Private ruling: Forfeiture of deposit and settlement payment
Published: July 2012

Ruling: Q1: Was the $X deposit paid by A, B C and D ('the Purchasers') pursuant to a Contract for the Sale of Land dated in a particular year ('Contract') and retained by the Applicant following the Purchasers' default consideration for a GST-free supply? | A1: Yes, the $X deposit paid by the Purchasers pursuant to the Contract and retained by the Applicant following the Purchasers' default was consideration for a GST-free supply. | Q2: Is the Applicant liable to account for GST in respect of the $xxx,000 of the 21 Day Settlement Sum which A and B paid to the Applicant pursuant to a Deed of Settlement and Release ('Deed') and which was deemed by the Deed to be on account of interest payable under the Contract and under a Lease dated the particular year ('Lease') between the Applicant as Lessor and Y Ltd as Lessee? | A2: No, the Applicant is not liable to account for GST in respect of the $xxx,000 of the 21 Day Settlement Sum which A and B paid to the Applicant pursuant to the Deed and which was deemed by the Deed to be on account of interest payable under the Contract and under the Lease. | Q3: Is the Applicant liable to account for GST in respect of the $yyy,000 of the 21 Day Settlement Sum which A and B paid to the Applicant pursuant to the Deed and which was deemed by the Deed to be on account of general damages and loss under the Contract and under the Lease? | A3: No, the Applicant is not liable to account for GST in respect of the $yyy,000 of the 21 Day Settlement Sum which A and B paid to the Applicant pursuant to the Deed and which was deemed by the Deed to be on account of general damages and loss under the Contract and under the Lease.

Relevant facts and circumstances: The Contract: The Applicant entered into a Contract for the Sale of Land ('Contract') in respect of the Property. The purchasers were A, B, C, and D as tenants in common ('Purchasers'). The Contract stated that the sale of the Property was subject to existing tenancies, that the purchase price of the Property was $Z million, and that a deposit of $X was to be paid in two equal instalments. The Completion Date of the Contract was in a subsequent month . The Contract also stated that the sale of the Property was GST-free as being the supply of a going concern and that if the Contract stated that the sale is a supply of a going concern then the parties agreed the supply of the Property was a supply of a going concern and the Applicant was obliged to carry on the enterprise conducted on the Property in a business-like way between the Contract Date and Completion. The Contract further stated that, notwithstanding any other provision of the Contract, the Purchaser agreed that the Lease (see below) to Y Ltd ('Lessee') would be entered into simultaneously with the Contract, that the Purchasers would not raise any objection to any term of the Lease, and in the event that the Lessee did not pay any rent under the Lease the Purchasers would pay the same to the Applicant on Completion and claim the same from the Lessee. The Lease: The recitals to the Deed (see below) stated that on the particular date (i.e. the same day as the Contract was entered into) the Applicant (as Lessor) and Y Ltd (as Lessee) entered into the Lease and that A and B guaranteed the Lessee's obligations under the Lease. The Lease was for a term of three years commencing on the same date the contract was entered into. Default: The Deed also stated that the Applicant issued a Notice to Complete in relation to the Contract, that the Purchasers failed to comply, and that the Applicant then terminated the Contract. According to the ruling request, the Applicant later sold the Property to another party for $W million plus GST. In addition, Y Ltd went into liquidation and disclaimed the Lease. Retention of deposit paid under Contract: The Contract stated that if the Purchasers did not comply with the Contract in an essential respect the Applicant could terminate the Contract by serving a notice and, after termination, keep or recover the deposit (to a maximum of 10% of the price). The ruling request stated that, after the Purchasers defaulted under the Contract, the Applicant retained the deposit of $X. Deed of Settlement and Release: The Deed is between the Applicant, two of the Purchasers (i.e. A and B), and Y Ltd (In Liquidation). The Deed recited that the other two Purchasers (C and D) refused to be parties to the Deed as they had no money to contribute to the settlement. The recitals to the Deed also stated that the Applicant commenced court proceedings against the Purchasers seeking specific performance of the Contract and/or damages, that the Court ordered that the Applicant was entitled to specific performance of the Contract and ordered a subsequent hearing for determination of damages, and that the parties then agreed to settle the Court proceedings plus all claims related to the Contract and the Lease on the terms set out in the Deed. The Deed provided for A and B to pay to the Applicant (in addition to two 'Instalment Amounts' (i.e. the $X retained deposit)) either: the Primary Settlement