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Ruling

Subject: GST and payments under a court order

Question 1

Are payments made by Entity 2 pursuant to the Court Orders 2(a), (b), (d), and (e) to compensate Entity 1 for lost past rent and lost future rent consideration for supplies made by Entity 1?

Answer

No. Payments made by Entity 2 pursuant to the Court Orders 2(a), (b), (d), and (e) to compensate Entity 1 for lost past rent and lost future rent are not consideration for supplies made by Entity 1.

Question 2

Are payments made by Entity 2 pursuant to Court Orders 2(c) and (g) to compensate Entity 1 for interest on damages for lost past rent and interest on damages for legal fees thrown away consideration for supplies made by Entity 1?

Answer

No. Payments made by Entity 2 pursuant to Court Orders 2(c) and (g) to compensate Entity 1 for interest on damages for lost past rent and interest on damages for legal fees thrown away are not consideration for supplies made by Entity 1.

Question 3

Are payments made by Entity 2 pursuant to Court Orders 2(f), 3, and 5; on account of damages for legal fees thrown away, the costs of the proceedings to restore Entity 2's registration as a corporation, and the costs of the Court action consideration for supplies made by Entity 1?

Answer

No. Payments made by Entity 2 pursuant to Court Orders 2(f), 3, and 5; on account of damages for legal fees thrown away, the costs of the proceedings to restore Entity 2's registration as a corporation, and the costs of the Court action are not consideration for supplies made by Entity 1.

Relevant facts and circumstances

The parties

Entity 1 is the lessor in a lease of land and buildings (lease) granted to Entity 3 in 200X for the use of the leased premises as a business.

The land subject to the lease was Crown land owned by The Trust which, pursuant to the relevant statute, had appointed Entity 1 to manage the Trust's affairs.

Entity 1 retained Entity 2 to negotiate the lease.

The mistake

Entity 2 proposed to Entity 1 that both landlords and tenant's fixtures and fittings should be taken into account for the purposes of the valuation used to calculate the rent payable under the lease. Entity 1 advised Entity 2 that Entity 1 intended that only the landlord's fixtures and fittings should be taken into account for that purpose.

When Entity 2 amended the relevant clause in the lease, however, Entity 2 amended the preamble to that clause to read:

For the removal of doubt the value of the following fixtures and fittings are to be ignored:

and added a subclause which referred to the tenant's fixtures and fittings.

Unfortunately that subclause ended with the word 'and' and on the following page there was a further subclause which referred to the landlord's fixtures and fittings.

The effect of this mistake was that both tenant's and landlord's fixtures and fittings were to be ignored when calculating the rent payable by Entity 3, as described in the judgment of the Court (see below) (Para 4):

Consequent upon execution of the agreement and lease, Entity 3 became liable to pay calculated ground rent, subject to discounts which I will later describe, rather than rent on the improved property.

The business on the leased premises had been destroyed by fire in 200Y but Entity 3 had elected, pursuant to the terms of an earlier lease (granted for a 10 year term and renewed for a further term which expired in 200X), to restore and repair the business (which prevented Entity 1 from terminating the earlier lease).

The business was rebuilt by 200X and payments of rent under the lease fell due with effect from July 200X. As the lease provided for the landlord to become owner of any building improvements at the end of the Z year term, Entity 3 sought a discount on the rent payable over the term of the lease to reflect Entity 3's contribution.

Entity 1's valuer considered that the commencing rent under the lease should have been $xxx,xxx (i.e. taking into account the landlord's fixtures and fittings). The annual rent paid by Entity 3 commenced at $xx,xxx (i.e. the ground rent subject to discounts) and had risen to $xx,xxx for the year ended July 20WW.

Entity 1 commenced court proceedings against Entity 3 seeking rectification on the basis of either mutual mistake or that Entity 3 was aware of the mistake but acted unconscionably. Those proceedings were dismissed.

