Corporate Guarantee under Rule 28(2) When 2 Fictions Collide

Corporate Guarantees under GST (Rule 28(2)) : When 2 Fictions Collide

The Madurai Bench of the Madras High Court (Order W.P.(MD) No. 2021 of 2025, decided on 06.10.2025) has reignited the debate over how Rule 28(2) and its Proviso interact when valuing corporate guarantees under GST.

Background

The Petitioner had extended a corporate guarantee to a related party without charging any fee. The Department invoked Rule 28(2) to impute an arm’s-length value, treating it as a taxable supply between related parties  The GST Department treated the act of issuing the guarantee as a taxable supply under Rule 28(2) of the CGST Rules, 2017, imputing a notional value on an arm’s-length basis.

The Petitioner challenged this valuation before the High Court, arguing that no consideration was received and that CBIC’s own clarifications supported the view that such transactions carry nil taxable value.

Justice G.R. Swaminathan examined a key interpretative conflict : when the law itself creates two competing fictions, which one should prevail?  “two fictions” that clash in Rule 28(2) of the CGST Rules, 2017 when applied to corporate guarantees or related party transactions.

Grounds of Writ

The Petitioner relied on the following key points:

1. No consideration was received for issuing the corporate guarantee, hence there was no supply within the meaning of Section 7 of the CGST Act.
2. CBIC Circular No. 199/11/2023-GST (17.07.2023) and Circular No. 210/4/2024-GST (26.06.2024) — both clarify that:
   • Corporate guarantees issued to related or group entities without consideration should be treated as having nil value, particularly when the recipient is eligible for full Input Tax Credit (ITC).
3. The assessing authority failed to consider these binding circulars and the Petitioner’s written submissions, violating the principles of natural justice.

Rule 28 of the CGST Rules, 2017:  Valuation of supply between distinct or related persons : Rule 28 of the CGST Rules, 2017 governs how to determine the value of supply when goods or services are exchanged between related or distinct persons, even when no actual consideration (payment) exists : such as between holding and subsidiary companies.

Text of Rule 28 of the CGST Rules, 2017:

When goods/services are supplied between related persons, the value shall be:

• (a) Open market value or
• (b) Value of like kind and quality, or
• (c) Cost + 10%, etc.

Then comes the Proviso, which changes the picture completely.

“Fiction of Value” : Rule 28(2)

Rule 28(2) of the CGST Rules, 2017 creates a legal fiction  it pretends there is an open-market value even if no such market value actually exists. Which says that in effect: “Even if you haven’t charged any price, we’ll assume there is a price : and we’ll impute it.” So, if Company A gives a corporate guarantee to support the loan of its subsidiary B without charging any fee, Rule 28(2) of the CGST Rules, 2017 tells the officer to assign a notional value (say 1% of guaranteed amount, as per RBI norms or OECD comparables) and levy GST on that imaginary consideration. This is the “fiction of value”  the law invents a value that doesn’t exist in reality.

The “Fiction of Actuality” : Proviso to Rule 28

Now the Proviso to Rule 28 of the CGST Rules, 2017 says: “Provided that where the recipient is eligible for full ITC, the value declared in the invoice shall be deemed to be the open market value of the goods or services supplied.”

This creates the opposite fiction it accepts whatever value the parties have declared (even zero, in some interpretations) as deemed to be correct, as long as the recipient can fully claim Input Tax credit. This is the “fiction of actuality” is the law pretends that the declared transaction value is real and acceptable.

When the Two Fictions Collide :

In corporate guarantee cases when The supplier (holding company) often charges no consideration. & The Department invokes Rule 28(2) saying a notional value must be imputed (fiction of value). Then The taxpayer invokes the Proviso of above rule of the CGST Rules, 2017 saying since the subsidiary (recipient) can take full Input Tax credit, the declared value (even zero) should be deemed the correct value (fiction of actuality). Hence, two fictions collide:

• One creates a value that never existed (valuation fiction).
• The other accepts the declared value as if it were genuine (actuality fiction).

The Madurai Bench (Justice G.R. Swaminathan) essentially examined: When both fictions apply, which one should prevail : valuation or actuality?

