Edited version of private ruling

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Ruling

Subject: GST and break fees

Question

Is a break fee paid by a tenant under a fixed term agreement pursuant to section 107 of the Residential Tenancies Act 2010 (NSW) consideration for a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No, a break fee paid by a tenant under a fixed term agreement pursuant to section 107 of the Residential Tenancies Act 2010 (NSW) is not consideration for a taxable supply.

Relevant facts

You carry on an enterprise as a real estate agency, acting on behalf of property owners and are registered for GST.

In acting on behalf of property owners you receive amounts paid as break fees by tenants terminating fixed term agreements early.

Clause 42 of the Residential Tenancy Agreement (version FM00401 - 01/11 copyright January 2011) (agreement) issued by the Real Estate Institute of New South Wales provides that the tenant must pay a break fee equivalent to 6 weeks rent if the fixed term is for 3 years or less and less than half of the term has expired or 4 weeks rent in any other case. Clause 42 states:

ADDITIONAL TERM - BREAK FEE

42. The tenant agrees that, if the tenant ends the residential tenancy agreement before the end of the fixed term of the agreement, the tenant must pay a break fee of the following amount:

42.1 If the fixed term is for 3 years or less, 6 weeks rent if less than half of the term has expired or 4 weeks rent in any other case, or

42.2 If the fixed term is for more than 3 years, $_____ .

This clause does not apply if the tenant terminates the residential tenancy agreement early for a reason that is permitted under the Residential Tenancies Act 2010.

Note. Permitted reasons for early termination include destruction of residential premises, breach of the agreement by the landlord and an offer of social housing or a place in an aged care facility.

Section 107 of the Residential Tenancies Act 2010 regulates the rights of the landlord and tenant under this clause.

Clause 43 of the agreement states:

43. The landlord agrees that the compensation payable by the tenant for ending the residential tenancy agreement before the end of the fixed term is limited to the amount specified in clause 42 and any occupation fee payable under the Residential Tenancies Act 2010 for goods left on the residential premises.

Section 107 of the Residential Tenancies Act 2010 states:

107 Landlord's remedies on abandonment

(1) The Tribunal may, on application by a landlord, order a tenant to pay compensation to the landlord for any loss (including loss of rent) caused by the abandonment of the residential premises by the tenant.

(2) The landlord must take all reasonable steps to mitigate the loss and is not entitled to compensation for any loss that could have been avoided by taking those steps.

(3) The compensation payable by a tenant under this section in respect of a fixed term agreement is limited to the amount of the applicable break fee for the tenancy, if the agreement provides for such a limitation.

(4) The "break fee" for a fixed term agreement for a fixed term of not more than 3 years is:

(a) an amount equal to 6 weeks rent if less than half of the fixed term had expired when the premises were abandoned, or

(b) an amount equal to 4 weeks rent in any other case.

(5) The "break fee" for a fixed term agreement for a fixed term of more than 3 years is the amount set out in subsection (4) or, if an amount is specified in the agreement, the amount specified. An agreement must not specify a break fee exceeding the amount (if any) specified by the regulations.

(6) The amount of any money paid by a tenant to a landlord on terminating a fixed term agreement before the end of the fixed term or before otherwise abandoning the premises (other than money previously due to the landlord under the residential tenancy agreement) is to be deducted from any amount payable to the landlord under this section.

(7) This section does not prevent a landlord from obtaining an occupation fee under Division 2 of Part 6 for goods left on the residential premises.

Reasons for decision

Summary

A break fee paid by a tenant under a fixed term agreement pursuant to section 107 of the Residential Tenancies Act 2010 (NSW) is not consideration for a taxable supply. Rather, the break fee is consideration for an input taxed supply and as such, not subject to GST.

Detailed reasoning

Section 7-1 of the GST Act provides that GST is payable on taxable supplies.

Under section 9-5 of the GST Act, you make a taxable supply if:

· you make a supply for consideration

· the supply is made in the course or furtherance of your enterprise

· the supply is connected with Australia, and

· you are registered or required to be registered for GST.