The Court proceedings and Orders

The Trust (first plaintiff) and Entity 1 (second plaintiff) then commenced proceedings against Entity 2 in the Court seeking damages for breach of retainer and negligence.

The Court issued reasons for findings, including a finding that there should be verdict and judgment in favour of the Trust and Entity 1, although any damages assessed were to be reduced by a percentage for contributory negligence and the Trust and Entity 1 were not entitled to recover the costs of the failed rectification proceedings.

The Court granted the parties leave to make submissions on damages and costs and, after receiving and considering those submissions, issued a judgment. The Court entered judgment for the Trust and Entity 1 against Entity 2 and made a number of Orders including the following:

Order 2 sets out the amounts which Entity 2 was required to pay to the Trust and Entity 1, taking into account the certain percentage reduction for contributory negligence:

2 [Entity 2] is to pay to [the Trust and Entity 1] the following amounts:

a. $xxx,xxx on account of damages for lost past rent;

b. $xx,xxx for GST (if payable) on the amount in sub-paragraph (a) above, but subject to the regime set out in Order 4 below;

c. $xxx,xxx on account of interest upon damages for lost past rent;

d. $xxx,xxx on account of damages for lost future rent;

e. $xx,xxx for GST (if payable) on the amount in sub-paragraph (d) above, but subject to the regime set out in Order 4 below;

f. $x,xxx on account of damages for legal fees thrown away; and

g. $x,xxx on account of interest upon damages for legal fees thrown away.

Order 3 deals with costs incurred in order to restore Entity 2's registration as a corporation so that the Court proceedings could be commenced.

3 [Entity 2] is to pay to [the Trust and Entity 1] the amount of $xx,xxx on account of the costs of the proceedings to restore the Defendant's registration as a corporation.

Order 4 addresses GST on the various amounts payable by Entity 2 to the Trust and Entity 1. Order 4(a) states that within 30 days the Trust and Entity 1 will issue a tax invoice to Entity 2 in relation to the damages components of Order 2 which bear, or possibly bear, GST and Order 4(b) states that Entity 2's obligation to pay the GST component of the award of damages is subject to a number of terms, including Entity 1 obtaining a ruling from the ATO indicating that Entity 1 is liable to remit GST to the ATO in relation to the damages and providing a copy of that ruling to Entity 2 (Order 4(b)(iii)).

Order 5 states that Entity 2 is to pay V% of Entity 1 costs of the action as agreed or assessed up to June 20WW.

Order 6 states that Entity 1 is to pay Entity 2's costs of the action on a full indemnity basis from June 20WW.

Order 7 states that, notwithstanding Order 6, there is no order as to costs, with the intent that each of the parties bear their own costs of and incidental to the listing of the matter before the court and various other matters that occurred in the relevant year.

Issue of tax invoice and payment

Entity 1 issued a tax invoice to Entity 2 for $x,xxx,xxx comprising:

$xxx,xxx plus $xx,xxx GST damages for lost past rent payable (per Order 2(a) and (b)); and

$xxx,xxx plus $xx,xxx GST for damages for lost future rent (per Order 2(d) and (e)).

Entity 1 advised that Entity 2 paid to Entity 1 all of the amounts referred to in the Orders, although no amount was paid to Entity 1 in relation to Order 7.

Ruling request:

Entity 1 lodged a request for GST private rulings confirming whether payments by Entity 2 to Entity 1 pursuant to the Orders:

for loss of past rent and loss of future rent;

to compensate Entity 1 for interest; and

to compensate Entity 1 for legal costs constitute consideration for supplies made by Entity 1.

Entity 1 submitted that there was a nexus between a taxable supply and the payments made by Entity 2 pursuant to Orders 2(a), (b), (d) and (e) as damages for lost past rent and damages for lost future rent respectively and that GST was payable in respect of those amounts.

