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Ruling

Subject: out-of-court settlement

Issues

1. Do you make a taxable supply when you agree to settle the dispute with the tenant at the settlement amount of $XXX (the Settlement Sum) in relation to the dispute with the entity?

2. Are you entitled to claim GST credit on the legal and counsel fees in connection with the dispute?

Answers

1. No, you do not make a taxable supply when you receive the Settlement Sum.

2. Yes, you are entitled to claim GST credit on the legal and counsel fees in connection with the dispute provided you have a valid tax invoice.

Relevant facts and circumstances

You are registered for goods and services tax (GST) in Australia.

You negotiated an agreement with the tenant to lease them your premises in Australia.

After some time, the tenant decided not to proceed with the lease. After a dispute, a Deed of Settlement and Release (the deed) was signed by you and the tenant. No liability was admitted. The tenant agrees to pay you the Settlement Sum. The quantum or method of calculation of the amount claimed is not specified in the deed.

The deed defines the dispute to be "failed lease negotiations regarding the premises". The deed also states that ' the parties agree that the payment of the Settlement Sum is in relation to the settlement of a damages claim and is not in connection with a taxable supply and therefore a tax invoice is not required to be provided in relation to the payment of the Settlement Sum".

The deed provides that each party is liable for their own costs of legal representation arising out of or in connection with this dispute. You incurred an outgoing of $XX which are legal and counsel fees in connection with the settlement of the dispute. You hold valid tax invoices for these expenses from the legal advisors, who are registered for GST in Australia.

Reasons for the decisions

1. Taxable supply

Goods and Services Tax Ruling (GSTR) 2001/4 considers the GST consequences of court orders and out-of-court settlements. It provides that an out-of-court settlement will include any form of dispute in which the terms of the resolution are agreed between the parties, rather than imposed by the court. We consider the settlement between you and the tenant is an out-of-court settlement for the purposes of GSTR 2001/4.  

The GST consequences of a court order or out-of-court settlement will depend on whether the payment made under an order or settlement constitutes consideration for a supply and, if so, whether the supply is in the nature of a taxable supply. 

A supply will be a taxable supply where the requirements of section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) are satisfied. Section 9-5 of the GST Act states:

You make a taxable supply if:

(a) you make the supply for *consideration; and

(b) the supply is made in the course or furtherance of an *enterprise that you *carry on; and

(c) the supply *is connected with Australia; and

(d) 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

GSTR 2001/4 provides guidance on the 'supply for consideration' requirement in paragraph 9-5(a) of the GST Act.

To determine if paragraph 9-5(a) of the GST Act is satisfied, we refer to paragraph 21 of GSTR 2001/4, which sets out the fundamental criteria that must be satisfied for there to be a 'supply for consideration', namely: 

o there must be a supply

o there must be a payment, and

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

Paragraphs 45 to 55 of GSTR 2001/4 explain that supplies related to out-of-court settlements fall within one of three categories. These categories are:

· earlier supply

· current supply

· discontinuance supply  

An earlier supply is a supply that occurred before the dispute arose, and which is the subject of the dispute. 

A current supply is one that may be created by the terms of the court order or out-of court settlement. 

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

· surrendering a right to pursue further legal action; or

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

· releasing another party from further obligation in relation to the dispute   

Paragraph 55 of GSTR 2001/4 provides that whether a discontinuance supply will be a taxable supply will depend on the requirements of section 9-5 of the GST Act being met in relation to that supply. 

In your case, the dispute is defined in the deed to be:" failed lease negotiations regarding the premises". You and the tenant mutually agreed without any admission of liability, to settle all matters in relation to the proposed lease in exchange for a settlement amount of $XXX (inclusive of all costs and interests), except for legal costs.

The deed provides that you give various releases to the tenant from any past, current or future claims and obligations and civil proceedings/action arising out of the dispute. Mutual releases by the tenant to you are also given in the deed. These undertakings and obligations, by all parties, would be supplies for GST purposes. However, in a settlement context, their main purpose is to bring about finality to a dispute. We consider that your supply of out-of-court settlement meets the description of a discontinuance supply, as both parties have agreed to discontinue any further action with respect to any current and future claims.

The next step is to consider whether there is a nexus between the payment of the Settlement Sum and the discontinuance supply (paragraph 93 of GSTR 2001/4). 

