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Ruling

Subject: GST and security deposits

Question 1

Will the proposed deposit received by the A from a non-resident purchaser in specific circumstances (detailed below) be a security deposit for the purposes of Division 99 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes.

Question 2

Will the proposed deposit received by A from an Australian resident purchaser in specific circumstances (detailed below) be a security deposit for the purposes of Division 99 of the GST Act?

Answer

Yes.

Relevant facts and circumstances

A is currently developing residential apartments that will be marketed for sale 'off the plan'. It is currently contemplated by A that it will collect a standard deposit from some potential purchasers and a larger deposit from others for these off the plan sales. A will use its discretion to determine what percentage deposit will be paid by each purchaser. In all circumstances, the decision will be based on which purchasers pose the greater settlement risk to A and, in those cases, it is proposed that A:

· will ask for a larger deposit. In the majority of cases where a larger deposit will be required, the purchasers will be foreign persons as defined in the Contract. That definition refers to the meaning of foreign person in section 5 of the Foreign Acquisitions and Takeovers Act 1975 (Cth) which broadly refers to natural persons who are not ordinarily resident in Australia or, in the case of a corporation or the trustee of a trust estate, where the natural persons hold a controlling interest or a substantial interest are not ordinarily resident in Australia.

· will ask for a larger deposit in some exceptional cases where the purchasers are Australian residents.

The relevant conditions set out in the Contract provide that where there is a breach of contract and the purchaser is in default, the vendor may claim forfeiture of the deposit. Pursuant to the Contract, the vendor can also, amongst other things, sue the purchaser to recover damages for breach of contract. If the Contract completes on or before the completion date, the deposit is applied as part of the consideration for the sale of the property and the vendor will pay the respective purchasers a guaranteed rate of interest that will be reflected as an adjustment at completion. In this instance the vendor will be entitled to the interest earned on the invested deposit (if applicable).

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Division 99

Reasons for decision

Issue 1

Question 1

Summary

The proposed deposit received by A from a non-resident purchaser will be a security deposit for the purposes of Division 99 of the GST Act.

Question 2

Summary

The proposed deposit received by A from an Australian resident purchaser will be a security deposit for the purposes of Division 99 of the GST Act.

Detailed reasoning both questions

Division 99 of A New Tax System (Goods and Services Tax) Act 1999 (GST Act) sets out special rules in relation to a deposit held as security for the performance of an obligation.

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

In Federal Commissioner of Taxation v. Reliance Carpet Co Pty Ltd (Reliance Carpet) [2008] HCA 22; (2008) 2008 ATC 20-028; (2008) 68 ATR 158 the High Court noted 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 (however, the forfeiture of a security deposit is not a payment in the nature of damages or liquidated 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.

Goods and Services Tax Ruling GSTR 2006/2 discusses security deposits. This ruling has been amended in parts to reflect the decision made in the High Court decision in Reliance Carpet. Paragraph 20 of GSTR 2006/2 provides that 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:

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

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

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

o be a reasonable amount.

Held as security

A security is held when it is paid to a person in the capacity of stakeholder. It is held for the benefit of the supplier to secure the recipient's obligations.

Paragraph 31 of GSTR 2006/2 states:

31. In analysing contracts, the courts have commonly described a deposit as an 'earnest' that is paid 'to bind the bargain'. A payment made as an earnest has been said to be '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 a part payment.

The larger deposits from both residents and non-residents have the characteristic of being held as a security. In either case the deposit will be held as security for the performance of the obligation to complete the contract for the sale of land and is not otherwise surrendered or applied as consideration for that supply unless there is a default under the contract or the contract is completed.

Performance of an obligation

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.

Both deposits have this characteristic. The special conditions outlined in the Contract reflect that the payment is intended to serve as an earnest to bind the contract and will be forfeited upon failure to carry out this obligation or applied against the consideration for the supply at completion.

Forfeiture

A security deposit must be at genuine risk of forfeiture. It is a fundamental requirement 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 obligation. There must be a mutual intention by the contracting parties to make the deposit subject to forfeiture. If such an intention is not present, the deposit is not a security deposit.

Both deposits have this characteristic; as the deposit will be forfeited to the vendor if the purchaser fails to complete the contract.

Reasonable

The question of what is a reasonable amount for a security deposit under a purchase contract is considered in paragraphs 67-79 of GSTR 2006/2. Paragraph 72 of GSTR 2006/2 states:

72. 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.

The view of the Commissioner as stated in paragraph 77 of GSTR 2006/2 is that for a deposit of greater than 10% in a purchase contract to be accepted as a security deposit to which Division 99 applies, suppliers must be able to show that they are at higher risk of significant losses in the event of default.

Paragraph 78 of GSTR 2006/2 list some factors that may be taken into account in determining the reasonableness of an amount paid as a security deposit for a purchase contract:

· duration of the contract and the time over which payment is to occur, as this may increase the risk of loss or devaluation 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 complete 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.

Paragraphs 83 and 84 of GSTR 2006/2 provide an example for special circumstances where a deposit is reasonable:

83. Xena is a specialist dressmaker from whom Alice has ordered her wedding dress. The material Alice has chosen is expensive and the design and colour of the dress is unusual. If Alice cancels her order for the wedding dress, Xena would find it difficult to find another buyer for the dress. As a consequence, Xena faces a significantly higher risk in the event of a default.

84. A sizeable deposit, approximately equal to one third of the total price of the dress, is paid by Alice when she places the order. This deposit is forfeited if Alice does not collect the dress. This deposit reflects the higher risk if the contract is not completed. In the special circumstances, the deposit is reasonable and is a security deposit.

Paragraph 37 of GSTR 2006/2 goes on to state that a deposit must be a deposit in more than name only. The paragraph states:

37. 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.

Hence, the conduct, intent and contract between the parties must support that the payment is a security deposit.

In your case, you will be making off the plan sales of residential apartments and are seeking a larger deposit from non-residents as well as from some Australian residents who you consider to be speculators who buy on the basis of short-term investment. You advise that in these cases, the risks that are contemplated are as follows:

Non-Residents

There is a very high risk factor associated exclusively with non-resident purchasers is the practical difficulties as well as the financial cost the vendor would encounter in the event of seeking to enforce any remedy ordered by the Australian courts (including an order for damages) against purchasers in foreign jurisdictions.

Residents with High Risk Profile

The risk factor associated predominantly with Australian resident purchasers is the potential exposure associated with purchasers who acquire property on a speculative basis. These purchasers essentially venture that Australian residential property prices will continuously increase. A considers that certain purchasers who buy on the basis of short-term investment have a high risk profile as they may choose not to complete if the residential property values do not increase over the term of the development.

On balance, the value of the deposit proposed for both these high risk transactions is considered to be a reasonable amount.