On Thursday 22 May 2008, the High Court handed down a significant decision for property owners and buyers.
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Overruling the decision of the Full Court of the Federal Court handed down in July last year, the High Court has ruled that GST is payable on a forfeited deposit.
In this article we discuss how this important decision might affect our property clients.
The facts
The parties entered into a contract of sale dated 10 January 2002 for the sale of commercial premises in Camberwell, Victoria. The contract provided that GST would be payable by the purchaser in addition to the sale price of $2.975 million.
A deposit of $297,500 (being 10% of the GST-exclusive purchase price) was paid by the purchaser. The parties agreed that settlement would take place on 10 July 2003.
When the purchaser failed to complete on that date and did not remedy the default as required by the vendor’s recission notice, the vendor (Reliance) rescinded the contract and kept the deposit.
Reliance received an assessment for payment of GST on the deposit from the Commissioner of Taxation. Assisted by a grant of test case funding from the Commissioner, Reliance objected to the assessment.
The Administrative Appeals Tribunal affirmed the Commissioner’s assessment and Reliance appealed succesfully to the Full Court of the Federal Court. The Commissioner appealed to the High Court.
The High Court’s reasoning
The key to understanding the High Court’s decision is the recognition that a taxable supply under the GST Act (Act) includes two initial elements:
- a supply; and
- consideration for the supply.
Reliance argued that as the sale had not settled and the title was not conveyed to the purchaser, nothing was supplied. Without a supply, GST is not payable.
This seems a logical argument. In fact, it was accepted by the Full Court of the Federal Court in its 2007 decision. However, to fully understand why the High Court’s rejected Reliance’s argument, it is necessary to look in some detail at the provisions of the Act.
“Supply”
The definition of “supply” in section 9-10 of the Act specifically provides that a supply includes “a grant, assignment or surrender of real property”. “Real property” includes “any interest or right over land” (section 195-1).
Therefore, a grant of any interest or right over land will be a supply for the purposes of the Act.
The Commissioner successfully argued that the benefit of the promise by the vendor to convey the land to the purchaser upon completion of the contract could be considered a “grant of real property” and therefore a supply under the Act. The Court also appeared to accept that the vendor’s obligations under the contract (such as maintaining the property in its present condition until settlement) could constitute a supply.
Applying this reasoning, the supply was made when the contract was entered into. The fact that the transaction did not proceed to settlement could not alter this conclusion.
“Consideration”
Under the Act, “consideration” includes “any payment, or any act or forebearance, in connection with a supply of anything” (section 9-15).
Given this expansive definition, once the Court found that there was a supply, it was clear that the deposit was a payment in connection with that supply. It was given as security for the purchaser’s promise to proceed with a conveyance of the property.
Under section 99-5 of the Act, such a deposit will not be treated as consideration for a supply “unless the deposit is forfeited or applied as all or part of the consideration for a supply”.
Therefore, the obligation to pay GST on the deposit arises when forfeiture or completion takes place, and not upon payment of the deposit money by the purchaser (section 99-10). It is at this point that the supply becomes a taxable supply and GST liability arises.
The impact for vendors and purchasers
If a sale of real property is likely to be subject to GST, the vendor should consider whether the deposit paid by the purchaser should include an amount for GST. This will avoid any unexpected costs down the track if the sale does not proceed.
For contracts already on foot, if the purchase price is expressed as being inclusive of GST, it is likely that the deposit paid by the purchaser includes an amount for GST.
However, if the contract provides that GST is payable in addition to the purchase price, it is possible that the purchaser may not have paid an amount for GST on the deposit.
In circumstances where the purchase price is GST exclusive, there is often a provision in the contract of sale which transfers liability for any GST onto the purchaser. Depending on the terms of the contract, if the sale does not proceed, the vendor should be able to rely on this provision to recover the GST amount from the purchaser.
Please contact a member of our property or tax teams if you would like to discuss the impact of this decision for your particular transaction.
1 Commissioner of Taxation v Reliance Carpet Co Pty Limited [2008] HCA 22 (22 May 2008)