Edited version of your written advice

Authorisation Number: 1012808100123

Ruling

Subject: GST and out of court settlement

Question:

Are you liable for goods and services tax (GST) in respect of the payment received from an Entity A under a Deed of Settlement (Deed)?

Answer:

No, the settlement payment does not constitute consideration for a taxable supply made by you, and will not be subject to GST.

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.

You are an Australian entity that is registered for goods and services tax (GST).

You entered into a Contract with an Entity A to purchase vacant land in Australia. The property was purchased for $X including GST.

The Entity A is registered for GST.

Prior to entering into the Contract you received a marketing brochure and information memorandum relating to the property. The information memorandum stated that the parcel of land has services running past and is already cleared and ready to build on. The land is unencumbered and has no covenants attached to the sale.

Prior to the settlement, you undertook searches and these searches did not reveal any easements on title or any statutory easements, or any work undertaken on the property which could have any adverse impact on building on the land.

After the settlement of the Contract, you engaged a surveyor to survey and mark the boundaries of the land. The surveyor reported back to you that there are two storm water pipes and one sewer pipe ('the pipes') diagonally across the property

You enquired about the pipes with the local Councils. They claimed that they had no details about the pipes.

Then you attempted to obtain development approval from the local Council for a retail development on the land comprising an upper level and lower level car park. The owner of the sewerage pipe rejected the development proposal and said that it would not approve any development over the pipes.

These undisclosed problems prevented the planned development and caused a significant reduction in the value of the land. Therefore, you lodged a damages claim against the Entity A totalling of $Y.

You and the Entity A entered into a Deed of settlement (Deed). The settlement amount of $Z was negotiated between parties inclusive of interest, costs, diminution in value and GST.

Under the Deed, the payment of the settlement sum is on the condition that if the local Council or any other Local Authority or other body requires you to grant to it an easement or easements with respect to any of the pipes after to the date of this Deed, you will agree to grant such easement or easements to the Local Council or any other Local Authority or other body, and will not make any claim or seek compensation from the Entity A with respect to the granting of such easement or easements.

Under the Deed, the Purchasers release and forever discharge and shall indemnify, and at all the times keep indemnified, the Entity A and their officers, employees, servants and agents from all actions, suits, claims and demands by the Purchasers, or by anyone claiming by, through or under the Purchasers, for compensation or damages arising out of or connected with the Purchasers' claim, and also against all costs, charges and expenses which may be incurred by the Entity A, their officers, employees, servants and agents in defending and/or settling such actions, suits, claims or demands.

You have provided a copy of the following documents:

• commercial contract

• letter of demand for damages claim

• Settlement Deed

• Tax invoice for sale of the property

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

Reasons for decision

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 you carry on; the supply is connected with Australia (as the supply is either done in Australia or made through an enterprise in Australia); and you are 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 you make 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'.

Paragraphs 51 to 54 of GSTR 2001/4 state:

51. Generally (it is suggested in most if not all cases), 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.

52. 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.

53. 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.

54. We consider that these conditions of settlement can create supplies for GST purposes. The supplies may be characterised as:

(i) surrendering a right to pursue further legal action .. or

(ii) entering into an obligation to refrain from further legal action..; or

(iii) releasing another party from further obligations in relation to the dispute...

We refer to supplies of these kinds as 'discontinuance supplies'. 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.

Under the Deed, you as the purchaser release and forever discharge and shall indemnify, and at all the times keep indemnified, the Entity A and their officers, employees, servants and agents from all actions, suits, claims and demands by the Purchasers, or by anyone claiming by, through or under the Purchasers, for compensation or damages arising out of or connected with the Purchasers' claim, and also against all costs, charges and expenses which may be incurred by the Entity A, their officers, employees, servants and agents in defending and/or settling such actions, suits, claims or demands.

Accordingly, the above condition in the Deed constitutes a supply for the purposes of the GST Act, and is referred to as a discontinuance supply. The next step is to determine if the settlement payment you receive was made in response to a supply.

In relation to discontinuance supply, paragraphs 106 to 109 of GSTR 2001/4 state:

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.

Furthermore, paragraphs 73, 110 and 111 of GSTR 2001/4 state:

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.

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply. 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.

On the basis of the facts provided, a sufficient nexus cannot be established between the discontinuance supply and the settlement payment. The settlement payment under the Deed is therefore considered to be in response to the damages claim rather than the discontinuance supply. Furthermore the settlement payment made in response to the out of court settlement will not constitute, by itself, consideration for a supply made by you.

Accordingly, the settlement payment does not represent consideration for a discontinuance supply under the terms of settlement, or any supply underpinning the damages claim. As one of the requirements for a taxable supply under section 9-5 of the GST Act is not satisfied, you are not making a taxable supply in relation to the settlement payment received. The settlement payment is not subject to GST and therefore you are not required to remit GST to the Australian Taxation Office (ATO) on the settlement payment.

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