Consideration in subsection 9-15(1) of the GST Act includes any payment in connection with a supply of anything. To determine if the discontinuance supply is a taxable supply, it is necessary to consider the terms of the settlement in the deed to establish whether there is a nexus between the payment of the Settlement Sum and the discontinuance supply.

Paragraphs 71 to 73 of GSTR 2001/4 provide guidance on where the subject of a claim is not a supply as follows:

Where the subject of a claim is not a supply

71. Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury.

72. When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation.

73. The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss, or injury, in itself does not constitute a supply under section 9-10 of the GST Act.

In addition, paragraphs 106 to 109 of GSTR 2001/4 state as follows: 

Discontinuance supply

106. 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.

107. 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.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

109. We consider that a 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

Similarly, paragraph 111 of the GSTR 2001/4 discusses the Tax Office view that claims for damages are not supplies under 9-10 of the GST Act.  

111. 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. 

In this instance there is no earlier or current supply relating to the Settlement Sum.

We consider that the subject of your dispute is a damage claim due to failed lease negotiation between you and the tenant. The dispute was settled by the settlement sum and was mutually agreed as a compensation to resolve the damages claim. The claim for damage is not lacking in substance and therefore there is no nexus between the discontinuance supply and the Settlement Sum.

Therefore you will not be making a supply for consideration in relation to the out-of-court settlement. Hence, the requirement of a supplier making a supply for consideration as set out in paragraph 9-5(a) of the GST Act is not satisfied. As such, there is no need to discuss the rest of section 9-5 of the GST Act.

In conclusion, you have not made a taxable supply under section 9-5 of the GST Act, and the settlement amount will not be subject to GST.

2. Entitlement to GST credits

You are entitled to claim input tax credits for the GST paid on your creditable acquisitions. Section 11-5 of the GST Act states:  

You make a creditable acquisition if:

(a)    you acquire anything solely or partly for a ^*creditable purpose; and

(b)    the supply of the thing to you is a ^*taxable supply; and

(c)    you provide, or are liable to provide, ^*consideration for the supply; and

(d)    you are ^*registered, or ^*required to be registered.

(* denotes a defined term under the GST Act)

You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise (for example, a business). You do not acquire the thing for a creditable purpose to the extent that the acquisition relates to making supplies that would be input taxed (such as, financial supplies and the sale and rental of residential properties), or the acquisition is of a private or domestic nature.

For a supply to be taxable under paragraph 11-5(b) of the GST Act, all the requirements of section 9-5 of the GST Act must be satisfied. Section 9-5 of the GST Act states:

You make a taxable supply if:

(a)    you make the supply for *consideration; and

(b)    the supply is made in the course or furtherance of an *enterprise that you *carry on; and

(c)    the supply *is connected with Australia; and

(d)    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.

From the facts given, the solicitor's and Counsel's (legal advisors) supply of the legal services to you satisfy the requirements of paragraphs (a), (b) (c) and (d) of section 9-5 of the GST Act as follows:

(a) The legal advisors make a supply of the legal services to you and in return receives consideration by way of payments;

(b) The legal advisors make the supply in the course or furtherance of their business;

(c) The legal advisors supply the legal services to you through an enterprise that they carry on in Australia, therefore the supply is connected with Australia (paragraph 9-25(5) (b) of the GST Act);

(d) The legal advisors are registered for GST.

In addition, the supply of the legal services is neither GST-free nor input taxed under any provision of the GST legislation. Hence the supply by the legal advisors to you satisfies section 9-5 of the GST Act.

Hence paragraph11-5(b) of the GST Act in relation to your creditable acquisitions is satisfied.

From the facts given, all the conditions of paragraphs 11-5(a) to (d) of the GST Act are satisfied, as follows:

(a)    You acquire the legal services in relation to the out of court settlement solely for use in your business and therefore the acquisitions are for a creditable purpose.

(b)   The supply of legal services to you is a taxable supply as above.

(c)   You provided consideration for the supply of legal services;

(d)   You are registered for GST in Australia. 

Accordingly, you have made creditable acquisitions of the supply of legal services in relation to the out-of-court settlement and are entitled to claim input tax credits for these creditable acquisitions provided you hold valid tax invoices.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-5(a).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-5(b).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-5(c).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-5(d).

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-15(1)

A New Tax System (Goods and Services Tax) Act 1999 section 11-5.

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