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Ruling

Subject: GST and attribution of input tax credits

Question

Can you attribute the full input tax credit on the acquisition of the commercial properties to the tax period in which you made the first and second initial payments (the initial payments)?

Answer

No.

Relevant facts and circumstances

You are registered for GST and our records show that you account for GST on a non-cash basis.

On a specified date you entered into a contract for the sale and purchase of the properties (the contract) with the vendor.

The properties are commercial properties. The contract provides that the properties do not comprise residential premises, commercial residential premises or farm land.

The contract provides that the sale of the properties is not a GST-free supply of a going concern. The sale is a taxable supply and is not subject to the margin scheme.

The purchase price is $X inclusive of GST.

The contract provides that you are required to pay the purchase price, together with any GST applicable, in the following manner:

(a) the deposit set out in the relevant schedule to the contract (the schedule) to the vendor, and

(b) the balance set out in the schedule to the vendor at settlement.

The schedule provides that the deposit is $Y. The contract provides that the deposit is paid in two instalments (being the initial payments) within the first month of the execution of the contract. The initial payments are non-refundable and are immediately forfeited to the vendor. However, where you satisfy all your obligations under the contract, on the day of the settlement the initial payments will be applied to the purchase price in the usual course.

The total sum of the initial payments is slightly over 10% of the purchase price.

The contract provides that for the avoidance of doubt, the initial payments are payments in the nature of a deposit paid by you to the Vendor pursuant to this contract (despite any other term or condition of the contract to the contrary) and the relevant provisions of the contract relating to the deposit and default shall apply in respect of these payments.

The relevant provisions of the contract relating to default and termination of the contract provide that if the contract is determined by the vendor under the relevant default clauses of the contract, all moneys paid or payable by you under the contract by way of deposit shall be forfeited to the Vendor.

The contract also provides that if the contract is determined by you under the relevant default clauses of the contract, the vendor will re-pay to you all moneys paid by you under the contract by way of deposit or otherwise.

In addition to the purchase price, you agreed to pay to the vendor a specified amount on account of all outgoings in respect of the properties between the date of the contract and the settlement date. This payment is non-refundable whether or not the settlement takes place under the contract.

The contract indicates that there was a previous contract for the sale and purchase of the properties (old contract) which was terminated when the new contract was entered into. A specified amount that you had paid as a deposit to the vendor pursuant to the old contract was forfeited to the vendor (forfeited sum).

You made a further payment on account of GST on the forfeited sum to which the vendor was absolutely entitled. This payment was in addition to any purchase price payable under the contract. The vendor agreed to provide you with a tax invoice in respect of the GST on the forfeited sum.

The contract provides that on the day of the settlement you are required to pay the balance of the GST inclusive purchaser price to the vendor.

The contract provides that you and the vendor agreed that the forfeited sum will be credited to the GST inclusive purchase price, and the initial payments will be applied to the GST inclusive purchase price in the usual course.

The contract provides that:

· The vendor granted approval for you to lodge development applications in relation to the properties and agreed to provide all necessary assistance by way of consents to lodge such applications and sign all the necessary application documentation to facilitate the lodgement of the development application.

· You are responsible for all the costs of the preparation and lodgement of the development application and incidental thereto.

· You and your surveyors, architects, engineers, consultants and other trades or professions related to the development application are granted access to the properties prior to settlement for the purpose of taking measurements, drawing plans, inspecting and any other activity incidental to the lodgement of development application.

· The vendor has granted you approval to erect a reasonable amount of temporary signage on the properties.

· The contract is not subject to successful gaining of any approvals by virtue of development applications lodged by you on or before settlement and you cannot delay or defer the settlement day.

Upon obtaining the development authorisations you must use your best endeavours to settle the contract within a specified number of days of the date of obtaining those development authorisations.

In the event that the development authorisations are unable to be obtained or have not been obtained, then the settlement must take place on the specified date.

The contract provides that if you obtain a private ruling from the Australian Taxation Office confirming that the initial payments comprise consideration for a taxable supply in the tax period during which the contract was entered into, then the vendor will provide you with a tax invoice.

You are acquiring the properties for a creditable purpose.

