COVID-19 has created unprecedented uncertainty for business, not just in Australia, but the whole world. How long this uncertainty will last is unknown. The Prime Minister has been telling Australians that this uncertainty is anticipated to last at least six months. There have also been reports that it will last for twelve months, possibly longer.
Given this uncertainty, suppliers or purchasers may be considering cancelling contracts for the supply of services or goods previously entered into or may have already cancelled these.
The cancellation of a contract has GST implications.
We consider below the implications where the supplier and purchaser account for GST using the non-cash basis of accounting for GST (i.e. where they account for GST on an accruals basis).
What is an adjustment event?
An adjustment event includes any event which has the effect of cancelling a sale or purchase of a service or good.
What are the implications of an adjustment event?
When an adjustment event occurs it is likely that:
- the supplier has accounted for too much GST on a supply; and
- the purchaser has accounted for too much input tax credit (GST credit) for an acquisition.
Where the above applies, each business may have to make an adjustment to the GST previously attributed to a particular tax period.
When does an adjustment event arise?
The requirement to make an adjustment does not always arise from an adjustment event.
In particular, one of the conditions for an adjustment to be required to be made is that:
- for the supplier - the GST on the supply; or
- for the purchaser - the GST credit on the acquisition
was attributed to an earlier tax period.
That is, the business must have attributed the GST to an earlier month (if it accounts for GST on a monthly basis) or an earlier quarter (if it accounts for GST on a quarterly basis).
Where the adjustment event occurs in the same tax period in which the GST on the supply or the GST credit on the acquisition is attributable, this requirement is not met. That is, an adjustment event does not arise. In this situation, the change to the GST payable or GST credit claimable resulting from the adjustment event is accounted for in calculating the GST payable or the GST credit claimable for the tax period.
Further, where the event does not give rise to an adjustment, there is no requirement for the supplier to issue an adjustment note to the purchaser.
Property Developer Pty Ltd has previously acquired land on which it proposes to undertake a mixed use development, with the intention of selling all commercial and residential premises constructed on the land. Property Developer Pty Ltd entered into a construction contract with Construction Company Pty Ltd in late January 2020.
Construction Company Pty Ltd issued Property Developer Pty Ltd with a tax invoice on 3 February 2020 for the mobilisation fee payable for commencing work on the project and Property Developer Pty Ltd paid this invoice on 24 February 2020 as it was keen for the construction to commence.
Given the rapid spread of COVID-19 in Australia since, Property Developer Pty Ltd’s board decided on 20 March 2020 to delay the development to a later point in time when there is more certainty.
As construction had not yet commenced (Construction Company Pty Ltd was still in the process of completing other construction projects), Property Developer Pty Ltd was allowed to cancel the contract with Construction Company Pty Ltd if it provided 10 days’ notice to Construction Company Pty Ltd. Property Developer Pty Ltd notified Construction Company Pty Ltd on 20 March 2020 that it would like to cancel the contract.
Construction Company Pty Ltd issued an adjustment note and a refund to Property Developer Pty Ltd on 31 March 2020.
Property Developer Pty Ltd and Construction Company Pty Ltd account for GST monthly using the accruals basis of accounting.
Impact of contract cancellation on Construction Company Pty Ltd
As Construction Company Pty Ltd issued a tax invoice to Property Developer Pty Ltd on 1 February 2020, it included the mobilisation fee in its February 2020 Business Activity Statement (BAS) and remitted the GST to the ATO when it lodged this BAS on 19 March 2020.
The cancellation of the contract triggers an adjustment event for Construction Company Pty Ltd. Construction Company Pty Ltd will be able to make an adjustment for the mobilisation fee and the GST on this in its March 2020 BAS.
Impact of contract cancellation on Property Developer Pty Ltd
As Property Developer Pty Ltd paid the mobilisation fee on 17 February 2020 and held a tax invoice, it included this fee as a purchase and claimed back the GST incurred through its March 2020 BAS.
The cancellation of the contract also triggers an adjustment event for Property Developer Pty Ltd. Property Developer Pty Ltd will be required to make an adjustment for the mobilisation fee and the GST credit previously claimed back though its March 2020 BAS.
What else do I need to know?
It is important to note that there are circumstances when a supplier is not able to claim back any GST that has previously been remitted to the ATO unless this has already been refunded to the purchaser.
