We regularly get asked to advise on the correct GST treatment of a forfeited deposit where the proposed transaction to which the forfeiture relates was to be GST-free or input taxed.
Before dealing with the specific question, it is useful to take a look at the GST rules that generally apply to deposits.
The GST treatment of deposits
Deposits are dealt with in Division 99, which includes the following summary in the explanatory section (section 99-1):
GST does not apply to the taking of a deposit as security for the performance of an obligation (unless the deposit is forfeited or is applied as consideration). GST is not attributable prior to forfeiture.
Division 99 applies such that genuine security deposits are not treated as consideration for GST purposes, until such time that the deposit is either forfeited or applied as all/part of the consideration for the supply.
The ATO’s public ruling on deposits , GSTR 2006/2, is a useful reference when dealing with deposit related issues.
Types of Deposit
Division 99 contemplates two types of security deposit – ‘purchase contracts’ and ‘hire arrangements’. These are referred to in GSTR 2006/2 as follows:
- One type of arrangement involves a contract for the purchase of real property, goods or services (a ‘purchase contract’), where the recipient pays a deposit to secure their obligations under the contract.
- The other type of arrangement in which a security deposit may be paid involves a contract for the hire of goods, where the supplier requires a deposit (or bond) to be paid to secure the payment of periodic rental instalments and/or the return of the goods on time and in good condition. In this Ruling, we will refer to lease, rent, hire-only and bailment arrangements as ‘hire arrangements’.
In this article we deal with the first type of deposit – one that involves a purchase contract.
Key features of deposits
The ruling sets out a number of factors that are expected to be present before an amount should be considered as a deposit of the type dealt with by Division 99.
Referring to the High Court decision in the Reliance Carpet Case (see paragraph 19 of the ruling), a deposit has several characteristics, including that it:
- 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.
Paragraph 20 of the ruling summarises the key features of deposits according to the ATO as follows:
- 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.
Amounts described and paid as ‘deposits’ in relation to most land sale arrangements (where the balance is payable on settlement) will fall within Division 99.
Forfeiture of a deposit
The forfeiture of a deposit is one of the matters specifically dealt with in s. 99-5(1).
Sub-section 99-5(1)(a) refers to a deposit not being treated as consideration, ‘unless the deposit (a) is forfeited because of a failure to perform the obligation’.
The High Court decision in the Reliance Carpet Case accepted that the vendor, when entering into a contract ‘entered into an obligation to do things’ and the payment of the deposit by the purchaser was in connection with the supply made by the vendor.
The ATO makes the following comments in GSTR 2006/2:
- The High Court reasoned that the payment of the deposit by the purchaser was in connection with the supply made by the vendor. The High Court said at paragraph 33:
“The payment of the deposit by the purchaser to the taxpayer was ‘in connection with’ a supply by the taxpayer, within the meaning of the definition of ‘consideration’ in s9-15(1)(a) of the Act…the payment of the deposit obliged the parties to enter into the mutual legal relations with the executory obligations and rights laid out in the Contract. Those legal relations were directed to the completion of the Contract by conveyance of the property to the purchaser by the taxpayer upon payment by the purchaser…
124A. The Commissioner is of the view that the High Court’s reasoning in Reliance Carpet is equally applicable to cases involving the forfeiture of deposits on contracts for the provision of goods and services generally.
- Furthermore, the intention of Division 99 is in part; to ensure that forfeited deposits are treated where appropriate as subject to GST when the forfeiture occurs. This interpretation is supported by the words of paragraph 99-5(1)(a) which states that a deposit is not to be treated as consideration for a supply unless it is forfeited. This means that a deposit must be treated as consideration for a supply upon forfeiture.
- The supply, for which the forfeited deposit is consideration, constitutes a taxable supply under section 9-5 if it meets the requirements in paragraphs (b) to (d) of that section and is not otherwise GST-free or input taxed.
Accordingly, forfeiture of a deposit in relation to a taxable supply would ordinarily be treated as taxable at the time of forfeiture.
Can a forfeited deposit be GST-free or input taxed?
The ATO accepts that if the deposit relates to a supply that would be GST-free, then the forfeiture of the deposit would also be GST-free. The ATO makes the following comments in GSTR 2006/2:
Example 13: Purchase contract – forfeiture of a deposit on a supply that would have been GST-free
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- Jo-Anne runs a small business and is registered for GST. She places an order for $1, 100 worth of prime quality beef for her restaurant. Prime quality beef is a special order item and her local supplier, who is registered for GST, requires a security deposit of $110 before filling the order. Jo-Anne pays this amount when placing her order. It is a condition of sale that the deposit will be refunded to Jo-Anne if the supplier is unable to fulfil the order but that Jo-Anne will forfeit the deposit if she decides to cancel the order. A week later, she cancels the order and the supplier informs her that her deposit will be forfeited.
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- The supply of beef would have been a GST-free supply. Upon forfeiture, the deposit is treated as consideration for a supply of a right to receive a supply of beef under the contract. This supply is a GST-free supply because it involves the supply of a right to receive a supply of beef which would have been GST-free. A similar outcome would arise if the underlying purchase contract was for an input taxed supply (for example, of ‘old’ residential premises). A forfeiture of a deposit under such a contract would be treated as input taxed.
The proposition is a little less clear cut where the underlying transaction is, for example, a GST-free supply of a going concern that involves a land transfer, where the GST free treatment relies on certain conditions being met and certain things occurring between the date of contract and settlement
For example, a contract for the sale of a leased building may be undertaken on a GST-free going concern basis with the purchaser warranting it is GST registered (or will be by settlement).
At the time of default, if the purchaser is not GST registered and, for example, the lease turnover is less than the GST registration threshold (so that the purchaser would not be required to be GST registered), an issue arises as to whether GST-free treatment applies to the forfeited deposit.
Whilst each situation must be properly considered, the use of the word “would” in sub-sections 9-30(1)(b) and 9-30(2)(b) suggests that at the time the deposit is paid, if the hypothetical transaction “would” have been GST-free or input taxed had it been completed as originally intended then the forfeited deposit will be GST-free or input taxed as applicable. This requires analysis of whether the proposed transaction was in fact eligible for GST-free (or input taxed) treatment. For example, a prospective sale of leased land from the lessor to the lessee would not have been eligible for going GST-free concern treatment (refer to paragraph 108 of GSTR 2002/5).
More challenging however are situations where the pre-conditions to secure GST-free treatment as a supply of a going concern are not present at the time of contract (or settlement) but were conditions/warranted in the contract as to being in place at settlement. For example, where the vendor warranted a lease would be in place at settlement but no lease was in place at the time of contract and/or time or forfeiture of the deposit.
This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.