The vendor is registered for GST.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 11-5

A New Tax System (Goods and Services Tax) Act 1999 section 11-15

A New Tax System (Goods and Services Tax) Act 1999 section 11-20

A New Tax System (Goods and Services Tax) Act 1999 section 29-10

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

A New Tax System (Goods and Services Tax) Act 1999 section 99-10

Reasons for decision

Summary

The initial payments are not consideration for a taxable supply made to you. The initial payments are a security deposit for the purposes of Division 99 of the A New Tax System (Goods and Service Tax) Act 1999 (GST Act). Therefore, the payments do not trigger attribution of an input tax credit on the acquisition of the properties in the tax period in which you made the initial payments.

Detailed reasoning

Creditable acquisition

Section 11-20 of the GST Act provides that an entity is entitled to an input tax credit for any creditable acquisition that it makes.

Section 11-5 of the GST Act states:

You make a creditable acquisition if:

· you acquire anything solely or partly for a creditable *purpose; and

· the supply of the thing to you is a *taxable supply; and

· you provide, or are liable to provide, *consideration for the supply; and

· you are *registered or *required to be registered.

(* denotes a term defined in section 195-1 of the GST Act)

Section 11-15 of the GST Act provides that you acquire a thing for a creditable purpose if you acquire it in carrying on your enterprise. However, you do not acquire the thing for a creditable purpose to the extent that the acquisition relates to making input taxed supplies or the acquisition is of a private or domestic nature.

In your case, based on the information provided, the acquisition of the properties meets all the requirements of section 11-5 of the GST Act. This is because you are making the acquisition for a creditable purpose, the supply to you is a taxable supply, you are liable to provide consideration for the supply and you are registered for GST.

Accordingly, you are entitled to an input tax credit for the acquisition of the properties pursuant to section 11-20 of the GST Act.

Attributing the input tax credit on the acquisition of the properties

Subsection 29-10(1) of the GST Act sets out the rules that determine the tax period in which an entity that accounts on a non-cash basis can attribute the input tax credits on a creditable acquisition. Subsection 29-10(1) of the GST Act states:

(1) The input tax credit to which you are entitled for a *creditable acquisition is attributable to:

(a) the tax period in which you provide any of the *consideration for the acquisition; or

(b) if, before you provide any of the consideration, an *invoice is issued relating to the acquisition - the tax period in which the invoice is issued.

Accordingly, we need to determine:

· whether the initial payments are consideration for the acquisition of the properties or are merely payments in the nature of a security deposit, and

· whether the vendor has issued an invoice for the supply of the properties.

Security Deposit

Subsection 99-5(1) of the GST Act prevents a security deposit from being treated as consideration for a taxable supply until such time that the deposit is either forfeited because of failure to perform the secured obligation, or is applied as all or part of the consideration for a supply.

The Explanatory Memorandum to the A New Tax System (Goods and Services Tax) Bill 1998 contemplates at least two types of security deposit arrangements to which Division 99 of the GST Act applies. It states at paragraphs 6.164 to 6.169:

6.164 If you make a security deposit, the intention is usually that it will be refunded to you when you meet the obligations to which the deposit relates. The deposit may be consideration for a taxable supply. However, it would be pointless for the supplier to charge GST on the deposit if the deposit is to be refunded, in which case the GST would have to be refunded to the supplier.

6.165 However, some security deposits later become incorporated in the consideration for a taxable supply. At some point the deposit ceases to be held as a security deposit and is offset against the remaining consideration that is payable. GST should be charged on such deposits if they become part of the consideration for the taxable supply.

6.166 Also, if a security deposit made in relation to a taxable supply is forfeited, GST should be payable on the deposit.

6.167 For these reasons, Division 99 provides special rules in relation to security deposits.

6.168 If a security deposit is made, it is treated as not being consideration for a supply (and hence not subject to GST) unless the deposit is forfeited or is applied towards the consideration for the supply. Section 99.5.

6.169 If the deposit is forfeited or is applied towards the consideration for the supply, GST is paid on the amount of the deposit. The GST is attributed to the tax period in which the deposit is forfeited or is applied towards the consideration. Section 99.10.

Goods and Services Tax Ruling GSTR 2006/2 explains the Commissioner's view on the operation of Division 99 of the GST Act.

