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The Federal Court Rules on Vendor’s Liability for GST on a Forfeited Deposit

In the recent decision of Reliance Carpet Co Pty Limited v Commissioner of Taxation [2007] FCAFC 99 (5th July, 2007 called “the Reliance decision”) the full Federal Court issued a significant ruling on a vendor’s liability to pay GST (Goods and Services Tax) on a forfeited deposit for the sale of real property.

Background to the Reliance Case

In 2001 the seller/vendor entered into an option agreement with the purchaser for consideration of $25,000.00 (“the option fee”) for the purchase of the property for $3,000,000.00 less the option fee. Eventually the purchaser exercised his option to purchase the property. Thereafter the parties agreed to a contract for sale for the sum of $2,975,000.00 plus GST.

The contract for sale provided that the purchaser pay a deposit of $297,500.00 with the balance of $2,677,500.00 to be paid on settlement. The purchaser was also granted an option to defer the settlement date for six months if the purchaser was required to relocate its business. The deposit was released to the vendor after which the purchaser exercised its option to defer settlement for six months.

The purchaser failed to pay the balance of the purchase price by the delayed settlement date and the contract was rescinded with the deposit forfeited by the purchaser.
Objection lodged with the ATO

An objection had been lodged with the Australian Taxation Office (“the ATO”) to an assessment of a GST by the vendor under the contract for sale, with respect to a purchase deposit that was forfeited following the rescission of a property sales contract.

The ATO ruled that a GST-registered vendor, who is selling real property in the course of carrying on an enterprise, will be liable for GST in the case of a forfeited deposit following a default by the purchaser under the contract for sale.

An appeal on the ATO ruling was made to the Administrative Appeals Tribunal (“the AAT”), which upheld the ruling of the ATO.

Subsequently the vendor appealed the decision to the Federal Court which held that the vendor was not liable for GST in respect of a forfeited deposit.
The Legislation

GST by law is payable on “taxable supplies” which are supplies sold as consideration with respect to a contract for sale. Consideration is to include “any payment or any act…in connection with a supply of anything”.

However, Section 99-5(1) of the A New Tax System (Goods and Services Tax) Act 1999 (“GST Act”) states that a deposit will not be treated as consideration unless the deposit:

(a) Is forfeited because of a failure to perform the obligation; or
(b) Is applied as all or part of the consideration for a supply.
The Full Federal Court Decision in the Reliance Case

The ATT held in the Reliance case that the vendor was liable for GST in respect to the forfeited deposit.

The Administrative Appeals Tribunal found that the forfeited deposit was consideration for supplies that the vendor provided when entering into the contract for sale. The supplies that the vendor used were obligations that the vendor had to the purchaser on entry into the contract for sale. The AAT found that these obligations included:

(a) The maintenance of the property in its present condition; and
(b) The payment of all rates, taxes, assessments, fire insurance premiums and other outgoings in respect of the land.

The AAT stated that, upon execution of the contract for sale, the vendor made a supply as it entered into the obligation to take actions under the contract. The payment of the deposit was the consideration the vendor received for this supply.

The full Federal Court found the reasoning of the AAT to be flawed. “When the vendor entered into the contract for sale,” they held, “it entered into a contract for the supply of real property; nothing more and nothing less”.

Consequently, there was no supply of provisional obligations either on the entering of the contract or afterwards, and when the contract was rescinded, the vendor had not made any supply to the purchaser.

With these findings being considered, the full Federal Court stated that Section 99-5(1) of the GST Act did not obligate the vendor to make a taxable supply to the purchaser and the vendor was not liable for GST with respect to the forfeited deposit.

If this decision of the full Federal Court in Reliance is not appealed to the High Court, it will be possible for vendors who have previously remitted GST in cases of a forfeited deposit may be able to apply to the ATO for a refund.

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