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Edited version of your written advice

Authorisation Number: 1051259916656

Date of advice: 27 July 2017

Ruling

Subject: GST and bank guarantee and security deposit

Question 1

Will section 99-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) apply to a security payment made by a foreign purchaser to the Australian entity in accordance with the Contract?

Advice

Yes. Section 99-5 of the GST Act will apply to the security payment made by the foreign purchaser to the Australian entity in accordance with the Contract.

Question 2

Under the provision of a bank guarantee as Additional Security to the Australian entity, has the Australian entity made a taxable supply?

Advice

Based on the facts given, under the provision of a bank guarantee as Additional Security to the Australian entity, the Australian entity has not made a taxable supply under section 9-5 of the GST Act.

Relevant fact

You are an Australian entity and registered for the goods and services tax (GST).

You hold a development site comprising of several lots of land in Australia. A multi-storey mixed-use development will be constructed on the development site.

The development will include residential apartments (Apartments), which you intend to commence marketing for sale 'off-the-plan' as new residential premises.

It is anticipated that a portion of purchasers of the Apartments will be foreign residents.

The purchase price will be expressed as a GST-inclusive amount.

Unless the purchaser negotiates special terms, the Contract will provide for a deposit of 10%.

Where the purchaser requires approval (Foreign Investment Review Board Approval) under the Foreign Acquisitions and Takeovers Act 1975 (Cth) to purchase an Apartment (ie, because the purchaser is a foreign resident), the purchaser will be required to provide an additional 10% under the Contract.

The additional security for foreign purchasers is in addition to the standard requirement for the payment of a 10% deposit. That means foreign purchasers may be required to provide security of 20% of the price, being:

    a) 10% as the standard deposit; and

    b) a further security of 10%, comprising either:

        i. a further payment of 10% of the price- referred to as a 'Security Payment'; or

        ii. (if the vendor chooses) security by way of bank guarantee for an amount equal to the Security Payment- referred as 'Additional Security’.

On completion you must return the Security Payment or Additional Security to the purchaser. But, if directed to do so by the purchaser, the Security Payment may be offset towards the purchaser's obligation to pay the balance of the price. However, if the additional 10% is provided by way of bank guarantee, it will be returned to the purchaser at completion and the purchaser will be required to provide the balance of the price by way of bank cheque.

The bank guarantee is an unconditional undertaking by the bank to make good the obligation of the purchaser to pay the security payment. No money is paid by the bank to the vendor unless a call is made on the bank guarantee (which only occurs in limited circumstances such as default by the foreign purchaser).

If the contract is terminated due to a default by the purchaser, the Security Payment or Additional Amount will be paid to and held by you, and you are entitled to deduct from the Security Payment and call on the Additional Security any loss recoverable by you as a consequence of the purchaser's default. However, you must account to the purchaser for any balance.

You consider the security payment of 10% in addition to the deposit of 10% from the foreign purchaser is reasonable as:

    ● The Apartments will be sold 'off-the-plan'. As the Apartments are yet to be constructed, there will be a prolonged period between exchange and completion to allow for the construction works. There is a genuine risk that during the contract period, the Australian property market may suffer decline or that international factors (eg, increased restrictions on the movement of funds out of particular jurisdictions) may affect the capacity of some purchasers to complete.

    ● While it may be customary to accept a 10% for most land contracts, the risk of the trust suffering loss from default is greater where the purchaser is a foreign resident as there are practical restrictions on the ability to sue and enforce judgment against foreign residents.

    ● The standard land contract in Australia provides that if the contract is terminated due to a default by the purchaser and the deposit of 10% is insufficient to cover the vendor's losses, the vendor may sue the purchaser to recover the amount of any losses exceeding the amount of the deposit. This contemplates that a 10% deposit may not be adequate to cover the vendor's loss but where there is a shortfall the vendor can sue the purchaser for damages. Such further recourse may not be practical where the purchaser resides in a foreign jurisdiction.

