Edited version of your private ruling

Authorisation Number: 1012449103711

Ruling

Subject: GST and settlement payment

Question

Is GST payable on the settlement payment?

Answer

Yes.

Relevant facts and circumstances

You are registered for GST.

You entered into a Franchise Agreement with an entity (Franchisee) on a specified date. The Franchise Agreement commenced on a specified date and was to expire on a specified date.

Under the Franchise Agreement the Franchisee was granted the right in accordance with the Franchise Agreement to perform certain tasks.

Under the Franchise Agreement the Franchisee had specific duties and was required to pay certain initial and on going fees.

Prior to expiration of the term of the Franchise Agreement, the Franchisee decided to terminate the Franchise Agreement. You advised that this was the nature of the dispute between you and the Franchisee.

You asserted your rights to an appropriate remedy through your lawyers and pursued the Franchisee for adequate compensation for several heads of claim including damages, losses under the contract and damages to reputation and resolved the dispute through negotiation.

On a specified date, you and the Franchisee entered into a deed of surrender and release (Deed of Release). The Deed of Release provides that:

· You and the Franchisee, without making any admission, each agreed to resolve this dispute by entering into the Deed of Release to record the parties' agreement to the surrender and release of the Franchise Agreement.

· You agreed to accept a surrender and release of the Franchise Agreement and released the Franchisee from further liability in terms of the Franchise Agreement from a specified date (the Surrender Date), subject to and conditional on the terms of the Deed of Release and the Franchisee abiding by their obligations set out in the Deed of Release.

· The Franchisee agreed to fully surrender and release any rights and/or entitlements they may have had with respect to the Franchise Agreement.

· The Franchisee agreed that no money/ies were owing by you in respect to the Franchise Agreement.

· The Franchisee was required to pay to by the Surrender Date a lump sum settlement payment of $X in consideration of you entering the Deed of Release.

· The Franchisee was to continue to meet all their obligations up to and including the Settlement Date.

· In consideration of you entering into the Deed of Release, the Franchisee released you from any and all obligations, actions, suits, claims and demands arising as result of the Franchise Agreement.

· You released the Franchisee from the Surrender Date from any and all obligations, actions, suits, claims and demands arising as a result of the Franchise Agreement.

· The parties acknowledged and agreed that from the Surrender Date the Franchisee, its associates and/or any of their financiers, had no rights and/or entitlements with respect to the Franchise Agreement, and you could deal with such as you saw fit in your absolute discretion with no recourse, compensation and/or liability whosoever to any party, including without limitation the Franchisee.

You advised that the entire $X that you received was a settlement payment.

The Franchise Agreement deals with termination of the Franchise Agreement and provides:

· If the Franchisee breaches a term of the Agreement, and you in consequence of the breach propose to terminate the Agreement and the provisions of the sub-clause Y of the Franchise Agreement do not apply, then you must first:

(a) give to the Franchisee a notice advising of the breach and of your intent to terminate the Franchise Agreement if the breach is not remedied in accordance with the notice issued; and

(b) advise the Franchisee of what is required to remedy the breach; and

(c) allow the Franchisee the period set out in the notice to remedy the breach.

If the Franchisee remedies the breach within the time specified in the notice, then you may not terminate the Agreement for such breach.

· A similar term in the Franchise Agreement deals with breaches by the Franchisor.

· If the Franchisee fails to remedy any breach in accordance with the above terms then you will have the right to terminate the Franchise Agreement upon written communication to the Franchisee of your intention to do so.

· Clause Y of the Franchise Agreement gives you the right to terminate the Franchise Agreement immediately by giving written notice of termination to the Franchisee in special circumstances including where the Franchisee voluntarily abandons the franchised business or the franchise relationship or agrees to a termination of the Agreement.

· The Franchise Agreement provides that such termination does not relieve the Franchisee of its financial or any of its ongoing obligations that survive termination as set out in the Franchise Agreement or any of your rights to recovery as set out in the Franchise Agreement, nor does it restrict, waive or reduce the rights available to you due to any breach of the Franchise Agreement by the Franchisee.

· In addition to any other right available to you as a result of terminating the Franchise Agreement due to an event of default/breach, the parties agree that you are entitled as a liquidated debt the minimum rate of a specified periodic payment that the Franchisee would have been liable to pay if the Franchise Agreement had not ended due to Franchisee default/breach and had continued to the end of the term of the Franchise Agreement.

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) Act 1999 section 9-15

A New Tax System (Goods and Services Tax) Act 1999 section 9-40

Reasons for decision

Summary

You are liable to pay GST on the settlement payment that you received under the Deed of Release as the payment is consideration for a taxable supply.

Detailed reasoning

Section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you must pay the GST payable on any taxable supply that you make.

A supply is a taxable supply if it meets the requirements of section 9-5 of the GST Act. Section 9-5 of the GST Act provides that you make a taxable if:

(a) you make a supply for consideration

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

(c) the supply is connected with Australia, and

(d) you are registered or required to be registered for GST.

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

In your case, the issue is whether you made a supply for which the settlement payment is consideration, and if so, is the supply a taxable supply.

The first requirement of a taxable supply is that the supply is made for consideration (paragraph 9-5(a) of the GST Act).

