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Ruling

Subject: GST and a settlement payment

Question:

Is an Australian company (you) liable for goods and services tax (GST) in respect of the settlement payment received under the settlement deed?

Answer:

No, the 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 company (you) carries on an enterprise as a sales agent for certain products.

You are registered for GST.

You and another Australian company (AusCo) had previously entered into a number of agreements, referred to as the sales agency agreements. As a result of these agreements, you held the exclusive right to act as AusCo's agent and promote certain products in Australia.

You have alleged that AusCo wrongfully repudiated the sales agency agreements and that you suffered consequential loss and damage, which was denied by AusCo. A Settlement Deed was then prepared to resolve matters and to terminate the sales agency agreements.

There are two payments to be made under the Settlement Deed, being the 'settlement payment' and the 'final payment'.

The final payment is in return for satisfactory performance by you of certain obligations and is not the subject of this private ruling.

The Settlement Deed refers to the 'settlement payment' in certain clauses.

You advise that the settlement payment is not a payment foreseen in the original sales agency agreements as a likely payment upon termination. Under these agreements the only payment to be made by AusCo upon termination, subject to certain conditions, to you is the commission on sales.

You have not issued a tax invoice to AusCo for any supply under the Settlement Deed.

The Settlement Deed (Deed) between you and AusCo provides (amongst other things) the following:

· You alleged that AusCo wrongfully repudiated the sales agency agreements and that you had suffered consequential loss and damage. AusCo has denied those allegations. By consent, the parties agree that the sales agency agreements will continue on their respective terms, except to the extent expressly modified by this Deed until termination date.

· Without admission and solely in the interest of avoiding any dispute in respect of the sales agency agreements, the parties agree to resolve all matters between them on the terms set out in this Deed.

· Transition period and obligations are outlined.

· Restraint - You agree to not undertake certain actions during the restraint period.

· Payments to you -

- AusCo will pay to you the 'settlement payment' as soon as possible after the commencement date, of this Deed.

- AusCo will pay the 'commissions' in accordance with the sales agency agreements.

- Subject to you performing all the respective obligations (including the restraint) of this Deed, AusCo will make the 'final payment' to you after the expiry of the restraint period.

- AusCo may deduct from the 'final payment' certain commissions paid under the sales agency agreements.

· Release and Indemnity -

- Upon payment of the settlement payment, you irrevocably release and discharge AusCo from all demands, claims, causes of action and/or suits arising out of or in connection with the sales agency agreements and the agency relationship whatsoever in law, in equity and/or under statute you have, had or may in the future have against AusCo, including in respect of any damage, loss or expense that the other party has suffered or incurred or may suffer or incur in the future.

- Upon payment of the settlement payment, AusCo irrevocably releases, and discharges you from all demands, claims, causes of action and/or suits arising out of or in connection with the sales agency agreements and the agency relationship whatsoever in law, in equity and/or under statute that AusCo has, had or may in the future have against you, including in respect of any damage, loss or expense that the other party has suffered or incurred or may suffer or incur in the future.

- The Deed may be pleaded by each party as a bar and complete defence to any demand, claim, cause of action and/or suit (other than those to enforce a term of this Deed or any term of any sales agency agreement that survives termination of that agreement).

- Upon execution of this Deed, you indemnify AusCo and in turn AusCo indemnifies you in relation to loss or damage; liability, claim or judgment; and legal costs and expenses, in connection with certain claims by a third party.

· Definitions of agency relationship; commissions; final payment (being for a certain amount); settlement payment (being for a certain amount); restraint period; and termination date are provided.

The sales agency agreements are provided.

· In consideration of you acting on behalf of AusCo in obtaining sales of the products to the customers, AusCo will pay you (as sales agent) the 'commission' for products sold (that is, on each sale of a product) in the territory pursuant to orders obtained by you, at the rates set out in the relevant schedule.