The Core Conflict

• Rule 28(2) introduces a fiction of value : deeming a notional open-market value even when none exists.
• The Proviso introduces a fiction of actuality : deeming the declared value to be acceptable if the recipient is eligible for full Input Tax credit.

The Court thus faced the jurisprudential question: When valuation fiction and transactional actuality collide, which governs?

Court’s Approach- Conceptual Resolution

“It is a well-settled principle of administrative law that when a defense raised by the noticee is not considered in the final order, the order is vulnerable on that ground.” The Court underscored that quasi-judicial authorities must address all relevant submissions and circulars before reaching a conclusion particularly when departmental circulars are binding on tax officers under Section 168 of the CGST Act.

The judgment underscores natural justice and legislative intent, preferring an interpretation that preserves commercial reality over mechanical application of deeming provisions.

The High Court Set aside the impugned GST order, holding that the assessing authority had failed to consider the Petitioner’s defense and the binding CBIC circulars. Remanded the matter back to the Department for fresh adjudication on merits, directing that the authority must duly consider The Petitioner’s defense, CBIC Circulars Nos. 199/11/2023 and 210/4/2024, and The evidentiary record before passing any fresh order.

The Court leaned toward the fiction that aligns with commercial reality and legislative intent, i.e., the Proviso. Because If the recipient can claim full ITC, there’s no loss of revenue to the exchequer. So Therefore, there’s no need to invent a fictitious value merely for the sake of form. Thus, the Proviso (fiction of actuality) overrides the deeming valuation rule when both can apply. It highlights that valuation under GST cannot disregard the substance of the transaction : especially when no consideration truly changes hands. (W.P. (MD) No. 2021 of 2025 — Decided by Justice G.R. Swaminathan, Madurai Bench of the Madras High Court)

In summary of above implication of above rule under CGST Rules, 2017

Aspect	Fiction of Value (Rule 28(2))	Fiction of Actuality (Proviso)
Nature	Deems a notional open-market value even if no consideration exists	Deems declared value (even nil) as acceptable if recipient gets full ITC
Purpose	Prevent undervaluation between related parties	Avoid redundant valuation when revenue neutral
Impact	Creates artificial tax incidence	Prioritizes commercial and legislative coherence
Favoured by	Tax department	Taxpayer and courts (in revenue-neutral cases)

Why It Matters

This ruling invites a rethink of corporate guarantee valuation under GST : moving beyond formulaic computation toward maintaining conceptual coherence within the GST framework. Key Takeaways for Practitioners

1. Binding Nature of Circulars: CBIC circulars clarifying “nil value” for intra-group guarantees are binding on departmental officers, even if not favourable to revenue.
2. Natural Justice: Failure to address the taxpayer’s defense — especially reliance on departmental circulars — renders an order vulnerable to judicial review.
3. Rule 28 Fictions: The case reinforces that the Proviso to Rule 28 (fiction of actuality) may override the main Rule 28(2) (fiction of value) in revenue-neutral situations where full ITC is available.
4. Remand Implication: Adjudicating authorities must balance valuation fiction with commercial reality while ensuring procedural fairness.

Practitioner’s Takeaway: Conceptual Summary

Legal Principle	Key Point
Fiction of Value	Imputed arm’s-length value under Rule 28(2)
Fiction of Actuality	Deemed acceptance of declared value when full ITC available
Judicial Preference	Courts favour actuality over artificial valuation where revenue is neutral
Administrative Principle	Non-consideration of defense/circulars = violation of natural justice

Each corporate guarantee case now entails a three-layered approach:

• Procedural defence : notice validity, opportunity of hearing.
• Interpretative fiction : deciding which deeming provision governs.
• Evidentiary record : establishing absence or presence of commercial consideration.

These are not mere valuation disputes anymore; they are tests of legislative coherence.
When this finally reaches the Tribunal, the question won’t simply be “how much tax is payable”  it will be “which legal fiction survives judicial scrutiny.”

This decision, while procedural in form, carries substantive implications: it reinforces that valuation under GST must be consistent with both legal coherence and administrative discipline. Corporate guarantees without consideration  where ITC neutralizes tax impact  cannot be artificially monetized merely through deeming provisions.