GST and 10% payment for supply of goods

Is the amount of 10% of the purchase price paid to the entity, a supplier of goods, under a standard commercial contract, a 'deposit' for the purposes of Division 99 of the A New Tax System (Goods and Services) Tax Act 1999 (GST Act), where the parties agree that the amount will be forfeited if the purchaser does not complete the purchase?

Yes, the amount of 10% of the purchase price paid to the entity under a standard commercial contract is a 'deposit' for the purposes of Division 99 of the GST Act.

This is because the amount is regarded as a reasonable amount, and the entity and purchaser expressly agree that it is to be forfeited if the purchaser does not fulfil its obligation to complete the purchase.

The entity is a supplier of goods. The entity enters into a standard commercial contract to supply goods to the purchaser.

The entity requires the purchaser to pay 10% of the price of the goods to secure the supply. The agreement between the parties is that this amount will be forfeited if the purchaser does not complete the purchase.

The entity is registered for goods and services tax (GST).

Under Division 99 of the GST Act, a deposit which is held to secure the performance of an obligation will not be treated as consideration nor attributed until such time as it is either forfeited or is applied as consideration.

Paragraph 4 of Goods and Services Tax Determination GSTD 2000/1 provides that Division 99 of the GST Act only applies to those deposits that are at risk of forfeiture on failure to perform an obligation under the agreement. If an amount is actually part payment for a supply, Division 99 of the GST Act does not apply.

Division 99 of the GST Act will only operate if the payment received by the supplier is a deposit. Therefore, it needs to be determined whether the 10% amount provided to the entity is a 'deposit' for the purposes of Division 99 of the GST Act.

'Deposit' is not defined for the purposes of the GST Act, however a number of court decisions have considered whether certain payments were truly deposits or were in fact what the courts refer to as either part payments or payments in the nature of a penalty.

In equity only a true deposit may be forfeited to a vendor upon breach of contract by a purchaser. Amounts which either represent part payments ( Dies and Another v British and International Mining and Financing Corporation, Limited (1939) 1 KB 725 and Reid Motors Ltd v Wood and Another (1978) 1 NZLR 319 (Reid's Case) or are in effect penalties Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd. [1993] AC 573 (Dojap's Case) must be returned by the vendor to the purchaser. The vendor may then, if the contract provides for it, seek to sue the purchaser for liquidated damages that result from the breach of the contract.

The principles established from these cases are that for a sum to be considered a deposit: • it must be a reasonable amount, and • the entity and the purchaser must agree, either expressly or by implication, that the deposit is to be forfeited on breach by the purchaser.

The question of what is reasonable was discussed in both Reid's Case and Dojap's Case .

In Reid's Case the court held that in the normal course of a business, a deposit as security for completion of a transaction is usually in the vicinity of 10% of the total price. In Dojap's Case the court held that 10% has been a customary deposit.

Based upon the principles in the above cases, a deposit as security for completion of a transaction would usually be in the vicinity of 10% of the total price, though each case needs to be decided on the merits of its particular facts.

As such, the 10% amount paid to the entity under a standard commercial contract would be regarded as a reasonable amount and may be treated as a deposit for the purposes of Division 99 of the GST Act.

A basic concept of a deposit is that both parties intend or understand that the sum of money will be forfeited if the payer breaches the terms of the contract. If the money is not intended to be forfeited then it could not truly be said to be a deposit.

In re Levy's Trusts 30 Ch D 119, the courts held at page 125: Clearly the word 'forfeit' means not merely that which is actually taken from a man by reason of some breach of condition, but includes also that which becomes liable to be so taken...It would be ridiculous to say that it was not forfeited because the forfeiture was not actually enforced...

Therefore, where the parties understand at the commencement of the contract that the amount will be forfeited, it is irrelevant whether the forfeiture is actually enforced by the supplier at the time of the breach.

As the agreement between the entity and purchaser is that the 10% amount will be forfeited if the purchaser does not complete the purchase, it is expressly agreed by the parties that the amount is intended to be forfeited on breach by the purchaser.

As the 10% amount provided to the entity is considered to be a reasonable amount in the circumstances and the entity and the purchaser expressly agree the deposit is to be forfeited on breach by the purchaser, the amount is a deposit for the purposes of Division 99 of the GST Act

Note 1: As the amount received is a deposit for the purposes of Division 99 of the GST Act, the entity does not need to attribute any GST payable until such time as it is either forfeited or is applied as consideration.

Note 2: The cases referred to are sale of land cases. A question arises as to whether the principles would apply in the case of a sale of goods. This point was considered in Dies and Another v British and International Mining and Financing Corporation, Limited (1939) 1 KB 725 and found that the rule had general application.