Sum $M plus interest); or the 21 Day Settlement Sum plus interest); or the 28 Day Settlement Sum plus interest) and stated that the relevant Settlement Sum shall: … (c) be deemed to be apportioned as to: (i) $xxx,000 towards interest payable under the Contract and the Lease; and (ii) the balance of the relevant Settlement Sum paid or payable as to general damages and loss under the Contract and the Lease in addition to the Instalment Amounts being applied as general damages and loss under the Contract and Lease. Upon signing the Deed the Applicant and A and B agreed to sign Settlement Orders, Default Orders, a Consent Judgment and Final Orders in relation to the Court proceedings. Upon receipt of the Settlement sum the Applicant agreed to discontinue the court proceedings against C and D and to release A, B, C, and D from all claims relating to the Contract and the Lease. The ruling request stated that A and B paid the Applicant the 21 Day Settlement Sum and a Cash Statement issued by the Applicant's solicitors records receipt of the first instalment and second instalment of settlement moneys. Submissions: The ruling request did not contain any submissions in support of the rulings sought. Further information: The Applicant's adviser subsequently confirmed that the former tenant of the Property, X Ltd, vacated the Property and that Y Ltd then occupied the Property pursuant to the Lease and paid the rent payable under the Lease to the Applicant for a number of months before Y Ltd went into liquidation and disclaimed the Lease. As the Deed states that A and B agreed to pay the Settlement Sum in full and final settlement of the 'Disputes' (defined to include all claims relating to the Contract and the Lease) we asked the Applicant's adviser to supply any available information which could support apportionment of the Settlement Sum between the supplies made pursuant to the Contract and the Lease. We received a copy of the Summons issued by the Applicant in the Supreme Court. Subsequently the Applicant's advisor stated that the Applicant's solicitor had no further information relevant to how the 21 Day Settlement Sum was apportioned between the Contract and the Lease, but did confirm that the apportionment of $xxx,000 towards interest payable under the Contract and Lease in the Deed was the result of negotiations between the solicitors acting for the Applicant and for A and B.

Relevant legislative provisions: A New Tax System (Goods and Services Tax) Act 1999, section 9-30(1)(b) and section 9-5.

Reasons for decision: Summary: Question 1 - forfeited deposit: | Detailed Reasoning - Summary:: The forfeited deposit was consideration for the supply of a right to receive a supply that would be GST-free. | Detailed Reasoning - Detailed reasoning:: GST treatment of a forfeited deposit under a standard land contract: Goods and Services Tax Ruling GSTR2000/28 applies to a 'standard land contract', i.e. 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 for the payment of the balance of the purchase price upon settlement. In our view the Contract satisfies the requirements of a 'standard land contract' as it was in writing, provided for payment of a $X deposit, provided for forfeiture of the deposit if the Purchasers defaulted, and provided for the deposit to belong to the Applicant on Completion. GSTR 2000/28 states (Paras 27 and 66) that Division 99 of the GST Act applies to a deposit paid under a standard land contract. Subsection 99-5(1) of the GST Act provides that a deposit held as security for the performance of an obligation is not treated as consideration for a supply unless the deposit is either forfeited because of a failure to perform the obligation or applied as all or part of the consideration for the supply. GSTR 2000/28 states (Para 96) that there may be GST consequences where the purchaser defaults under a standard land contract and the stakeholder pays the deposit to the vendor: In this case, the vendor has made a supply for consideration and, if the other elements of a taxable supply as defined in section 9-5 are satisfied, there will be a taxable supply by the vendor. Paragraph 9-30(1)(b) of the GST Act: GSTR 2000/28 also deals with forfeiture of a deposit in relation to a GST-free or input taxed supply. GSTR 2000/28 refers to Reliance Carpet Company Pty Ltd v FCT [2006] ATC 2006 in which the High Court held (Paras 37-8) that a vendor makes a supply upon entering into a standard contract for the sale of real estate, including the grant to the purchaser of contractual rights exercisable over or in relation to land, in particular of the right to require conveyance of the land to the purchaser upon completion of the sale. GSTR 2000/28 states: 97F. 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. 