Edited version of your private ruling

Authorisation Number: 1012449823401

Ruling

Subject: GST treatment of court ordered payments.

Question 1

Is the payment that is made to you in compliance with a court order, consideration for a supply?

Answer

No. The payment is not consideration for a supply.

Question 2

(a) Is any part of the payment that is made by you to indemnifying creditors in compliance with a court order under section 564 of the Corporations Act 2001 consideration for a supply?

(b) If so, is this payment consideration for a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

(a) Yes. A payment by you to indemnifying creditors for supplies made after 1 July 2000 under the indemnification agreement is consideration for a supply.

(b) No. This payment is consideration for an input taxed financial supply provided that all of the conditions in subregulation 40-5.09(1) of the A New Tax System (Goods and Services Tax) Regulations 1999 are met.

Relevant facts and circumstances

You are a liquidator for a company and you are registered for GST.

You commenced court proceedings and were awarded a court ordered payment.

You entered into an indemnification agreement with creditors of the company for the purpose of undertaking litigation action. Under this agreement you agreed to endeavour to procure an order of the Court under section 564 of the Corporations Act 2001 to apply any recovered amounts in a certain order of priority.

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

A New Tax System (Goods and Services Tax) Act 1999 Section 40-5

A New Tax System (Goods and Services Tax) Regulations 1999 40-5.09

A New Tax System (Goods and Services Tax) Regulations 1999:

Subregulation 40-5.09(1), Subregulation 40-5.09(3) table item 2

Sub regulation 40-5.06(1)

Reasons for decision

Division 58 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that the liquidator as representative of an incapacitated entity is liable for GST in respect of taxable supplies which are taken to have been made by the incapacitated entity from the date of the liquidator's appointment until the liquidator's responsibility ends.

We will consider whether the payment that is made to you is consideration for a supply.

A supply will be a taxable supply if the requirements of section 9-5 of the GST Act are met.

Under section 9-5 of the GST Act, you make a taxable supply if:

(a) you make the supply for consideration; and

(b) the supply is made in the course or 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.

To satisfy paragraph 9-5(a) of the GST Act, there must be a sufficient nexus between a particular supply and a particular payment for there to be a supply for consideration.

The term supply is defined in section 9-10 of the GST Act. A supply can be 'any form of supply whatsoever' and includes a supply of goods or services.

Under subsection 9-15(1) of the GST Act, consideration includes:

o any payment, or any act or forbearance, in connection with a supply of anything; and

o any payment, or any act or forbearance, in response to or for the inducement of a supply of anything.

Subsection 9-15(2A) of the GST Act explains that consideration can include payments made in compliance with a court order or court settlement.

Goods and Services Tax Ruling GSTR 2012/2 (GSTR 2012/2) discusses the nexus between consideration and supply in the context of financial assistance payments.

Paragraphs 125 to 128 provides guidance on the meaning of 'in connection with' for the purposes of section 9-15 of the GST Act.

125. While caution needs to be exercised in applying decisions on connective terms in other contexts, the term 'in connection with' is of wide import and has been held to be broader in scope than 'for'. For example, in the High Court decision in Berry v. FC of T, Kitto J considered the meaning of consideration 'for or in connection with' in the context of former section 84 of the Income Tax Assessment Act 1936, a provision which included consideration for or in connection with goodwill in a lease premium. Kitto J held that 'in connection with' was a broader test than 'for' and commented that consideration will be in connection with property where 'the receipt of the payment has a substantial relation, in a practical business sense, to that property'.

126. In Vidler v. FCT, (Vidler) the Administrative Appeals Tribunal stated:

The GST Act uses expressions such as 'make [a] supply for consideration' (s 9-5(a)) and 'consideration for the supply' (s 75-10(2)), but then, in the Dictionary in s 195-1 and also in the definition in s 9-15(1)(a), embraces within the concept of 'consideration' any payment that is made 'in connection with' a supply. The introduction of that broader concept 'in connection with' cannot have been accidental. It must be assumed that the object of the legislation is to cast the net more widely than would have been the case if, in both s 195-1 and s 9-15(1)(a), the relationship between 'supply' and 'consideration' had been governed by the word 'for' rather than the expression 'in connection with'.

