GST refunds on forfeited deposits under sale of land contracts

A deposit forfeited by a purchaser to a vendor under a rescinded sale of land contract is not taxable for GST. The Commissioner may have to refund GST to taxpayers who have previously paid GST on forfeited deposits. Anna Tang and Inna Shibalova

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Facts

The facts in Reliance Carpet[1] are as follows:

• Reliance Carpet owns property in Camberwell, Victoria (Property).
• Reliance Carpet entered into a standard sale of land contract (Contract) to sell the Property.
• The Purchaser paid a deposit of 10% of the purchase price.
• The Purchaser failed to pay the balance of the purchase price as required under the Contract.
• Reliance Carpet terminated the Contract and kept the deposit.
• The Purchaser requested a tax invoice from Reliance Carpet for the forfeited deposit. Reliance Carpet refused stating that the deposit was retained as damages in part satisfaction of its losses.
• The Commissioner of Taxation claimed that the forfeited deposit was consideration for a taxable supply under Division 99 of the GST Act and assessed Reliance Carpet as being liable to pay GST on the deposit.

The issue: Was the deposit a "taxable supply"?

The key issue in Reliance Carpet was whether the forfeited deposit could be considered as payment in consideration of a taxable supply, given that the Property was not supplied to the Purchaser.

Division 99 of the GST Act contains special rules for dealing with deposits. A deposit held as security for the performance of an obligation is not consideration for a supply unless the deposit is forfeited or is applied as all or part of the consideration for a taxable supply.

For Division 99 to apply, as the Full Federal Court pointed out, a relevant taxable 'supply' must still be made.

The arguments

Reliance Carpet argued before the AAT, and then before the Full Federal Court, that the deposit was not subject to GST as it was not possible to identify a taxable supply for which the forfeited deposit was consideration.

The Commissioner responded that:

1. it was possible to identify a taxable supply; and
2. even if a supply could not be identified, Division 99 deems there to be a taxable supply in these circumstances for the purposes of GST.

The AAT decision: Obligations between payment of deposit and settlement amount to a relevant supply

The AAT held that the forfeited deposit was subject to GST on the basis that the forfeited deposit was consideration for a taxable supply. The AAT was of the view that the Contract created a number of obligations owed by Reliance Carpet to the Purchaser which together constituted a relevant taxable 'supply'. These obligations included:

1. transferring title to the Property on settlement;
2. maintaining the Property in its current condition;
3. paying all outgoings; and
4. maintaining appropriate insurance cover in respect of the Property.

The payment of the deposit by the Purchaser was therefore consideration for the taxable supply by Reliance Carpet of these obligations. Accordingly, the forfeited deposit was subject to GST.

The Full Federal Court's decision: No relevant supply by vendor to purchaser

The Full Federal Court unanimously found in favour of Reliance Carpet.

The Court rejected the AAT finding that the relevant taxable supply was the supply of obligations by Reliance Carpet to the Purchaser under the Contract. The Court considered the AAT's finding "artificial". The Court held that it was not possible to identify a taxable supply for which the forfeited deposit could be considered as consideration. Therefore, the forfeited deposit was not subject to GST.

The Court also rejected the Commissioner's argument that Division 99 deems there to be a taxable supply. Rather, the Court held that Division 99 only applies GST to those forfeited deposits for which a taxable supply could be readily identified.

Implications of case

A number of commentators predict there will be a flood of taxpayers seeking refunds for GST paid in respect of forfeited deposits. The amounts refunded may add of up to millions of dollars.

In view of this, it is unsurprising that on 3 August 2007 the ATO announced that it would seek leave to appeal the decision in the High Court.

More information

For more information in relation to this article, contact Anna Tang on 03 9288 0555 or Inna Shibalova on (03) 9240 0772.

For more information about tax and revenue queries generally, contact Maddocks and ask for a member of the Maddocks Tax and Revenue Team:

• in Melbourne on 03 9288 0555 or
• in Sydney on 02 8223 4100.

[1] Reliance Carpet Co Pty Limited v Commissioner of Taxation [2007] FCAFC 99