97G. A supply contemplated to be made under a standard land contract may meet the description of a supply that is GST-free or input taxed. A security deposit is paid in relation to the contract. If the deposit is forfeited, it is consideration for a supply the vendor makes when it enters into a contract consisting of the obligations it undertakes and the consequent rights it grants. The Commissioner considers that paragraphs 9-30(1)(b) and 9-30(2)(b) would be applicable in a case where a security deposit is forfeited in relation to a standard land contract where the contemplated supply would have been GST-free or input taxed. Broadly those provisions state that a supply consisting of a right to receive another supply that would be GST-free or input taxed is also GST-free or input taxed, as the case requires. Paragraph 9-30(1)(b) of the GST Act provides that a supply is GST-free if it is a supply of a right to receive a supply that would be GST free under Division 38 of the GST Act or under a provision of another Act. Division 38 of the GST Act includes subsection 38-325(1) which provides that a supply of a going concern is GST-free if the supply is for consideration, the recipient is GST registered or required to be so registered, and the supplier and recipient have agreed in writing that the supply is of a going concern. Consequently, if the Applicant made a supply pursuant to the Contract of a right to receive a supply of a going concern which would have satisfied subsection 38-325(1), the forfeited deposit was consideration for the supply of a right to receive a supply that would be GST-free and was therefore consideration for a supply which was GST-free pursuant to paragraph 9-30(1)(b). Subsection 38-325(2) of the GST Act defines a 'supply of a going concern' as a supply under an arrangement under which: (a) the supplier supplies to the recipient all of the things that are necessary for the continued operation of an enterprise; and (b) the supplier carries on, or will carry on, the enterprise until the day of the supply (whether or not as part of a larger enterprise carried on by the supplier. Goods and Services Tax Ruling GSTR 2002/5 states (Para 15) that it is not the supply itself which must satisfy the conditions in paragraphs 38-325(2)(a)and (b) but the arrangement under which a supply is made. In the present case we consider that the relevant arrangement was the Contract plus the Lease. Both were entered into on the particular date and the Contract stated that the sale was 'subject to existing tenancies' (rather than vacant possession) and that Completion was to occur on a subsequent date. GSTR 2002/5 also states (Para 21) that the requirements of paragraphs 38-325(2)(a) and (b) of the GST Act must be satisfied in relation to an 'identified enterprise', and refers to the 'enterprise' definition in section 9-20 of the GST Act (which includes an activity done on a regular or continuous basis in the form of a lease, licence or other grant of an interest in property). We consider that the 'identified enterprise' was the leasing of the Property to Y Ltd pursuant to the Lease. Paragraph 38-325(2)(a) of the GST Act requires the supplier to supply to the recipient all of the things that are necessary for the continued operation of the 'identified enterprise' and Goods and Services Tax Ruling GSTR 2005/5 states: 31. The term 'operation of an enterprise' is different to that of 'carrying on an enterprise'. As defined in section 195-1, 'carrying on' an enterprise includes doing anything in the course of the commencement or termination of an enterprise while operation of an enterprise requires something more than this. The activity must be one which can properly be described as a business or undertaking capable of being handed over to the transferee in such a state that it may be carried on by the transferee if it so wishes. The particular business or undertaking must remain active and operating at the time of the supply. 32. The Commissioner considers that for GST purposes whether the supplier continues to operate the enterprise is determined having regard to the substance of the matter rather than its form. Hence, a provision in the sale agreement to that effect is not conclusive. The Deed stated that Y Ltd went into liquidation and disclaimed the Lease, but the Applicant's adviser confirmed that Y Ltd occupied the Property pursuant to the Lease and paid the rent payable under the Lease to the Applicant for a number of months. We therefore consider that if the Contract had been completed, the requirement in paragraph 38-325(2)(a) of the GST Act would have been satisfied. Paragraph 38-325(2)(b) of the GST Act requires that the supplier carries on the identified enterprise until the day of the supply and GSTR 2002/5 states (Para 161) that the day of the supply is the date on which the recipient assumes effective control and possession of the enterprise carried on by the supplier. In the present case the Purchasers would have assumed effective control and possession of the enterprise on the Completion Date under the Contract. For the reasons set out above in relation to paragraph 38-325(2)(a) we accept that the Applicant would have carried on the identified enterprise (which includes anything done in the course of the commencement of the enterprise) until the day of supply. Paragraph 38-325(1)(a) of the GST Act states that the supply of a going concern is GST-free if the supply is for consideration. The front page of the Contract stated that the Price of the Property was $Z million. Paragraph 38-325(1)(b) of