· You are an independent contractor and acts as AusCo's agent only. You are not an employee of AusCo for any purposes.

· Your duties and covenants are outlined (including restraints during the term of the agreement).

· AusCo's and your right to terminate (the agreements) are outlined.

· Payments upon termination:

- Upon termination or expiry of this agreement, AusCo shall pay to you such sums of commission calculated in accordance with this agreement as are owing to you to the date of termination of this agreement and including commissions relating to all orders placed by you. However, if the termination is caused by your breach, then AusCo shall not be liable to pay the commission related to the order(s) that caused the breach.

- This clause also allows repayment of commission for any invoices raised during the term of this agreement, under certain conditions.

· The terms, commission and territory are outlined.

The sales agency agreements also provide (amongst other things):

§ Restraints - In consideration of AusCo entering into this agreement, you agree to the restraints for a period of time following the end of the term, and are restrained from certain activities.

§ Termination - If (a) a party commits a material breach of this agreement and such breach is incapable of remedy, or such breach is capable of a remedy and the party has failed to remedy the breach or (b) an insolvency event occurs in respect of a party, then the other party may terminate this agreement by written notice.

§ Payments after the term - At the end of the term, AusCo will pay to you any commission that is owing to you. However, if the termination is caused by your breach, then AusCo will not be liable to pay the commission related to the order(s) that caused the breach. After the end of the term, AusCo will pay you a fee for a period of time ('restraint payments'). In consideration of AusCo making each restraint payment, you must comply with the restraints until the date of the last restraint payment.

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 1999 (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 in the Settlement Deed (as shown under 'Release and Indemnity') to discontinue the allegations and claims, and to release from any demands, claims and actions which you have, had or may in the future have, constitute a supply for the purposes of the GST Act, which is referred to as a discontinuance supply.

You alleged that AusCo wrongfully repudiated the sales agency agreements and that you had suffered consequential loss and damage, which AusCo has denied. Accordingly, as part of the terms of the Settlement Deed, the sales agency agreements are/will be terminated, and AusCo has agreed to make a 'settlement payment' to you to resolve all matters between the parties. Therefore, it is necessary to determine if this payment was made in response to a 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 are two payments to be made under the Settlement Deed, being the 'settlement payment', and the 'final payment' (other than the commissions in accordance with the sales agency agreements). It would appear that the 'final payment' relates to you performing certain obligations under the Settlement Deed and/or sales agreements (including the restraints during the restraint period). This final payment is not the subject of this private ruling.

You advise that the settlement payment is not a payment foreseen in the original sales agency agreements as a likely payment upon termination. Under these agreements the only payment to be made by AusCo upon termination, subject to certain conditions, to you is the commission on sales. The references to the 'settlement payment' is provided for under certain clauses and in the definition (of the Settlement Deed) to mean a certain amount.

You alleged that AusCo wrongfully repudiated the sales agency agreements and that you had suffered consequential loss and damage, which AusCo has denied. However, AusCo has agreed to make a 'settlement payment' to you of a certain amount to resolve all matters between the parties. Upon payment of the 'settlement payment' to you, there is an agreement in the Settlement Deed to discontinue the allegations and claims, and to release from any demands, claims and actions.

On the basis of the facts 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 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 payment received, and therefore you are not required to remit GST to the Australian Taxation Office (ATO) on the settlement payment.

Additional Information - apportionment

Where payment made under a court order or out-of-court settlement has a sufficient nexus with more than one supply, 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.

Where the terms of the settlement include a dissection and itemisation of the payment into the heads of claim, that itemisation will be accepted as representing the amounts of these relevant parts to the extent that it is made on a reasonable basis. The appointment should be determined by the parties on a reasonable basis. Where a payment is apportioned in a manner that cannot be justified in terms of reasonableness, the general anti-avoidance provisions of the GST Act may have application.

Further information is provided in GSTR 2001/4 which is available at the ATO website at www.ato.gov.au