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Ruling

Subject: GST and out-of-court settlements

Question

Are the payments made pursuant to an out-of-court Deed of Settlement by the Defendants, in an action between you (Plaintiff) and the Defendants, consideration for any taxable supply made by you?

Answer

No.

Relevant facts and circumstances

You are registered for goods and services tax (GST).

You contracted to have something constructed.

After completion, faults were found with the construction.

Litigation was commenced, with you and the Defendants deciding to enter into an out-of-court settlement (Deed).

The Deed contains clauses that require the Defendants to pay you for damages incurred.

There are also clauses in the Deed that release all the relevant parties from any claim with respect to the damages claimed by you.

You and the Defendants met their own costs.

Relevant legislative provisions

All references are to the A New Tax System (Goods and Services Tax) Act 1999:

Section 9-5

Section 9-10

Section 9-40.

Reasons for decision

Section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you must pay GST on any taxable supply that you make.

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 an enterprise that you carry on

· the supply is connected with Australia, and

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

Note that the supply is not a taxable supply to the extent that it is GST-free or input taxed. However in this case, any possible supply identified in the Deed would not be GST-free or input taxed under the GST Act or any other Act.

Goods and Services Tax Ruling 2001/4 (GSTR 2001/4) considers the GST consequences resulting from court orders and out-of-court settlements (available from the ATO website www.ato.gov.au). It provides that an out-of-court settlement will include any form of dispute in which the terms of the resolution are agreed between the parties rather than imposed by the court. Given this, the Deed between you and the Defendants is an out-of-court settlement for the purposes of GSTR 2001/4.

Therefore, it now becomes necessary to determine whether the payments made by the Defendants under the Deed are consideration for a supply made by you, and if so, whether the supply is taxable under section 9-5 of the GST Act.

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

o there must be a supply

o there must be a payment, and

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

There must be a supply

The term supply is a broad concept for GST purposes and is defined in section 9-10 of the GST Act to include any form of supply whatsoever. Given the broad meaning of supply, GSTR 2001/4 sets out three different types of supplies that could be involved in an out-of-court settlement. These are:

o an earlier supply - where the subject of the dispute is an earlier transaction in which a supply was made involving the parties

o a current supply - a new supply created by the terms of settlement, or

o a discontinuance supply - where as a condition of settlement one or all of the parties agree to release each other from all, or some of the existing claims and/or further claims and obligations.

The dispute between you and the Defendants does not relate to any of the terms or conditions of the original construction project and therefore is not related to an earlier supply. Neither has a new supply been created as a consequence of the terms of the Deed. Therefore, we need to determine if you have made a discontinuance supply.

Paragraph 50 to 55 of GSTR 2001/4 discusses supplies related to discontinuance of action and characterises a discontinuance supply 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 obligation in relation to the dispute 

The Deed releases all the relevant parties from any claim with respect to the loss and damage claimed by you. Given this, the terms of the Deed indicate that there may be a discontinuance supply given you and the other parties have agreed to discontinue any further action in relation to the faulty construction.

There must be a payment

Under the clauses contained in the Deed you were paid by the Defendants, therefore this requirement is satisfied.

There must be sufficient nexus between the supply and the payment

The Deed makes it clear that the payments are principally a payment for damages resulting from a breach of contract and / or negligence by the Defendants.

Paragraph 106 of GSTR 2001/4 states:

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.

Further to this, paragraph 109 of GSTR 2001/4 explains 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 is so lacking in substance that the payment could only have been made for the discontinuance supply.

In view of the above, we consider the settlement sum you received is for damages and has no nexus with the discontinuance supply provided in the Deed.

Further to this, paragraphs 71 and 111 of GSTR 2001/4 also provides that claims for damages are not supplies under 9-10 of the GST Act.

71. 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 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.

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.

Therefore, your claim for damages in relation to the faulty construction does not constitute a supply for GST purposes and the payments are not consideration for any supply made by you. Therefore, you have not made a taxable supply under section 9-5 of the GST Act with the payments consequently not being subject to GST.