Edited version of your private ruling

Authorisation Number: 1012320930896

Ruling

Subject: GST & Litigation Funding

Questions

1. Is the application fee received by Entity A from a litigant, for assessing if litigation funding can be granted, consideration for a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Ac)?

2. Is Entity A making a financial supply by agreeing to fund litigation expenses in return for a percentage of any successful judgement or settlement pursuant to the Litigation Funding Agreement under item 2 or 7 of the table in subregulation 40-5.09(3) of the A New Tax System (Goods and Services Tax) Regulations (GST Regulations)?

Answers

1. Yes, the application fee received by Entity A from a litigant, for assessing if litigation funding can be granted, is consideration for a taxable supply under section 9-5 of the GST Act.

2. Yes, Entity A is making a financial supply of an interest in a credit arrangement under item 2 of the table in subregulation 40-5.09(3) of the GST Regulations by agreeing to fund litigation expenses in return for a percentage of any successful judgement or settlement pursuant to the Litigation Funding Agreement.

Relevant facts and circumstances

For the avoidance of doubt references to the applicant and litigant throughout this ruling mean the same parties.

Entity A’s purpose is to provide funds to legal practitioners for payment of disbursements necessary for the conduct of litigation on behalf of their respective clients.

The client, being the litigant, retains a solicitor to act on its behalf. The retainer provides that the solicitor will not charge fees for its professional services. A further condition of the retainer is that solicitors will not charge clients for counsel fees until there is a successful outcome to the litigation.

The client instructs solicitors to seek funds from Entity A for the purpose of disbursements incurred by the solicitors.

The solicitors act for clients in the litigation on a no-win-no-fee basis. Accordingly, if a successful outcome can be achieved by way of judgement or settlement the solicitors will receive payment for their professional costs.

Applications for financial assistance detailing the nature of the claim, estimated damages, and an estimate of the costs involved to pursue the litigation are submitted to Entity A. These applications are prepared by the solicitors on behalf of their clients and submitted to Entity A with an application fee, inclusive of GST.

The majority of applications are for individuals pursuing civil damages claims, for example, workplace injury or professional negligence. Entity A will only accept applications where the solicitor and counsel are acting on a no-win-no-fee basis.

If an application is accepted, Entity A sends a letter of offer to the applicant and its solicitor. Subsequently, Entity A, the applicant and its solicitor enter into a tripartite agreement (the Litigation Funding Agreement).

In accordance with the Litigation Funding Agreement, Entity A agrees to fund the costs of third party disbursements which are incurred in the contemplation of, or in the conduct of the litigation.

Entity A retains the right to fund only those disbursements it agrees to fund, and the amount provided is at Entity A’s absolute discretion.

The solicitor contractually engages a service provider to prepare a report/finding for the applicant. The service provider invoices the solicitor for the service provided, who in turn forwards the invoice to Entity A. On receipt of the invoice, Entity A writes a cheque to the service provider which is sent to the applicant’s solicitor to be forwarded on to the service provider.

Most payments are made out to the third party directly however, occasionally payments are made as reimbursement to the solicitor.

There is no contractual relationship between the service provider and Entity A even though Entity A may make its cheques payable to the service provider. In these instances Entity A will forward the cheque to the solicitors for delivery to the service provider.

Where a successful settlement or judgement is achieved, Entity A is entitled to percentage of the net judgement or settlement sum received in addition to the recovery of all costs incurred in relation to of third party disbursement funding provided. However Entity A is not entitled to recoup any of its expenditure where the applicant is unsuccessful in their proceedings.

Entity A is registered for GST.

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 section 9-10.

A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations):

Subregulation 40-5.09(1) and (3)

Reasons for decision

Question 1

The Application Fee

Entity A Scheme submits that the application fee received from a litigant is consideration for a taxable supply. We agree with this submission for the following reasons.

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

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

* Denotes a term defined in the GST Act.

The first requirement for a taxable supply requires an entity to make a supply for consideration. Section 9-10 of the GST Act provides the meaning of a supply as ‘any form of supply whatsoever’.

In this case the identified supply provided by Entity A to applicants is the services in relation to accepting and assessing their respective application for litigation funding.

Consideration is defined in section 9-15 of the GST Act and includes ‘any payment … in connection with a supply. Accordingly, the application fee Entity A receives from the respective applicant is consideration for the supply of assessing the application for litigation funding.

This supply by Entity A is connected with Australia and is made in the course or furtherance of an enterprise. Further Entity A is registered for GST.

On this basis, the elements of section 9-5 of the GST Act are satisfied. Thus when Entity A receives the application fee it is consideration for a taxable supply.

For completeness, the supply of services by Entity A of assessing whether litigation funding can be granted is neither an input taxed supply or GST free supply.

Question 2

The nature of granting litigation funding

Entity A submits that by agreeing to fund litigation expenses pursuant to the terms of the Litigation Funding Agreement (in return for a percentage of any successful judgement or settlement), is an indemnity or credit arrangement that is input taxed. We consider that the better view is that the litigation funding is consideration for a credit arrangement.

