Goods and Services Tax Determination

GSTD 2011/1

Goods and services tax: is an ex gratia payment by an insurer in response to a claim under an insurance policy a payment made 'in settlement of a claim'?

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Preamble

Ruling

1. Yes, an ex gratia payment by an insurer in response to a claim made under an insurance policy is a payment made in settlement of a claim for the purposes of section 78-10 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).^[1]

2. The payment may be made to the insured or to a third party, where the payment is made in settlement of the claim.

Example

3. The Rundle Insurance Company (RIC) made a taxable supply of an insurance policy to Larry and Edith. The supply of the insurance policy was solely a taxable supply and there was no entitlement to an input tax credit for the premium paid. The insurance policy provides cover over Larry and Edith's residential premise which includes cover for flooding caused by a storm. Larry and Edith's residential premises were affected by flooding for which Larry and Edith made a claim on their insurance policy. RIC were in dispute with Larry and Edith about whether the flooding fell within the terms of the policy. RIC made an ex gratia payment to Larry and Edith on agreement from Larry and Edith that they would take no further action against RIC in relation to the flooding event. The ex gratia payment constitutes a payment in settlement of a claim under an insurance policy for the purposes of section 78-10.

Date of effect

4. This Determination applies both before and after its date of issue. However, this Determination will not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of this Determination (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10).

Commissioner of Taxation
29 June 2011

Appendix 1 - Explanation

5. In response to a claim by a policy holder, an insurer may choose to make a payment of an amount which is not strictly due under the terms of the policy. The payment will be made to the insured or to a third party. The insured will be asked to sign a document (including electronically) releasing the insurer from all liability under the policy, or otherwise be recorded as doing so, such as through recorded telephone conversations. The payment is made for economic reasons such as for goodwill, but without an admission of liability.

6. These payments are commonly known as ex gratia payments.

7. Subsection 78-10(1) stipulates that an insurer has a decreasing adjustment if, in settlement of a claim under an insurance policy, the insurer:

(a)

makes a payment of money; or

(b)

makes a supply; or

(c)

makes both a payment of money and a supply.

8. Subsection 78-10(2) sets out the conditions for the decreasing adjustment.

9. It must be determined if an ex gratia payment constitutes a payment that is made in settlement of a claim for the purposes of subsection 78-10(1).

A claim under an insurance policy

10. The term 'claim' is not defined in the GST Act and therefore takes its ordinary meaning. The Legal Dictionary^[2] defines 'claim' as

The assertion of a right or demand to a right to property or to a remedy, a cause of action, and the grounds in pleadings upon which relief is claimed...

11. The meaning of the term 'insurance policy' in section 195-1 is:

A policy of insurance (or of reinsurance) against loss, damage, injury or risk of any kind, whether under a contract or a law. However, it does not include such a policy to the extent that it does not relate to insurance (or reinsurance) against loss, damage, injury or risk of any kind.

12. Therefore the phrase 'a claim under an insurance policy' means exercising a right, under a contract or statute, to remedy against loss, damage, injury or risk. The phrase also means asserting, making a demand to, and a right, under a contract or statute, to such remedy.

13. Hence, a claim may be made under an insurance policy irrespective of whether or not there is a right to remedy under the terms of the policy.

In settlement of a claim

14. The term 'settlement' is not defined in the GST Act and therefore takes its ordinary meaning. The Legal Dictionary defines 'settlement' as:

A disposition of property; the compromise or resolution of a claim or dispute

15. In the context of insurance, the term 'settled' has been held to mean 'adjustment of the loss', or accepting liability for the loss.^[3] This might seem to preclude an ex gratia payment, for which no liability is accepted.

16. However, in the context of insurance the Legal Dictionary defines an ex gratia payment as:

Insurance A payment made by way of settlement of a claim without admission of liability: Edwards v. Skyways Ltd [1964] 1 All ER 494 at 500...