'Supply' is defined in section 9-10 of the GST Act. Subsection 9-10(1) of the GST Act provides that a supply is any form of supply whatsoever. Subsection 9-10(2) of the GST Act provides a non-exhaustive list of things that are included as supplies and states:

(2) Without limiting subsection (1), supply includes any of these:

(a) a supply of goods;

(b) a supply of services;

(c) a provision of advice or information;

(d) a grant, assignment or surrender of *real property;

(e) a creation, grant, transfer, assignment or surrender of any right;

(f) a *financial supply;

(g) an entry into, or release from, an obligation:

(i) to do anything;

(ii) to refrain from an act;

(ii) to tolerate an act or situation;

(h) any combination of any 2 or more of the matters referred to in paragraphs (a) to (g).

Subsection 9-15(1) of the GST Act provides that 'consideration' includes any payment, or any act or forbearance 'in connection with', 'in response to' or 'for the inducement of' a supply of any thing.

The Commissioner's view on the meaning of 'supply' is explained in Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: Supplies (GSTR 2006/9). GSTR 2006/9 sets out a number of propositions to assist in analysing a transaction to identify the supply or supplies made in the transaction. Proposition 5 provides that 'to make a supply' an entity must do something'. The action required by proposition 5 does not have to be the supply itself. If an entity takes some action that causes a supply to occur, that can be sufficient (paragraph 74 of GSTR 20006/9).

Goods and Services Tax Ruling GSTR 2009/3 Goods and services tax: cancellation fees (GSTR 2009/3), discusses the GST consequences of payments made when an arrangement under which a particular supply was intended to be made (intended supply) does not proceed or does not proceed in the manner originally contemplated.

GSTR 2009/3 provides that a payment made on the termination of an agreement may be consideration for a release from an obligation to do anything, refrain from an act or tolerate an act or situation (release supply).

Paragraphs 51 to 61 of GSTR 2009/3 discuss the concept of a release supply. Paragraphs 51 and 52 of GSTR 2009/3 state:

Release supply

51. A customer who has entered into a contract may not wish to, or may be unable to complete the contract. A term in the original contract may grant to the customer the right to terminate the contract upon payment of a cancellation fee in these circumstances.

52. Alternatively, the parties to the contract may enter into another contract under which one party (usually the supplier) upon payment of a cancellation fee agrees to release the other party (usually the customer) from performing the latter's obligations under the original contract.

Paragraphs 55 of GSTR 2009/3 states:

55. Without limiting subsection 9-10(1), a supply includes the supply of services, the creation or surrender of any right and the release from an obligation under paragraphs 9-10(2)(b), 9-10(2)(e) and 9-10(2)(g) respectively. In the context of the broad definition of supply, and having regard to the things included as supplies as set out in subsection 9-10(2), the Commissioner's view is that, if it is not consideration for any other supply, a cancellation fee may be consideration for the creation or surrender of rights and/or a release supply that occurs when an arrangement is cancelled, and/or a combination of these supplies under paragraph 9-10(2)(h).

Further, at paragraph 64, GSTR 2009/3 provides that the Commissioner does not accept the view that when an intended supply is cancelled, no supply is made on cancellation and that the cancellation fee cannot be consideration for the intended supply, nor consideration for a different supply, but is an amount of damages.

Paragraph 64 of GSTR 2009/3 states:

64. … The fact that an amount paid in relation to a cancelled arrangement might be described as 'damages', a 'penalty' or 'compensation' does not mean that the amount is not thereby consideration for a supply. An amount can have both the character of damages, a penalty or compensation and also be consideration in connection with a supply.

At paragraph 65, GSTR 20009/3 provides that regardless of whether an amount paid or payable is damages as properly understood (whether it is paid or payable under a liquidated or agreed damages clause or otherwise), the fundamental question to be answered in an Australian GST context is whether the amount is consideration for a supply.

As stated about, paragraph 52 of GSTR 2009/3 provides another scenario of release supply. This is where the parties to the contract enter into a separate agreement under which the supplier agrees to release the other party from performing their obligations under the terms and conditions of the original agreement for a fee. The separate agreement provides the other party with a right to terminate the original contract. In this situation the supplier makes a release supply for which the payment under the new agreement is consideration.

In your case, the Franchisee decided to terminate the contract. You and the Franchisee entered into a separate agreement, being the Deed of Release. The effect of the Deed of Release was that it granted the Franchisee the right to terminate the Franchise Agreement before the end of the term of that agreement for which the Franchisee agreed to pay an amount as consideration.

We consider that the settlement payment is in connection with a release supply as described in paragraph 55 of GSTR 2009/3. That is the payment that you received from the Franchisee is consideration for releasing the Franchisee from their obligations under the Franchise Agreement. As such, the requirement of paragraph 9-5(a) of the GST Act is met.

The release supply meets the other requirements of section 9-5 of the GST Act as:

· you made the release supply in the course of your enterprise

· the release supply is connected with Australia

· your are registered for GST, and

· the release supply is not GST-free or input taxed.

As the release supply meets all the requirements of section 9-5 of the GST Act, the supply is a taxable supply. You are therefore liable to pay an amount equal to 1/11 of the settlement payment as GST.

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