Edited version of private ruling

Authorisation Number: 1011752847356

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Ruling

Subject: GST and guarantees and indemnities

Question 1

Does the lodgement and subsequent draw down from an incomplete works bond constitute consideration for a taxable supply made by you?

Answer

No. The incomplete works bond is not consideration for any taxable supply that you make. Therefore, you are not liable for GST in relation to the lodgement of, or the draw down from, the incomplete works bond.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are a government related entity.;

Under your government planning laws you are empowered to implement planning schemes and planning instruments;

In accordance with this legislative framework, you implemented a specified scheme which in broad terms, provides the framework for managing development in a specified way;

The scheme incorporates various planning policies, one of which deals with certain works and provides for the bonding of incomplete works associated with the reconfiguring of land;

The bonding of incomplete works is a common practice and is usually called for when approvals are granted to develop land;

Broadly, this process requires developers to provide a bond to a government related entity which can be called upon if approved works are not completed to a satisfactory level. The amount of the incomplete works bond is generally calculated according to a specified method;

An incomplete works bond effectively guarantees that a developer's obligations under development and works approvals will be fulfilled and that a government related entity will be compensated if it incurs costs to complete or rectify works which were the responsibility of the developer under the relevant approval;

Incomplete works bonds are generally provided in the form of a bank guarantee. Under a bank guarantee, a financial institution guarantees to fund the completion of work or pay an amount to a government related entity up to an agreed value;

In this context, on a specified date you approved a development application lodged by a developer to reconfigure land located at a particular address in Australia, into a number of residential lots and parkland;

On a specified date, a contractor, on behalf of the developer, made an application to bond incomplete works in respect of the specified development to a specified value;

You advised the developer that an incomplete works bond of a specified amount was required to be provided in the form of a bank guarantee;

A bank guarantee for this amount was provided to you by a financier in respect of this development;

Due to certain events, the developer could not complete the development;

You estimated that works valued at a specific amount had not been completed in respect of the development at the time that the developer ceased working on the development. As a result, you called for an amount of $X from the financier under the terms of the bank guarantee. This amount was received by you on a specified date;

At the time of this private ruling application, the bond call-up amount has been applied by you in the following ways:

$X has been allocated to specified reinstatement works which were the responsibility of the developer but completed by you;

$X has been allocated to certain other works which were to be funded by the developer but were paid for by you;

These capital items will become your property;

The remaining bond of $X continues to be held by you.

Your contentions:

You have not made an identifiable supply in connection with the drawing down of the incomplete bonds works. The bond draw downs occurred as a direct result of the actions or inactions of the developer rather than any form of positive action taken by you which has anything passing from you to either the developer or the financier;

The payments made under a performance bond arrangement of this nature do not represent consideration for a supply made by you. Rather, they are in the nature of an indemnity specifically designed to rectify the losses suffered by you as a result of the failure of developer to fulfil its obligations;

This view is supported by paragraph 136 of GSTR 2006/1 which states:

If the supply that the service provider makes to the recipient is inferior or incomplete, and the recipient receives a payment from the surety, this payment is made to meet the surety's obligations under the performance bond. It is not an adjustment to the price of the original supply, nor is it consideration for a separate supply by the recipient.

It follows that the payment made by the financier to you is not consideration for a taxable supply made by you and therefore GST is not payable in respect of these payments.

Reasons for Decision

In this case, it is relevant to consider whether the incomplete works bond is a guarantee or indemnity that falls within the scope of item 7. Specifically, whether it is a 'performance bond' as listed in Part 5 of Schedule 7 to the Goods and Services Tax (GST) Regulations.

For GST purposes, certain 'interests' listed in the table in sub-regulation 40-5.09(3) of the A New Tax System (Goods and Services Tax) Regulations can be financial supplies when they are provided, acquired or disposed of. Financial supplies are input taxed under the GST Act and therefore are not subject to GST.

Item 7 in the table lists 'a guarantee, including an indemnity (except a warranty for goods or a contract of insurance or reinsurance)'. Part 5 of Schedule 7 to the GST Regulations gives the following examples of things included under item 7:

· An indemnity that is not a contract of insurance;

· A surety bond that is a guarantee; and

· A performance bond.

[note: These terms are not defined in the GST Act or GST Regulations.]

At general law, a guarantee is an agreement whereby one entity (the surety) agrees to be liable for the obligations of another (the principal) if the principal defaults. An indemnity is an obligation to an entity (the creditor) assumed by another (the surety) under which the surety agrees to keep the creditor harmless from risks arising from dealings with a third party.