    ● You will enter into the contracts for the sale of the Apartments as trustee of a Trust and as a trustee you must employ best practices to protect the unitholders.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-10

A New Tax System (Goods and Services Tax) Act 1999 section 99-5

Detailed reasoning

Question 1

Subsection 99-5(1) of the GST Act provides that a deposit held as security for the performance of an obligation is not treated as consideration for a supply, unless the deposit:

    a) is forfeited because of a failure to perform the secured obligation; or

    b) is applied as all or part of the consideration for a supply.

Goods and Services Tax Ruling GSTR 2006/2 discusses the characteristics of security deposits for GST purposes and Goods and Services Tax Ruling GSTR 2000/28 discusses the application of Division 99 of the GST Act in regard to a deposit held under a standard land contract.

According to paragraph 20 of GSTR 2006/2, for a payment to be considered a 'security deposit’ for the purposes of Division 99 of the GST Act, it should have the following characteristics:

    1. be held as a security for the performance of an obligation;

    2. the contract, conduct and intent of the parties to the contract must be consistent with the payment being a security deposit;

    3. be at risk of forfeiture upon failure to perform the obligation; and

    4. be a reasonable amount.

We will now apply the facts to the above.

1. Be held as a security for the performance of an obligation;

Paragraphs 22 to 23 and 27 to 29 in GSTR 2006/2 state:

      22. A deposit is 'held' when it is paid to a person in the capacity of stakeholder. Normally, in commercial situations, the supplier will be the holder of the security deposit. It makes no difference who holds the deposit, provided it is 'held' for the benefit of the supplier to secure the recipient's obligations.

      23. An amount ceases to be a security deposit when that amount is applied as consideration, or forfeited, regardless of whether it is held by the supplier or a third party at that time. However, there are occasions where a deposit may be released without it being considered to be applied

      27. A security deposit is held to secure, or to act as a guarantee, for the performance of the recipient's obligations under a contract. The nature of the obligations is usually dependent upon the intentions of the parties, as evidenced by the terms and conditions (express or implied) of a contract and the conduct of the parties.11

      28. In a purchase contract, the supplier ordinarily seeks to secure, by way of a security deposit, the recipient's obligations to complete the contract and pay the contracted purchase price. Upon the recipient performing its obligations, the supplier is obliged either to apply the deposit for the recipient's benefit, usually by applying it towards the total purchase price of the supply, or by returning it to the recipient.

      29. However, if the recipient fails to perform their obligations, then the security deposit is at risk of forfeiture.

The proposed contract for sale of land provides that the foreign purchaser must pay the full deposit of 10% of the price on contract date and a security payment of 10% of the price on the date following the contract to secure performance of its obligations under the contract to the vendor.

The first requirement is satisfied as it is accepted that the security payment is being held to secure the foreign purchaser’s obligations to complete the contract and pay the contracted purchase price.

2. The contract, conduct and intent of the parties to the contract must be consistent with the payment being a security deposit;

According to paragraph 37 in GSTR 2006/2, the fact that a certain payment is labelled a 'deposit' does not make it a security deposit at law. Whether a particular payment is a security deposit is a question of fact, determined by looking at the terms of the contract and the intention of the parties to the contract.

Paragraph 34 in GSTR 2006/2 further states that a payment that is not intended to act as an earnest to ensure the contract is completed is not a security deposit

The security payment is to secure the foreign purchaser’s obligations to complete the contract and pay the contracted purchase price. The security payment will be retained until completion of the contract or earlier termination of the contract. Where the contract goes through to completion, the security payment will be returned to the purchaser or offset against the purchase at the request of the purchaser. Where the purchaser defaults, the vendor can hold the security payment for twelve months after completion, use the payment to deduct any loss recoverable and may start proceeding to sue the purchaser.

It is accepted that the second requirement is satisfied as the purpose of the security payment is to bind the foreign purchaser to the contract entered with the vendor.

3. Be at risk of forfeiture upon failure to perform the obligation

In regard to forfeiture the following paragraphs in GSTR 2006/2 state:

      51. A fundamental requirement of a security deposit is that the parties to a contract clearly understand at its commencement, either through an express term, or by implication, that the deposit may be forfeited if the recipient fails to perform the secured contractual obligations. It is necessary, in the Commissioner's view, that there be a mutual intention by the contracting parties to make the deposit subject to forfeiture. If this intention is not present, the deposit is not a security deposit.

