Edited version of your written advice

Authorisation Number: 1012754090394

Ruling

Subject: GST and out of court settlement

Question:

Is an Australian company (you) entitled to claim an input tax credit for the payment made by you to Company A in relation to an out of court settlement?

Answer

Yes, you are entitled to claim an input tax credit for the payment made by it to Company A in relation to an out of court settlement.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

An Australian Company ('you') is a company in Australia that is registered for goods and services tax (GST).

Company A is an Australian entity that is registered for GST.

You and Company A entered into Bailment Agreement. Under clause X of the Bailment Agreement, you were required to pay Company A-

• the bailment fee calculated according with the terms of the Bailment Agreement for all goods taken by You on bailment from Company A;

• on demand any costs, charges, expenses and liabilities of any kind (including legal costs on a full indemnity basis) incurred by Company A.

You failed to pay the amount due and payable under the Bailment Agreement to Company A. Subsequently Company A commenced the Proceedings.

You and Company A entered into a Deed of Settlement (Deed). The settlement amount of $XXX was negotiated between parties in lieu of the total amount owing by you and its directors to Company A.

Under clause X of the Deed:

Subject to and conditional upon Company A receiving the Agreed amount on the payment date and the parties otherwise complying with the terms of the deed, Company A:

(a) Releases the parties and each of them and their servants, agents and employees from any claim they may have now, have had in the past or may have at the time of the future in respect of or arising out of the Bailment Agreement, the Guarantees and/or the proceedings; and…

Under the Notice of Discontinuance, the plaintiff (Company A) discontinues the whole of claim against first Defendant (you), second Defendant, third Defendant and fourth Defendant. The first Defendant (you) discontinues the whole of claim against the Plaintiff.

You paid $XXX to Company A as per the Deed. Company A did not issue a tax invoice for the settlement amount.

Company A's solicitor advised that by the reason of the settlement you are no longer liable to Company A for any unpaid amounts. Company A treated the settlement sum of $XXX as not being consideration for a supply and therefore not taxable supply.

You have provided a copy of the following documents:

• Bailment Agreement;

• Statement of Claim,

• Amended Statement of Claim and

• Settlement Deed

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 11-1

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

A New Tax System (Goods and Services Tax) Act 1999 Section 11-15

A New Tax System (Goods and Services Tax) Act 1999 Section 11-20

Reasons for decision

Entitlement to input tax credits

You are entitled to the input tax credit for any 'creditable acquisition' that you make.

Section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a creditable acquisition if:

(a) you acquire anything solely or partly for a creditable purpose

(b) the supply of the thing to you is a taxable supply

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

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

The term 'creditable purpose' is defined in section 11-15 of the GST Act, which provides that you acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise. However, you do not acquire the thing for a creditable purpose to the extent that:

(a) the acquisition relates to making supplies that would be input taxed, or

(b) the acquisition is of a private or domestic nature.

From the facts given, you satisfy paragraph 11-5(a), 11-5(c) and 11-5(d) as follow:

(a) You have acquired the bailment services for creditable purpose and

(c) you provided consideration for the supply, and

(d) you are registered for GST and were registered at the time of the acquisition.

The next step is to determine whether the supply is taxable supply (as per requirement under paragraph 11-5(b) of the GST Act).

Taxable supply

GST is payable on a taxable supply. You make a taxable supply if all the requirements of section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) are satisfied as follows:

(a) you make the 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.

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

The facts indicate that the supply (or supplies) is made in the course of an enterprise (business) that Company A carries on; the supply is connected with Australia (as the supply is either done in Australia or made through an enterprise in Australia); and Company is registered for GST. Therefore, the requirements of paragraphs 9-5(b) to 9-5(d) of the GST Act are met. What remains to be determined is whether Company A makes a supply for consideration, and if so, whether the supply is GST-free or input taxed.

Supply for consideration

To be a taxable supply, there must be a 'supply for consideration'.

Goods and Services Tax Ruling GSTR 2001/4 provides guidance on court and

out-of-court settlements.  In particular, paragraph 21 of the GSTR 2001/4 sets out the fundamental criteria that must be satisfied for there to be a 'supply for consideration', namely:

(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.

The term 'supply' is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever' and includes 'a creation, grant, transfer, assignment or surrender of any right', and 'an entry into, or release from an obligation: to do anything, or to refrain from an act, or to tolerate an act or situation'. Paragraph 22 of GSTR 2001/4 provides that a supply is essentially 'something which passes from one entity to another'.

As outlined in paragraphs 44 to 55 of GSTR 2001/4, the supplies that are related to an out-of-court settlement fall within three categories of supply: earlier supply, current supply and discontinuance supply, which are discussed below.