Under a guarantee, the principal has the primary obligation to the creditor and the surety has the secondary obligation. The surety has no obligation under the guarantee unless the principal defaults on their primary obligation. The surety cannot have a primary liability, nor can their liability be greater than the principal's liability. If the primary obligation is extinguished, so is the guarantee.

In an indemnity, the surety assumes a primary obligation from the time the contract is made, whether or not the principal defaults. Consequently, the creditor can recover directly from the surety under an indemnity without waiting for default by the principal.

In both, contracts of guarantee or indemnity, the surety has a right of recovery for losses against the principal. That is, they have the right to be indemnified or reimbursed by the principal.

GSTR 2006/1 (which explains how guarantees and indemnities are treated under the A New Tax System (Goods and Services Tax) Act 1999)) explains that the common characteristics of guarantees and indemnities covered by item 7 are those arrangements that involve three parties and in each arrangement, there is an underlying indemnity which flows from the relationships between the parties. Because of this, the nature of the risk undertaken by the surety in these arrangements is the risk that the principal will be unable to reimburse the surety if it is required to make a payment.

Performance bonds

In commercial practice, performance bonds are given for the quality, timeliness or some other measure of supplies being made to an entity. In such cases, the recipient contracts for the service provider to make a supply to the recipient and the surety guarantees the quality or timeliness of the completed work. That is, the recipient contracts for a particular outcome. A performance bond guarantees that outcome.

If the work is not satisfactorily completed, the recipient has the right to call on the surety under the bond. The surety may choose to complete the work itself instead of making a payment (where this is provided for in the bond document and there is no legal impediment) or pay an amount of money.

Paragraph 47 of GSTR 2006/1 defines performance bonds as follows:

In a performance bond, a surety is liable for the performance, by a service provider of the conditions under the service provider's contract with the recipient of the services. The surety's obligation is to make good the service provider's obligation. Performance bonds don't usually cover an obligation of the service provider to make payment, but rather an obligation to perform services, or carry out other work, or meet conditions in a contract. A performance bond may take the form of a guarantee (that is, the surety has a secondary liability), but are commonly indemnities (where the surety takes on a primary liability along with the service provider).

In this case, in accordance with the scheme, you requested the developer to lodge an 'incomplete works bond'. This was to guarantee the works to be fulfilled by the developer and to ensure that you would be compensated if you had to incur costs to complete or rectify works which were the responsibility of the developer. The incomplete works bond was in the form of a bank guarantee provided by a financier.

Following certain events which caused the developer to default on the terms of the development approval, you had to complete works and as a consequence called upon the financier to release an equivalent amount (to you) under the terms of the bank guarantee. These funds were then allocated to reinstatement works which were the responsibility of the developer but completed by you and other works which were to be funded by the developer but were paid for by you. These capital works are your property.

The facts support that the 'incomplete works bond' provided in the form of the bank guarantee by the financier, is a performance bond for GST purposes that falls within the scope of item 7.

The GST consequences for transactions under a performance bond are explained in detail in paragraphs 126 to 139 of GSTR 2006/1. Essentially, if the supply that the service provider (e.g. a developer) makes to the recipient is inferior or incomplete, and the recipient receives payment from the surety (e.g. a bank or financier), this payment is made to meet the surety's obligations under the performance bond. It is not an adjustment to the original supply, nor is it consideration for a separate supply by the recipient. If the surety is called upon to make a payment to the recipient, the payment is made as a result of the exercise of the recipient's rights under the indemnity.

Where the surety pays money, this is not consideration for the release of the surety from an obligation under paragraph 9-10(2)(g), nor is it consideration for the surrender of the recipient's rights under paragraph 9-10(2)(e) of the GST Act. Rather, the payment discharges (whether fully or partly) the surety's obligations under the contract. Accordingly, there is no supply to the surety by the recipient in consideration of the payment by the surety.

Further, the payment of money is also not a supply by the surety because of subsection 9-10(4) of the GST Act which provides (in general terms) that a supply does not include a supply of money.

Applying the principles in GSTR 2006/1 to the circumstances of this case, we accept that you are not making a supply in relation to the taking of, or draw down from, the incomplete works bond in order to complete the works yourself as a consequence of the default by the developer under the development agreement. As the payments that are called for by you, to be drawn from the 'incomplete works bond', is not 'consideration' for any supply that you make, you will not be liable for GST on the lodgement of, or draw down from, the incomplete works bond.