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Ruling

Subject: goods and services tax (GST) and security deposits

Question 1

Will the (certain percentage) deposit (which all purchasers will pay) and a '(something)' received by you from non-resident purchasers in the circumstances described below be security deposits for the purposes of Division 99 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

The (certain percentage) deposit (which all purchasers will pay) would be a security deposit for the purposes of Division 99 of the GST Act.

The (something) payment would not be a security deposit for the purposes of Division 99 of the GST Act.

Question 2

Will the (certain percentage) deposit (which all purchasers will pay) and a '(something) ' received by you from some Australian resident purchasers in the circumstances described below be security deposits for the purposes of Division 99 of the GST Act?

Answer

The (certain percentage) deposit (which all purchasers will pay) would be a security deposit for the purposes of Division 99 of the GST Act.

The (something) payment would not be a security deposit for the purposes of Division 99 of the GST Act.

Relevant facts and circumstances

You are currently developing residential units in Australia, which will be marketed "off the plan".

It is currently contemplated that you will collect a (certain percentage) deposit from purchasers to secure the purchasers' contractual obligations under the sale contract.

It is further contemplated by you that you will collect a further '(something)' (capped at a certain percentage) from some purchasers to secure the purchaser's contractual obligations under the contract.

You will use your discretion to determine if you will seek to collect the '(something)' amount from the respective resident and non-resident purchasers. In all circumstances, the decision will be based on which purchasers pose the greater settlement risk to you and in those cases if is proposed that you will ask for both a certain percentage deposit and a '(something)' amount collectively referred to as a certain percentage deposit.

It is anticipated that the (certain percentage) deposit will be required where the purchasers are foreign persons as defined in the contract.

You will ask for a (certain percentage) deposit and a '(something)' payment in some exceptional cases where the purchasers are Australian residents.

The commercial drivers behind requiring a (certain percentage) deposit and a '(something)' payment from some potential purchasers include the following:

· in the current economic climate, where recessionary risk fears heighten the risk of default by purchasers, in some cases a (certain percentage) deposit is required to act as an effective earnest to bind the contract, particularly where a long delay between entry into an off the plan contract (from a certain month and year) and settlement (anticipated in a certain month and year), gives rise to an even higher likelihood of a change in circumstances on the part of the respective purchasers;

· the (certain percentage) deposit is appropriate in order to act as a earnest to bind the contract in circumstances where the purchaser is a non-resident, as in the event of a default, it would be difficult to enforce any judgement for damages in respect of those potential non-resident purchasers;

· the amount of the deposit is consistent with the fact that, in the current economic environment, most banks require purchasers, buying off the plan to have a certain percentage deposit before they will fund the balance of the purchase price;

· only purchasers that are truly committed to the off the plan purchase will exchange contract, as evidenced by their ability and willingness to fund a certain percentage deposit; and

· the property sold "off the plan" will be customised in some respects according to the wishes of the purchasers (eg internal colour scheme, as described in a certain clause of the contract) and it may therefore be difficult to sell the property on a timely basis and for the same price to another purchaser in the event that the original purchaser defaults.

The sale contract provides that if the purchaser does not comply with this contract (or a notice under or relating to it) in an essential respect, the vendor can terminate by serving a notice. After the termination the vendor can keep or recover the deposit (to a maximum of a certain percentage of the price) and hold any other money paid by the purchaser under this contract as security for anything recoverable under this clause for a certain period after the termination; or if the vendor commences proceedings under this clause within a certain period, until those proceedings are concluded.

The sale contract provides that the purchaser has requested the vendor to enter into this contract with the purchaser and the vendor does so in consideration of the payment of the extra security by the purchaser as security for the performance of the purchaser's obligations to the vendor and all losses, damages, costs and expenses incurred by the vendor as a result of termination of this contract in accordance with a certain condition set out in the sale contract.

The sale contract provides that if the contract is properly terminated by the vendor:

· the parties authorise the (something) holder to release the (something) and any interest earned on the (something) to the vendor; and

· the vendor must hold the (something) and any interest earned on the (something) in accordance with certain conditions set out in the sale contract.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-15(1)

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

A New Tax System (Goods and Services Tax) Act 1999 subsection 99-5(1)

Reasons for decisions

Questions 1 and 2

Summary

The (certain percentage) deposit that all purchasers will pay will be a security deposit for the purposes of Division 99 of the GST Act because:

· it will be held as a security for the performance of an obligation (the purchaser's obligation to purchase the property (etc)

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

· it will be at risk of forfeiture upon failure to perform the obligation, and

· it will be a reasonable amount.

The (something) payment will not be a security deposit for the purposes of Division 99 of the GST Act. This is because the sale contract does not evidence a clear understanding between the vendor and purchaser at the time of commencement of the sale contract that the payment may be forfeited if the purchaser fails to perform their contractual obligations.