the GST Act states that the supply of a going concern is GST-free if the recipient is registered or required to be registered. We have not been able to confirm that the Purchasers were registered for GST at Completion but a clause of the standard conditions in the Contract provided an incentive for them to do so as it obliged the Purchasers to pay an extra $X on account of GST on Completion if the Purchasers were not GST registered at that date. Paragraph 38-325(1)(c) of the GST Act requires that the supplier and recipient have agreed in writing that the supply is of a going concern. This requirement was satisfied as the standard conditions in the Contract stated that if the Contract states that the sale is a supply of a going concern (which it did) then the parties agree the supply of the Property is a supply of a going concern. For the reasons set out above we consider that paragraph 9-30(1)(b) of the GST Act applies and that the forfeited deposit was consideration for the supply of a right to receive a supply that would be GST-free. Question 2 - the 21 Day Settlement sum apportioned to interest: Summary : The $xxx,000 of the 21 Day Settlement sum apportioned to interest under the Deed does not have a connection to a supply and the Applicant is not required to account for GST in relation to that portion of the 21 Day Settlement Sum. | Detailed Reasoning - Detailed reasoning:: The Deed states that A and B agree to pay the Applicant the Primary Settlement Sum in full and final settlement of the Disputes and defines 'Disputes' as: The Proceedings, all Claims relating to the Contract and all Claims relating to the Lease. 'Proceedings' is defined in the Deed as the proceedings in the Supreme Court, 'Claims' is very broadly defined to include any present or future, actual or contingent claim, 'Contract' is defined as the Contract for Sale of Land, and 'Lease' is defined as the lease dated the particular date. The Deed states that the Settlement Sum (i.e. the two Instalment Amounts (which equal the $X retained deposit) plus the 21 Day Settlement Sum) shall be deemed to apportioned as to: $xxx,000 towards interest payable under the Contract and Lease; and The balance of the relevant Settlement Sum paid or payable as to general damages and loss under the Contract and Lease in addition to the Instalment Amounts being applied as general damages and loss under the Contract and Lease. The Applicant's advisor confirmed that the apportionment of $xxx,000 towards interest payable under the Contract and Lease was the result of negotiations between the solicitors acting for the Applicant and for A and B. Pursuant to the Contract, in the event that the purchase price ($Z million) was not paid on the Completion Date interest was payable by the Purchasers to the Applicant at the rate of 10% per annum from the Completion Date until the date of payment to the Applicant. Interest at 10% on $Z from completion date until a certain month in the subsequent year (when the second instalment of the 21 day Settlement Sum was payable) amounts to $D, so the apportionment of $xxx,000 of the 21 Day Settlement Sum towards interest payable under the Contract and Lease appears to be reasonable. Goods and Services Tax Determination GSTD 2003/1 deals with whether payment of judgment interest is consideration for a supply. Although GSTD 2003/1 describes 'judgment interest' in terms of 'payments made in compliance with a court order' (Para 3), we note that the Deed was entered into after court proceedings had commenced and included a Consent Judgment in favour of the Applicant against A and B for $M which was to be filed in the court in the event that a hearing to determine the damages resulting from the Applicant's entitlement to specific performance of the Contract was scheduled before the Settlement Sum was paid in full. We therefore consider that the principles set out in GSTD 2003/1 can be applied to the portion of the 21 Day Settlement Sum which the Deed apportioned to interest. GSTD 2003/1 distinguishes between 'pre-judgment interest' (i.e. to compensate a successful plaintiff for the loss suffered by being kept out of his or her money during the relevant period) and 'post-judgment interest' (i.e. interest payable solely because of the delay in payment of the judgment debt). In our view the $xxx,000 apportioned to interest under the Deed is 'pre-judgment interest'. GSTD 2003/1 states (Paras 13-14): 13. The power to award pre-judgment interest exists irrespective of the cause of action, with the claim for interest considered to be separate and distinct from the underlying claim in the cause of action. The resulting assessment of the interest is over and above the awarding of the damages by the court or jury. Accordingly, we consider the awarding of pre-judgment interest is separate to the cause of action and has no connection to any supply which may be the basis of the cause in action. 