Edited version of private ruling

Authorisation Number: 1011505002323

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: GST and entitlement to input tax credit in respect to the acquisition of legal services

Question

Are you entitled to an input tax credit in respect to the acquisition of legal services?

Answer

No

Relevant facts and circumstances

An entity (hereafter referred to as you) is registered for goods and services tax (GST).

After 1 July 2000, a relative of yours (your relative) was engaged in the construction of a commercial development in Australia.

An error made by a contractor, caused months of delay - the extra works and holding costs turned what would have been a profitable project into a negative result which left no option for your relative to enter into a voluntary liquidation.

Subsequently, the liquidator decided to sue the contractor to recover losses and damages.

Your relative's next enterprise was another business in Australia operated by a private company. This business was funded by your commercial business.

Your relative's business faced the global financial crisis and was placed into administration. The appointed administrators were also the liquidators of the construction business.

The liquidators of the construction business needed to pursue a negligence claim against the contractor and requested your relative to be the plaintiff for the recovery action in court.

As the liquidators had no funds to pursue the court action and the possibility that your relative may be declared bankrupt due to the problem of the other business, an alternate plaintiff must be found. You offered that your enterprise take the action against the contractor because you had been recognised a creditor of both failed businesses.

You have entered into two deeds: a Deed of Assignment (DoA) and Deed of Company Arrangement (DoCA) that were approved by both sets of creditors for the two businesses).

The DoA was created to assign the Cause of action to you whereby you became the plaintiff for the action against the contractor.

The DoCA was created to allow the other failed business, to continue to trade provided that you pay to the Deed Administrator a fixed percentage of all net proceeds received from the pending legal action by the construction company against the contractor. That is, the net proceed of the litigation would be split between the two sets of creditors of which you made up part of the latter.

You have acquired the Cause of Action under the DoA in consideration of the following covenants under a clause of the DoA:

· the Assignee will, at his own expense, promptly pursue the Cause of Action by instituting proceeding in the Court against the contractor claiming damages for negligence and breach of contract and thereafter expeditiously prosecuting the proceedings in accordance with rules of the court;

· the Assignee, at his own expense, instruct a law firm to act for him in respect of the proceedings;

· should the Assignee either obtain a judgement in his favour in the proceedings or agree to an out of court settlement with the contractor in relation to the claims made in the proceedings and in either case receive payment of an amount or moneys pursuant to the judgement or the settlement then the Assignee will:

o promptly reimburse the Assignor and the Liquidators for any expense or costs reasonable incurred by them in complying with their covenants.; and

o promptly pay to the Assignor an amount equal to an agreed percentage of the net proceeds;

· The Assignee will obtain the prior consent of the Assignor and the Liquidators before agreeing to any out of court settlement of the proceedings.

You have entered into a cost agreement with the law firm. The key points are:

· The lawyers act for you on the assignment of the Cause of action and proceedings against the contractor.

· The agreement can be terminated by either you or the law firm. Then, you will be required to pay professional fees and charges for work done and for expenses and disbursements incurred up to the date of determination.

· The law firm will only render a tax invoice for their professional fees and outlays and you will only become liable to pay their tax invoices if a successful outcome is achieved in respect of the proceedings (where an award of damages is made in your favour or if a settlement is received which the lawyers consider to be reasonable).

· If you are unsuccessful in the litigation you may be ordered to pay the other party's costs.

Negotiations between parties commenced and an agreement was reached. Under the agreement the litigation was settled for a sum of money.

You received a tax invoice, which included GST, for the legal services from your legal representative.

Reasons For Decision

Section 7-1 of the GST Act provides that an entitlement to an input tax credit arises for a creditable acquisition.

Only the entity that makes the creditable acquisition is entitled to the input tax credit.

Section 11-5 of the GST Act defines a creditable acquisition. It states:

You make a creditable acquisition if:

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

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

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

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

*Note that the asterisks denote a defined term in the GST Act, but they do not alter the meaning of the word.

The first requirement in section 11-5 of the GST Act is that the entity makes the acquisition solely or partly for a creditable purpose.

