical: whether such support is a taxable supply, whether the absence of consideration matters, how value should be determined, and whether a demand can be raised for past periods.

The Gujarat High Court has answered these questions in a balanced manner. It has not accepted the taxpayers' argument that a corporate guarantee is entirely outside GST. At the same time, it has not accepted the Department's attempt to apply Rule 28(2) mechanically and harshly. The result is a judgment that upholds the taxability framework while controlling its arbitrary application.

GST Taxes Supply, Not Merely Consideration

The first major question was whether a corporate guarantee without consideration constitutes a supply. The petitioners argued that there was no consideration, commission, fee, or independent service. They relied on the Service Tax position, particularly the principle in Commissioner of CGST And Central Excise Versus M/s Edelweiss Financial Services Ltd. - 2023 (4) TMI 170 - SC Order, where a corporate guarantee without consideration was not taxed under the Service Tax regime.

The Gujarat High Court distinguished this argument by pointing to the structural difference between Service Tax and GST. Under the Service Tax regime, Section 65B(44) of the Finance Act, 1994 required an activity to be for consideration. Therefore, if a corporate guarantee was issued without consideration, the service itself was not taxable. GST is different because Section 7(1)(c) of the CGST Act specifically includes activities specified in Schedule I, even when made without consideration.

Entry 2 of Schedule I covers the supply of goods or services, or both, between related persons or distinct persons, when made in the course or furtherance of business. Therefore, under GST, the absence of consideration is not always decisive. Once the transaction falls within Schedule I, the law can treat it as a supply even without consideration. This is the first major departure from the Service Tax position.

Corporate Guarantee Was Treated as a Supply Between Related Persons

The Court examined the legal structure of a corporate guarantee under the Indian Contract Act, 1872. Under Section 126, a contract of guarantee is one to perform the promise or discharge the liability of a third person in case of default. The holding company is the surety, the subsidiary is the principal debtor, and the bank or financial institution is the creditor.

The Court also considered Sections 127, 140 and 145 of the Contract Act. Section 127 provides that anything done or any promise made for the benefit of the principal debtor may be sufficient consideration for the surety's guarantee. Section 140 addresses the surety's right of subrogation after payment. Section 145 recognises the principal debtor's implied promise to indemnify the surety. These provisions helped the Court conclude that the guarantee is not a meaningless internal comfort. It has legal consequences.

The benefit of the guarantee ultimately goes to the subsidiary, which obtains credit support. The holding company undertakes a legal obligation for the subsidiary's benefit. On that basis, the Court held that the arrangement can be treated as a supply of service between related persons under Section 7(1)(c) read with Schedule I.

The Business Test Was Applied Broadly

The petitioners argued that issuing guarantees was not their core business. They were not banks or financial institutions. Accordingly, they contended that the guarantee could not be treated as a supply made in the course or furtherance of business.

The Court rejected this narrow approach by referring to the wide definition of "business" under Section 2(17) of the CGST Act. The definition includes trade, commerce, manufacture, profession, vocation, adventure, wager or similar activity, whether or not for pecuniary benefit. It also includes activities incidental or ancillary to such activities. Importantly, the definition does not require volume, frequency, continuity or regularity.

A holding company may not be in the business of lending. However, when it supports its subsidiary by giving a guarantee to enable finance, the act is connected with the group's commercial interest. It protects the holding company's investment and facilitates the subsidiary's business activity. Accordingly, the activity was held to be in the course or furtherance of business.

Schedule II Classified the Supply as a Service

The Court also addressed Schedule II. This is important because Schedule II does not, by itself, create supply. It only classifies an activity as a supply of goods or a supply of services once the activity first qualifies as supply under Section 7(1). This principle has already been recognised in several GST disputes.

After holding that a corporate guarantee can fall within Section 7(1)(c) read with Schedule I, the Court examined Entry 5(e) of Schedule II. This entry treats agreeing to the obligation to refrain from an act, to tolerate an act or a situation, or to do an act as a supply of service. A corporate guarantee involves an agreement by the holding company to undertake an obligation in case the subsidiary defaults. Therefore, it could be classified as a supply of service.

The Court also considered Section 2(93), which defines "recipient". Where no consideration is payable for a supply of service, the recipient is the person to whom the service is rendered. Even though the subsidiary may not be a direct party to the guarantee contract between the holding company and the bank, the benefit of the guarantee is rendered to the subsidiary. Thus, the subsidiary was treated as the recipient.

