Could decision on GST and forfeited deposits open door to more GST changes?

Vendors retaining a forfeited deposit may not be liable to pay GST, following a decision in the Full Federal Court which could also have broader implications for the operation of the GST law.

Taxpayers should carefully consider the implications of this case in determining whether or not GST should be paid on deposits forfeited to them, and whether they should seek refunds on any GST already paid. The decision of the Full Federal Court in Reliance Carpet Co Pty Limited v Commissioner of Taxation [2007] FCAFC 99 also raises the prospect for significant refunds to be sought by taxpayers who have remitted GST on forfeited deposits.

The contract, the deposit, and the collapse of the sale

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remedy of the purchaser's default within 14 days, but the purchaser failed to remedy the default, so the contract was rescinded and the deposit was forfeited to Reliance.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 remit GST on the deposit retained after the collapse of the sale. This turned on the nature of a "supply" in the context of the special provisions of the GST law relating to deposits.

Forfeited deposits, "supply", and the GST Act

The A New Tax System (Goods and Services Tax) Act 1999 ("GST Act") contains special rules relating to deposits. A deposit paid significantly in advance of a supply would still form part of the consideration provided for that supply and could (where the supplier accounts on a non-cash basis) trigger a liability for the whole of the GST payable on the supply.

This would lead to significant practical difficulties: the vendor, having received as little as 5 percent of the consideration for the supply, may be required to pay 10 percent of the GST exclusive amount of the supply to the Australian Taxation Office.

Division 99 of the GST Act was intended to operate to delay the time at which the deposit is treated as "consideration" (and as a result giving rise to a GST liability) until the deposit is either:

• applied as part of the consideration for the supply; or
• forfeited to the supplier.

The Full Federal Court considered the operation of these provisions in the context of the fundamentals of the GST - that is, that GST is a tax imposed on "supplies". In order for there to be a GST liability, there must have been a supply. In the case of the forfeited deposit however, the Court struggled to identify any supply by the vendor to the purchaser for which the forfeited deposit could be consideration.

The Commissioner argued for the existence of three different types of supplies made as part of the transaction for which the deposit could be consideration:

• interim obligations (obligations pending between contract and completion that would have merged on completion);
• rescission obligations; and
• deemed supply under Division 99.

The Full Federal Court determined that none of these supplies could be identified in the present case. As there was no supply, there could be no taxable supply. Accordingly, the Commissioner failed in his attempt to tax the forfeited deposit.

Should you seek a refund or not?

As noted above, the immediate result of this case is that taxpayers should carefully consider whether or not GST should be paid on deposits forfeited to them.

This case also raises the prospect for significant refunds to be sought by taxpayers who have remitted GST on forfeited deposits. Enthusiasm for refunds however should be tempered. It would be most surprising if the Commissioner did not seek special leave to the High Court. Alternatively, a legislative solution may be considered.

In the interim, it is important to consider:

• whether refunds should be sought in relation to GST paid on forfeited deposits; and
• whether GST should be paid in the future on forfeited deposits.

It is also possible that the case will be limited by reference to the rescission process under the Victorian Transfer of Land Act 1958. A decision impact statement would be expected to emerge from the ATO in the next few weeks.

Other problems identified by the Court

Perhaps of more significance is the Court's approach to the legislative intention. The Court recognised that Parliament did intend to tax deposits forfeited in these circumstances, but its view was that the mechanism set out in Division 99 merely allowed the "forfeited deposit to be treated as consideration for an unidentified supply."

There are many mechanisms under the GST Act that are defective, for example:

• Division 147 is inadequate to deem the "representative entity" to bear the GST consequences supplies and acquisitions of the "incapacitated entity" on whose behalf it acts.
• Division 70 deems acquisitions eligible for reduced input tax credits to have been made for a creditable purpose, arguably denying the market value deeming rules of Division 72 any role for such supplies - notwithstanding that a full input tax credit is not available.

No doubt, the Commissioner had hoped for judicial support to address these legislative shortcomings in the day-to-day administration of the GST. Perhaps such hope has been misplaced and the Commissioner should be pushing harder for legislative intervention in the GST Act. This case could well be the catalyst for retrospective legislation to address the shortcomings in the GST law identified by the Full Federal Court.