The High Court's decision in Commissioner of Taxation v Reliance Carpet Co Pty Limited [2008] HCA 22 confirms that GST is payable on the forfeiture of deposits. While the decision concerns real property transactions, the Court's wide concept of "supply" means the implications of the decision have much broader application and ramifications.
The purchase of land
The case arose out of the purchase of land in Victoria. The purchaser, following exercise of a purchase option, paid a deposit to the vendor, Reliance. The purchaser failed to pay the purchase price on the date due for payment under the contract for the sale of land. Reliance served a rescission notice on the purchaser requiring remedy of the purchaser's default within 14 days, but the purchaser failed to remedy the default, so the contract was rescinded and the deposit was forfeited to Reliance.
Both Reliance and the Commissioner accepted that the sale of the land would have been subject to GST and that Reliance would have been liable to remit GST on the sale of the land to the purchaser. The question raised by the case was whether Reliance was liable to pay GST on the deposit retained after the collapse of the sale.
The matter was first heard in the Administrative Appeals Tribunal ("AAT") where the Tribunal held that GST was payable on the forfeiture of the deposit. On appeal to the Full Federal Court, the AAT decision was overturned as the Court struggled to identify any supply by the taxpayer to the purchaser for which the forfeited deposit could be consideration. As such, the Court determined that as there was no supply, there could be no taxable supply and therefore GST was not payable on the forfeited deposit.
High Court decision
The High Court preferred the view of the AAT supporting the argument that there was a supply of interim obligations made by the taxpayer to the purchaser. As such, the operation of Division 99 (specifically section 99-10) of the A New Tax System (Goods and Services Tax) Act 1999 ("GST Act") ensured that the consideration for such supply was the forfeited deposit albeit that the supply and consideration lacked temporal coincidence.
The High Court held that, while there was always an interim obligation supply made by the taxpayer, the effect of Division 99 was to ensure that such a supply would only be taxable where the deposit was forfeited. That is, it was only at the time of forfeiture, "by reason of the failure by the purchaser to complete the Contract that the supply represented by the making of the Contract became a taxable supply".
The High Court acknowledged that the effect of its decision was that in the context of the transaction, there were, in fact, two supplies made by the taxpayer, being the:
- supply of interim obligations - which could be characterised as a grant by the taxpayer to the purchaser of contractual rights exercisable over or in relation to land, in particular the right to require the conveyance of the land to the purchaser upon completion; and
- supply of the land.
However, the High Court stated that upon the proper construction of the GST Act, the effect of Division 99 was to ensure that there was only one taxable supply, by applying the consideration to either the supply of interim obligations (where the deposit was forfeited) or supply of the land (where the contract proceeded to completion).
How does this decision affect you?
The decision reflects a very wide concept of "supply" for the purposes of the GST Act and accordingly requires you to look beyond economic concepts of supply to legal concepts and construction to better understand the legal obligations contemplated by the parties that may give rise to supplies.
While the decision is specific to real property transactions which have very particular interim obligations supplied at the time of exchange, the concepts discussed are a timely reminder that the definition of supply is very broad and captures a range of obligations made by parties in varied contexts.
For real property transactions, you should ensure that GST payable on a forfeited deposit is appropriately canvassed in your contractual arrangements by including an appropriate GST gross up clause. For other transactions, you should consider the ramifications of arrangements that you enter into that involve the making of a deposit in order to secure the performance of an obligation and properly safeguard against potential GST consequences that could result should the deposit be forfeited.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.