Actionable Claim and Shareholder Activity Arguments Did Not Succeed

The petitioners also argued that a corporate guarantee is an actionable claim or shareholder activity. This was an attempt to bring the transaction outside the GST net, particularly by invoking Schedule III and the concept of actionable claim.

The Court rejected this argument. An actionable claim under Section 2(1) of the CGST Act derives its meaning from Section 3 of the Transfer of Property Act, 1882. A corporate guarantee is a contingent secondary obligation of a surety. It is not the same as a transferable claim to an unsecured debt or a beneficial interest in movable property. The Court also distinguished between a pledge and a guarantee. A pledge is the bailment of goods as security, while a guarantee is a promise to discharge another person's liability in case of default.

The shareholder-activity argument, based on transfer pricing or Organisation for Economic Co-operation and Development (OECD) material, also did not control the GST analysis. GST is governed by its own statutory language. If the CGST Act treats certain related-party supplies without consideration as taxable, income-tax or transfer-pricing principles cannot override that statutory scheme

Continuous Supply Was Rejected, but Annual Valuation Still Survived

Another important issue was whether a corporate guarantee constitutes a continuous supply of services. Section 2(33) of the CGST Act, 2017 defines continuous supply of services as the provision of services continuously or on a recurrent basis under a contract for a period exceeding three months, with periodic payment obligations.

The Court held that a corporate guarantee may create a continuing obligation, but it does not entail periodic payment obligations when issued without consideration. Therefore, it cannot be treated as a continuous supply of services merely because the guarantee remains in force for several years.

At the same time, the Court accepted that the outstanding guarantee exposure may have to be considered year-wise. Section 13 deals with the time of supply of services. Where ordinary invoice or payment rules do not apply, reference may be made to the date on which the recipient records the service in its books. The "per annum" expression in Rule 28(2) was therefore understood with reference to the subsisting guarantee amount, and not mechanically with reference to the original guarantee amount, even after repayments or reductions in exposure.

Rule 28(2) Was Upheld as a Valid Valuation Machinery

The challenge to Rule 28(2) was central to the case. Rule 28 addresses the valuation of supplies between distinct or related persons. Rule 28(2), inserted with effect from 26.10.2023, specifically provides for the valuation of corporate guarantee services supplied to a related person located in India by way of providing a corporate guarantee to a bank or financial institution on behalf of the recipient. The rule deems the value to be one per cent of the amount of such guarantee offered per annum, or the actual consideration, whichever is higher. The "per annum" language was inserted by Notification No.12/2024-Central Tax dated 10.07.2024, with effect from 26.10.2023.

The Court examined Section 15 of the CGST Act. Section 15(1) adopts the transaction value where the supplier and recipient are not related, and the price is the sole consideration. Related-party transactions may not fall within Section 15(1). Section 15(4) permits valuation in the prescribed manner where the value cannot be determined under Section 15(1). Section 15(5), with a non-obstante clause, enables special valuation for notified supplies. Section 164 confers rule-making power.

Relying on the Supreme Court's reasoning in Directorate General of Goods And Services Tax Intelligence (Hqs) & Ors. Versus Gameskraft Technologies Private Limited And Ors. - 2026 (5) TMI 1822 - Supreme Court, the Court upheld the validity of Section 15(4) and Rule 28(2). The Court accepted that corporate guarantees are difficult to value because there may be no open market value, no commission, or varying rates in commercial practice. A special valuation rule could therefore be prescribed.

The Words "Whichever Is Higher" Were Too Harsh

The Court, however, did not approve Rule 28(2) in its full literal harshness. The main difficulty lay in the expression "whichever is higher". This meant that even where the actual consideration or commission was lower than one per cent, the taxpayer would still have to apply one per cent. The petitioners pointed out that the actual guarantee commission in some cases may be 0.25% or 0.30%.

The Court applied the principle from Wipro Ltd. Versus Assistant Collector of Customs & Others - 2015 (4) TMI 643 - Supreme Court, where the Supreme Court held that a notional or uniform valuation rule cannot be imposed where actual value is ascertainable. A fiction may be useful where actual value is not available, but it becomes arbitrary if it ignores actual value despite its availability. The Court also relied on Munjaal Manishbhai Bhatt Versus Union of India - 2022 (5) TMI 397 - GUJARAT HIGH COURT, where a fixed one-third deduction towards land value under GST was read down when actual land value was ascertainable.

