Edited version of your written advice

Authorisation Number: 1051410651081

NOTICE

This is an edited version of a revised private ruling. It replaces the edited version of the private ruling with the authorisation number 1051375490573

Date of advice: 27 November 2018

Ruling

Subject: GST and early release of deposit

Question

For the purposes of section 75-10(2) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), does the interest that is allowed as a deduction to the purchase price reduce the consideration for the supply of the unit?

Answer

No

Relevant facts and circumstances

You are registered for GST, accounting for GST on an accruals basis.

You own the property on which you constructed a multi-unit residential development.

Construction of the complex commenced in YYYY and was completed in YYYY.

The contract of sale pro-forma specifies a deposit of xx% of the price, unless otherwise stated’. All purchasers in this development were given the option of paying a different deposit amount – the most common being a xx% deposit. They were also invited to authorise early release of the deposit – in exchange for payment of interest on the deposit if the purchaser proceeds to completion – with varying rates up to xx% per annum. Interest was payable at settlement by way of a reduction or discount to the purchase price. Some purchasers initially declined this offer but subsequently sought to participate.

The offer is a standing offer for all purchasers, although there is no requirement or obligation for any purchaser to participate. No interest is payable if the purchaser does not agree to the early release of the deposit. Interest is payable if the purchaser proceeds to completion of purchase of property under the contract. Further, the deposit (and any interest accrued) is repayable by you on demand if the Contract is rescinded or terminated by the purchaser as per the conditions in the contract of sale.

The offer to participate is made prior to initial entry into the contract, but is not required to be taken up at that time in order to participate. In some cases, purchasers will only take up the offer after they obtain external advice about potentially agreeing to pay a higher deposit amount to you. The advice can be sought after initial entry into the contract, given the primary desire on the part of the purchaser at that time is to secure a particular unit, but in the knowledge that your offer is still able to be taken up after initial entry into a contract to purchase, that is, there is no re-negotiation involved as the offer is a standing offer.

Upon the purchaser consenting to the deposit being released, the released funds are authorised by the purchaser to be used for general working capital requirements on your development projects, including project costs. These are not limited to construction costs. Other costs can include purchase of the actual development site, consultancy and marketing, among others. There may also be additional costs associated with variations (after bank and mezzanine funding has been secured) or obtaining another builder if the head builder is unable to complete construction.

The early release and interest option makes it easier to lock in purchasers to buy units (for example, under pre-sale agreements), which in turn puts the developer in a stronger position when dealing with the banks and mezzanine funders.

The early release model is one of a number of purchase price discount tools you use to lock-in purchasers and unlock working capital to deal with the day-to-day lumpy nature of cash flow constraints associated with development projects, with early release deposit funds also potentially used to assist with general working capital and management of overall cash flow on other development projects outside of the project itself.

On DDMMYYYY, you entered into a contract for sale (contract) of Lot xx / Unit xx in the development to a 3rd party purchaser. The cover page contains the following details:

● The purchase price is $xxxx.

● The deposit is xx% ($xxx)

● The margin scheme will be used

The contract contains the standard conditions as incorporated in the Contract for the sale of land – 2005 edition as authorised by The Law Society of New South Wales and the Real Estate Institute of New South Wales.

The following special clauses are also included:

xx. The Deposit

Notwithstanding the provisions of clause X, if the vendor, in its absolute discretion, agrees to accept a bond or guarantee for the amount of the deposit in and to the effect of the bond or guarantee annexed to this contract in lieu of payment of the whole or part of the deposit, then the following provisions apply.

The purchaser must, as an essential term, pay to the vendor the amount stated in the bond or guarantee by settlement cheque on completion or at such other time as is provided for the deposit to be paid to the vendor.

If the vendor terminates this contract then, to the extent that the deposit has not already been paid by the issuer of the bond or guarantee, the purchaser must, as an essential term, immediately pay the deposit (or so much as has not been paid pursuant to the bond or guarantee) to the vendor.

In the event that the purchaser tenders, and the vendor accepts (within the vendor’s absolute discretion), a bond or guarantee that has an expiry date prior to the registration date, then the purchaser:

● must serve a replacement bond or guarantee (in a form and/or on terms that are, in the vendor’s absolute discretion, acceptable to the vendor) on the vendor no later than 28 days prior to the expiry date of the current bond or guarantee; and

● acknowledges that the purchaser’s obligations under this clause XX are essential and a failure by the purchaser to comply with such obligations entitles the vendor to terminate this contract.

xx. Payment of the deposit by instalments*

Notwithstanding any other clause of or notation made on or to this contract, the parties agree that the deposit is xx% of the price.

The deposit is to be paid by instalments as follows:

● sum of $ on the making of this contract (first instalment); and

● the second instalment (being x% of the price less the first instalment) by 5.00 pm on the date which is 14 days after the date of this Contract.

