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Ruling

Subject: GST and out-of-court settlement

Question:

Is an Australian entity (you) liable for goods and services tax (GST) in respect of the settlement sum received for the out-of-court settlement?

Answer:

No, the out-of-court settlement payment does not constitute consideration for a taxable supply made by you, and will not be subject to GST.

Relevant facts and circumstances:

An Australian entity (you) carries on an enterprise.

You are registered for GST.

You were the successful bidder at an auction to purchase a property (property) from the executor of a deceased estate.

The contract could not be signed on the day of the auction as it was incomplete. It was subsequently executed by the parties soon after the auction.

The contract was entered into in the course of your enterprise.

The purchase price for the property was $XXXX.

A caveat (the first caveat) was later lodged on the property by a relative of the deceased.

Proceedings in the Court (the proceedings) were instituted by the plaintiff. The executor of the deceased estate was the first defendant in the proceedings. You were the second defendant in the proceedings. The matter was set for trial.

At the time the contract to acquire the property was entered into, the proceedings had not then been commenced.

There were several caveats (some were withdrawn). A caveat was lodged by the plaintiff just prior to the time of settlement of the contract. Hence, the contract could not be completed.

Proceedings were commenced by the plaintiff seeking various reliefs against the first and second defendants (that is, the executor of the deceased estate and you, respectively).

You filed a counterclaim against the plaintiff and the first defendant for specific performance of the contract.

Prior to the trial date, the parties reached an out-of-court settlement in relation to the proceedings. A copy of the terms of settlement was provided.

In accordance with the terms of settlement:

(a) the plaintiff paid you the settlement sum;

(b) a Notice of Discontinuance was filed with the Court discontinuing the plaintiff's claim against you and your counterclaim against the plaintiff and first defendant;

(c) the contract for the property between you and the vendor (first defendant) was mutually terminated.

In addition, the terms of settlement provides (amongst other things):

· Upon payment of the settlement sum by the plaintiff to the second defendant (that is, you):

(a) the plaintiff will discontinue the proceedings against the second defendant and the second defendant will discontinue its counterclaim in the proceedings against the plaintiff and the first defendant, with no order as to costs;

(b) the second defendant will take all such steps as are reasonably required in order to cause (a particular) caveat number to be removed and shall not lodge any further caveat thereon;

(c) the first defendant and the second defendant will mutually terminate the contract for the property; and

(d) the second defendant will use all reasonable endeavours to make application upon payment of the settlement sum to the Commissioner of State Revenue for refund of the duty paid by the second defendant on the contract for the property.

· Upon receipt by the second defendant of the settlement sum, the plaintiff and the second defendant jointly and severally release and discharge each other and the first defendant from all actions, suits, claims, demands, causes of action, costs and expenses, legal, equitable, under statute and otherwise, and all other liabilities of any nature.

· The plaintiff and the second defendant agree to bear their own costs of and incidental to the proceedings (as against each other).

· Forthwith upon termination of the contract for the property, the first defendant and second defendant agree to cause the stakeholder to refund the deposit (without any deduction or set-off) for the property to the second defendant. The plaintiff has no objection to the deposit being so refunded to the second defendant (and authorises the first defendant to pay the agents commission otherwise than from the deposit).

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999, Section 9-5

A New Tax System (Goods and Services Tax) Act 1999, Section 9-10

A New Tax System (Goods and Services Tax) Act 1999, Section 9-15

Reasons for decision

GST is payable on a taxable supply. You make a taxable supply if all the requirements of section 9-5 of the A New Tax System (Goods and Services Tax) Act (GST Act) are satisfied as follows:

(a) you make the supply for consideration;

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

(c) the supply is connected with Australia; and

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

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

A supply for consideration is one of the requirements that must be considered in determining whether a particular supply is a taxable supply.   

Goods and Services Tax Ruling GSTR 2001/4 GST consequences of court orders and out-of-court settlement provides guidance on court and out-of-court settlements.  In particular, paragraph 21 of the GSTR 2001/4 sets out the fundamental criteria that must be satisfied for there to be a 'supply for consideration', namely: 

(a) there must be a supply

(b) there must be a payment, and

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

Paragraphs 51 to 54 of the GSTR 2001/4 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:

(a) surrendering a right to pursue further legal action .. or

(b) entering into an obligation to refrain from further legal action..; or

(c) releasing another party from further obligations in relation to the dispute...

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 of the GST Act being met in relation to that supply.

Consequently, your agreement to discontinue the proceedings and counter claims, withdraw the caveat, and release from any claims which you may have, constitute a supply for the purposes of the GST Act, which is referred to as a discontinuance supply.

As part of the terms of settlement, the contract for the sale of the property was terminated, and the plaintiff has agreed to make a payment to you of the settlement sum in satisfaction of your claims. Accordingly, it is necessary to determine if this payment was made in response to your supply.

In relation to discontinuance supply, paragraphs 106 to 109 of GSTR 2001/4 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.

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.

On the information provided, there is nothing to suggest that the subject of the dispute lacks substance to the extent that it can be construed the payment is only made for the discontinuance supply.  In accordance with paragraphs 106 to 108 of GSTR 2001/4 above, as a sufficient nexus cannot be established between the discontinuance supply and the settlement payment, it is considered that the settlement payment under the agreement is in response to the damages claim rather than the discontinuance supply. 

Furthermore, the settlement payment made in response to a court order or out-of-court settlement will not constitute, by itself, consideration for a supply made by you. This is confirmed by paragraphs 73, 110 and 111 of GSTR 2001/4 which state:

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.

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply. If a payment made under a court order is wholly in respect of such a claim, the payment will not be consideration for a supply.

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.

Accordingly, the settlement sum (payment) does not represent consideration for a discontinuance supply under the terms of settlement, or any supply underpinning the damages claim. As one of the requirements for a taxable supply under section 9-5 of the GST Act is not satisfied, you are not making a taxable supply in relation to the settlement sum (payment) received.