Edited version of private ruling

Authorisation Number: 1011754981737

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Ruling

Subject: GST and out-of-court settlement

Question

Are the proceeds received by you, representing out-of-court settlement proceeds, considered to be consideration for a taxable supply made by you under section 9-5 of A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No, the proceeds received by you, representing out-of-court settlement proceeds, are not consideration for a supply at all and therefore there is no taxable supply made by you under section 9-5 of the GST Act.

Relevant facts and circumstances

You are registered for GST.

You purchased land (property) a few years ago.

One lot of land on the property contained a mine (mine) containing certain mine material (product).

You were approached by entities who wanted to purchase the product.

You sought permission from the relevant authorities (authorities) in order to extract the product.

The authorities advised you that before you could extract the product, the mine had to be registered and provided you with a list of requirements to obtain registration.

You advised the authorities that the mine on your lot of land had in the recent past been used as a mine and therefore the mine must be registered and the registration must be current. You approached the authorities on many occasions with evidence that the mine had been used as a mine.

However the authorities denied that the mine was registered. Due to the onerous registration process you ceased efforts in relation to obtaining registration of the mine.

You subsequently sold the lot of land on the property containing the mine a year later at a much reduced value on the basis that there was no value in the mine due to it not being registered as advised by the authorities.

A short time after the sale, you witnessed the product being extracted from this lot of land.

You approached the authorities and were advised that the paperwork had been discovered confirming that the mine was a registered mine.

It was estimated that the mine has a life expectancy of many years.

You commenced legal action against the authorities on the basis that had the registration of the mine been discovered earlier, you would not have sold the lot of land containing the mine.

You have provided a copy of the Statement of Claim at these legal proceedings. The Statement of Claim shows that you claimed for damages, interest, costs and such further and other orders as the court sees fit and just.

A clause in the Statement of Claim provides that the value of the land sold, with the benefit of the registration, which had not lapsed, was substantially in excess of what you sold it for.

Another clause in the Statement of Claim provides that you suffered loss and damage due to the negligence of the authorities.

An out-of-court settlement was reached between the parties and you received an amount in compensation. The settlement sum was a global amount and undissected.

You did not issue a tax invoice to the authorities.

You have provided a copy of the Deed of Release and Settlement.

The Deed of Release and Settlement provided that without admission as to liability, the parties agreed to resolve the proceedings on the terms contained within the Deed. The Deed provided that you agreed to release all claims you have or might have had, or in future may have, against the authorities in respect of, or in relation to, the matters the subject of the proceedings on the terms in the Deed. In return the authorities were to pay you a certain amount of money.

Reasons for decision

Section 9-40 of the GST Act provides that you must pay the GST on any taxable supply that you make.

Section 9-5 of the GST Act 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)

All the criteria in section 9-5 of the GST Act must be met for there to be a taxable supply.

The GST consequences of an out-of-court settlement will depend on whether the payment made under a settlement constitutes consideration for a supply and, if so, whether the supply is a taxable supply.

In your case, the payment by the authorities to you is an out-of-court settlement to resolve a damages claim.

Goods and Services Tax Ruling GSTR 2001/4 (which is available at www.ato.gov.au) sets out the Australian Taxation Office's view on the GST consequences resulting from court orders and out-of-court settlements. It analyses, amongst other things, the concept of supply and the nexus that must exist between a payment and a supply in order to establish the relationship of a supply for consideration.

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

(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.

Essentially, a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

The term supply is defined in subsection 9-10(1) of the GST Act to include any form of supply whatsoever.

GSTR 2001/4 explains that supplies related to out-of-court settlements fall within one of the three categories. These categories are:

· earlier supply

· current supply, and

· discontinuance supply.

An earlier supply is a supply that occurred before the dispute arose, and which is the subject of the dispute.

A current supply is one that may be created by the terms of the court order or out-of-court settlement.

A discontinuance supply 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.

However, whether any of these supplies 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.

In your case, you commenced legal proceedings against the authorities to seek compensation as the authorities were alleged to have been negligent in making representations to you concerning the mine which resulted in you suffering loss and damage. The legal proceedings however were discontinued as this matter was resolved under the terms of an out-of-court settlement between you and the authorities. Without admission as to liability, the parties mutually released each other from all claims in connection with the legal proceedings now and in the future and you received an amount in compensation. The settlement sum was a global amount and undissected.

In this instance there is no earlier supply or current supply relating to the payment. However, there is a discontinuance supply as under the terms of the out-of-court settlement between you and the authorities it was agreed that the legal proceedings now and in the future would be discontinued for which you received the settlement sum.

To determine if the discontinuance supply is a taxable supply, it is necessary to consider the terms of the settlement to establish whether there is a nexus between the payment of the settlement amount and the discontinuance supply.

Also, consideration needs to be given to paragraphs 106 and 107 of GSTR 2001/4 which provide further guidance on a 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.

Further, paragraph 109 of GSTR 2001/4 states:

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 a discontinuance supply.

We do not consider that paragraph 109 of GSTR 2001/4 applies in this case, as based on the information and documents that you have provided, we do not consider that the claim, which is the subject of your dispute, is lacking in substance.

With respect to an out-of-court settlement, paragraph 111 of GSTR 2001/4 expands on paragraph 106 of GSTR 2001/4, and makes the following comment:

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.

Paragraphs 71 to 73 of GSTR 2001/4 explain why a claim for damages, loss or injury is not a supply as follows:

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.

In your case the dispute arose from the authorities' alleged negligence causing you to suffer loss and damage. You made a claim for damages by commencing legal action. The dispute was settled by the parties out of court where a certain sum was paid by the authorities to you to resolve the damages claim.

In line with paragraph 111 of GSTR 2001/4 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.

Therefore, as the payment made is not consideration for a supply at all, then the payment is not consideration for a taxable supply. As you have not made a taxable supply under section 9-5 of the GST Act to the authorities, you are not liable to pay GST.