The purchaser may, prior to the expiry of the time for payment of the second instalment, tender a bond or guarantee for the deposit (such bond or guarantee must be for xx% of the price) and if the vendor, in the vendors absolute discretion, accepts the bond or guarantee for the deposit, the vendor will refund any part of the deposit paid in cash or by cheque.

By letter dated DDMMYYYY, you and the purchaser agreed in writing to vary the terms of the contract for sale with a view to authorising the release of the deposit to you (the variation).

Under the variation, the purchaser agreed to release the deposit as per the following clauses:

a) The Contract for Sale between you as the vendor and myself as the purchaser in relation to the above property is dated DDMMYYYY.

b) The Contract Price is $xxxx and the Deposit paid is $xxx

c) Interest, at the rate of xx% per annum, is to be calculated on the Deposit from the date the Deposit is released to you and will accrue in arrears on each anniversary of the release date and then be paid by you as a deduction from the purchase price on completion of the Contract.

d) In accordance with the Contract, the Deposit will become your property on completion of the Contract.

e) The Deposit (and any interest accrued) is repayable by you on demand if the Contract is rescinded or terminated by me as per the conditions in the contract of sale.

f) …

a. The release of the Deposit to you is in the form of an unsecured loan and I have made my own assessment of the risk that may entail; and

b. You have not given me any promise or representation as to your intended purpose, use or application of the Deposit the only restriction on the released Deposit funds is that they be used for the purpose of funding your development projects.

Completion of the sale of Unit xx to the purchaser occurred on DDMMYYYY.

At completion, a settlement statement was prepared. In addition to the purchaser allowing for water rates, council rates, owners corporation insurance and cost of a section 109 certificate, you, as vendor, allowed an amount on account of LPI registration fees on discharge of mortgage registration as well as interest on the early release of the deposit.

Total interest payable by you to the purchaser was $xxxx. This was calculated as follows:

● Number of days: xxx

● Interest rate: xx%

● Part price released: $xxx

● Interest first year: $xx

● Interest second year $xx

● Interest third year: $xx

● Interest fourth year $xx

After allowances made by both the purchaser and you and taking into account the deposit, other amounts previously paid and interest payable by you on completion of sale to the purchaser, the balance payable by the purchaser at settlement was $xxxx.

This private ruling does not consider:

● Whether, in light of the increase in the deposit and / or early release of the deposit, the payment retains its characterisation as a deposit for GST purposes.

● Whether the supply is ineligible for the margin scheme.

● Whether section 75-11 has any application.

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 9-15

A New Tax System (Goods and Services Tax) Act 1999 section 75-10

A New Tax System (Goods and Services Tax) Act 1999 section 75-11

Reasons for decision

In this ruling,

● unless otherwise stated, all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

● all reference materials, published by the Australian Taxation Office (ATO), that are referred to are available on the ATO website ato.gov.au

Under section 9-5, you make a taxable supply if:

● you make the supply for consideration

● the supply is made in the course or furtherance of an enterprise that you carry on

● the supply is connected with the indirect tax zone

● you are registered, or required to be registered.

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

On the facts provided, your supply of unit xx to the purchaser was a taxable supply as all four elements of section 9-5 are satisfied. Further, your supply of the unit was not GST-free or input taxed.

Under section 75-10:

● if a taxable supply of real property is under the margin scheme, the amount of GST on the supply is 1/11 of the margin for the supply.

● subject to subsection 75-10(3) and section 75-11, the margin for the supply is the amount by which the consideration for the supply exceeds the consideration for your acquisition of the real property.

The issue here is whether the interest amount of $xxxx:

● was consideration for a separate supply by the purchaser, or

● reduced the amount of consideration you received for your supply of the unit to the purchaser.

The contract for the sale of unit xx provides:

a) that the deposit, if invested, is at the risk of the person finally entitled to it,

b) any interest is to be shared equally and

c) that if the deposit is released early it is a charge on the land.

Schedule 1 of Goods and Services Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions describes a loan as a credit arrangement under which the lender provides the use of its funds on specified terms under a business contract.

The letter varying the contract provides:

a) that the deposit is to be released to the vendor,

b) interest is payable at xx%,

c) releasing the deposit amounts to an unencumbered loan,

d) on completion the deposit becomes the property of the vendor,

e) the interest is payable as a deduction from the purchase price at settlement and

f) if settlement does not occur because the purchaser rescinds or terminates, then the deposit and any interest is repayable on demand to the purchaser.

The legal character of the arrangement depends on its substantial operation, not on the formality of what document or documents it may be contained within. The effect of the Contract and letter of variation is that money that is the property of the purchaser is lent as an unsecured loan to the vendor. Unlike the original contract it is therefore at the risk of the purchaser.

