Edited version of private ruling

Authorisation Number: 1011831623492

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Ruling

Subject: GST and out-of-court settlements

Questions

1. Are you liable to pay GST under section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) in respect of any supply you may make under an out-of-court settlement in consideration for the settlement amount?

Answer: No.

2. Are you entitled to claim input tax credits (GST credits) under section 11-20 of the GST Act in respect of the acquisition of rectification works from a builder (Builder) as contemplated by the out-of-court settlement?

Answer: Yes.

Relevant facts and circumstances

You are registered for GST.

You are the corporate body for residential units (Apartments).

You commenced proceedings against the Apartment builder (AB) claiming damages resulting from defects during the construction phase.

You and the other relevant parties have agreed to settle the matter by means of an out-of-court settlement (Agreement).

The Agreement requires that AB progressively pays you (or as directed by you) a settlement amount (Settlement).

The Agreement also requires that, at your direction, AB will make progressive payments of the Settlement to the Builder as tax invoices are issued to you by the Builder.

The Agreement provides that you direct AB to make all approved payments direct to the Builder on your behalf.

The Agreement requires that upon the execution of the Agreement you will release and forever discharge AB from all or any claims against it in relation to the construction defects.

You are to enter into a separate building contract with the Builder that would make you liable to pay for the rectification works undertaken by them.

The Australian business register confirms that the Builder is registered for GST.

Relevant legislative provisions

GST Act

Section 9-5

Section 9-40

Section 11-5

Section 11-20

Reasons for decision

Summary

The Settlement is payment for damages and not for a supply made by you.

GST credits can be claimed on acquisitions from the Builder purchased using the Settlement.

Detailed reasoning

1. Are you liable to pay GST under section 9-40 of the GST Act in respect of any supply you may make under the Agreement in consideration for the Settlement?

Goods and Services Tax Ruling GSTR 2001/4 provides the ATO view on the GST consequences of out-of-court settlements. It analyses, amongst other things, the concept of supply and the nexus that must exist between a payment and a supply in order to establish the relationship of a supply for consideration. In particular paragraphs 21 and 22 of GSTR 2001/4 state:

23. A supply for consideration is the first step towards there being a taxable supply. However, for there to be a supply for consideration, three fundamental criteria must be met:

i. there must be a supply

ii. there must be a payment ; and

iii. there must be a sufficient nexus between the supply and the payment for it to be a supply for consideration

24. Essentially, a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

Supply

The term supply under subsection 9-10(1) of the GST Act includes as a supply any form of supply whatsoever. GSTR 2001/4 explains further that supplies related to court orders and out-of-court settlements fall within one of the three following categories:

· earlier supply

· current supply

· discontinuance supply

Earlier supply

An earlier supply is a supply that occurred before the dispute arose and which is the subject of the dispute. Paragraph 101 of GSTR 2001/4 further provides that where the only supply (other than a discontinuance supply) in relation to a court order or out-of-court settlement is an earlier supply, and a sufficient nexus exists between the payment made under that order or settlement and the earlier supply, the payment will be consideration for that earlier supply.

In your case, the earlier supply is the building and consequential supply of the Apartments. The Agreement, however does not concern itself primarily with this supply. The supply of the Apartments (at that time) was made and paid for to the satisfaction of all concerned parties. Although there is now a dispute as to the quality of the construction, this is not related to the original transactions of the earlier supply for example, as to whether the amount of consideration paid was correct. Hence, the Settlement is not payment for an earlier supply.

Current Supply

Paragraph 48 of GSTR 2001/4 provides that a current supply (but not a discontinuance supply) is one that is created by the terms of the court order or out-of court settlement.

Upon examination of the Agreement, there are no terms within the Agreement that requires you to supply anything to AB or to any other party.

Hence, the Settlement is not payment for a current supply.

Discontinuance supply

Paragraph 54 of GSTR 2001/4 provides that a discontinuance supply may be characterised as:

· surrendering a right to pursue further legal action

· entering into an obligation to refrain from further legal action, or

· releasing another party from further obligations in relation to the dispute.

In your case, the Agreement requires that upon the execution of the Agreement you will release and forever discharge the Builder from all or any claims against it in relation to the construction defects. Consequently, there is a discontinuance supply within the terms of the Agreement as per paragraph 54 of GSTR 2001/4.

However, to determine if the discontinuance supply is a taxable supply, it is necessary to consider the terms of the Agreement to establish whether there is a nexus between the payment of the Settlement and the discontinuance supply.

In relation to a discontinuance supply, paragraph 106 of GSTR 2001/4 states:

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 damages 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.

Paragraph 109 of GSTR 2001/4 further provides that a payment made under a settlement deed such as the Agreement may have a nexus with a discontinuance supply, only if there is overwhelming evidence that the claim is so lacking in substance that the payment could only have been made for the discontinuance supply.

In your case, we consider that the Agreement is primarily concerned with rectifying the construction defects and the discontinuance supply is more in the nature of a term or condition of the Agreement rather than it being the subject of the Agreement.

Hence, following the guidance provided by paragraphs 106 and 109 of GSTR 2001/4, the Settlement is not considered payment for the discontinuance supply but payment for damages.

The distinction between a damages claim and a discontinuance supply is explained at paragraphs 110 and 111 of GSTR 2001/4. With respect to an out-of-court settlement, paragraph 111 states:

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.

As stated there are no earlier or current supplies within the Agreement. Consequently given the guidance provided by paragraph 111 of GSTR 2001/4, the payment of the Settlement is payment for damages and not consideration for any supply made by you.

Consequently, there are no GST consequences arising from the payment of the Settlement.

2. Are you entitled to claim GST credits under section 11-20 of the GST Act in respect of the acquisition of rectification works from the Builder as contemplated by the Agreement?

The terms of the Agreement make it clear that it is you that is the recipient of the settlement and not the Builder, albeit the Settlement has to be used to rectify construction defects and progressively paid to the Builder as they issue you with tax invoices.

You are also to enter into a separate building contract with the Builder that would make you liable to pay for the rectification works undertaken by them.

Hence, it is you that is acquiring goods and services from the Builder (a GST registered entity) for which you are paying for through the progressive payments of the Settlement paid to the Builder. These goods and services are also being used by you to rectify building defects (part of carrying on your enterprise). Consequently, when you acquire the Builder's goods and services you will be making creditable acquisitions under section 11-5 of the GST Act and therefore entitled to claim any GST included in the Builder's prices under section 11-20 of the GST Act.

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