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Ruling

Subject: GST and out-of-court settlement

Question

Is the payment made by the defendants under the deed of settlement subject to GST?

Answer

No. The payment made by the defendants under the deed of settlement is not subject to GST.

Relevant facts and circumstances

You, an entity, filed a court proceeding against the defendants for negligence and/or breach of contract.

The terms of settlement provide that:

· You have made a claim against the defendants for breach of contract and duty of care for the design, project management and construction works.

· In full settlement of your claim including costs, outlays and interest and any claims at all related to the use of the constructed works, each defendant will pay you an amount being the defendant's contribution and each defendant shall bear its own costs of proceeding.

· The defendants' are severally liable to make the contributions.

· The parties acknowledge that the defendants' payment and other obligations under this term of settlement are several and not joint.

· In consideration of the payment, the defendants will be automatically released from the claim and any current or future claim at all related to the claim including any third party claim, current or in the future, in any way connected with the use of the constructed works.

· You also release every officer, employee and agent of the defendants.

· You undertake not to bring or continue any other claim or proceedings against the defendants that is in any way connected with the claim or the use of the constructed works; and prevent anyone acting in its name or its behalf or any of its successors or assigned from bringing any claims or proceedings.

· You will continually indemnify the defendants, anyone acting in their names and any successor or appointee against any claim or proceeding that may be brought by any person acting in its name or its behalf or any of its successors or third party in any way connected with the claim or the use of the constructed works.

· You agree that this term of settlement may be pleaded as a bar to any action, claim, suit or proceeding commenced at any time by you or any other person on behalf of you against the defendants, in any way connected with the claim or the use of the constructed works.

· Each defendant will automatically release each other defendant from the claim, the proceeding and any future claims at all related to the claim.

· You will file a Notice of Discontinuance against the defendants in the proceedings upon satisfaction of the term of settlement by all parties.

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 subsection 9-10(1)

Reasons for decision

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.

Section 9-5 of A New Tax System (Goods and Services Tax) Act 1999 (GST Act) states:

You make a taxable supply if:

(a) you make a 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 *GST-free or *input taxed.

(Asterisks denote terms defined in section 195-1 of the GST Act.)

In your case, the payment by the defendants was made to settle a dispute in accordance with the terms of settlement. A supply will be taxable where section 9-5 of the GST Act is satisfied.

Goods and Services Tax Ruling GSTR 2001/4 (GSTR 2001/4) sets out the Commissioner's view on the GST consequences resulting from court orders and 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.

Paragraph 21 of GSTR 2001/4 provides that 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.

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

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

o earlier supply

o current supply

o 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.

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;

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

However, whether a discontinuance supply would be a taxable supply would then depend on the requirements of section 9-5 of the GST Act being met in relation to that supply.

In your case, you informed that the claim is for breach of contract and duty of care.

In this instance there is no earlier supply or current supply relating to the payment received. Under the terms of settlement you received an amount of money as an out-of-court settlement representing compensation for breach of contract and duty of care by the defendants.

In paragraphs 71 to 73 of GSTR 2001/4, the Commissioner puts forth the view that the subject of the dispute may not give rise to a supply at all:

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.

Paragraph 106 of GSTR 2001/4 states:

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.

The Commissioner further expands on his view on damages in GSTR 2001/4 at paragraphs 110 and 111:

Damages

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply made by the aggrieved party. If a payment made under a court order is wholly in respect of such a claim, the payment will not be consideration for a supply.

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 your case the dispute arose from the defendants' breach of contract and duty of care.

The dispute was settled by the parties out of court where an amount of money was paid by the defendants to you as compensation to resolve the damages claim. In line with the Commissioner's view discussed above, we consider that the payment was not consideration for a supply.

Therefore, 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.

Accordingly, the payment made by the defendants under the deed of settlement is not subject to GST.

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