The fact that a purchaser can trigger release of the deposit of xx% at any time after entering into the contract does not alter the legal character of the arrangement if and when it is taken up.

Clause (d) of the letter of variation appears an attempt to say that on settlement the loan is no longer repayable. The nature of a loan is not that money paid belongs to the person paying it. Advancing a loan merely creates a debtor / creditor relationship, even if money is deposited at a bank. Should the debtor become insolvent and unable to repay the advance it is just a debt that cannot be repaid.

The provisions of the Contract and letter of variation also clearly establish that the purchaser lent the vendor the deposit for an interest payment of xx% which also becomes a debt owing by the vendor to the purchaser. Clauses (c), (d) and (e) of the letter of variation merely stipulate mechanisms for how that debt (deposit and interest on it) will be repaid:

● If the contract settles, the debt will be paid by applying it to the purchase price.

● If the contract is rescinded or terminated, the debt will be paid to the purchaser.

The interest is consideration for a financial supply constituted by release of the deposit of xx% as an unsecured loan.

The payment of interest by the vendor to the purchaser for a loan made to the vendor of the deposit is not a discount of the original purchase price. The fact that the purchaser agrees to have their entitlement to interest set-off, applied or ‘allowed’ in part satisfaction of the purchase price is irrelevant. A direction or agreement in these terms does not change the legal character of the interest arrangement.

While the Commissioner’s view is that the early release of the deposit constitutes an unsecured loan to the vendor, for which interest is paid, it is also arguable that the amount of $xxxx was consideration that you paid for the purchaser’s supply of entering into the variation.

Under subsection 9-15(1), consideration includes:

a) any payment, or any act or forbearance, in connection with a supply of anything; and

b) any payment, or any act or forbearance, in response to or for the inducement of a supply of anything.

Under paragraph 9-10(2)(g), supply includes:

g) an entry into, or release from, an obligation:

(i) to do anything; or

(ii) to refrain from an act; or

(iii) to tolerate an act or situation;

The offer to participate in the early release model is a standing offer for all purchasers, although there is no requirement or obligation for any purchaser to participate. No interest is payable if the purchaser does not agree to the early release of the deposit.

The standing nature of the offer meant that it did not have to be taken up prior to exchange and could be taken up after the contracts were signed – as it was in this instance.

The contract, as signed on DDMMYYYY, called for a deposit of xx%. With the contract signed and the deposit paid, you were obligated to construct and supply the residential unit. The purchaser was obligated to pay the balance of the contract price at settlement.

By letter dated DDMMYYYY, you and the purchaser agreed in writing to vary the terms of the contract for sale with a view to authorising the release of the deposit to you (the variation).

Neither the payment of the additional xx%, nor the early release of the deposit secured, for the purchaser, any additional obligation for you to proceed to settlement. Therefore, the question arises as to what additional benefits were conferred on the purchaser by entering into the variation.

As a result of entering into the variation, the purchaser was entitled to be paid ‘interest’, at a very attractive rate, from release to settlement. In entering into the variation, the purchaser took on an additional risk (total or partial loss of the deposit) in the event that you failed to fulfil your obligations under the contract.

In entering into the variation, the purchaser agreed to the release of the deposit such that it was no longer required to be held in the Real Estate Trust account. The funds became available to you for your immediate use. The inducement for the purchaser to enter into the variation was the interest to be paid by you.

The amount of $xxxx was consideration that you paid for the purchaser’s supply of entering into the variation, the actual amount of consideration (labelled as ‘interest’ in the variation) being calculated by reference to the deposit amount, time and a specified interest rate.

You contend that the consideration for the supply of the unit by you to the purchaser is equal to the monetary (cash) consideration provided by the purchaser in accordance with the terms of the agreement governing the sale of the unit, that is, the deposit paid on entry into the contract for sale plus the balance paid on completion / settlement (net of settlement adjustments in favour of both the purchaser and you ($xxxx).

Goods and Services Tax Determination GSTD 2004/4 Goods and services tax: can consideration for a supply be provided or received without transferring money (such as where the parties only make book entries recording their agreement that the supply is paid for)? explains that, in the absence of the transfer of money (or non-monetary consideration), consideration can be provided or received by way of setting off mutual liabilities in accordance with the doctrine of set-off.

Paragraph 2 of GSTD 2004/4 explains that a set-off can occur if each party has made a supply to the other and each party is required to pay the other for the supply made to it.

Paragraph 11 of GSTD 2004/4 explains that for the doctrine of set-off to apply there have to be mutual liabilities of amounts presently payable between two parties.

Paragraph 13 of GSTD 2004/4 further explains that if mutual liabilities to pay for supplies are set off against each other, each of the supplies are separate supplies with separate consideration. It is the liabilities to pay for the supplies that are set off against each other; the supplies themselves are not set off.

