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Ruling

Subject: GST and out-of-court settlement

Questions

1. For the purposes of the goods and services tax (GST) has any supply occurred when you the defendant made the agreed payment to Company X (plaintiff) under the Deed of Settlement? (Deed)?

2. If Company C is liable to pay GST are they entitled to claim back the GST paid on the payment made to the plaintiff under the Deed of Settlement?

3. If an apportionment of the payment is required between you and Company C, how should this apportionment be done?

Advice

1. No, no supply has occurred when you the defendant made the agreed payment to the plaintiff Company X under the Deed. Accordingly, GST is not applicable to this payment.

2. Not applicable as GST is not applicable to the payment made under the Deed.

3. Not applicable as GST is not applicable to the payment made under the Deed.

Relevant facts

You were an employee of Company X for several years. You resigned from your work and started your own business through a company, Company C.

Company C is registered for GST and you are the director of Company C.

Company X commenced proceedings in the State District Court for breach of restraint of trade ('the Proceedings') to stop Company C from trading.

You (the defendant), Company C and Company X (the plaintiff) agreed to settle the whole of the disputes including the Proceedings under a Deed of Settlement (Deed).

The terms of settlement are as follows:

Agreement

The parties have reached the following agreement in full and final settlement of the dispute:

1. That the defendant pay to the plaintiff the sum of XXX ('the Settlement monies') within fourteen (14) days of execution of this Deed ('the payment').

2. That contemporaneously with the payment referred to in clause 1 above, the parties shall consent to an order that the Orders made in the State District court be set aside.

3. That contemporaneously with the payment referred to in clause 1 above, the parties shall sign all necessary documents and take all steps required to:

3.1 effect the setting aside of the Order referred to in clause 2 above; and

3.2 effect a discontinuance of the proceeding ('the proceeding').

4. That subject to the payment the parties acknowledge and agree that the facts and matters pleaded by the plaintiff's statement of claim in the Proceeding are, by this settlement, compromised and further:

4.1 the parties release, discharge and indemnify the other with respect to any and all causes of actions, claims or proceedings which either party may presently have against the other which relate to the matters involved in the Proceeding, including any claims against Company C, now or in the future arising out of or in connection with the facts and matters pleased in the Proceeding;

4.2 this settlement may be pleaded as a bar to any action, suit or proceeding commenced by either party against the other, or against Company C, in respect of any of the matters referred to in this settlement.

5. That subject to the payment the parties acknowledged and agreed that the terms set out under the heading 'Termination of Employment 'in paragraph Y of the letter of offer of employment to the defendant dated XXX shall not apply and be of no force or effect and as such the defendant is not either on his own accord or on behalf of any other person or entity...

6. …

7. .…

8. ..…

9. Release. Discharge and Indemnity

Subject to the terms of this Deed, the parties hereby release, discharge and indemnify each other with respect to any and all causes of actions, claims or proceedings which either party may presently have against the other but for the execution of this document which relates to the matters involved in the dispute.

Relevant legislative provisions

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 decisions

Question 1

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

Goods and Services Tax Ruling GSTR 2001/4 sets out the Commissioner'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.

According to paragraph 21 of GSTR 2001/4 three fundamental criteria must be met for there to be a supply for consideration and these three criteria are:

(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 under subsection 9-10(1) of the GST Act includes any form of supply whatsoever. GSTR 2001/4 explains that supplies related to out-of-court settlements fall within one of three categories which are:

(i) earlier supply;

(ii) current supply;

(iii) 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;

· releasing another party from further obligations in relation to the dispute.

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 the supply.

Under the Deed of Settlement an agreed amount was paid to the plaintiff as an out-of-court settlement representing compensation and the terms in the Deed provide for discontinuance of the Proceeding and the setting aside of the Order referred to in clause 2 of the Deed subject to payment.

In this instance, there is no earlier supply or current supply relating to the agreed payment and the Deed includes a discontinuance supply.

In regard to discontinuance supply, paragraphs 106 to 109 of GSTR 2001/4 state the following:

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.

Furthermore, the distinction between a damages claim and a discontinuance supply is explained at paragraphs 110 and 111 of GSTR 2001/4. Paragraph 111 of GSTR 2001/4 states the following:

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 where there is an identifiable discontinuance supply under the settlement.

In this case, there is no earlier or current supply and we consider the payments made under the Deed are more in the nature of payments for damages rather than consideration for the discontinuance supply as the Deed does not give the discontinuance supply a separately ascribed value and the discontinuance supply is just a term or condition of the settlement. The payment under the settlement is in respect of the damages claim and therefore does not have a sufficient nexus with the discontinuance supply.

Accordingly, in line with paragraph 111 of GSTR 2001/4 the agreed payment is not consideration for a supply regardless of the discontinuance supply under the Deed.