Her Majesty Revenue & Customs (“HMRC”) recently updated their guidance and practice in the United Kingdom regarding the VAT status of forfeited deposits, following a judgment of the European Court of Justice (“ECJ”) (ECJ Case C-277/05). This again causes the question as to how forfeited deposits should be treated under the South African VAT Act to be raised.
The ECJ considered whether a deposit paid by a client to an hotelier for the reservation of a room is subject to VAT when the client does not arrive and forfeits the deposit. The ECJ considered that the deposits were intended to mark the conclusion of the contract between the hotelier and the client, to encourage fulfilment of the contract and to provide fixed compensation for the hotelier should the contract not be fulfilled as agreed. On this basis the ECJ held that the deposit retained by the hotelier was not subject to VAT because the hotelier did not make any identifiable supply of any service to the client.
The HMRC updated their guidance and practice based on this judgment to stipulate that deposits retained by hoteliers for client no-shows are not subject to VAT, and to allow refunds of VAT to hoteliers who previously accounted for VAT on such deposits retained.
The HMRC policy further stipulates that where a client makes a guaranteed booking in terms of which the hotelier guarantees a specific room for the client for a specific period, the hotelier is contractually obliged to retain that room for the client for the agreed period. In these circumstances the “deposit” is in effect consideration for keeping the room available and is subject to VAT. This follows the High Court decision in C&E Comrs v Bass plc (1993) STC 42.
In line with these judgments the HMRC policy stipulates that a cancellation fee charged to a client to cancel a reservation falls outside the scope of VAT because it is not paid for any identifiable service. However, if the cancellation fee is charged in respect of a guaranteed room, the fee is subject to VAT because the hotelier has undertaken to keep a specific room available.
Section 7(1)(a) of the VAT Act requires that for VAT to become payable there must be a supply of goods or services by a vendor in the course or furtherance of an enterprise carried on by the vendor. If there is such a supply, then VAT is payable on the consideration received for the supply.
The definition of “consideration” in section 1 of the VAT Act specifically excludes a deposit (whether refundable or not), unless the supplier applies the deposit as consideration for the supply, or if the deposit is forfeited. Accordingly, a deposit only becomes consideration when the deposit is applied against the purchase consideration for a supply of goods or services, or when the deposit is forfeited.
A deposit is excluded from the definition of “consideration” because of the uncertainty as to its application when it is received. If the deposit is applied against the purchase consideration of goods or services, then it clearly forms part of the consideration for such supply, and is then subject to VAT. If the supplier defaults and the deposit is returned to the client, then there is no supply, no consideration and also no VAT implication. However, if the client defaults and the supplier retains the deposit, the question is whether such retained deposit (which is then consideration by definition), is paid in respect of, in response to or for the inducement of goods or services.
The ECJ found in the C-277/05 case that the forfeited deposit represents fixed compensation for the hotelier for the loss suffered due to the client exercising his cancellation option. Such compensation does not constitute a fee for a service and forms no part of the taxable amount for VAT purposes.
The New Zealand Tax Authority views forfeited deposits in the same light as the HMRC. It states that where a vendor cancels a contract as a consequence of the failure of a purchaser to perform the contract, the deposit retained by the vendor relates to compensation for the purchaser’s breach and not to any supply under the contract. The deposit represents liquidated damages for the breach of the contract, being a pre-estimate of damages in respect of a breach.
With regard to fixed property sales, the New Zealand Revenue Authority considers that the forfeiture and retention of the deposit because of the purchaser’s breach of the contract is an action against the purchaser rather than the provision of a right of a benefit or advantage to the purchaser. The forfeited deposit is therefore not subject to VAT.
The Australian High Court in the case of Commissioner of Taxation v Reliance Carpet Co (Pty) Ltd came to a different view with regard to a forfeited deposit in respect of a fixed property sale. In that case the High Court examined all the events that actually occurred and found that there was indeed a supply, and provided two reasons for reaching such conclusion. Firstly it found that there was a supply because the vendor entered into various obligations when the contract was concluded. There was the primary obligation to transfer title to the purchaser upon payment of the balance of purchase price, but there were other obligations as well, such as maintaining the property in its present condition, to pay all rates, taxes, assessments, fire insurance premiums and other outgoings in respect of the land and to hold the existing policy of fire insurance for itself and in trust for the purchaser to the extent of their respective interests. The High Court considered that the carrying out of such obligations comprised a supply. Secondly, the vendor granted rights to the purchaser in relation to the land, and the granting of such rights was also considered to comprise a supply.
The definition of “supply” in the South African VAT Act is very wide and includes “all forms of supply”. The definition of “services” is equally wide and includes “anything done or to be done, including the granting, assignment, cession or surrender of any right, or the making available of any facility or advantage”. However, the underlying principle remains, i.e. the forfeited deposit can only be subject to VAT if it is retained in respect of, in response to or for the inducement of the supply of goods or services. If it is retained as compensation for a loss suffered, then there is no supply of anything, and the amount retained is not subject to VAT.
The underlying agreement between the supplier and the recipient must therefore be carefully analysed (or drafted) to determine the exact nature of the deposit payable by the client. If it is intended to compensate the supplier for a loss suffered in the case of default by the client, then the deposit retained by the supplier should not be subject to VAT.