In relation to damages for loss of past rent, Entity 1 submitted:

We submit that there is an earlier supply in relation to the lost past rent. The substance of the dispute is the payment of rent.The payment of rent for commercial premises is ordinarily a taxable supply for the provision of those premises and is subject to GST. The dispute with Entity 2 is essentially for the underpayment of rent. The payment by Entity 2 of the sum of $xxx,xxx although paid by Entity 2 who is not the tenant, is a substitution for an amount that would otherwise be payable by the tenant and accordingly the sum ordered to be paid is a direct substitution of rent.

In relation to damages for loss of future rent, Entity 1 submitted:

For similar reasons given above in relation to earlier supplies the payment of the sum of $xxx,xxx for lost future rent is a direct substitution for rent that would have otherwise been received as rent in future years. Similarly if the plaintiffs had been successful in their litigation against the lessee and obtained increased rental payments in the future they would be in the nature of rent.

Alternatively this amount could also be regarded as an extension into the future of an earlier supply.

Entity 1 submitted that there was no nexus between a taxable supply and any amounts payable under any of the other Orders and that GST was therefore not payable in respect of those amounts.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) 1999 Act, section 7-1

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

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

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

A New Tax System (Goods and Services Tax) 1999 Act, Division 19

Reasons for decision

Question 1

Summary

Payments made by Entity 2 pursuant to Orders 2(a), (b), (d) and (e) of the Court to compensate Entity 1 for lost past rent and lost future rent do not constitute consideration for supplies made by Entity 1.

Detailed reasoning

Payment made pursuant to a Court order may be consideration

Section 7-1 of the A New Tax System (Goods and Services Tax) 1999 Act (GST Act), provides that GST is payable on taxable supplies. For a supply to be a taxable supply, it must meet the requirements of section 9-5 of the GST Act, which states that:

You make a taxable supply if:

(a) you make the supply for *consideration; and

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

(c) the supply is *connected with Australia; and

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

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

(The asterisks indicate terms defined under section 195-1 of the GST Act).

'Supply' is defined in subsection 9-10(1) of the GST Act as any form of supply whatsoever. However, a supply of money is expressly excluded from the definition of supply by subsection 9-10(4) of the GST Act.

'Consideration' is defined in section 9-15 of the GST Act to include any payment in connection with, in response to, or for the inducement of a supply of anything and subsection 9-15(2A) states:

It does not matter:

(a) whether the payment, act or forbearance was in compliance with an order of a court, or of a tribunal or other body that has the power to make orders; or

(b) whether the payment, act or forbearance was in compliance with a settlement relating to proceedings before a court, or before a tribunal or other body that has the power to make orders.

Goods and Services Tax Ruling GSTR 2001/4 deals with the GST consequences of court orders and out of court settlements and discusses subsection 9-15(2A) as follows:

99. This provision negates any argument that the characterisation of a payment according to section 9-15 either as consideration for a supply or otherwise could be affected by the payment being made in compliance with a court order or settlement relating to proceedings before a court.

GST treatment of court orders

GSTR 2001/4 states that the GST consequences of a court order will depend on whether a payment made under the order constitutes consideration for a taxable supply (Para 17). GSTR 2001/4 describes:

an 'earlier supply' (i.e. a supply that occurs before a dispute arises and is the subject of the dispute);

a 'current supply' (i.e. a supply that occurs as part of resolution of a dispute); and

a 'discontinuance supply' (e.g. a plaintiff releasing a defendant from all future claims)

and states that an earlier supply may be the subject of a dispute resolved by court order, a current supply may arise as a result of a court order, e.g. transferring assets to another entity pursuant to a court order (Para 68), but that there is no discontinuance supply in relation to a dispute resolved by court order because the court order settles the dispute without either party surrendering a right, entering into an obligation or releasing another party from obligations (Para 69).

GSTR 2001/4 then discusses disputes which do not relate to a supply:

Where the subject of a claim is not a supply

71. Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury.

72. When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation.

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 made by the aggrieved party. 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.

