Edited version of private advice

Authorisation Number: 1012676195732

Ruling

Subject: GST and security deposit

Questions

1. Please confirm that deposits as a percentage of the agreed purchase price of apartments sold constitute a 'security deposit' for the purposes of Division 99 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).

2. The GST payable on the supply of the apartments is attributable to the tax period in which the security deposit is applied as part of the consideration for the supply, at the date of settlement.

3. If the security deposit is forfeited by the purchaser, GST is payable on the amount so forfeited and is attributed to the tax period in which the forfeiture takes place.

Answers:

1. Yes, we confirm the above.

2. Yes, we confirm the above.

3. Yes, we confirm the above.

Relevant facts and circumstances

You are an Australian Private company, and are registered for GST. You, account for GST on an accruals (non-cash) basis. You supply taxable supplies of new residential premises (property).

You propose a two-tier deposit arrangement for prospective purchasers. Overseas purchasers pay a higher deposit than Australian residents upon exchange of contracts.

In the event of a purchaser's default in respect of the contract, you are entitled to:

• Retain or recover the deposit paid by the purchaser; and

• Sue the purchaser for any deficiency of resale (in excess of the deposit) and recover reasonable costs, if the relevant apartment(s) is sold within 12 months of termination or recover damages for breach of contract.

Where the purchaser has the right to rescind the contract, clause 19 of the contract provides that the deposit must be refunded, and the purchasers can claim damages, costs or expenses arising out of a breach of the contract.

Relevant legislative provisions

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

A New Tax System (Goods and Services Tax) Act 1999 Division 29-5

Reasons for decision

Question 1:

Security deposits

Division 99 of the 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. Goods and Services Tax Ruling (GSTR) 2006/2 discusses security deposits GSTR 2006/2 states at paragraphs 19A to 20:

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.

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 for the performance of an obligation

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 14 of Goods and Services Tax Ruling (GSTR) 2000/28 states:

14. A ' deposit' under land law is an earnest given to bind the bargain; it is a guarantee that the purchaser means business; and on completion, it becomes part payment of the purchase price (see Howe v . Smith (1884) 27 Ch D 89 at 101; Brien v . Dwyer and Another (1978) 141 CLR 378 at 392; Federal Commissioner of Taxation v. Reliance Carpet Co Pty Ltd [2008] HCA 22; 2008 ATC 20-028; (2008) 68 ATR 158 ( Reliance Carpet ) at paragraphs 22 to 27).

The deposits have the characteristic of being held as a security. In either case the deposit will be held as security for the performance of the purchasers' 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.

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

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.

Since paragraph 14 of GSTR 2000/28 provides a deposit under land law is an earnest given to bind the bargain, we consider that the deposits have the characteristic of security deposits, and not a part payment.

Be at risk of forfeiture upon failure to perform the obligation:

Paragraphs 51 and 52 of GSTR 2006/2 states:

Deposit subject to forfeiture

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.

Paragraphs 64 and 65 of GSTR 2000/28 particularly discuss deposits paid under a standard land contract:

64. A deposit paid under a standard land contract serves a number of purposes. If the contract goes through to completion, the deposit goes against the purchase price. But its initial purpose is as security for the performance of the contract. Fry LJ in Howe v . Smith makes this plain:

'The deposit is not merely a part payment, it is also an earnest to bind the bargain so entered into and creates by fear of its forfeiture a motive in the payer to perform the rest of the contract...That earnest is lost by the party who fails to perform the contract.'

65. The purpose of a deposit under a standard land contract is also explained by WD Duncan and Stephen E Jones as follows:

'The deposit is expressly stated in the contract to be in part payment of the purchase price. While the payment bears the character of a part payment under an executory contract, it is also expressly stated to be a deposit and liable to forfeiture where the purchaser is in default. A part payment would not be so forfeited

The deposits will be forfeited to the vendor if the purchaser fails to complete the contract. The contract provides that the deposits will be forfeited upon failure to carry out this obligation.

Be a reasonable amount:

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

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).

Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573 (Dojaps case) considered whether a deposit of 25 percent for a sale of land was a reasonable amount. The plaintiffs had argued that a 25 percent deposit was common practice in Jamaica at the time of the sale of the property by auction and so it should be considered reasonable in the circumstances. The decision by Lord Browne-Wilkinson, at 580, states: 

...the correct approach is to start from the position that, without logic but by long continued usage both in the United Kingdom and formerly in Jamaica, the customary deposit has been 10 per cent. A vendor who seeks to obtain a larger amount by way of a forfeitable deposit must show special circumstances which justify such a deposit

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.

In your case, you will be making off the plan sales of residential properties and expect some purchasers will not be Australian residents for the purposes of subsection 6(1) of the Income Tax Assessment Act 1936. You are seeking the standard deposits from Australian resident purchasers and a higher than the standard deposit from purchasers who are not ordinarily residents in Australia.

We consider your submissions and accept there are special circumstances to justify a higher than usual amount of deposits. On balance, we consider that the deposits are considered to be reasonable amounts.

Accordingly, the deposits will constitute a 'security deposit' for the purposes of Division 99 of the GST Act.

Questions 3 and 4: Attributing the GST on your taxable supplies

Subsection 29-5(1) of the GST Act applies to taxpayers who account for GST on an accruals (non-cash) basis and states:

The GST payable by you on a taxable supply is attributable to:

(a) the tax period in which any of the consideration is received for the supply; or

(b) if, before any of the consideration is received, an invoice is issued relating to the supply - the tax period in which the invoice is issued.

However, 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.

In your situation, you supply taxable supplies of new residential premises in Australia. Purchasers pay a deposit upon exchange of contracts. The deposits have been considered as security deposits under Division 99 of the GST Act.

Section 99-10 of the GST Act deals with attribution of the GST relating to deposits that are forfeited and states: 

(1) The GST payable by you on a taxable supply for which the consideration is a deposit that was held as security for the performance of an obligation is attributable to the tax period during which 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.

(2) This section has effect despite section 29-5 (which is about attributing GST for taxable supplies).

Accordingly, we confirm that the GST payable on the supply of the properties is attributable to the tax period in which the security deposit is applied as part of the consideration for the supply, at the date of settlement. If the security deposit is forfeited by the purchaser, GST is payable on the amount so forfeited and is attributed to the tax period in which the forfeiture takes place.