Private ruling: GST and security deposits
Date of advice: 19 December 2017
Published: May 2018

Ruling: Q1: Will the payment of a 20% deposit by foreign purchasers be considered as the payment of a security deposit for the purposes of Division 99 of the A New Tax System (Goods and Services Tax Act) 1999 (GST Act)? | A1: Yes

Relevant facts and circumstances: You are registered for GST and carry on an enterprise of property development. You account for GST on a cash basis. You own property situated at a specified location (the Property). You intend to construct a residential apartment complex on the Property. Preliminary construction works have commenced, however, finance is required to bring the works to completion. A number of pre-sale contracts have been entered into for the sale of apartments and you intend to recommence marketing for off-the-plan sales. The marketing campaign will commence immediately. It is anticipated that a portion of the purchasers of the apartments will be foreign residents. Subject to special conditions negotiated by the particular purchasers (which may vary from contract to contract), the ‘off-the-plan’ contracts for the sale of the apartments will be made in accordance with a draft pro forma contract (Master Contract). You have provided a copy of the draft Master Contract. The Master Contract states: ‘The price is inclusive of GST which is payable by the vendor (see clause XX)’. Clause XX of the Master Contract states: ‘The Price shown in this contract includes GST. If the vendor is liable to pay GST in respect to the sale or supply of the property, the purchaser will not be obliged to pay that GST’.’ The Master Contract also states: ‘ Normally, if a party must pay the price or any other amount to the other party under this contract, GST is not to be added to the price or amount.’ The Master Contract provides for details to be included regarding the price, deposit (being ‘10% of the price, unless otherwise stated’) and balance payable. In the case of a foreign purchaser, the Master Contract will provide for a deposit of 20% of the price. The Master Contract does not contain a specific term or condition regarding the imposition of a 20% deposit for foreign purchasers. In such cases, the Master Contract will be completed by inserting an amount equivalent to 20% of the price as being the deposit. The Master Contract provides that the purchaser must pay the deposit to the deposit holder as stakeholder. In the event that a purchaser does not comply with the Master Contract in an essential respect, the vendor can terminate the contract with the Master Contract stating the vendor can ‘keep or recover the deposit (to a maximum of 10% of the price)’. Clause XXX of the Master Contract amends the above clause replacing it with ‘keep or recover the deposit (including interest earned on it)’. The Master Contract provides that on completion of the contract the purchaser must pay to the vendor the ‘price’ (less any deposit paid)’.

Relevant legislative provisions: A New Tax System (Goods and Services Tax Act) 1999 Division 99 | Subsection 99-5(1)

Reasons for decision: Summary: Note: In this reasoning, unless otherwise stated, ● all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) ● reference material(s) referred to are available on the Australian Taxation Office (ATO) website www.ato.gov.au Subsection 99-5(1) provides that 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 secured obligation; or b) is applied as all or part of the consideration for a supply. Goods and Services Tax Ruling GSTR 2006/2 Goods and services tax: deposits held as security for the performance of an obligation discusses the characteristics of security deposits for GST purposes. Goods and Services Tax Ruling GSTR 2000/28 Goods and services tax: attributing GST payable or an input tax credit arising from a sale of land under a standard land contract discusses the application of Division 99 in regard to a deposit held under a standard land contract. According to paragraph 20 of GSTR 2006/2, 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; ● the contract, conduct and intent of the parties to the contract must be consistent with the payment being a security deposit; ● be at risk of forfeiture upon failure to perform the obligation; and ● be a reasonable amount. | Detailed Reasoning - Held as a security for the performance of an obligation: Paragraphs 22 to 23 and 27 to 28 in GSTR 2006/2 state: 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. 23. An amount ceases to be a security deposit when that amount is applied as consideration, or forfeited, regardless of whether it is held by the supplier or a third party at that time. However, there are occasions where a deposit may be released without it being considered to be applied 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. 11 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. The Master Contract provides that the purchaser must pay the deposit to the deposit holder as stakeholder. Paragraph 13 of GSTR 2000/28 considers that a ‘standard land contract’ is a written contract for the sale of land that provides for: ● the payment of a deposit that is either to be forfeited if the purchaser defaults or applied as consideration on settlement; and ● the payment of the balance of the purchase price upon settlement. We consider that the Master Contract is a ‘standard land contract’ for GST purposes taking into account clauses contained in the Master Contract. Paragraph 64 of GSTR 2000/28 expresses the view that we consider a deposit paid under a standard land contract serves a number of purposes although the initial purpose of the deposit is as security for the performance of the contract thus in this case satisfying the first characteristic of a security deposit for the purposes of Division 99. | Detailed Reasoning - The contract, conduct and intent of the parties to the contract must be consistent with the payment being a security deposit: Paragraph 34 of GSTR 2006/2 states that a payment that is not intended to act as an earnest to ensure the contract is completed is not a security deposit. According to paragraph 37 in GSTR 2006/2, 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. Again, with reference to terms and conditions contained in the Master Contract, the deposit paid by either a resident or foreign purchaser is designed to ensure the completion of the contract with the purchaser fulfilling their obligations. As such we consider the second characteristic of a ‘security deposit’ is satisfied. | Detailed Reasoning - Be at risk of forfeiture upon failure to perform the obligation: The Master Contract provides that if the purchaser does not comply with the Master Contract in an essential respect, the vendor can terminate the contract and keep or recover the deposit (including interest earned on it). We note that the relevant clause in the Master Contract does not limit the amount retained to 10% upon a material default by the purchaser. We consider the relevant clause of the Master Contract satisfies the third characteristic of a ‘security deposit for Division 99 purposes. | Detailed Reasoning - Be a reasonable amount: Paragraph 72 of GSTR 2006/2 considers that 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. Paragraph 77 provides that 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. Paragraphs 78 and 79 of GSTR 2006/2 state: 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). You consider the deposit of 20% to be reasonable for the following reasons: ● The Apartments will be sold 'off-the-plan'. As the Apartments are yet to be constructed, there will be a prolonged period between the exchange of contracts and completion to allow for the construction works. There is a genuine risk that during the contract period, the local property market may suffer decline or that international factors (eg, increased restrictions on the movement of funds out of particular jurisdictions) may affect the capacity of some foreign purchasers to complete. ● While it may be customary to accept a 10% for most land contracts, your exposure to the risk of suffering loss from default is greater where the purchaser is a foreign resident as there are practical restrictions on the ability to sue and enforce judgment against foreign residents. ● The Master Contract provides that if the contract is terminated due to a default by the purchaser and the deposit is insufficient to cover the vendor's losses, the vendor may sue the purchaser to recover the amount of any losses exceeding the amount of the deposit. This contemplates that the typical 10% deposit may not be adequate to cover the vendor's loss but where there is a shortfall the vendor can sue the purchaser for damages. Such further recourse may not be practical where the purchaser resides in a foreign jurisdiction. In this case we consider that a deposit of 20% is reasonable in the circumstances the purchaser is a foreign resident. Therefore the fourth characteristic of a security deposit is satisfied. The 20% deposit payable by foreign purchasers satisfies all of the characteristics of a ‘security deposit’ as listed in paragraph 20 of GSTR 2006/2 and will be treated as a ‘security deposit’ for the purposes of Division 99. Consequently, the deposit held as security is not treated as consideration for the supply of an apartment unless the deposit is: ● forfeited pursuant to the Master Contract or ● is applied as all or part of the consideration for the supply of the apartment in accordance with the Master Contract. Therefore any GST payable in regard to such deposits is attributable to the tax period in which the amount is forfeited or applied as part of the consideration upon completion of the contract.