Analysis of the Court's judgment and Orders

In the ruling request it was submitted (Appendix A, p. 4):

We submit that there is an earlier supply in relation to the lost past rent. The substance of the dispute is the payment of rent.

We disagree. The judgment of the Court indicates that the Trust and Entity 1 sought damages from Entity 2 for either breach of retainer (i.e. breach of the contract pursuant to which the Trust and Entity 1 engaged Entity 2) or negligence. The judgment states:

This is an action seeking damages for breach of retainer or negligence brought against what was an incorporated solicitor's practice.

The Court found that Entity 2 owed Entity 1 a duty of care:

There is no dispute that the defendant owed their client a duty of care. Part of the discharge of that duty necessitated carrying out explicit instructions.

and that Entity 2 had breached that duty of care, despite the facts that Entity 2 sent the amended lease to Entity 1 accompanied by a letter seeking Entity 1's approval of the amended lease and Entity 1 officials failed to review the amendments made to the lease:

Neither the expression in the particular letter nor the history of formal interaction between the two parties operates to discharge the defendant from liability for the breach of duty manifest in their failure to carry out the express instructions.

The Court also found that Entity 2's breach of the duty of care caused loss to the Trust and Entity 1:

To the extent that the defendant challenged causation, in accordance with the precepts now incorporated in statute, two inquiries are apt. First, was the negligence, that is the failure to carry out instructions which became incorporated by the mistake, a necessary condition of the occurrence of the loss, and second, is it appropriate for the liability of the defendant to extend to harm so caused? I would answer both inquiries in the affirmative.

The Court also noted that Entity 1 conceded some contributory negligence, i.e. Entity 1's failure to check the amended lease and confirm that Entity 2 had carried out Entity 1's instructions:

In final submissions, the plaintiffs conceded contributory negligence. That concession was appropriate…

Any assessment of damages therefore will be reduced by a percentage.

The Court then calculated the damages payable in respect of the loss suffered by the Trust and Entity 1 under the various heads claimed by the Trust and Entity 1, i.e.

losses to date due to the rent being calculated based on ground rent;

losses into the future for the same reason;

legal fees paid to Entity 2 by Entity 1;

costs associated with the rectification proceedings which were dismissed; and

costs associated with restoring Entity 2's registration as a corporation.

After receiving further submissions the Court issued a Supplementary Judgment. The claim by Entity 1 for reimbursement of legal fees paid to Entity 2 was abandoned because Entity 1 had never paid the relevant invoices, but amounts for reimbursement of legal fees paid by Entity 1 to Entity 2 were held to be recoverable as damages. The Court stated:

The question really is whether the defendant would have been entitled to have been paid for work negligently performed.

and stated that the amounts payable by Entity 2 under this head also should be reduced by a percentage for contributory negligence.

The Court held that the costs incurred by Entity 1 in restoring Entity 2's registration as a corporation was recoverable as damages because that restoration was an essential step before the Court proceedings could be commenced.

The Court was satisfied that the Trust and Entity 1 had proved loss in respect of rent income and therefore were entitled to be compensated for that loss.

When discussing costs the Court stated:

Nevertheless, the plaintiffs have been significantly successful in proving the core contention of the statement of claim that, as a result of the defendant's negligence, substantial loss has been and will be incurred. I have not found it necessary to distinguish between the defendant's breach of duty in tort or deriving from his retainer.

Application of GSTR 2001/4 to the facts

The Court's judgment indicates that the Trust and Entity 1 sought damages for breach of contract and negligence and that the Court found that the Trust and Entity 1 were successful in proving that loss has been and will be incurred as a result of Entity 2's negligence. We therefore consider that the dispute in the present case 'does not relate to a supply' as explained in paragraphs 71 to 73 of GSTR 2001/4 (above).

