GST on Corporate Guarantees and Liquidated Damages: The 2026 Position

Executive Summary

The questions of gst corporate guarantee liquidated damages taxability have been among the most actively contested issues in indirect tax jurisprudence since the introduction of the Goods and Services Tax regime under the Central Goods and Services Tax Act 2017 (CGST Act) and its State counterparts. Two distinct but frequently encountered commercial transactions — the provision of a corporate guarantee by a parent company in favour of its subsidiary, and the receipt of liquidated damages or breach-of-contract penalties — engage entirely different GST analysis, yet both have generated significant litigation, divergent advance rulings, and competing regulatory positions. As of June 2026, the legal position on both questions has been partially settled by CBIC circulars, though active litigation continues, particularly on corporate guarantees. This article provides a structured analysis of the statutory framework, the current regulatory position established by CBIC circulars, and the judicial and appellate authority on both questions. A comparative table contrasting the GST treatment of corporate guarantees and liquidated damages is presented for ease of reference.

Statutory Framework

CGST Act 2017: Supply, Consideration, and Schedule I

The foundational framework for both questions is the definition of “supply” under Section 7 of the CGST Act 2017. Section 7(1)(a) defines supply as including all forms of supply of goods or services or both made or agreed to be made for a consideration by a person in the course or furtherance of business. Section 7(1)(c) read with Schedule I of the CGST Act extends the definition of supply to include certain transactions made without consideration that are deemed to constitute supply — specifically, Schedule I paragraph 2 provides that supply of goods or services or both between related persons or between distinct persons (as specified in Section 25), when made in the course or furtherance of business, is a deemed supply even where no consideration passes.

This extended definition under Schedule I is the statutory fulcrum of the corporate guarantee dispute: where a parent company provides a guarantee to a lender on behalf of its subsidiary without charging a guarantee fee, the transaction may constitute a deemed supply under Schedule I paragraph 2 if parent and subsidiary are “related persons” within the meaning of the CGST Act’s Explanation to Section 15.

The definition of “consideration” under Section 2(31) of the CGST Act 2017 includes any payment made or to be made in relation to a supply. On the liquidated damages question, the analysis turns on whether the amount received as liquidated damages or penalty for breach of contract constitutes “consideration” for a “supply” of a service — specifically, whether the tolerance of breach or the forbearance from suing constitutes a taxable service.

Notification 13/2017-CT(Rate): Entry 5B and Reverse Charge

Notification No. 13/2017-Central Tax (Rate) dated 28 June 2017 specifies categories of services subject to reverse charge mechanism (RCM), meaning the recipient is liable to pay GST rather than the supplier. Entry 5B to this notification (inserted with effect from 27 October 2023 by Notification No. 15/2023-CT(Rate)) specifies that services supplied by a bank guarantee issuer to its subsidiary or associate company constitute a supply liable to GST under reverse charge where the recipient is a body corporate located in the taxable territory and the supplier is a related person providing the guarantee without actual consideration or at a value below the open market value. This notification entry, read with CBIC Circular No. 204/16/2023-GST dated 27 October 2023, established the operative framework for taxing corporate guarantees under RCM.

CBIC Circular No. 204/16/2023-GST: Corporate Guarantee Valuation

CBIC Circular No. 204/16/2023-GST dated 27 October 2023 is the primary regulatory instrument on the GST treatment of corporate guarantees between related persons. The circular clarified:

First, that a corporate guarantee provided by a parent company or holding entity to a bank or financial institution on behalf of its subsidiary (where the parent receives no explicit guarantee fee) constitutes a supply of service by the parent to the subsidiary under Schedule I paragraph 2, being a supply between related persons in the course or furtherance of business.

Second, that the value of such supply is to be determined under Rule 28(2) of the CGST Rules 2017, which was specifically amended to provide that where a corporate guarantee is provided by a related person and the actual consideration is nil or below the open market value, the value of the supply shall be taken as 1 percent of the amount of the guarantee offered per annum, or the actual consideration charged, whichever is higher.