On this reasoning, the Court held that Rule 28(2) need not be struck down in its entirety. The 1% benchmark can apply where actual consideration is absent or not ascertainable. However, the expression "whichever is higher" was read down because it denied the taxpayer the benefit of actual lower consideration. This is perhaps the most practically important part of the judgment. The rule survives, but its arbitrary edge has been softened.

Pre-26.10.2023 Levy Was Held Unconstitutional

The Court then examined whether Rule 28(2) could apply to corporate guarantees furnished before 26.10.2023. Many guarantees in the batch were executed before Rule 28(2) was inserted, and some even predated the GST regime.

The Court considered the principles governing retrospective and retroactive laws. A taxing statute may operate retrospectively or retroactively in proper cases, but such power is subject to constitutional limitations. If a law imposes an unexpected burden on past transactions and unduly disturbs settled commercial arrangements, it may violate Articles 14 and 19(1)(g).

The Court held that applying Rule 28(2) to guarantees furnished before 26.10.2023 would be harsh and unfair. Taxpayers had arranged their affairs under the law as it then stood. The valuation machinery was introduced only from 26.10.2023. Therefore, the GST levy under Rule 28(2) on corporate guarantees furnished before that date was declared violative of Articles 14 and 19(1)(g). However, if such guarantees continue after 26.10.2023, the levy may apply from that date.

Circulars Cannot Travel Beyond the Judgment

The petitioners also challenged CBIC Circular No.204/16/2023-GST dated 27.10.2023 and Circular No.225/19/2024-GST dated 11.07.2024. The Court recognised that circulars can explain and operationalise the statutory framework. They do not, by themselves, create the levy.

This distinction is important. A circular may guide officers, clarify administration, and reduce uncertainty. But it cannot override the Act, the Rules, or the Court's interpretation. Since the Court read down "whichever is higher" and struck down the pre-26.10.2023 levy, the circulars could survive only to the extent they were consistent with the judgment.

Accordingly, the circulars were set aside to the extent they ran contrary to the Court's observations and directions. Revenue was given liberty to issue fresh circulars or administrative instructions in line with the judgment.

Section 74 Cannot Be Invoked Merely Because the Issue Is Debatable

The Court's treatment of Section 74 is equally important. Section 74 applies where tax has not been paid or has been short-paid by reason of fraud, wilful misstatement, or suppression of facts to evade tax. The provision carries serious consequences, including penalties. Therefore, it cannot be invoked mechanically.

The Court recognised that the taxability of corporate guarantees was a complex interpretative issue. The petitioners took the view that no GST was payable because there was no consideration. The Department took a different view. Such disagreement over the operation of Section 7,Schedule I, Section 15, Rule 28(2), the Contract Act, and related provisions could not, by itself, constitute fraud or suppression.

The Court relied on M/s. UNIWORTH TEXTILES LTD. Versus COMMISSIONER OF CENTRAL EXCISE. RAIPUR - 2013 (1) TMI 616 - Supreme Court, PUSHPAM PHARMACEUTICALS COMPANY Versus COLLECTOR OF C. EX., BOMBAY - 1995 (3) TMI 100 - Supreme Court, and COLLECTOR OF CENTRAL EXCISE Versus H.M.M. LIMITED - 1995 (1) TMI 70 - Supreme Court. These judgments explain that suppression requires deliberate withholding of material facts with intent to evade. Mere failure to declare, especially in a bona fide interpretational dispute, is not enough. On that basis, the Section 74 notices and order were quashed.

The Final Balance Struck by the Court

The judgment strikes a clear balance. Corporate guarantees should not be considered completely outside GST just because no fee is paid, but Rule 28(2) must not be enforced harshly or retroactively. While taxability remains, arbitrary valuations, pre-26.10.2023 demands, and mechanical Section 74 allegations have been limited. This sends a practical message to both taxpayers and the Department: corporate guarantee transactions must now be evaluated under GST, but such assessment should rely on fair valuation, appropriate timing, and legally sound procedures.

Corporate Guarantee Taxability Now Has a Roadmap

Torrent Power is likely to become a leading GST judgment on corporate guarantees because it offers a balanced roadmap. It recognises the wide scope of supply under Schedule I and the need for valuation machinery when open market value is difficult to determine. At the same time, it insists that valuation must remain reasonable, timing must be fair, and proceedings must be legally disciplined.

The lasting principle is clear. A corporate guarantee may be taxable under GST, but valuation cannot be confiscatory, a deeming rule cannot ignore actual lower consideration, and an interpretational dispute cannot automatically amount to suppression.

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