Detailed reasoning

Subsection 99-5(1) of the GST Act states:

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 obligation; or

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

Paragraph 19A of Goods and Services Tax Ruling GSTR 2006/2 discusses the meaning of deposit. It states:

19A. In Federal Commissioner of Taxation v. Reliance Carpet Co Pty Ltd [2008] HCA 22; (2008) 2008 ATC 20-028; (2008) 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.

GSTR 2006/2 sets out the features of a security deposit for the purposes of Division 99 of the GST Act. It states:

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.

Held as security

Paragraph 22 of GSTR 2006/2 discusses the concept of holding a deposit as security. It states

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.

Performance of an obligation

Paragraphs 27 to 29 of GSTR 2006/2 discuss holding a deposit as security for performance of an obligation. They state:

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.

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.

Subject to forfeiture

Paragraphs 51 and 52 of GSTR 2006/2 discuss the deposit subject to forfeiture requirement. They 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.

Reasonable amount

Paragraphs 72 and 77 to 79 of GSTR 2006/2 discuss the reasonable amount requirement. They state:

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.

77. The Commissioner considers that cases such as Coates and Hoobin are exceptional. It is the Commissioner's view that for a deposit that exceeds 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 a higher risk of significant losses in the event of default. In Coates and Hoobin , the major risks turned upon the length of time of the contract and the loss in value of the asset faced by the supplier in the event of mismanagement of an associated enterprise, neglect, breach of law and other allied factors.

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).

Paragraph 110 of GSTR 2006/2 states:

110. In the Commissioner's view, the forfeiture of a security deposit is not a payment in the nature of damages or liquidated damages.

The (certain percentage) deposit (which all purchasers will pay)

The sale contract provides that if the purchaser does not comply with this contract (or a notice under or relating to it) in an essential respect, the vendor can terminate by serving a notice. After the termination the vendor can keep or recover the deposit (to a maximum of a certain percentage of the price).

Therefore, the (certain percentage) deposit (which all purchasers will pay) will be held as a security for the performance of the purchaser's obligation to purchase the property (etc) and it is at risk of forfeiture upon failure to perform these obligations. The contract is not inconsistent with the (certain percentage) deposit being a security deposit. There is no evidence that the conduct and intent of the parties to the contract is inconsistent with the payment being a security deposit. A (certain percentage) deposit is reasonable. Therefore, the (certain percentage) deposit is a security deposit under Division 99 of the GST Act.

The (something) payment

The sale contract provides that if the purchaser does not comply with this contract (or a notice under or relating to it) in an essential respect, the vendor can terminate by serving a notice. After the termination the vendor can keep or recover the deposit (to a maximum of a certain percentage of the price) and hold any other money paid by the purchaser under this contract as security for anything recoverable under this clause for a certain period after the termination; or if the vendor commences proceedings under this clause within a certain period, until those proceedings are concluded.

The sale contract provides that the purchaser has requested the vendor to enter into this contract with the purchaser and the vendor does so in consideration of the payment of the (something) by the purchaser as security for the performance of the purchaser's obligations to the vendor and all losses, damages, costs and expenses incurred by the vendor as a result of termination of this contract in accordance with a certain condition set out in the sale contract.

The sale contract provides that if the contract is properly terminated by the vendor:

· the parties authorise the (something) holder to release the (something) and any interest earned on the (something) to the vendor; and

· the vendor must hold the (something) and any interest earned on the (something) in accordance with certain conditions set out in the sale contract.

Based on certain clauses of the sale contract, if the purchaser defaults on its obligation to purchase the property (etc), the (something) payment will be released to you and you will retain the (something) payment, but only for a temporary period. The clauses of the sale contract do not indicate that the (something) payment is at risk of being permanently lost by the purchaser.

Therefore, the sale contract does not evidence a clear understanding between the vendor and purchaser at the time of commencement of the sale contract that the payment may be forfeited if the purchaser fails to perform their contractual obligations.

Instead, there is a clear understanding between the parties at the time of entering into the contract that these monies will be set aside if the purchaser defaults and may be utilised to settle a future damages order of a court. Where the (something) monies are utilised in this way, your liability to repay the (something) monies to the purchaser would be offset against the purchaser's liability to pay you damages.

Furthermore, a payment of damages cannot constitute forfeiture of a deposit (in accordance with paragraph 110 of GSTR 2006/2) and where you make such an offset, the offset would be akin to payment of damages.

Hence, the requirements of a security deposit set out in paragraphs 51 and 52 of GSTR 2006/2 are not met.

We consider that a deposit of a certain percentage in your case would be reasonable given the higher risk of you making significant losses where you enter into a contract with the sorts of purchasers who pay the certain percentage deposit, based on the circumstances you have set out in your submission.

However, as the sale contract does not evidence a clear understanding between the vendor and purchaser at the time of commencement of the sale contract that the (something) payment may be forfeited if the purchaser fails to perform their contractual obligations it will not be a security deposit under Division 99 of the GST Act.

Additional information

The (something) payment will constitute part consideration for your sale of the property when you receive it, in accordance with subsection 9-15(1) of the GST Act, as the payment will have a sufficient nexus with your sale of the property.