GST and 25% payment for supply of goods

Is the amount of 25% 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?

No, the amount of 25% of the purchase price paid to the entity, a supplier of goods, under a standard commercial contract is not a 'deposit' for the purposes of Division 99 of the GST Act.

The amount is treated as if it were a part payment for the supply of the goods.

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 25% of the purchase price of the goods to secure the supply. The agreement 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 25 % 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 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 found that a 50% deposit was clearly unreasonable and could not be considered to be a true deposit. 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. It would be most unusual for a deposit to be as high as 50% of the contract price, let alone exceed that figure. In the particular circumstances it was held that the deposit was in fact a part payment for the purchase of the goods.

In Dojap's Case , the court held that a deposit for a sale of land of 25% with a clause clearly stipulating that it would be forfeited was not reasonable and as such was considered to be in the nature of a penalty. Their Lordships noted at page 580 that: ... the customary deposit has been 10 per cent. A vendor who seeks to obtain a larger amount by way of a forfeitable deposit must show special circumstances which justify such a deposit.

Based upon the principles in the above cases, a deposit as security for completion of a transaction under a standard commercial contract 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.

The 25% amount paid to the entity under a standard commercial contract would be regarded as an unreasonably large amount for a deposit and would not fit within the ambit of Division 99 of the GST Act. This is despite the fact that the agreement is that this amount will be forfeited if the purchaser does not complete the purchase.

In Dojap's Case it was found that as the contract provided for the deposit to be paid in one single global sum equal to 25% of the purchase price then the whole sum had to be paid back less any damage the bank could actually prove as liquidated damages.

Applying the above principle, the entity requires the purchaser to pay 25% of the purchase price of the goods to secure the supply. Therefore, the entire 25% amount paid to the entity would not be a deposit and would be considered to be in the nature of a penalty.

Accordingly, the amount of 25% of the purchase price paid under a standard commercial contract, to the entity is not a 'deposit' for the purposes of Division 99 of the GST Act. As the amount is not a deposit for the purposes of Division 99 of the GST Act, it is treated as if it were in fact a part payment for the goods.

Note 1: As the amount received is not a deposit for the purposes of Division 99 of the GST Act, the entity must attribute any GST payable in accordance with the normal attribution rules in section 29-5 of the GST Act.

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.