Third, that the tax is payable by the recipient (the subsidiary) under the reverse charge mechanism, not by the parent company providing the guarantee. The circular also addressed the question of input tax credit (ITC): the subsidiary as the recipient of the supply paying GST under RCM is entitled to claim ITC of the GST paid under RCM, subject to the general ITC conditions under Section 16 and the restrictions under Section 17(5) of the CGST Act.

CBIC Circular No. 178/10/2022-GST: Liquidated Damages

CBIC Circular No. 178/10/2022-GST dated 3 August 2022 addressed a range of contentious issues regarding amounts received in the context of transactions that might constitute “tolerating an act” or “refraining from an act” — categories specified in Schedule II to the CGST Act as deemed services. Paragraph 7 of the circular specifically addressed liquidated damages, penalty for delay, amounts received for breach of contract, and similar payments. The CBIC concluded that:

Amounts received as liquidated damages for a party’s failure to perform a contractual obligation — such as a contractor’s failure to complete a project within time or a buyer’s failure to off-take contracted quantities — do not constitute consideration for any supply. They are in the nature of a deterrent for breach of contract and a compensation for the damage suffered by the recipient, not a payment for any service. Accordingly, such amounts are not taxable under GST.

The circular drew a distinction between amounts received as genuine liquidated damages for breach and amounts received for agreeing to tolerate a breach prospectively — the latter, where there is a genuine agreement to allow a party to default in exchange for a payment, may constitute a taxable supply of the service of tolerating an act. The test articulated in the circular is whether there is a “supply” for which the payment is the consideration, or whether the payment is compensatory in character for a breach that the recipient would have preferred not to have occurred.

Procedural Landscape 

Comparative Table: Corporate Guarantees vs Liquidated Damages — GST Treatment

Judicial Challenges to the Corporate Guarantee Framework

The CBIC’s position on corporate guarantees, as crystallised in Circular No. 204/16/2023-GST and the amended Rule 28(2), has faced significant challenge before the High Courts. The principal ground of challenge is the constitutional and statutory validity of Rule 28(2) of the CGST Rules 2017, which was introduced to specifically address the corporate guarantee valuation. Challengers have argued that:

Rule 28(2) operates harshly in cases where the guarantee is provided purely for commercial reasons within a corporate group and without any element of “service” in the economic sense, and that the deeming of a supply under Schedule I should not automatically import a specific valuation rule that operates mechanically without regard to the actual nature of the guarantee.

The imputed guarantee fee of 1 percent of the guarantee amount per annum may be arbitrary where the actual open market value of the guarantee (having regard to the creditworthiness of the guarantor and the risk assumed) is significantly different from 1 percent, and the rule does not permit the taxpayer to demonstrate a more appropriate open market value by an alternative method.

The retrospective aspects of the Circular and the Rule, to the extent they purport to govern guarantees already in existence when the notification and rule came into force in October 2023, have been contested on the ground that retrospective tax liability should not be imposed by executive action. As of June 2026, these challenges remain active, and the precise status of any particular High Court judgment should be verified from the most recent reported decisions before reliance is placed on the outcome.

The Liquidated Damages Distinction: Toleration of Act vs Compensation

While CBIC Circular No. 178/10/2022-GST has largely resolved the question of pure liquidated damages, a residual characterisation risk remains for payments that may be characterised as “toleration of an act” rather than pure compensation. The issue arises in the following categories of commercial arrangements:

Take-or-pay contracts, where a buyer is contractually entitled to reduce offtake below the minimum quantity by paying a specified amount — this is sometimes characterised as the buyer purchasing a right to reduce offtake (i.e., the seller providing the service of tolerating reduced offtake), which would be taxable. Following Circular 178/10/2022-GST, the CBIC’s position is that if the payment is genuinely an automatic consequence of the breach (and the seller had no prior agreement to grant a right to reduce offtake), it is not taxable. However, where the contract is specifically structured as a “right to reduce” in exchange for a fee, the characterisation may tip towards a taxable supply.

Early termination fees and exit fees in long-term service contracts, loan pre-payment penalties, and similar contractual payments continue to be evaluated on the specific facts of each arrangement, and the line between compensation and consideration for a service remains a fact-specific determination.

