18 April 2006
GST Ruling on deposits for perfomance of an obligation
The Commissioner of Taxation has issued GST Ruling 2006/2 in relation to deposits held as security for the performance of an obligation. The Ruling has potential implications in all commercial and property matters where deposits are taken. The Ruling explains the ATO’s view of the law as it applied from 1 July 2000, so it is retrospective in effect. For the full Ruling go to the ATO website www.ato.gov.au. This bulletin focusses on some of the key aspects of the Ruling.
Under GST law, a supplier who receives a deposit can defer payment of GST until a later time, usually receipt of part or full payment, or when an invoice is issued. The Ruling adopts a narrow view of what is a deposit with the result that many payments previously regarded as deposits could now be treated as part payment, triggering earlier attribution of GST. The Ruling has already attracted criticism from the tourism industry. The Australian Financial Review reported on 7 April 2006 that the ATO is running two test cases on the issues dealt with in the Ruling.
Characteristics of a security deposit
The ATO view is that for a payment to be considered as a "security deposit" it should have the following characteristics:
Be held as a security for the performance of an obligation.
The contract, conduct and intent of the parties must be consistent with the payment being a security deposit.
Be at risk of forfeiture upon failure to perform the obligation.
Be a reasonable amount.
It does not matter if a deposit is held "by a person in the capacity of stakeholder". It appears that the ATO accepts that release of a deposit by a stakeholder to the vendor may not necessarily mean that the money ceases to be a deposit, provided the vendor receives the money as an amount still in the nature of a deposit.
Deposit vs part payment
The Ruling refers to case law that a deposit is paid to act as an "earnest" to ensure the contract is completed. The fact that a certain payment is labelled a "deposit" does not automatically make it a security deposit at law. This is a question of fact determined by looking at the terms of the contract and the intention of the parties. The accounting treatment may evidence that a deposit has been either forfeited or applied as consideration for a supply - eg it is no longer refundable. This can be indicative of a deposit no longer held as security.
Where forfeiture is a term or condition of the contract, the Commissioner will accept on its face that the deposit is at risk. However, if a contrary commercial practice is made known to the recipient at the time of entry into contract, this may lead to the conclusion that the parties have openly bargained to remove the forfeiture clause.
The deposit must be reasonable in amount
Perhaps the most controversial aspect of the Ruling is the Commissioner’s view that for a deposit to be a security deposit the amount of the deposit must be reasonable. It is the Commissioner’s view that the principles applied by the courts under the rules of equity are equally applicable to determine what is a security deposit for the purposes of the GST Act. If an amount is unreasonably high it is not a security deposit and the amount may be consideration for the supply at the time it is paid, triggering GST liability.
So what is a reasonable deposit?
According to the Ruling, what constitutes a reasonable amount for a deposit under a purchase contract depends upon the degree of risk that the supplier takes in respect of a breach or termination of the contract by the recipient. If the supplier seeks a large security deposit, then the supplier needs to demonstrate that special circumstances exist.
The factors the Commissioner will take into account in determining the reasonableness of an amount of a security deposit include:
duration of the contract and the time over which payment is to occur;
uniqueness of the goods or the process involved in the supply;
the vulnerability of the goods to loss in value; and
other extraordinary conditions of the contract.
These factors are not exhaustive. The Ruling states that reasonableness of any deposit is to be determined on the facts and circumstances of each case at the time the contract is entered into having regard to industry practices and norms, although this should be balanced against the supplier’s capacity to impose an unreasonable deposit upon the recipient.
The practical problem is that suppliers may be unsure at what level deposits they take are "too high". The Ruling refers to case law which indicates that for property transactions a 10% deposit is common practice and it appears a 10% deposit would be viewed by the Commissioner as being reasonable in property sales.
GST and forfeited deposits
The Commissioner’s view is that if a deposit is forfeited when a contract is terminated, it is a consideration for a supply. The Commissioner’s view is that the forfeited deposit is consideration for the act of rescission and/or the surrender of rights and/or release from obligations. This confirms the view that GST will effectively diminish the deposit retained by the supplier on forfeiture by one eleventh. Suppliers may wish to ensure that deposits are "grossed up" for GST to ensure the full benefit of a deposit is retained in the event of forfeiture.
Where to from here?
We may have to wait for test cases to confirm that the Courts view the matters in the same way as the Commissioner of Taxation.
In the meantime, there will be a level of uncertainty about GST treatment of deposits and in particular when a deposit is unreasonably large.
Author: Oliver Shtein