You are supplying the residential unit, for which the purchaser is liable to pay you $xxxx (including adjustments for rates, water, etc, of $xx.

The purchaser has entered into the variation which is an unsecured loan of the deposit to you, for which you are liable to pay them $xxxx in interest.

Under clause (c) of the variation, the ‘interest’ is to be paid by you as a deduction from the purchase price on completion of the Contract, ie it is to be set off against the amount of $xxxx which the purchaser is liable to pay you for your supply of the residential unit.

As explained in paragraph 13 of GSTD 2004/4, this set off arrangement did not reduce the consideration that you received for your supply of the property for GST purposes.

Settlement adjustments

You have contended that the amount allowed as interest in reducing the balance purchase price payable by the purchaser at settlement has the effect of reducing the overall consideration for the single supply of real property by you for GST purposes and is entirely consistent with the Commissioner's views expressed in Goods and Services Tax Determination GSTD 2006/3 Goods and services tax: are settlement adjustments taken into account to determine the consideration for the supply or acquisition of real property?

We do not agree with this contention.

The consideration for the supply is the contract price, subject to valid settlement adjustments.

As noted at clause xx of the contract for sale, when a property is sold, the vendor (seller) is normally entitled to all income (for example. rent) and is responsible for all outgoings (for example. council rates, water rates) up until the date of settlement.

At settlement, “adjustments” will be made. For example: the council rates are paid for the whole year. The purchaser must pay an additional amount to the vendor for the proportion of the year the purchaser will own the property. Usual adjustments are council rates, water rates, strata body corporate contributions, and land tax.

Outgoings such as council rates, water rates and land tax are unavoidable amounts payable to third parties as a consequence of ownership or (in the case of the section 109 certificate and the fees on discharge of mortgage registration), the acquisition/disposal of the property.

Outgoings such as council rates, water rates and land tax are liabilities, usually raised annually, which attach to the property. They are payable by the current owner, whoever that may be at a particular time.

As explained in paragraph 3 of GSTD 2006/3, the contract will usually require the recipient to pay an extra amount to the supplier for the balance of the rates or land tax period that reflects the recipient's period of ownership.

In the absence of such settlement adjustments, either the purchaser or the seller would incur the expense for the full year, despite only owning the property for part of the year.

In your case, the interest to be paid to the purchaser is not a liability related to ownership of the property or as a consequence of ownership of the property between contract and settlement; it is merely the interest on the unsecured loan of the amount of the deposit.

As, you are always 100% liable for this expense, there is no apportioning of this expense between the seller and the purchaser to reflect their period of ownership. Accordingly, the compounding of the interest and subsequent application of the interest to reduce the final amount due by the purchaser at settlement is not in the nature of a settlement adjustment.

The fact that the interest is paid at settlement (rather than annually, quarterly) and is paid by way of application to the amount due at settlement (rather than to the purchaser’s bank account) is a contractual agreement between the parties.

The interest is not otherwise a settlement adjustment either. The reason is that it does not involve a liability or entitlement arising from ownership or use of the property. The entitlement of a purchaser to interest arises by reason of an unsecured loan arrangement. By agreement, that entitlement is simply set-off against the purchase price. In other words, the interest is no more than a source from which part of the purchase price is paid on settlement. It is not relevant that the interest is not physically paid over, nor does it matter that the arrangement is within the sale contract.

Comparison with rental guarantee

You contend that, consistent with the views of the Commissioner in Goods and Services Tax Determination GSTD 2014/3 Goods and services tax: do payments made by a vendor to a purchaser of real property when the rent received falls below a rental yield guaranteed by the vendor give rise to an adjustment event for the purposes of Division 19 of the A New Tax System (Goods and Services Tax) Act 1999?, the agreement on the part of the purchaser to release the deposit to you in return for interest to be paid at settlement as a reduction in the overall purchase price payable cannot represent consideration for any separate supply made by the purchaser to you. As the obligation to pay interest as a purchase price reduction arises under the terms of the overall contract for sale of the property, the better view is that the interest calculated and paid at settlement as a purchase price reduction has the effect of merely reducing the overall consideration for the supply of the unit, ie, it is not consideration for any separate supply by the purchaser.

We do not agree with this contention. The facts in this case are simply that interest is paid for access to money that becomes an unsecured loan to the vendor.

A rental guarantee adjustment involves an agreed reconciliation between the parties concerning rental income received by reason of ownership or use of the property. An allowance or set-off agreed for interest due under the unsecured loan arrangement has nothing to do with ownership or use of the property. The vendor simply uses the money for anything it likes. It pays interest to the purchaser purely by reason of its use of the money, not the property. In summary, the circumstances giving rise to the payment of interest in your case are factually different to the circumstances giving rise to the payment of a ‘rental guarantee’ as considered in GSTD 2014/3.

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