127. The Tribunal then went on to say:

..... It is not sufficient to establish a relationship or an association of some kind between a payment and some act, activity or event that is not a taxable supply, or perhaps not a supply at all, and argue from that position that the payment is not consideration for a supply. For if, despite that relationship or association, there is nevertheless a 'connection' between a payment and some act, activity or event that is a supply, then the payment will form (at least part of) the consideration for that supply.

128. Further, the fact that a voluntary payment can be consideration for a supply under section 9-15 means that there does not have to be an enforceable relationship for there to be a sufficient nexus between the supply and the payment. However, the payment must have a sufficient nexus to a supply.

Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) discusses the GST consequences of payments that arise under a court order.

In your submission you contend that paragraph 67 of GSTR 2001/4 provides support for the view that the extinguishment of a judgment debt by its payment does not constitute a supply by the judgment creditor for GST purposes. We agree that the making of the court ordered payment is not in relation to a supply made by the judgment creditor of a surrender of any rights or release from an obligation in respect of the creditor's right to the court ordered payment.

However a supply may still arise or have arisen in relation to a payment under a court order if the payment has a connection with a supply which relates to the subject matter of the claim. Accordingly we will consider the subject matter of the claim to determine if there is a connection with the payment and the subject matter of the claim for the litigation action.

Paragraphs 71-73 of the GSTR 2001/4 provides guidance on claims where no supply has been made.

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 damages, loss, or injury, in itself does not constitute a supply under section 9-10 of the GST Act.

Further, paragraph 110 of GSTR 2001/4 affirms that a payment made under a court order which is wholly in respect of a damages claim will not be consideration for a supply.

We consider that the payments can be characterised as payments for losses. We consider that the advice in paragraph 73 of GSTR 2001/4 applies because this payment for the loss is the substance of the dispute. Consequently this payment cannot be characterised as consideration for a supply by you.

Even though we hold the view that there is no supply for which the payment has been made, we considered paragraph 68 of GSTR 2001/4 which explains that supplies under court orders may fall within one of two categories.

These categories are:

(i) Earlier supply

(ii) Current supply

Paragraph 46 of GSTR 2001/4 explains that an earlier supply exists where an earlier transaction between the parties is the subject of the dispute. Paragraph 68 of GSTR 2001/4 explains that a current supply is a new supply which is created by the terms of the court order.

In conclusion, the subject of the dispute in the court proceedings does not concern a supply. Therefore the payment awarded to you under the court order is not consideration for a supply.

As the payment made to you does not represent consideration for any supply, it cannot be consideration for a taxable supply. Consequently you have not made a taxable supply for which you receive the payment under the court order. Therefore a GST liability does not arise from the court ordered payment.

Question 2

Note: All references to section 564 are references to section 564 of the Corporations Act 2001.

The reasoning for question 1 explains the requirements of a taxable supply under section 9-5 of the GST Act and specifically the requirement under subsection 9-5(a) of the GST Act for there to be 'a supply for consideration'. As stated in the aforementioned reasoning there must be a connection between the supply and the consideration to satisfy subsection 9-5(a) of the GST Act.

We will consider whether the payment that is made by in compliance with an order of the court under section 564 is consideration for a supply.

GSTR 2001/4 explains the GST consequences resulting from court orders and in particular the circumstances in which there is a link or nexus between a payment in compliance with a court order and a supply. GSTR 2001/4 considers court ordered payments in the context of a dispute between parties.

In the case of a court order under section 564 the court is not making an order in respect of a dispute. Under section 564 an applicant is seeking an order of the court to change the order of the distribution of assets on the winding up of the company because property or expenses of the company have been recovered as a result of indemnities provided by creditors of the company.

Even though the court order under section 564 is not as a result of a dispute, the principles in GSTR 2001/4 which require a nexus between the supply and the consideration still apply.

We will give consideration to the question of whether there is a connection between the court ordered payment under section 564 and any supply made by the indemnifying creditors which would satisfy the requirement under subsection 9-5(a) of the GST Act that there be a 'supply for consideration'.