Credit Arrangement

Item 2 in the table at subregulation 40-5.09(3) of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) (Item 2) mentions an interest in or under:

A debt, credit arrangement or right to credit, including a letter of credit

The Commissioner defines ’credit arrangement’ (as a stand-alone term) in Schedule 1 (Glossary of Terms) to Goods and Services Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions (GSTR 2002/2) in the following terms:

An arrangement under which an entity lends money on terms that include deferred repayment, or under which payment of a debt owed by one entity to another is deferred or time is allowed to pay.

The Glossary in GSTR 2002/2 also defines ‘debt’ as:

An amount due from one entity to another or a presently existing obligation to pay an ascertainable amount at a future time.

To satisfy the Glossary definition of ‘credit arrangement’, either money must be ‘lent’ by one entity to another under deferred repayment terms, or a debt must come into existence otherwise than pursuant to a loan arrangement, and the creditor must allow the debtor time to pay the debt.

In this case, money is lent by Entity A to an entity (i.e. the litigant) however, if the action does not succeed, Entity A does not receive anything. On the other hand if the action were to be successful, the Court would order payment in favour of the litigants.

For successful litigation cases clause 4 of the Litigation Funding Agreement enables Entity A to recover what they have provided plus a percentage of the judgement or settlement sum. As such, the litigants have entered into a contractual obligation to pay Entity A if the action is successful. Accordingly, Entity A's entitlement to any payment at all is contingent on the success of the action. Therefore, the issue is, if an entity has an obligation to repay a sum of money which was lent to it based on a contingent event, if that amounts to a debt.

An ‘interest in or under a debt’ is considered in paragraph 22 of Goods and Services Tax Ruling GSTR 2004/4: assignment of payment streams including under a typical securitisation arrangement (GSTR 2004/4) which states:

Subregulation 40-5.09(3) deals with interests in or under debt. The term interest, in relation to debt, extends to an existing contractual right to a debt that will arise in the future.

Further paragraphs 81 to 84 of GSTR 2004/4 explain that in the context of hire purchase agreements and royalty payments, payments may be subject to contingencies. In such cases even though the payment may be subject to contingencies, the right to the payment stream is nevertheless a presently existing right that is property and an interest for the purposes of item 2 of subregulation 40-5.09(3).

ATOID 2007/29, which is about GST and contingent debts, cites two court cases in support of the view that:

A conclusion that an interest in a debt includes an interest in a contingent debt for the purposes of item 2 is consistent with the above decisions. This conclusion is also consistent with the views of the Tax Office stated in Goods and Services Tax Ruling GSTR 2004/4…

Based on the above, it can be concluded that an obligation to repay a sum of money based on a contingency is a debt.

Therefore, the final issue to address is if, an obligation to repay based on a successful outcome of an event qualifies as a “contingency”. To this end ATOID 2007/19 and ATOID 2007/15 provides guidance.

ATOID 2007/29 deals with an agreement under which a contributing entity advanced a sum of money to another entity for a specific project. If the project were sufficiently profitable, the amount contributed (but not more than that) would be repaid.

On the other hand ATOID 2007/15 dealt with an agreement under which a contributing entity advanced a sum of money to another entity in consideration for a right to receive a share of the net revenue. The amount of the net revenue was at a rate up to an extent of the contribution amount, and thereafter, at a lesser rate. There was no obligation placed on the entity to repay any amount invested by the contribution entity.

In both ATOID 2007/29 and ATOID 2007/15 there was no entitlement to anything if the respective entities made losses.

ATOID 2007/29 concluded that the recipient of the advance had provided an interest in a debt to the contributor, though the repayment of the debt was contingent. This can be contrasted with ATOID 2007/15, where there was no separate obligation of the enterprise operator to repay any of the contribution amount to the contributing entity. In the case of ATOID 2007/15 there was no credit arrangement. In ATOID 2007/15 the contributor’s entitlement was open-ended. That is, it would only receive a share of the recipient’s net revenue at a certain rate up to the extent of the contribution amount, and thereafter at a lesser rate.

ATOID 2007/15 concludes that:

The arrangement entered into by the entity therefore does not have the characteristics of a loan, because there is no presently existing obligation for the enterprise operator to repay the amount contributed, now or in the future, and there is no debtor-creditor relationship.

It is our view that Entity A's funding is more like the scenario depicted in ATOID 2007/29, rather than ATOID 2007/15. Therefore, under the term of the Litigation Funding Agreement the litigant had a contingent debt. That is, at any given time the litigant had a presently existing obligation placed on it to pay the contribution amount on the happening of an event namely, the success of the case (a contingency).

Whilst it is also arguable that there is no time given for the entity to pay the money back in a loss situation it is difficult to distinguish this situation from the facts in ATOID 2007/15 where one of the conditions was for the fund user to make a profit - a contingent event.

In conclusion we are of the view that Entity A makes a financial supply, subject to the conditions in subregulation 40-5.09(1) being satisfied, that is input taxed. As such there is no GST imposed on the funding amount under the Litigation Funding Agreement.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).