Forfeited Deposits From Cancelled Land Sale Agreements

IRD has issued an Exposure Draft PUB00434 which discussed the income tax treatment of forfeited deposits in the hand of the vendor arising from cancelled land sale agreements.

IRD determined that the forfeited deposits will be income to the vendor in following circumstances:

A forfeited deposit will be business income (s CB1), if the sale of land in relation to which agreement was cancelled was part of the current operations of the business or an ordinary incident of a business. (i.e., sale of land held on revenue account – property dealer). Forfeited deposit from sale of land held on capital account will not be income to the Vendor.

A forfeited deposit is income from a profit- making scheme if the Vendor is carrying on a profit-making undertaking or a scheme that involves the sale of land (s CB3). IRD is of the view that the same would apply if the vendor decided to abandon the profit-making scheme following the cancellation of the
As no supply has occurred the forfeited deposit will not be subject to GST.
A forfeited deposit is income if under ordinary concepts it has the character of income (s CA 1(2)). IRD’s view is that the nature of a deposit is a compensation for failure of the buyer to settle the transaction as opposed to being a penalty. The compensation payments take the character of what they replace.

For example, if the proceeds of the sale would have been taxable had the sale of land gone ahead (e.g., under land sale rules) then the forfeited deposit replaces that taxable income.

If proceeds from sale of land would not be taxable income to the vendor, then the forfeited deposit is nothing more than compensation for loss of capital

IRD further considers, that a forfeited deposit is not income to the vendor under the land sale rules as there is no “disposal” of land if the agreement is cancelled and the settlement does not take place.

November 2023