Paragraphs 18 to 20 of GSTR 2006/2 state:

18. To fall within the provisions of Division 99, the amount received by the supplier must be a 'deposit'.

19. he term 'deposit' is not defined in the GST Act. However, judicial decisions have indicated that the term 'deposit' has a particular meaning in a commercial context.

19A. In Federal Commissioner of Taxation v. Reliance Carpet Co Pty Ltd [2008] HCA 22; 2008 ATC 20-028; 68 ATR 158 (Reliance Carpet) the High Court noted at paragraphs 22 to 27 of the decision that the term 'deposit' had several aspects. These aspects include that a deposit: could be counted towards the payment of the purchase price; be brought into account in assessment of damages; be a token provided by the purchaser as 'an earnest to bind the bargain'; and provide a form of security for performance by the purchaser.

20. For a payment to be considered a 'security deposit' for the purposes of Division 99, it should have the following characteristics:

· be held as a security for the performance of an obligation: see paragraphs 21 to 30;

· the contract, conduct and intent of the parties to the contract must be consistent with the payment being a security deposit: see paragraphs 31 to 50;

· be at risk of forfeiture upon failure to perform the obligation: see paragraphs 51 to 64; and

· be a reasonable amount: see paragraphs 65 to 108.

Below we consider whether the initial payments have the four characteristics of a security deposit for the purposes of Division 99 of the GST Act.

Held as a security for the performance of an obligation

Paragraphs 21 to 30 of GSTR 2006/2 provide that for Division 99 of the GST Act to apply the deposit must be 'held' as security for the performance of an obligation. The GST Act does not explain the concept of deposit that is 'held'.

As stated in paragraph 22 of GSTR 2006/2, 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.

Paragraph 23 of GSTR 2006/2 provides that an amount ceases to be a security deposit when that amount is applied as consideration, or is forfeited, regardless of whether it is held by the supplier or a third party at that time.

In your case the initial payments are paid to the supplier. Although the contract states that these payments are forfeited to the vendor upon payment, the contract also makes it clear that these payments are in the nature of a deposit paid by you to the vendor under the contract and that the relevant provisions in the contract relating to the deposit and default apply in respect of these funds. Accordingly, these funds will only be forfeited to the vendor if you default otherwise they will be applied to the GST inclusive purchase price in the usual course upon settlement.

Based on the above, the initial payments are amounts held by the supplier as a security for the performance of your obligations under the contract.

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

Whether a particular payment is a security deposit depends on the terms of the contract and the intention of the parties to the contract.

As stated in paragraph 31 of GSTR 2006/2, the courts have described a deposit as an 'earnest' that is paid 'to bind the bargain'. The Macquarie Dictionary, 2001, rev. 3^rd edn, The Macquarie Library Pty Ltd, NSW, provides that such a payment is 'a portion of something given or done in advance as a pledge of the remainder'. This can be distinguished from paying the first instalment of the total price in a purchase contract, which is to be paid over a period of time, that is, an initial instalment payment, or part payment.

Paragraph 32 of GSTR 2006/2 states:

32. In Howe v. Smith (1884) 27 Ch D 89 (Howe), Fry, LJ described a deposit in the following terms:

It is not merely a part payment, but is then also an earnest to bind the bargain so entered into, and creates by the fear of its forfeiture a motive in the payer to perform the rest of the contract.

In your case, the initial payments are not merely part payments. Their initial purpose is as security for the performance of the contract.

Be at risk of forfeiture upon failure to perform the obligation

Paragraphs 51 to 53 of 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.

Paragraphs 54 to 56 of GSTR 2006/2 provide that although many standard contracts contain forfeiture clauses, the parities to the contract may have an understanding that the forfeiture will not be enforced. In these situations the deposit is not a security deposit.

However, paragraph 57 of GSTR 2006/2 states:

57. Where forfeiture is a term or condition of the contract, the Commissioner will accept, prima facie, that the deposit is at risk. However, if the commercial practice is made known to the recipient at the time of entry into the contract, this may lead to the conclusion that the parties have openly bargained to remove the forfeiture clause.

In your case, the contract contains a forfeiture clause which provides that the initial payments are subject to forfeiture upon your failure to perform your obligations under the contract. Accordingly, we accept that the initial payments are at risk of forfeiture.

