Corporate Guarantees : A lingering controversy

September 27,2017
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Mr. Sanjay Kumar (Senior Director, Tax, Transfer Pricing, Deloitte Haskins & Sells LLP)

Ms. Neha Gupta (Manager, Transfer Pricing, Deloitte Haskins & Sells LLP)

Growth in India’s outbound investment has increased the capital financing transactions between an Indian parent and its subsidiaries outside India such as borrowing/ lending of short term/ long term nature, guarantee etc. Corporate guarantee has been a subject matter of considerable dispute. Result being that more than 80 case laws have been adjudicated[1], 5unilateral APAs have been signed – 4 for provision of corporate guarantee[2] and 1 for payment of corporate guarantee fees.

Black’s law dictionary, 2nd edition defines guarantee as “A contractual agreement where one party (the guarantor) provides payment to a second party (the beneficiary) should the contracting party default on its obligations.”

Australian taxation office (ATO)’s discussion draft on Intra-group finance guarantees and loans (Para 83) defines Guarantee as:

“A guarantee is a legally binding commitment by the parent that it will meet the liabilities arising under the terms of a loan from an independent party in the event of a default by the borrowing subsidiary.”

In Indian context Rule 10TA, the Safe Harbour Rules define corporate guarantee as:

“corporate guarantee” means explicit corporate guarantee extended by a company to its wholly owned subsidiary being a non-resident in respect of any short-term or long-term borrowing.

Explanation - For the purposes of this clause, explicit corporate guarantee does not include letter of comfort, implicit corporate guarantee, performance guarantee or any other guarantee of similar nature.”

Corporate guarantee – The debate so far

One of the key issues litigated on corporate guarantee before the tax law amendment in 2012 was whether corporate guarantee transaction is covered by the definition of “international transaction”. Tribunal in some cases held that corporate guarantee is not an international transaction (Four Soft Ltd.[3]) while in others it ruled otherwise (Nimbus Communications Ltd[4]).

Due to varied rulings, in 2012, the definition of international transaction was amended with retrospective effect from April 01, 2002, which provided that “international transaction” shall also include capital financing, including any type of long-term or short-term borrowing, lending or guarantee etc.

Post amendment, case laws dealt with the question that when a transaction does not have any "bearing on profits, income, losses or assets" of the enterprise (Section 92B(1)) on a real basis and also does not involve any cost, can it still be subjected to ALP adjustment. Again, the Tribunal ruled both in favour (case of Bharti Airtel Limited[5]) and against (Everest Kanto Cylinder Ltd).

Determination of ALP for corporate guarantee transactions i.e. whether incurrence of cost for a certain capital financing transaction and subsequent receipt of adequate remuneration that fully recovers the said cost, require any further compensation came up as another issue before the tribunal, which was ruled against the assesse (Everest Kanto Cylinder[6]).

The above shows that the issue lacks clarity and consistency. Post amendment of definition, even though there was little to no scope for debate on its characterization as an international transaction, the benchmarking approach of corporate guarantee has still been a matter of contention.

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