2.12 If there is an obligation on a subcontractor who is in breach of a construction contract to pay liquidated damages to the contractor, is the payment made by the subcontractor's insurer in settlement of the contractor's claim consideration for a taxable supply?
For source of ATO view, refer to:
- the general principles in GSTR 2006/10 Goods and services tax: insurance settlements and entitlement to input tax credits
- paragraphs 110 to 114 of GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements.
Payment by the insurer in settlement of the claim will either be made:-
(a) to the subcontractor, in reimbursement of the amount paid, or to be paid, by the subcontractor to the contractor by way of liquidated damages; or
(b) to the contractor direct by way of liquidated damages due by the subcontractor.
If payment is made by the insurer to the subcontractor, who is the insured, section 78-45 of the GST Act will apply and the payment will not be treated as consideration for a supply made by the insured.
Although this will be the situation in most cases, the payment will be treated as consideration for a supply made by the insured if:
- the insured paid all or part of the premium
- was entitled to an input tax credit for the premium paid
- did not, at or before the time a claim was first made under the insurance policy since the last payment of a premium, inform the insurer that the insured was entitled to the input tax credit.
If the insured understated the entitlement to an input tax credit to the insurer then the payment is treated as consideration to the extent the entitlement was understated. If the payment is made to the contractor direct (a third party) then the payment will not be treated as consideration for a supply to the insurer by the contractor.
If the subcontractor, having settled its claim with its insurer under the relevant policy of insurance, makes payment of liquidated damages in discharge of its liability to the contractor, the payment will not be treated as consideration for a supply to the subcontractor by the contractor in accordance with the ATO view set out in Issue 2.10 above.