Edited version of private ruling

Authorisation Number: 1011663803111

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Ruling

Subject: GST and out-of-court settlement

Question

Is the Settlement Sum that you have received under the Deed of Settlement consideration for a taxable supply?

Answer

No, the Settlement Sum that you have received under the Deed of Settlement is not consideration for a taxable supply.

Relevant facts and circumstances

You commenced legal proceedings against Y seeking relief in relation to alleged royalty obligations.

Prior to 2 December 1998, you entered into an Option Agreement with X. You granted X the option to acquire certain rights (rights) over a specified land during a specified period (option period). The consideration for the exercise of the option was a specified lump sum (lump sum) payable upon the exercise of the option, and an on going payment as royalties.

Prior to 1 July 2000, X, Y and you entered into the Agreement for the Sale and Purchase of the Option Rights (Sale Agreement). Under the Sale Agreement, you agreed to the sale of the Option Rights by X to Y.

Prior to 1 July 2000, Y exercised the option to acquire the rights. Y paid the lump sum and the transfer was registered prior to 1 July 2000.

Under the Sale Agreement, Y agreed to be bound by and observe all the terms and conditions, restrictions, covenants and obligations in the Option Agreement as if it was expressly named as a party to the Option Agreement in place of X.

The primary issue in the proceedings was whether Y was obliged to pay the royalties.

Pursuant to the Deed of Settlement between you and Y, the parties agreed to settle the dispute. Y paid a specified amount (Settlement Sum) to you.

Pursuant to the Deed of Settlement, amongst other things, each party released and discharged the other party from any claim against the other party in respect of:

§ any present or future payment obligation in connection with the Option Agreement or the Sale Agreement

§ the proceedings

§ the subject matter of the dispute or any part of the dispute, and

§ anything related to the dispute.

The Deed of Settlement does not state how the Settlement Sum was reached. You advised that all the negotiations were conducted verbally.

Your contentions:

You state:

If the obligation to pay royalties did exist, any subsequent payment including the payment of the Settlement Sum would have been consideration for a supply made before 1 July 2000 and therefore outside the scope of the GST.

There is no nexus between the discontinuance supply and the Settlement Sum that you have received as there is no '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'.

Summary

The Settlement Sum that you received under the Deed of Settlement is not consideration for a supply. Consequently, GST is not payable as the requirements of section 9-5 of the GST Act are not met.

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.

Section 9-5 of the GST Act defines a taxable supply. It states:

You make a taxable supply if:

(a) you make the supply for *consideration; and

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

(c) the supply is *connected with Australia; and

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

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

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

Paragraph 9-5(a) of the GST Act requires that the supply is for consideration.

Goods and Services Tax Ruling GSTR 2001/4 provides the ATO view on the GST consequences of court orders and out-of-court settlements. Paragraph 22 of GSTR 2001/4 provides that a supply is essentially 'something which passes from one entity to another'. Further, paragraph 25 of GSTR 2001/4 states:

Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release.'

Paragraph 21 of GSTR 2001/4 provides that for there to be a supply for consideration, the following three fundamental criteria must be met:

§ there must be a supply

§ there must be a payment, and

§ there must be sufficient nexus between the supply and the payment for it to be a supply for consideration.

Accordingly, it is necessary to determine whether the Settlement Sum that you received is consideration for a supply and if so, whether the supply meets the other requirements of section

9-5 of the GST Act.

Paragraphs 42 to 44 of GSTR 2001/4 deal with supplies related to an out-of-court settlement. These paragraphs state:

42. The statutory definition of 'supply' is very broad. In the context of an out-of-court settlement, a supply referred to under any of the paragraphs within subsection 9-10(2) could be related to an out-of-court settlement.

43. 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), or it may be created by the terms of the settlement itself. 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 (refer paragraph 71).

44. For the purposes of this Ruling, supplies that are related to an out-of-court settlement fall within the three categories of supply described below. This characterisation assists in the subsequent analysis of consideration for a supply, which commences at paragraph 100. 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.

GSTR 2001/4 provides that the three different categories of supply that may relate to an

out-of-court settlement are:

§ an earlier supply

§ a current supply, and

§ a discontinuance supply.

Earlier supply

Paragraphs 46 to 47 of GSTR 2001/4 explain what is an 'earlier supply':

46. … 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'.

Example - Earlier supply

47. Widget Company supplies toys to a retailer. A dispute between the parties over payment for the toys is subsequently resolved through an out-of-court settlement, with the retailer paying all monies owed. The supply of the toys, that is the subject of the dispute, is an earlier supply because it occurred before the dispute arose.

In this case, we do not consider that the Settlement Sum was a payment for an earlier supply.

Furthermore, we agree with your contention that if the obligation to pay royalties did exist, any subsequent payment including the payment of the Settlement Sum would have been consideration for a supply made before 1 July 2000 and therefore outside the scope of the GST.

Current supply

A current supply is a new supply that is created by the terms of the settlement.

We do not consider that a new supply was created by the terms of the Deed of Settlement.

Discontinuance supply

Paragraphs 51 to 55 of GSTR 2001/4 deal with discontinuance supply and 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 [paragraph 9-10(2)(e)]; or

(ii) entering into an obligation to refrain from further legal action [paragraph 9-10(2)(g)]; or

(iii) releasing another party from further obligations in relation to the dispute [paragraph 9-10(2)(g)].

55. In this Ruling, 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 being met in relation to that supply.

Paragraphs 106 to 109 of GSTR 2001/4 explain when a sufficient nexus exists between a payment made under an out-of-court settlement and the discontinuance supply. These paragraphs 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.

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.

We agree with your contention that, in this case, there is no nexus between the discontinuance supply and the Settlement Sum that you have received as there is no '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'.

In conclusion, the Settlement Sum that you received under the Deed of Settlement is not consideration for a supply made to Y. Consequently, GST is not payable, as the requirements of section 9-5 of the GST Act are not met.