14. As there is no connection to a supply which may be the basis of the cause in action, pre-judgment interest is not additional consideration for those supplies. We consider that there is not sufficient nexus between a payment of pre-judgment interest and any earlier supply relating to the dispute, nor to any current supply arising out of the court order finalising the dispute. Applying GSTD 2003/1, we consider that the $xxx,000 apportioned to interest under the Deed does not have a connection to a supply, cannot be consideration for a supply, and the Applicant is not required to account for GST in relation to that portion of the 21 Day Settlement Sum. Question 3 - the portions of the $yyy,000 of the 21 Day Settlement Sum apportioned to damages under the Contract and damages under the Lease | Detailed Reasoning - Summary:: The portions of the $yyy,000 of the 21 Day Settlement Sum apportioned to damages under the Contract and damages under the Lease relate to claims for damages for breach of the Contract and breach of the Lease which cannot be characterised as supplies made by the Applicant. Consequently the Applicant is not required to account for GST in relation to that $yyy,000. | Detailed Reasoning - Detailed reasoning:: According to the Deed, the $yyy,000 balance remaining of the 21 Day Settlement Sum (i.e. after $xxx,000 has been apportioned to interest) was apportioned to 'general damages and loss under the Contract and Lease'. In relation to portion of the $yyy,000 apportioned to damages under the Contract, the Deed recited that the court ordered that the Applicant was entitled to specific performance of the Contract and that there was to be a subsequent hearing for determination of damages resulting from that entitlement to specific performance. The Deed also stated that if the damages hearing was scheduled after payment in full of the 21 Day Settlement Sum, the Applicant would file Final Orders that the proceedings be discontinued with no order as to costs and if that hearing was scheduled before payment in full of the 21 Day Settlement Sum the Applicant would seek an adjournment of the damages hearing. Goods and Services Tax Ruling GSTR 2001/4 discusses 'supply' in the context of an out of court settlement and states (Para 17): The GST consequences of a court order or out-of-court settlement will depend on a number of matters, including whether a payment made under the order or settlement constitutes consideration for a supply and, if so, whether the supply is in the nature of a taxable, input taxed, or GST-free supply… In considering the GST consequences of court orders or out-of-court settlements, this ruling focuses on the 'supply for consideration' requirement. However, a supply for consideration will not be a taxable supply unless the other requirements set out in section 9-5 are also satisfied. For example, many settlements will not result in a taxable supply because the entity making the supply will not be doing so in the course or furtherance of an enterprise. GSTR 2001/4 also states (Paras 71-3): 71. Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury. 72. When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation. 73. The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss, or injury, in itself does not constitute a supply under section 9-10 of the GST Act. In our view the portion of the $yyy,000 apportioned to damages under the Contract relates to a claim for damages arising out of breach of the Contract which cannot be characterised as a supply made by the Applicant. Consequently the Applicant is not required to account for GST in relation to that portion of the $yyy,000. In relation to the portion of the $yyy,000 apportioned to damages under the Lease, the Lease stated that each of the covenants by the Lessee (e.g. the covenants to pay rent, to pay periodic outgoings, use the premises only for the permitted use etc) was an essential term of the Lease, that the Lessee covenanted to compensate the Applicant for the loss or damage suffered by reason of the Lessee's repudiation or breach of any covenant, and the Applicant was entitled to recover damages against the Lessee in respect of repudiation or breach of covenant for the damage suffered by the Applicant during the entire term of the Lease. The Lease also stated that the Applicant's entitlement to damages was not affected or limited by, for example, the Lessee abandoning or vacating the premises. We consider that the portion of the $yyy,000 apportioned to damages under the Lease relates to a claim for damages for breach of the Lease which cannot be characterised as a supply made by the Applicant. Consequently the Applicant is not required to account for GST in relation to that portion of the $yyy,000. | Detailed Reasoning - Disclaimer:: You cannot rely on the rulings in the Register of private binding rulings in your tax affairs. You can only rely on a private ruling that we have given to you or to someone acting on your behalf. The Register of private binding rulings is a public record of private rulings issued by the ATO. The register is an historical record of rulings, and we do not update it to reflect changes in the law or our policies. The rulings in the register have been edited and may not contain all the factual details relevant to each decision. Do not use the register to predict ATO policy or decisions.

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