Advance Rulings: Divergence and Limitation

Advance rulings of the Authority for Advance Rulings (AAR) on both corporate guarantees and liquidated damages have been divergent, reflecting the uncertain state of the law prior to the CBIC circulars. It is important to note that AAR rulings are binding only on the applicant and on the specific jurisdiction’s tax authorities, and do not bind other taxable persons or other states. The divergence in AAR rulings on corporate guarantees — with some AARs holding the provision of a guarantee to be a taxable supply and others holding otherwise — was a primary driver of the CBIC’s decision to issue Circular No. 204/16/2023-GST to establish a uniform national position.

Key Judicial Precedents

The Supreme Court of India in Commissioner of Central Excise, Pune v. Ultratech Cement Ltd (2010) 11 SCC 314 (decided under the pre-GST service tax framework) examined the taxability of amounts received in connection with breach of contract and held that for a levy to be sustainable, there must be a “service” provided and a “consideration” paid for it — a payment made as compensation for damages, without the element of a consensual exchange, cannot be treated as consideration for a service. While this decision is of the pre-GST era, its analytical framework regarding the necessity of a supply-consideration nexus informs the current GST analysis and has been cited in the context of the CBIC’s circular on liquidated damages.

On the question of the validity of delegated legislative instruments (rules and notifications) that expand the scope of a tax beyond what the parent statute envisages, the Supreme Court in Union of India v. Mohit Minerals Pvt Ltd (2022) 10 SCC 700 held, in the context of the GST Council’s recommendations and corresponding notifications, that delegated legislation under GST must operate within the framework of the CGST Act and that notifications extending tax liability must have a statutory basis. This decision, though focused on ocean freight, is cited in the High Court challenges to Rule 28(2) to argue that a rule which deems a supply and imposes a specific valuation formula must be traceable to and consistent with the parent Act.

The Gujarat High Court and the Bombay High Court, among others, have admitted writ petitions challenging the validity of Notification 15/2023-CT(Rate) and Rule 28(2) as they apply to corporate guarantees, and the final adjudication on these petitions is awaited as of June 2026. Until the High Courts or the Supreme Court deliver a final ruling, the CBIC’s circular position — that corporate guarantees between related persons attract GST at 18 percent on 1 percent of the guaranteed amount per annum under RCM — remains the operative regulatory position to be complied with.

Conclusion

The gst corporate guarantee liquidated damages landscape in June 2026 presents two sharply contrasting scenarios. On corporate guarantees, the CBIC has established a clear (if contested) framework through Circular No. 204/16/2023-GST and the amended Rule 28(2): guarantees by parent companies in favour of subsidiaries are taxable at 18 percent of an imputed fee of 1 percent of the guarantee amount per annum, payable by the subsidiary under reverse charge. Active High Court litigation challenges this framework on substantive and constitutional grounds, and the ultimate judicial outcome may significantly alter the position. Pending final adjudication, businesses must comply with the current circular position while monitoring court developments.

On liquidated damages, CBIC Circular No. 178/10/2022-GST has provided substantial clarity: amounts received as compensation for breach of contract, delay, or failure to perform are not taxable under GST. The residual risk of characterisation — where a payment is treated as consideration for a prospective tolerance of an act — requires careful examination of the specific contractual language and the commercial substance of each arrangement.

The issues of GST on corporate guarantees and liquidated damages highlight a broader tension within the GST regime between the principle that only genuine economic supplies should be taxable and the administrative objective of taxing transactions that may generate economic value despite the absence of explicit monetary consideration. While the GST treatment of liquidated damages has largely been clarified through CBIC Circular No. 178/10/2022-GST, the taxability and valuation framework for corporate guarantees continues to be the subject of judicial scrutiny. The outcome of the pending litigation before the High Courts and, if necessary, the Supreme Court, is likely to have significant implications for inter-company financing arrangements across corporate India. Until a final judicial pronouncement is rendered, businesses should comply with the existing regulatory framework while closely monitoring developments in this evolving area of GST law.