Be a reasonable amount

Paragraph 65 of GSTR 2006/2 provides that, for a deposit to be a security deposit for the purposes of Division 99 of the GST Act, the amount of the deposit must be reasonable.

As stated in paragraph 68 of GSTR 2006/2, where the amount is unreasonable, it is not a security deposit merely because the parties label the amount a deposit or agree that it is to be subject to forfeiture.

What constitutes a reasonable amount for a deposit under a purchase contract depends on the facts and circumstances of each case at the time that the contract is entered into.

At paragraph 77, GSTR 2006/2 provides that for a deposit that exceeds 10% in a purchase contract to be accepted as a security deposit for the purposes of Division 99 of the GST Act, the supplier must be able to show that they are at a higher risk of significant losses in the event of default.

In your case, we consider that the initial payments are reasonable amounts as a security deposit for the purposes of Division 99 of the GST Act.

Consequently, the initial payments are security deposits as they meet the four characteristics of a security deposit for the purposes of Division 99 of the GST Act.

Paragraph 160 of GSTR 2006/2 provides that under Division 99 of the GST Act, a security deposit is not treated as consideration for a supply until it is either forfeited because of failure to perform the obligation or is applied as all or part of the consideration for that supply. Therefore, the payment of the security deposit does not trigger attribution of an input tax credit under paragraph 29-10(1)(a) or paragraph 29-10(2)(b) of the GST Act (where the recipient accounts on a cash basis). Accordingly, a recipient is not entitled to claim an input tax credit when the security deposit is paid.

In your case, you are not entitled to attribute the input tax credit on the acquisition of the properties under paragraph 29-10(1)(a) of the GST Act to the tax period in which you made the initial payments as these payments are not consideration for the acquisition of the properties.

GSTR 2006/2 provides that where the recipient makes a further payment in addition to the initial deposit, or obtains an invoice, and the recipient accounts on a non-cash basis, the recipient may attribute an input tax credit for the creditable acquisition under the basic rules contained in section 29-10 of the GST Act.

Sale of land under a standard land contract

Goods and Services Tax Ruling GSTR 2000/28, deals with the attribution of GST payable or input tax credit arising from a sale or acquisition of land under a standard land contract.

GSTR 2000/28 provides that under a standard land contract, a purchaser is entitled to the input tax credit on the acquisition of land in the tax period in which the settlement occurs.

Paragraph 13 of GSTR 2000/28 defines a standard land contract, for the purposes of that ruling, to be a written contract for the sale of land that provides for:

· the payment of a deposit that is either to be forfeited if the purchaser defaults or applied as consideration on settlement, and

· the payment of the balance of the purchase price upon settlement.

We consider that the contract meets the requirements in paragraph 13 of GSTR 2000/28 and therefore it is a standard land contract for the purposes of GSTR 2000/28.

Paragraph 27 of GSTR 2000/28 confirms that Division 99 of the GST Act applies to a deposit paid under a standard land contract. As a result, the payment of a deposit under a standard land contract will not trigger attribution of GST payable or input tax credits at the time the deposit is paid. This is the case whether the purchaser accounts for GST on a cash or a non-cash basis.

GSTR 2000/28 also provides that a standard land contract is not an invoice for GST purposes as it does not notify an obligation to make a payment.

Paragraphs 52 and 53 of GSTR 2000/28 provide that consistent with commercial practice, the issue of an invoice is likely to be proximate to or after the supplier's completion of all that the supplier is required to do to become entitled to the payment. A standard land contract does not capture the essence of a commercial invoice as described in that ruling. This means that entering into a standard land contract will not trigger attribution of GST payable under paragraph 29-5(1)(b) of the GST Act or attribution of input tax credits under paragraph 29-10(1)(b) of the GST Act.

For further information on what is an invoice for the purposes of the GST Act, refer to Goods and Services Tax Ruling GSTR 2000/34.

Similarly in your case, the contract is not an invoice therefore the entry into the contract does not trigger attribution of input tax credits under paragraph 29-10(1)(b) of the GST Act.

As Division 99 of the GST Act applies to the initial payments and the contract is not an invoice, the input tax credit for the acquisition of the properties is attributable to the tax period in which the settlement occurs, provided you hold a tax invoice.