      52. The important consideration is the intention or understanding between the parties to the contract at its commencement. Therefore, if, at the time that the deposit was paid it was intended and clearly understood that the deposit was subject to forfeiture upon the failure of the recipient to perform their obligations, the deposit is a security deposit.

      53. If this clear understanding exists between the parties at the commencement of the contract, it is not relevant whether the forfeiture is actually enforced by the supplier upon the breach of some term or condition.

      110. In the Commissioner's view, the forfeiture of a security deposit is not a payment in the nature of damages or liquidated damages. A liquidated damages clause sets out the amount of damages in advance and must be a genuine pre-estimation of the loss likely to be suffered by the injured party on termination; it is an 'admitted....pre-assessment'. A liquidated damages clause removes the necessity to pursue and prove the amount of a loss in a claim for breach of contract in the courts with consequent benefits of timeliness and reduction in associated legal costs. Upon a breach, the injured party claims the agreed amount as a debt due and payable by the party in breach.

      111. The purpose of a security deposit, on the other hand, is to act as an earnest to guarantee the performance of the recipient's obligations under the contract. If the recipient fails to perform their obligations under the contract, the deposit is forfeited at the option of the supplier. The forfeiture is a consequence of the recipient's failure to perform the secured obligations. Although forfeiture of the deposit provides some relief to a supplier, if it is reasonable, it need not bear any relationship to the amount of any estimated or actual loss or damage suffered

      116. In addition, the forfeiture of a security deposit does not prevent the supplier from pursuing a claim in the courts for damages upon breach of the contract.

      117. Although forfeited security deposits are taken into account in the assessment of damages payable, this does not alter the characterisation of the initial payment. If it is intended that the amount is to be liquidated damages, it is the Commissioner's view that it is not a security deposit for the purposes of Division 99.

      118. The object of damages is, as far as possible, to compensate the injured party for any loss suffered and return them to the same position that they would have been in if the contract had not been entered into.51 If the amount forfeited as a security deposit is not taken into account in calculating damages, then the supplier may be placed in a better position than they would have been in, had the contract not been entered into.

      119. Although a forfeited deposit can be taken into account in the calculation of loss in an action for damages, the right to its retention bears no relationship to the existence of any loss, an award for damages, or the parties' rights to undertake an action for damages for the breach.

      120. In the Commissioner's view, a deposit, or a forfeited deposit, is not in the nature of damages when paid or forfeited, and for this reason, remains within the scope of the GST Act.

The sale contract provides that where the contract is terminated due to a default by the purchaser the vendor can hold the security payment for twelve months after completion and use the payment to deduct any loss recoverable and may start proceeding to sue the purchaser.

It is accepted that the third requirement is satisfied since there is a clear understanding between the vendor and purchaser that the vendor is allowed to keep the security payment where there is a failure by the purchaser to perform the obligation under the sale contract.

4. Be a reasonable amount.

According to paragraph 72 of GSTR 2006/2, what constitutes a reasonable amount for a deposit under a purchase contract depends upon the degree of risk to the supplier upon a breach or termination of contract by the recipient. If the supplier seeks a large security deposit, then that supplier needs to demonstrate that special circumstances exist

Paragraphs 78 and 79 of GSTR 2006/2 state:

    78. The Commissioner considers that the factors that may be taken into account in determining the reasonableness of an amount paid as a security deposit for a purchase contract include:

      ● duration of the contract and the time over which payment is to occur, as this may increase the risk of loss or devaluation of the asset by neglect, illegal act, mismanagement or adverse conditions during that period;

      ● uniqueness of the goods or the process involved in the supply, including:

      ● unusual designs or sizes that render a completed product very difficult to sell in the event of default;

      ● the use of special materials that could not be used on other jobs; and

      ● the purchase of highly specialized equipment which could only be used in the performance of the contract at risk;

      ● the vulnerability of the goods to loss in value; or

      ● other extraordinary conditions of the contract.

