DECEMBER 24, 2020

By K Srinivasan (IRS)

PERSONAl and Corporate guarantees explained

Banks have long since developed an unwritten convention of obtaining personal/corporate guarantees from the Directors of the Corporations and the holding/subsidiary companies between one another, to secure the Loans advanced by them to those companies.

Personal Guarantees and the propriety of obtaining the same by the Creditors

Though it may not be the requirement under the RBI Circular (Circular No. RBI/2009-10/70 DBOD. No. Dir. BC. 14 /13.03.00/2009-10 July 1, 2009 refers) that a PG be given by a director in certain specified cases therein, the Banks still insist on the execution of a Personal guarantee by the Directors, against the term loans given by them to the companies.

But, this is widely described as lacking the Authority of Law, both under the Companies Act and the Indian Contracts Act, since the said practice is said to be against the principle of limited guarantee, enshrined in the Companies Act, both for shareholders and as well as directors of the company.

The company is not strictly a person and it can act only through its directors and the relationship between the two is one of Principal and Agent.

Therefore, the general principles of Agency are said to govern the relations of the directors with the Company with regard to the persons dealing with the company through its directors.

The directors of the company contract in the name and on behalf of the company only and, therefore, it is the company which is liable for the acts done in good faith by the directors in this regard. [Ferguson Vs Wilson (1866) LR 2 Ch LR 77 36 LJ Ch 67 15 LT 230 refers]

In short, despite a PG executed by the director of a company, due to the needs of the company for funds, the Banks have made it a prerequisite for sanctioning the term loan, by undue insistence is unlawful and void.

Salary Vs Commission

In view of the peculiar nature of the Principal-Agent relationship between the company and some of its directors, is at times referred to as commission instead of salary.

The word salary is more often associated with an Employer-employee relationship, arising out of a CTC contract and therefore comes directly under the purview of Income Tax without any room for doubt or discussion.

Whereas, the word commission, has a different connotation and meaning leading up to the Principal-Agent relationship and therefore has an element of service to it and has a possibility of falling under the ambit of indirect tax.

This is precisely the reason, why a class of directors is called as whole time directors (WTD) /Executive directors (ED) distinguished from other Part time directors and Professional directors and Promoter directors.

It is possible that some type of remuneration may be paid to a WTD/ED who is an employee of the company, besides his salary which is termed as a fee or a commission to indicate the difference that the former is a salary for the purpose of his official duties whereas the latter is for certain services provided by him to the company, in his individual or personal capacity which is beyond the call of his duty.

Accordingly, since remuneration is commonly understood to be distinctly different from salary and reported not as Income but under other appropriate Schedule as other than Income for the purpose of deduction of TDS.

Limited liability protection under the Companies Act

The companies Act also offers certain protection to the directors of the company from being liable for the debts of the company. This is guaranteed under Sec 13(2) of the CA that companies limited by shares or guarantee shall state that the liability of their members is restricted.

Further, Sec 270(1) of the Act provides that if not required by the Articles, a director may not have any share qualification, meaning there is no need not hold any shares of the company compulsorily. Therefore, a director may come to acquire only limited liability in such a case, as a member of the company in accordance with Sec 13(2) ibid.

These above views have been upheld by the Delhi HC in the following cases:

1. Indian Overseas Bank Vs R.M. Marketing & Services (P) Ltd (2001) 107 Corp Cas 606 Del

2. J.B Exports Ltd and another Vs BSES Rajadhani Power Ltd (2004) Comp Corp Cas 106 Del

So much for Salary Vs remuneration and Company Law Vs PG of directors. Be that as it may. Whether it is unlawful to obtain a PG from the director or not is not so much the primary objective of this discussion as evaluating the taxability of the same from the GST angle. There are other regulators to take care of the propriety aspect of banks insisting on the PG from the directors.

Personal Guarantee of Directors

Whether PG given by a director amounts to a taxable supply of a service under GST?

To understand that, visiting the provisions of the GST Act w.r.t the definition of Goods Vs Services becomes imperative.

The word service has to be traced to the definition of Sec 2(102) ibid. which includes anything other than goods, money and securities for which separate consideration is charged. However, the intent of such services should be looked into from the capacity of a director in this context.

Business test passed

One more question that arises in the case of the PG given by a director against a Bank loan/Debt, after being held as a service in lieu of a consideration, is whether it is in the course of furtherance of business or not?

The term business under GST Act vide Sec 2(17) is too wide to embrace trade, commerce, profession regardless of frequency, volume or continuity of a transaction.

Relevant to our context, is guarantee given by a director in his professional capacity is looked upon by both the company and the creditor-bank as worthy of a credit standing.

Therefore, it has come to be known as the director's business to do such an act resulting in the furtherance of his profession compared to someone whose business it is not to do such an act.

Accordingly, services like giving guarantee by a director against loan taken by company, for a fee, commission or remuneration, by whatever name it is called, would be covered under the scope of the definition of business and hence a justified taxable supply.

GST on Corporate Guarantee

Corporate guarantee is a guarantee given by any corporation, by recognizing the financial obligations by a company towards a bank often by a Parent/holding company to its subsidiary and vice versa on behalf of one another against a debt to the bank in the form of term loan to meet generally working capital needs, is a normal business practice.

Corporate guarantee differs from a personal guarantee in the sense that PG is a promise made by a director or a collective promise of a set of directors, thereby assuming personal responsibility of repayment upon default by the borrower-company to the bank.

But the liability to GST may slightly vary between an Employee Director and a Shareholder director/Partner in an LLP, who does not take any remuneration generally for giving such guarantees. It may still be liable to GST for rendering such service under RCM by the Company.

Guarantee without consideration, still valuable and taxable

Having said that, what about the PG/CG given by Non-employee directors and Partners in an LLP, without consideration, whether it is taxable and if so on what basis it will be taxed?

Yes, both are taxable even if given without consideration in the former case on a Principal-Agent relationship vide Para 3(b) of Schedule II to Sec 7 of the Act while in the latter case it will fall under Para 2 of Schedule II to Sec 7 ibid as a related party transaction.

Valuation of the above transactions even if without a consideration will be still considered being a taxable supply of service and value determined appropriately as per Sec 15(4) of the Act read with determination of value of supply under the GST rules.

End Note

A last word on the Guarantees regarding the underlying supply of the PG given by a director by charging a fee is in the nature of an actionable claim different of course from securities or money.

It is still covered under the exclusion-category of Para 6 of Schedule II to Sec 7 of the GST Act as neither a supply of goods or services.

Therefore, PG/CG given by the director/s or by one corporation to another related to it, as between holding and subsidiary companies, undoubtedly attract GST as a taxable supply since it answers all the requirements of Sec 7 namely, a taxable supply of service, involving a consideration, towards rendering of a service in the course of furtherance of business, in the considered opinion of the Author.

[The views expressed are strictly personal.]