Edited version of private ruling

Authorisation Number: 1011622969965

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Ruling

Subject: GST and settlement payment

Question

Are you entitled to claim an input tax credit on the settlement payment that you paid to your subcontractor?

Answer

No. You are not entitled to claim an input tax credit on the settlement payment that you paid to your subcontractor.

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 registered for goods and services tax (GST).

You had entered into a contract with another entity (subcontractor) for the distribution of the goods that you manufacture.

When you sold your business to a third party, you terminated your then existing contract with your subcontractor.

The subcontractor commenced action against you in court and sought compensation for the loss and damage suffered as a result of the termination of the contract.

You and the subcontractor agreed to settle the claim out of court on the terms contained in a Deed of Release and Indemnity (the Deed) to avoid the expenses of litigation.

Under the Deed, you paid the subcontractor an amount in full settlement of the dispute and the subcontractor agreed to release and discharge you from any claims or liabilities arising in any way out of or in connection with the Deed.

Your request for a tax invoice in relation to the settlement payment was declined.

Reasons for decision

You are entitled to an 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) 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.

(* denotes a defined term in section 195-1 of the GST Act.)

All the requirements set out in paragraphs 11-5(a) to 11-5(d) of the GST Act must be satisfied for you to be entitled to the input tax credits.

Based on the facts provided, if there is any supply from the subcontractor to you, you are able to satisfy the requirements of paragraphs 11-5(a), 11-5(c) and 11-5(d) of the GST Act. However, the question arises as to whether the requirement in paragraph 11-5(b) of the GST Act, that the supply to you is a taxable supply, is satisfied.

Section 9-5 of the GST Act provides that a supply is a taxable supply if:

(a) the entity makes the supply for consideration

· the supply is made in the course or furtherance of an enterprise that the entity carries on

· the supply is connected with Australia, and

· the entity is registered or required to be registered for GST.

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

In order for you to have made a creditable acquisition and claim an input tax credit in relation to the settlement payment, there must be a taxable supply of something to you. Also, for there to be a taxable supply, the subcontractor must make a 'supply for consideration' under paragraph 9-5(a) of the GST Act.

'Supply' is any form of supply whatsoever, and includes:

· a surrender of any right; and

· any entry into, or release from, an obligation to do anything, or refrain or tolerate an act or situation.

'Consideration' includes:

· any payment, or any act or forbearance, in connection with a supply of, anything; and

· any payment, or any act or forbearance, in response to or for the inducement of a supply of anything.

For there to be a supply for consideration, there must be a sufficient nexus between a particular supply and a particular payment.

Goods and Services Tax Ruling GSTR 2001/4 'Goods and Services Tax: GST consequences of court orders and out-of-court settlements', explains how a payment (or act of forbearance) that is made in compliance with a court order or out-of-court settlement should be treated for the purposes of the GST Act

GSTR 2001/4 also sets out three broad categories of supplies that may be related to an out of court settlement. They are:

· earlier supplies

· current supplies, and

· discontinuance supplies.

Earlier supplies are supplies that may have occurred prior to settlement. A current supply is one that may be created by the terms of the settlement. Discontinuance supplies usually result from the terms of a settlement, and generally ensure no further legal action in relation to the dispute, provided the terms are complied with.

Paragraph 54 of GSTR 2001/4 provides that the conditions of settlement can create supplies for GST purposes. The supplies may be characterised as:

· surrendering a right to pursue further legal action

· entering into an obligation to refrain from further legal action, or

· releasing another party from further obligations in relation to the dispute.

In some situations the subject of the dispute may not be a supply at all. Paragraphs 71 to 73 of GSTR 2001/4 state:

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.

Based on the information provided, you terminated the then existing contract with your subcontractor when you sold your business to a third party. The subcontractor commenced action against you in the court and sought compensation for the loss and damage suffered as a result of the termination of their contracts.

You agreed with the subcontractor to settle out of court by entering into the Deed and paying an amount to them. Under the terms and conditions of the Deed, the subcontractor agreed to give up their legal rights to pursue future claims, suits, demands and actions against you.

On the information provided, the subcontractor has not made an earlier or current supply to which the settlement payment has sufficient nexus. However, the terms of the settlement gave rise to a discontinuance supply.

Paragraphs 106 and 107 of GSTR 2001/4 outline the ATO's view on the GST treatment of 'discontinuance supplies' and they 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.

Further, paragraph 111 of GSTR 2001/4 discusses the matter of damages claimed and paid as the result of an out-of-court settlement. It states:

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 such, although the subcontractor's acceptance to finalise the dispute without further legal action may constitute supplies within the meaning of paragraphs 9-10(2)(e) or 9-10(2)(g) of the GST Act, the settlement payment does not have sufficient nexus to these supplies. Therefore, the amount paid by you under the Deed is not consideration for a taxable supply made by the subcontractor to you.

Consequently, you have not satisfied paragraph 11-5(b) of the GST Act. Therefore, as you have not made a creditable acquisition under section 11-5 of the GST Act, you are not entitled to input tax credits on the settlement payment.