We do not agree with the submissions made in the ruling request that the payments made by Entity 2 pursuant to Orders 2(a) and (b) in respect of past rent relate to an 'earlier supply' and that the payments made pursuant to Orders 2(d) and (e) relate to a 'current supply'. In our view the 'past rent' and 'future rent' calculations made by the Court merely addressed the various ingredients of the loss which the Trust and Entity 1 suffered as a result of the breach of retainer or negligence by Entity 2, as discussed in the Court's judgment:

The plaintiffs claim damages under several separate heads and they will need to be considered individually.

The first ingredient consists of losses to date by reason of the receipt of rents from Entity 3 on a ground rent calculation only as opposed to larger rent which would have been expected to have been received but for the error calculated to date and into the future during the term of the Z year lease now held by Entity 3.

Consequently the payments made by Entity 2 pursuant to Orders 2(a), (b), (d), and (e) for lost past rent and lost future rent are not consideration for a supply and are not subject to GST.

Adjustment Event

Entity 1 provided a copy of a tax invoice issued by Entity 1 to Entity 2 for the lost past rent and lost future rent plus GST on those amounts and the ruling request states that all of the amounts referred to in the Orders were paid to Entity 1.

As a result of this ruling Entity 1 is obliged by Order 4(b)(iv) of the Court's Orders to return the GST components of the awards of damages for lost rent to Entity 2 by the relevant date.

The amounts paid by Entity 2 pursuant to Orders 2(a), (b), (d), and (e) have been treated as consideration for a taxable supply made by Entity 1. As a result of this ruling and Order 4(b)(iv) there may be an adjustment event within the meaning of paragraph 19-10(1)(a) of the GST Act, Entity 1 may have a decreasing adjustment, and Entity 2 may have an increasing adjustment.

Question 2

Summary

Payments made by Entity 2 pursuant to Order 2(c) (interest on damages for lost past rent) and Order 2(g) (interest on damages for legal fees thrown away) of the Court are not consideration for taxable supplies made by Entity 1.

Detailed reasoning

GSTR 2001/4 states:

116. Where a court order (issued in accordance with the court's judgment on the case) itself dissects and itemises the payment into the heads of claim relating to the individual supplies and / or item of damages, that itemisation will be accepted as representing the amounts of these relevant parts.

Orders 2(c) and 2(g) respectively require Entity 2 to pay amounts 'on account of interest' in respect of lost past rent (whereas lost future rent was discounted for the vicissitudes which weighed against the lease operating uninterrupted for the next Z years) and in respect of legal fees paid by Entity 1 to Entity 2 'from the date of payment'.

In our view Orders 2(c) and 2(g) are intended to compensate Entity 1 for not having the use of the past rent between the date it would have been paid (i.e. from July 200X) and the date the Orders were made and for not having the use of the money paid for legal fees between the dates Entity 1 paid the relevant invoices and the date of the Orders were made.

We therefore consider that the amounts which Entity 2 are required to pay 'on account of interest' are similar to a charge for late payment as discussed in Goods and Services Tax Advice GSTA TPP 018, i.e. consideration for a financial supply and therefore not subject to GST:

Goods and services tax: Can an interest charge be a change in consideration and therefore an adjustment event (as opposed to a financial supply)?

Answer

No, an interest charge is consideration for a financial supply and does not give rise to an adjustment event.

Explanation

Goods and Services Tax Ruling GSTR 2000/19 making adjustments under Division 19 for adjustment events (as amended) explains how division 19 of the GST Act operates. In relation to late payment charges it comments:

29. A charge for late payment that is consideration for the supply of an interest in a credit arrangement does not give rise to an adjustment event. The charge is consideration for a financial supply. Whether a charge for late payment is consideration for the acquisition of an interest in a credit arrangement will depend on the facts of each case. The description given to the charge (for example, as 'damages' or 'liquidated damages') by the parties is relevant but not conclusive. It is necessary to determine the true character of the arrangement having regard to the terms of the agreement and other relevant circumstances.