Subsection 11-15(1) of the GST Act provides that an entity acquires a thing for a creditable purpose to the extent that it acquires the thing in carrying on its enterprise. Therefore, the acquisition of the legal services is for a creditable purpose if the entity acquires the thing (legal services) in carrying on its enterprise.

In this case:

You entered into the DoA that assigned the Cause of Action to you whereby you became the plaintiff for the action against the Contractor.

You engaged a law firm to act for you in respect of the proceedings in the Court of your state against the Contractor claiming damages for negligence and breach of contract in relation to the professional work undertaken by that firm for the construction business.

You were responsible for the legal costs, but in the event of securing a favourable judgement or settlement then the legal costs will be deducted from the proceeds, the net proceeds would be passed to the liquidators.

Your intention to become the plaintiff and involved in the litigation, was that if successful, the proceeds would be applied to satisfy creditors, including you.

Under the DoA:

· You will, at your own expense, pursue the Cause of Action by instituting proceedings in the Court of your state against the Contractor.

· You will, at your own expense instruct the law firm to act for you in respect of the proceedings. You have been advised by the law firm that:

o if the litigation was successful, the legal cost will be deducted from the settlement amount prior to being passed to the liquidators

o if you were unsuccessful in the litigation you might be ordered to pay the other party's costs.

· Should you receive payment of an amount of damages or moneys pursuant to the judgement or settlement out of court, you will pay to the construction business a fixed percentage of the net proceeds. [That is, the rest of the net proceeds will go to the Deed Administrator of DoCA]. The term "net proceeds" means the amount above less legal costs and other costs incurred by you or the liquidators in relation to the litigation.

· You will obtain the prior consent of the construction business and the liquidators before agreeing to any out of court settlement of the proceedings.

Under the assignment, you acquire rights similar to those of the assignor and are put in the same position with reference to those rights as that in which the assignor stood at the time of the assignment for consideration of 45% of the net proceeds of the settlement.

You have advised that the reasons for you to enter into the DoA and incur the legal costs were that:

o 'this gave the only opportunity to recoup damages from the Contractor which would then go to satisfy creditors'.

o as the DoA was linked to DoCA, the Deed also allowed the other business to continue trading which firstly gave an opportunity (if the other business was sold) to recoup your loan.

o 'the balance would be split between the two sets of creditors of which you made up the latter'.

You are carrying on an enterprise of providing a commercial business. You contended that your action was ultimately aimed at recouping some monies you loaned to the other business.

You acquired legal services to negotiate compensation (in the form of a settlement) for damages for negligence and breach of contract in relation to the professional work undertaken by the contractor to the construction business (which was assigned to you).

Taking into account all of the above, the link between the acquisition of the legal costs and your enterprise was too remote and it is considered that the legal costs were not acquired to carry on your enterprise.

You did not acquire the legal services in carrying on the enterprise of providing a commercial business. However, it is necessary to determine whether the legal expenses were acquired by you in carrying on any other enterprise.

Section 9-20 of the GST Act provides that an enterprise includes an activity in the form of a business or in the form of an adventure all concerned in the nature of trade. There would be an expectation that an enterprise would at some stage make supplies.

In your case, your action against the contractor is not considered to be a supply under section 9-10 of the GST Act as explained in paragraphs 71 to 73 of Goods and Services Tax Ruling GSTR 2001/4 GST consequences of court orders and out-of-court settlements:

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.

You acquired legal services to negotiate compensation for damages for negligence and breach of contract in relation to the professional work undertaken by the Contractor for the construction business.

In relation to the legal proceedings under the DoA, you have not made any supply because the subject of the claim for damages is not a supply, as explained above. An enterprise, where its nature was only making acquisitions without making supplies, and ended after the acquisition was made, is not being carried on.

Therefore, the acquisition of legal services was not acquired in carrying on an enterprise, either your business enterprise or any other enterprise.

It follows that the requirement in paragraph 11-5(a) of the GST Act is not satisfied. As you are not making a creditable acquisition, you are not entitled to any input tax credits for the legal expenses incurred under the DoA.