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

A supply of residential premises (other than a supply of commercial residential premises or a supply of accommodation in commercial residential premises provided to an individual by the entity that owns or controls the commercial residential premises), by way of lease, hire or licence is input taxed under subsection 40-35(1) of the GST Act.

This means that no GST is payable on rent paid by a tenant under a Residential Tenancy Agreement because the rent paid is consideration for an input taxed supply.

On the basis of the information provided, it is now necessary to determine whether the amounts you receive as break fees on early termination of fixed term agreements are also consideration for an input taxed supply.

Goods and Services Tax Ruling GSTR 2009/3 Goods and services tax: cancellation fees, provides relevant guidance on the GST consequences resulting from payments made when:

· an arrangement under which a particular supply was intended to be made (intended supply) does not proceed, or

· does not proceed in the manner originally contemplated.

These payments can include the forfeiture of all or part of the consideration for the intended supply and are referred to as 'cancellation fees'.

In particular, paragraphs 64 to 66 of GSTR 2003/9 state, in so far as they are relevant:

64. …….. The fact that an amount paid in relation to a cancelled arrangement might be described as 'damages', a 'penalty' or 'compensation' does not mean that the amount is not thereby consideration for a supply. An amount can have both the character of damages, a penalty or compensation and also be consideration in connection with a supply.

65. Regardless of whether an amount paid or payable is damages as properly understood (whether it is paid or payable under a liquidated or agreed damages clause or otherwise), the fundamental question to be answered in an Australian GST context is whether the amount is consideration for a supply. The classification of an amount as consideration for a supply or as damages is to be made in accordance with Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements.

66. GSTR 2001/4 sets out the Commissioner's views on when damages are, and are not, consideration for a supply. The Commissioner takes the view that payments that are called 'damages' resulting from court orders and out-of-court settlements need to be examined to establish whether the payment relates to a supply

It is considered that the break fees are cancellation fees, as subsection 107(3) of the Residential Tenancies Act 2010 provides that they are compensation which is payable by the tenant in respect of the fixed term agreement, and also an out-of-court settlement by agreement between the parties.

Relevant guidance on whether the break fees are consideration for a supply is provided in Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements. In particular, paragraphs 44 to 46 of GSTR 2001/4 discuss 'supplies' related to out-of court-settlements and state:

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.

Earlier supply

45. Each and every supply is subject to GST provided the supply satisfies the requirements of a taxable supply. The GST Act does not prescribe any sequencing or hierarchy of supplies for taxing purposes. GST becomes payable on the relevant supply.

46. In these circumstances, 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'.

Further, paragraphs 100 and 101 of GSTR 2001/4 discuss which supply has the nexus with the consideration and state:

100. As discussed above, a sufficient nexus between a payment made under a court order or out-of-court settlement and a supply must exist to create the 'supply for consideration' relationship. Our views on where such a relationship exists are set out below.

Earlier supply

101. Where the only supply (other than a 'discontinuance' supply61) in relation to a court order or out-of-court settlement is an earlier supply and a sufficient nexus exists between the payment made under that order or settlement and the earlier supply, the payment will be consideration for that supply.

In the circumstances in which the break fees are paid, it is considered that sufficient nexus exists between the payment of the break fees and the earlier supply of residential premises.

Paragraph 115 of GSTR 2001/4 explains that where a payment has a sufficient nexus with an earlier supply that is input taxed, the payment will also be treated as input taxed. Paragraph 115 states:

115. Where payment made under a court order or out-of-court settlement has a sufficient nexus with more than one supply, with one or more supplies being taxable and one or more being GST-free or input taxed, the payment will be for each of the relevant parts. This will also be the case where the payment is partly for an item of damages which is not a supply.

As stated previously, a supply of residential premises by way of lease, hire or licence is input taxed under subsection 40-35(1) of the GST Act. As the break fees relate to a supply of residential premises, they are also input taxed.

Therefore, a break fee paid by a tenant under a fixed term agreement pursuant to section 107 of the Residential Tenancies Act 2010 (NSW) is not consideration for a taxable supply. Rather, the break fee is consideration for an input taxed supply and, as such, not subject to GST.