    79. These factors are not an exhaustive list. The reasonableness of any deposit, is to be determined on the facts and circumstances of each case at the time that the contract is entered into. It is also relevant to take into consideration industry practices and norms, although this should be balanced against the supplier's capacity to impose an unreasonable deposit upon the recipient (refer to paragraph 71).

You consider the security payment of 10% in addition to the deposit of 10% from the foreign purchaser is reasonable as:

    ● The Apartments will be sold 'off-the-plan'. As the Apartments are yet to be constructed, there will be a prolonged period between exchange and completion to allow for the construction works. There is a genuine risk that during the contract period, the Australian property market may suffer decline or that international factors (eg, increased restrictions on the movement of funds out of particular jurisdictions) may affect the capacity of some purchasers to complete.

    ● While it may be customary to accept a 10% for most land contracts, the risk of the trust suffering loss from default is greater where the purchaser is a foreign resident as there are practical restrictions on the ability to sue and enforce judgment against foreign residents.

    ● The standard land contract in Australia provides that if the contract is terminated due to a default by the purchaser and the deposit of 10% is insufficient to cover the vendor's losses, the vendor may sue the purchaser to recover the amount of any losses exceeding the amount of the deposit. This contemplates that a 10% deposit may not be adequate to cover the vendor's loss but where there is a shortfall the vendor can sue the purchaser for damages. Such further recourse may not be practical where the purchaser resides in a foreign jurisdiction.

    ● You will enter into the contracts for the sale of the Apartments as trustee of the XYZ Trust and as a trustee you must employ best practices to protect the unitholders.

Having regards to the duration of the 'off-the-plan’ contract for apartments not yet constructed, the degree of risk of making supplies to foreign purchasers, the 10% security payment in addition to the deposit of 10%, is considered to be a reasonable amount in this circumstance.

It is therefore accepted that the fourth requirement is satisfied.

Summary

Accordingly, the 10% security payment is considered to be a security deposit for the purposes of Division 99 as the four characteristics for a security deposit are satisfied.

Question 2

GST is payable on a taxable supply. A supply is a taxable under section 9-5 of the GST Act if:

    a) The supplier makes the supply for consideration; and

    b) The supply is made in the course of an enterprise that the supplier carries on’ and

    c) The supply is connected with the indirect tax zone (Australia); and

    d) The supplier is registered or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free.

All of the above must be satisfied for the supply to be a taxable under section 9-5 of the GST Act.

Supply for consideration

A bank guarantee is an agreement under which the bank agrees to be liable for the obligations of the purchaser if the purchaser defaults. When you enter into a guarantee contract with the bank you have acquired a further asset being the contractual rights under the guarantee (that is a right to call on the bank for payment).

Goods and Services Tax Ruling GSTR 2006/1 explains how guarantees are treated under the GST legislation.

According to paragraphs 63 and 64 in GSTR 2006/1, when you enter into a bank guarantee with the bank, the bank will make a supply of an interest to you and the supply made by the bank will be a financial supply where the other conditions in subregulation 40-5.09(1) of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST regulations) are met.

Further, when you acquire the interest from the bank you will also make a financial supply where the other conditions of subregulation 40-5.09(1) of the GST regulations are met.

Subregulation 40-5.09(1) of the GST Regulation provides that the provision or disposal of an interest mention in subregulation (3) or (4) is a financial supply if:

      a) The provision, acquisition or disposal is :

          i. for consideration; and

          ii. in the course or furtherance of an enterprise; and

          iii. connected with the indirect tax zone; and

      b) The supplier is:

          i. Registered or required to be registered; and

          ii. A financial provider in relation to supply of the interest.

From the facts given you will not receive any payment when the bank guarantee is entered into. In this instance there is no financial supply being made by you and the bank since there is no consideration for the provision and acquisition of the interest under the bank guarantee.

In this instance you have not made any supply to the bank since under the bank guarantee you have made an acquisition and not a supply.

Accordingly, the provision of the bank guarantee as additional security is not consideration for a taxable supply since there is no supply being made by you to the bank.