Earlier supply

In relation to an 'earlier supply', paragraphs 45 and 46 of GSTR 2001/4 state:

45. Each and every supply is subject to GST provided the supply satisfies the requirements of a taxable supply. The GST Act does not prescribe any sequencing or hierarchy of supplies for taxing purposes. GST becomes payable on the relevant supply.

46. In these circumstances, where the subject of the dispute is an earlier transaction in which a supply was made involving the parties, that supply is referred to in this ruling as an 'earlier supply'

A supply related to an out-of-court settlement may have occurred prior to the settlement (and in fact have been the subject of the dispute in the first place) - referred to as the earlier supply; or it may be created by the terms of the settlement itself - referred to as the current supply. There may be more than one supply that is related to a settlement. In addition, the subject of the dispute may not be a supply at all. We also note that the existence of a particular supply in relation to a given settlement will not necessarily mean a sufficient nexus exists between that supply and a payment made under the settlement.

Based on the facts provided, under the Bailment Agreement, you were required to pay Company A the bailment fee and any costs, charges, expenses and liabilities of any kind (including legal costs on a full indemnity basis) incurred by Company A.

You failed to pay Company A the amount due and payable under the Bailment Agreement. Subsequently, Company A commenced the Proceedings. Company A and you entered in to the Deed to resolve the Proceedings. As a result of the Deed, you are no longer liable to pay Company A any unpaid amounts. The subject of the dispute is in relation to earlier transaction (that is, a supply of bailment services that occurred before the dispute arose) and therefore there is an 'earlier supply' in relation to this settlement.

Furthermore, in accordance with the Deed, you paid the Company A the amount of $XXX. There is a sufficient nexus between the earlier supply and the payment, and hence the requirement that there is a supply for consideration under paragraph 9-5(a) of the GST Act is satisfied.

The earlier supply is not input taxed or GST-free under any provisions in the GST legislation.

Discontinuance supply

Generally, the terms of a settlement, in finalising a dispute, will ensure no further legal action in relation to that dispute, provided that the terms of the settlement are complied with. This often takes the form of a plaintiff releasing a defendant from some (or all) of the existing claims and from further claims and obligations in relation to that dispute.

Sometimes, where a dispute involves counter claims, the terms of the settlement may provide for each party to release the other from such claims and obligations. Where court proceedings have commenced, the filing of a notice of discontinuance pursuant to the relevant court rules may also be required to ensure the court is advised that a particular action will not proceed. We consider that these conditions of settlement can create supplies for GST purposes (paragraphs 51 to 54 of GSTR 2001/4).

We refer to supplies of these kinds as 'discontinuance supplies'. However, whether a discontinuance supply is a taxable supply will depend on the requirements of section 9-5 of the GST Act being met in relation to that supply.

Under the Deed, clause X addresses the release between the parties. Company A agreed that after receiving the agreed amount, Company A will release the parties and each of them and their servants, agents and employees from any claim they may have now, have had in the past or may have at the time of the future in respect of or arising out of the Bailment Agreement, the Guarantees and/or the proceedings.

Furthermore, under the Notice of Discontinuance, the plaintiff (Company A) discontinues the whole of claim against first Defendant (you), second Defendant, third Defendant and fourth Defendant. The first Defendant (you) discontinues the whole of claim against the Plaintiff.

In relation to the GST treatment of discontinuance supplies and damages, paragraphs 106 to 108 and 111 of GSTR 2001/4 further state:

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.

…

Damages

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.

As outlined above, there is an 'earlier supply' made by Company to you in accordance with the Deed. The payment of the amount of $XXX is not solely for a discontinuance supply or for damages. Further, Company A's solicitor advised us that by the reason of the settlement you are no longer liable to Company A for any unpaid amounts. There is no evidence provided to indicate that the part of the $XXX is for a damages claim.

Company A is making an earlier supply in relation to Bailment Agreement in return for the amount (consideration). Paragraph 9-5(a) of the GST Act is satisfied as there is sufficient nexus between the earlier supply and the consideration. Therefore, all the requirements of section 9-5 of the GST Act are satisfied and Company A is liable for GST on the settlement amount of $XXX received from you in accordance with the Settlement Deed.

Summary

As discussed above, you acquired the bailment services for creditable purpose, the supply to you is a taxable supply, you provided consideration for the supply, and you were registered for GST at the time of the acquisition. Therefore, you satisfy all the requirements of section 11-5 of the GST Act and are entitled to claim an input tax credit for the payment made to Company A in relation to the out of court settlement.

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