Vendor-financed transactions could lead to GST headaches
Tax Telegraph, September 2013
In a subdued market, when things aren’t selling fast, banks are lending more cautiously and prospective purchasers are squeezed for cash, vendor financing can be an effective way for businesses to ensure that important sales proceed.
But, as one taxpayer recently discovered, the decision to provide vendor finance to a customer resulted in an unexpected GST exposure, one that cost the taxpayer $90,000 (this and all other figures are approximate).
The taxpayer was a family trust. The transaction in question was a 2008 sale of trust property, a large block of vacant commercial land on the outskirts of Townsville, for an agreed price of $3.5 million (including $318,000 GST).
After entering into the contract, the purchaser informed the trust that it would be unable to pay all of the purchase price at settlement. At settlement, the purchaser provided $2 million and the parties executed a ‘Settlement Balance Facility Agreement’ for the balance of $1.5 million. The Agreement was worded as an arrangement involving the provision of a 45-day loan by the trust to enable the purchaser to fulfil its obligation to pay for the land (i.e. with the trust’s obligation to advance the loan being off-set against the purchaser’s obligation to pay for the land). Security for the loan was provided by a subordinate registered mortgage over the land.
When after 45 days the purchaser failed to pay any of the amounts owed, the parties varied the Agreement to require that the purchaser instead pay $500,000 and transfer three developed lots to the trust. In 2009, the trust received the $500,000, but not the lots. In 2011, a bank exercised its power of sale as mortgagee in possession of the land, but there were insufficient funds available from the sale to distribute any amount to the trust.
How much GST was the trust obliged to pay to the ATO?
The trust was a cash-basis GST taxpayer. It took the view that it was only obliged to remit GST to the extent that it had actually received payment for the land. As the purchaser had only paid amounts totalling $2.5 million, the trust had only remitted GST of $227,300 to the ATO. The ATO was not satisfied with this. It asserted that the trust was liable for GST on the full $3.5 million, and that the trust therefore had an outstanding GST liability of $90,000.
The Administrative Appeals Tribunal heard the dispute in June 2013. The Tribunal focused on the contractual arrangements that the parties had made, readily concluding that there were three distinct dealings – a contract for sale of the land, a vendor finance loan agreement, and a (subordinated) mortgage over the land to secure repayment of the loan. The Tribunal rejected the trust’s argument that the arrangement, in substance, amounted to a sale of the land on (45 days) credit – there was, the Tribunal said, “plainly a loan agreement and a loan” and the fact that things had not turned out as planned was not a basis for recasting the arrangement.
The Tribunal concluded that the fact of the loan meant that the trust had received the whole of the $3.5 million consideration for the sale of the land at settlement and was liable to GST based on this amount. (Thereafter, it was a question of the trust recovering the loaned amount from the purchaser under the terms of the loan agreement and the mortgage, and its failure to do so did not alter the GST liability on the sale).
This decision should sound a warning for any business offering vendor finance to customers, whether on a regular or one-off basis.
Vendor finance is often provided because a purchaser is having difficulty accessing bank or other third party finance – for example, due to an inadequate deposit, a less than perfect credit history, or delay in getting bank loan approval in circumstances where the vendor needs a quick sale – and as a result there will often be a higher level of risk associated with these transactions. While the terms of a vendor finance loan arrangement would ordinarily reflect the higher than normal risk that the purchaser will default, the potential GST exposure that could also result is very unlikely to have been factored in.
If your business offers vendor finance, you should consider whether your circumstances may have resulted in a GST exposure in cases where purchasers have defaulted on repaying loaned amounts after settlement. Consideration should also be given to reviewing the structure and terms of your sale and financing arrangements to identify whether GST exposures of this kind can be avoided in future.
While the Tribunal’s decision concerned a cash-basis GST taxpayer, accruals basis GST taxpayers would also be adversely affected in the same circumstances. In such a case, similar logic by a Tribunal would mean any bad debt was referrable to the loan, not to the property sale, meaning there would be no GST bad debt adjustment.
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