For completeness, we find that a current supply will not arise under the court ordered payment.

A court ordered payment under section 564, on the winding up of a company, is a payment from the company to those who are entitled to assets of the company under corporations law.

An order under section 564 to alter the order of the payments to creditors is necessary because under corporations law, assets of the company must be paid out in a certain way unless the court orders that it is appropriate to alter the priority and amount of the payment.

The court will consider an application that is made for an order under section 564 and will decide whether to approve or modify the order. The order for the distribution of the funds will be at the discretion of the court.

Whilst the court considers a number of factors when making an order under section 564, the key factors for consideration are that the creditor who is owed monies is entitled to the funds of a company on winding up (subject to certain priorities in payment under corporations law) and that the creditor who has borne a risk in pursuing the debt owed, ought to be rewarded in recognition of the risk.

In making an order under section 564 the courts balance the requirements of all creditors against the risk borne by the indemnifying creditors. In this instance, the indemnifying creditors may receive two payments under the court order. These payments may be paid in priority to the other statutory payment obligations under corporation law.

2nd payment: A payment made in respect of the original proof of debt owed to the creditors

For a payment that may be made under section 564 which represents a payment to the creditor for the original proof of debt that is owed to the creditors, this payment is not consideration for a supply that is subject to GST. In this case, this payment is consideration for transactions that occurred prior to the implementation of the GST. These transactions are out of scope supplies and a GST liability will not arise in respect of these payments.

It does not matter that the order of priority of the payment for the original debt owed to the creditors may change or that the creditors may receive a greater proportion of the debt owed due to the court order under section 564. The payment arises because the creditor is entitled to funds of the company on winding up and this debt was established prior to the action taken by the indemnifying creditors. Accordingly, we consider that there is no nexus between the payment for the original debt and a supply made under the indemnification agreement. In this instance, the payment made under section 564 for amounts in whole or in part of the original debt owed to the creditor will not be subject to GST.

1st payment: A payment made to reimburse the indemnifying creditors in whole or in part for amounts that were advanced by the indemnifying creditors under the agreement

The question arises as to whether the payment by you to reimburse indemnifying creditors for funding the litigation is consideration for a supply made under the indemnification agreement for supplies made after 1 July 2000.

Under the indemnification agreement (agreement), the indemnifying creditors agreed to indemnify you.

We hold the view that the indemnity provided by the indemnifying creditors under the agreement is a supply for the purposes of section 9-10 of the GST Act.

Where an indemnifying creditor receives a payment from you to reimburse the amounts that the indemnifying creditor paid under the agreement, we consider that this payment has a sufficient nexus with supplies made by the indemnifying creditors under the agreement. The repayment by you of funds advanced by the indemnifying creditors is consideration for the supply by the indemnifying creditors under the agreement. Accordingly, subsection 9-5(a) of the GST Act has been satisfied as there is a supply for consideration.

This means that provided that all of the other requirements under section 9-5 of the GST Act are met and the supply is not GST free or input taxed, the supply will be a taxable supply. GST free supplies and input taxed supplies are listed under Division 38 and Division 40 of the GST Act, respectively. A supply under the agreement is not GST free under Division 38 of the GST Act.

We will consider whether the supply is an input taxed financial supply under Division 40 of the GST Act.

Financial supplies are defined in subdivision 40-A of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations.)

Subregulation 40-5.09(1) of the GST Regulations provides that the provision, acquisition or disposal of an interest listed in subregulation 40-5.09 (3) or (4) is a financial supply if

(a) the supply:

· is for consideration;

· is in the course or furtherance of an enterprise;

· is connected with Australia; and

(b) the supplier is:

· registered or required to be registered for GST; and

· a financial supply provider in relation to the supply of the interest.

Item 2 in the table in subregulation 40-5.09(3) of the GST Regulations (Item 2) lists an interest in or under a debt, credit arrangement or right to credit, including a letter of credit.

The Commissioner defines 'credit arrangement' in Schedule 1 (Glossary of Terms) to Goods and Services Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions (GSTR 2002/2) in the following terms:

An arrangement under which an entity lends money on terms that include deferred repayment, or under which payment of a debt owed by one entity to another is deferred or time is allowed to pay.