Question 3

Summary

The payments made by Entity 2 pursuant to Order 2(f) (on account of damages for legal fees thrown away), Order 3 (on account of the costs of restoring Entity 2's registration) and Order 5 (V% of the Plaintiffs' costs of the Court action up to June 20WW) do not constitute consideration for supplies made by Entity 1 and are not subject to GST.

Detailed reasoning

The ruling request asked whether payments by Entity 2 'to compensate Entity 1 for legal costs' were consideration for taxable supplies made by Entity 1.

The submissions in the ruling request relating to legal costs, however, referred to both:

Order 2(f) (Entity 2 to pay $x,xxx on account of damages for legal fees thrown away); and

Order 5 (Entity 2 to pay V% of the costs of the plaintiffs' costs of the Court proceedings as agreed or assessed up to June 20WW)

It was submitted that Order 2(f) and Order 5 were covered by paragraphs 147 to 149 of GSTR 2001/4 (see below).

The ruling request also included a submission that the amount payable by Entity 2 pursuant to Order 3 on account of the costs incurred by the Trust and Entity 1 in the court proceedings to restore Entity 2's registration as a corporation was in the nature of damages and not consideration for a supply.

The Order 2(f) amount is the sum of fees of charged by Entity 2 to Entity 1 reduced by a certain percentage for contributory negligence, as discussed in the Court's judgment:

Heads of damage

The plaintiffs claim damages under several separate heads and they will need to be considered individually.

…

The second ingredient are some fees for 'the legal work' charged by the defendant for acting for Entity 1 on the Entity 3 lease.

and:

The plaintiffs submit that these sums are recoverable as damages in the action either as 'wasted expenditure or expenditure incurred by reasons of the defendant's breach of duty'.

and:

I will include these components (with appropriate interest) in the damages assessment. It will therefore be vulnerable to reduction by reason of the finding of contributory negligence.

In our view this discussion confirms that the Order 2(f) amount is an ingredient of the damages payable by Entity 2 to compensate the Trust and Entity 1 for the loss resulting from Entity 2's breach of retainer or negligence. For the reasons set out above in Question 1 we therefore consider that the amount payable by Entity 2 pursuant to Order 2(f) is not consideration for a supply made by the Trust or Entity 1.

GSTR 2001/4 states:

Costs

145. When a dispute is finalised, either by a court giving judgment or through negotiation of a settlement, the unsuccessful party in the action may be required to pay the costs or part of the costs that have been incurred by the successful party in bringing or defending the claim. These costs, referred to as party costs, could include barrister's fees, solicitor's costs, fees for various expert reports and court costs.

146. In any legal action the parties concerned are required to pay their legal advisers the solicitor client costs incurred and the supply of these legal services will attract GST and be GST inclusive sums to the extent that they are not GST-free. Both parties to a dispute, as recipients of a supply of legal representation respectively, may be entitled to an input tax credit for a creditable or partly creditable acquisition of these services.

147. For the purposes of this Ruling, we are concerned with the subsequent stage when the successful party is able to recover costs wholly or partly through a court order for costs or by negotiation of an amount in a settlement.

148. As we have seen for a supply to be a taxable supply the conditions under section 9-5 of the GST Act must be met. In the instance of the payment of costs under the court order or settlement there is no supply for consideration from the successful party to the unsuccessful party. This is essentially paying compensation for costs or losses incurred in the dispute and will be treated in the same manner as damages under paragraphs 110 and 111.

149. Accordingly, the payment of court ordered costs or costs negotiated in a settlement in the circumstances described will not be consideration for an earlier or current supply. It does not matter that the payment of the costs order or settled amount is made by an entity other than the unsuccessful party.

Based on the analysis in paragraph 148 of GSTR 2001/4, we consider that there is no supply for consideration made by either the Trust or Entity 1 in relation to the amounts paid by Entity 2 pursuant to Order 3 and Order 5 because those payments are merely compensation for costs incurred by the Trust and Entity 1 in the dispute.