17. The Encyclopaedic Australian Legal Dictionary^[4] defines ex gratia payment in the insurance context in a similar fashion:

Insurance

A payment made by way of settlement of a claim without admission of liability: Edwards v. Skyways Ltd [1964] 1 All ER 494. In insurance law, an insurer may offer the insured an ex gratia payment to settle a claim when there is a dispute between the parties as to the right to claim under the policy. The insured will generally be asked to sign a document releasing the insurer from all liability under the policy.

18. The issue dealt with in Edwards v. Skyways was whether the commitment to make an ex gratia payment was enforceable. On this matter Megaw J states:

The words 'ex gratia' or 'without admission of liability' are used simply to indicate-it may be as a matter of amour propre, or it may be to avoid a precedent in subsequent cases- that the party agreeing to pay does not admit any pre-existing liability on his part; but he is certainly not seeking to preclude the legal enforceability of the settlement itself by describing the contemplated payment as 'ex gratia'. [Emphasis added.]

19. Edwards v. Skyways is often cited as authority in legal references for what are ex gratia payments, and for their enforceability.

20. It follows from this that an ex gratia payment, in the insurance context, may be made 'in settlement of a claim' where the insurer is released from all liability in relation to the claim.

A payment

21. Subsection 78-10(1) stipulates that an insurer has a decreasing adjustment if, in settlement of a claim under an insurance policy, the insurer:

(a)

makes a payment of money; or

(b)

makes a supply; or

(c)

makes both a payment of money and a supply.

22. At paragraphs 7 and 8 of Goods and Services Tax Ruling GSTR 2006/10 Goods and services tax: insurance settlements and entitlement to input tax credits, the Commissioner states:

7. Under a general insurance policy, there are a number of alternatives available to an insurer in settling a claim. For example, if insured goods are damaged, lost or stolen, an insurer may:

•

reimburse the insured or a third party with a cash payment for replacing or repairing the goods;

•

provide the insured or a third party with a voucher to replace the goods;

•

arrange to pay the supplier directly for goods being supplied to the insured or a third party;

•

organise for a supplier to repair the goods or to supply replacement goods to the insured or a third party; or

•

acquire replacement goods and supply them to the insured or a third party.

8. For the purposes of this Ruling, when we use the term 'third party', we are referring to an entity that the insured has a liability to. For example, the insured has a liability to an entity because of damage caused by the insured to that entity. Consequently, the insurer may make a payment or a supply to that entity in settlement of the insured's claim under the policy.

23. Therefore, as a claim under an insurance policy can be settled by making a payment of money, making a supply, or both, it follows that a claim can be settled ex gratia in all of those ways as well. Hence, where we have referred to making an ex gratia payment in settlement of a claim in this Determination, it includes making a supply or making both a payment and a supply.

24. The payment may be made to the insured or to a third party, where the payment is made in settlement of the claim.

Not previously issued as a draft

References

ATO references:
NO 1-30VRAJW

Related Rulings/Determinations:

TR 2006/10
GSTR 2006/10

Subject References:
creasing adjustment
ex gratia payments
Goods and services tax
GST insurance policy
GST special rules
GST net amounts & adjustments
insurance settlement under an insurance policy

Legislative References:
ANTS(GSTA) 1999 78-10
ANTS(GSTA) 1999 78-10(1)
ANTS(GSTA) 1999 78-10(2)
ANTS(GSTA) 1999
TAA 1953

Case References:
Edwards v. Skyways Ltd
[1964] 1 All ER 494

Street v. Royal Exchange Assurance
(1914) 111 LT 235

Other References:
The Australian Oxford Dictionary, 2004, rev. 2nd edn, Oxford University Press, Melbourne
Mozley & Whiteley's Law Dictionary; Black's Law Dictionary; Butterworth's Australian Legal Dictionary
Encyclopaedic Australian Legal Dictionary Online LexisNexis
Explanatory Memorandum to the A New Tax System (Indirect Tax and Consequential Amendments) Bill (No. 2 1999)