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Edited version of your written advice

Authorisation Number: 1051255568901

Date of advice: 25 July 2017

Ruling

Subject: GST and payments in relation to out-of-court settlement

Question

Are the settlement sums paid as out-of-court settlement pursuant to the Deed of Release, subject to goods and services tax (GST)?

Answer

The compensation payment for the missing items and the payment for the legal cost are not subject to GST. The payments for the use of disputed items and retained items are subject to GST. Please refer to the reasons for decision.

Relevant facts and circumstances

    ● The entity is registered for goods and services tax (GST).

    ● The entity has been in a long dispute with a lessor.

    ● The dispute was in relation to the use of entity’s business assets after the repossession of leased land and improvements by the lessor following the expiration of the lease.

    ● Following an order for possession granted by the Tribunal and an unsuccessful appeal, the entity provided possession of the property to the lessor.

    ● The lessor brought fresh claims against the entity and the entity counterclaimed.

    ● The dispute was settled by a Deed of Release resulting in the lessor paying the entity a total sum known as settlement sum.

    ● As per the Deed of Release, the settlement sum comprises of:

      ● An amount exclusive of GST for the use of the disputed items and retained items up to 20XX

      ● An amount inclusive of GST for the use of the disputed items up to 20YY.

      ● An amount inclusive of GST for the use of the retained items up to 20ZZ.

      ● An amount exclusive of GST in full and final compensation for the missing items.

      ● An amount exclusive of GST for the legal cost.

    ● The Deed of Release provides the following:

      ● The lessor releases and forever discharges the entity from the proceeding.

      ● Subject to lessor performing all of its obligations, the entity releases and forever discharges the lessor from the proceeding.

    ● According to the Deed of Release, both parties undertake not to commence proceedings against each other subject to the payment of the settlement sum.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 – section 9-5

A New Tax System (Goods and Services Tax) Act 1999 – subsections 9-10(1) and (2)

Reasons for decision

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if you make the supply for consideration; and the supply is made in the course or furtherance of an enterprise that you carry on; and the supply is connected with the indirect tax zone; and you are registered or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The term 'supply’ is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever’ and includes an entry into, or release from, an obligation to do anything; or to refrain from an act; or to tolerate an act or situation (Paragraph 9-10(2)(g) of the GST Act).

Goods and Services Tax Ruling GSTR 2001/4 deals with the GST consequences of court orders and out-of-court settlements and discusses the meaning of supply. Paragraph 22 of GSTR 2001/4 provides that a supply is essentially 'something which passes from one entity to another’.

Further, paragraph 25 of GSTR 2001/4 states:

    25. Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release.

Therefore, the term 'supply’ covers not only the subject of the transaction – the thing that passes – but also includes the action by which the thing passes from one entity to another. In addition, by use of the words 'make’ in the phrase 'you make the supply’ in paragraph 9-5(a) of the GST Act, there is a requirement for a supplier to take some action to cause a supply to be made.

In this case, it is important to consider what has been supplied in relation to the components of the settlement sum agreed between the parties. In the context of an out-of-court settlement, a supply referred to under any of the paragraphs within subsection 9-10(2) could be related to an out-of-court settlement.

A supply related to an out-of-court settlement may have occurred prior to the settlement or it may be created by the terms of the settlement itself. There may be more than one supply that is related to a settlement and in addition, the subject of the dispute may not be a supply at all.

Taxable supply in relation to out-of-court settlement

Each and every supply is subject to GST provided the supply satisfies the requirements of a taxable supply, as explained above. GST becomes payable on the relevant supply. Where the subject of the dispute is an earlier transaction in which a supply was made involving the parties that supply is referred to as 'earlier supply’.

Section 9-15 of the GST Act provides that a payment will be consideration for a supply if the payment is 'in connection with’ a supply and 'in response to’ or 'for the inducement’ of a supply. There must be a sufficient nexus between a particular supply and a particular payment, which is provided for that supply, for there to be a supply for consideration.

There are two elements to the definition of consideration. The first is the payment by one entity to another and the second is the nexus that must be established between the payment and a supply.

According to the Deed of Release, the lessor is required to pay the entity for the use of fittings and other items. The entity has made 'earlier supply’ of fittings and other items for periods specified in the Deed of Release. Based on the facts provided, there are sufficient nexus between the supply of fittings and other items for rental purposes and the payments made by the lessor for these supplies. Therefore, these supplies are taxable supplies and GST should be payable on these supplies.

Compensation and damages

According to the Deed of Release, the lessor and the entity have undertaken not to sue each other subject to the payment of the settlement sum. The settlement sum includes the following payments by the lessor:

      ● An amount exclusive of GST in full and final compensation for the missing items.

      ● An amount exclusive of GST for the legal cost.

Tax Office view in GSTR 2001/4 is that certain conditions of settlement can create supplies for GST purposes such as the supplies listed in Paragraph 9-10(2)(g) of the GST Act . Such supplies are referred to as discontinuance supplies. To determine whether the discontinuance supply would be a taxable supply, it is necessary to consider the terms of the Deed of Release to establish whether there is a nexus between the payment and the discontinuance supply.

Paragraph 106 and 107 of GSTR 2001/4 state:

    Discontinuance supply

    06. Where the only supply in relation to an out-of-court settlement is a 'discontinuance’ supply, it will typically be because the subject of the dispute is a damage claim. In such a case, the payment under the settlement would be in respect of that claim and not have a sufficient nexus with the discontinuance supply.

    07. In most instances, a 'discontinuance’ supply will not have a separately ascribed value and will merely be an inherent part of the legal machinery to add finality to a dispute which does not give rise to additional payment in its own right. They are in the nature of a term or condition of the settlement, rather than being the subject of the settlement.

According to paragraph 109 of GSTR 2001/4, the payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

Based on the facts provided, we do not consider that the above two payments were made in relation to discontinuance supplies. The payments were made for the loss of items supplied by the entity to the lessor and to compensate the legal cost incurred by the entity.

According to paragraph 111 of the GSTR 2001/4, if a payment is made under an out-of-court settlement to resolve a damages claim and there is no earlier or current supply, the payment will be treated as payment of the damages claim and will not be consideration for a supply at all, regardless of whether there is an identifiable discontinuance supply under the settlement.

Although both parties agreed not to commence proceedings against each other subject to the payment of settlement sum, we note that the above two payments do not have a nexus to discontinuance supplies and therefore are not subject to GST.