The glossary in GSTR 2002/2 also defines 'debt' as:

An amount due from one entity to another or a presently existing obligation to pay an ascertainable amount at a future time.

To satisfy the glossary definition of 'credit arrangement', either money must be 'lent' by one entity to another under deferred repayment terms, or a debt must come into existence otherwise than pursuant to a loan arrangement, and the creditor must allow the debtor time to pay the debt.

In this case, funds were advanced by the indemnifying creditors to you however, if the litigation action did not succeed and the court does not make an order pursuant to section 564 in their favour, the indemnifying creditors may not receive a payment. As the litigation action was successful and the court may make an order under section 564 in favour of the indemnifying creditors, the indemnifying creditors may receive a reimbursement of their costs in whole or in part.

As such, you have entered into a contractual obligation to endeavour to secure a payment under section 564 in order to repay the indemnifying creditors if amounts are recovered as a result of the litigation. Accordingly, the indemnifying creditor's entitlement to any reimbursement of amounts advanced under the agreement is contingent on the success of the action. Therefore, the issue is, whether an entity that may have an obligation to repay a sum of money which was lent to it based on a contingent event amounts to a debt.

An 'interest in or under a debt' is considered in paragraph 22 of Goods and Services Tax Ruling GSTR 2004/4: assignment of payment streams including under a typical securitisation arrangement (GSTR 2004/4) which states:

Subregulation 40-5.09(3) deals with interests in or under debt. The term interest, in relation to debt, extends to an existing contractual right to a debt that will arise in the future.

Further paragraphs 81 to 84 of GSTR 2004/4 explain that in the context of hire purchase agreements and royalty payments, payments may be subject to contingencies. In such cases even though the payment may be subject to contingencies, the right to the payment stream is nevertheless a presently existing right that is property and an interest for the purposes of item 2 of subregulation 40-5.09(3).

ATO Interpretative Decision 2007/29 (ATOID 2007/29) concerns GST and contingent debts. ATOID 2007/29 cites two court cases in support of the view that:

A conclusion that an interest in a debt includes an interest in a contingent debt for the purposes of item 2 is consistent with the above decisions.

This conclusion is also consistent with the views of the Tax Office stated in Goods and Services Tax Ruling GSTR 2004/4…

Based on the above, it can be concluded that an obligation to repay a sum of money based on a contingency is a debt.

Therefore, the final issue to address is if, an obligation to repay based on a successful outcome of an event qualifies as a "contingency".

ATOID 2007/29 deals with an agreement under which a contributing entity advanced a sum of money to another entity for a specific project. If the project were sufficiently profitable, the amount contributed (but not more than that) would be repaid.

In ATOID 2007/29 the contributor was not entitled to anything if the respective entity made losses. ATOID 2007/29 concluded that the recipient of the advance had provided an interest in a debt to the contributor, though the repayment of the debt was contingent.

We hold the view that the funding by the indemnifying creditors is similar to the arrangement which is described in ATOID 2007/29. Therefore, under the terms of the agreement there is a contingent debt. That is, at any given time you had a presently existing obligation to pay the contribution amount on the happening of certain events; namely, the success of the litigation and the success of the application to the court pursuant to section 564.

We are of the view that a repayment made by you to the indemnifying creditors for the amounts that were advanced under the agreement is consideration for a financial supply that is mentioned in item 2 of the table in subregulation 40-5.09(3).

Further, we find that as the interest in the debt was created by the indemnifying creditors in making the supply, these entities are financial supply providers for the purposes of sub regulation 40-5.06(1) of the GST Regulations.

Provided that all of the other conditions in subregulation 40-5.09(1) of the GST Regulations have been satisfied, the consideration will be for an input taxed financial supply. On this basis, GST will not apply to the repayments of the amounts advanced by the indemnifying creditors.

In addition, we consider that it is not necessary to consider the transitional rules that apply to agreements that span 1 July 2000 (A New Tax System (Goods and Services Tax Transition) Act 1999) because we have determined that the payment under section 564 which relates to supplies made after 1 July 2000 is an input taxed financial supply.