Edited version of your private ruling

Authorisation Number: 1012462161799

Ruling

Subject: GST and out-of-court settlements

Question

Are goods and services tax (GST) payable on receipt of a payment as a result of an out-of-court settlement?

Answer

No, GST is not payable on receipt of a payment as a result of an out-of-court settlement.

Relevant facts and circumstances

· Entity A is registered for GST.

· Entity A and Entity B became involved in a dispute in relation to the lease of premises with Entity B initiating proceedings in the County Court.

· Entity A lodged a Defence and Counterclaim citing loss and damage as a result of breaches of the lease by Entity B.

· Both the parties attended a mediation to settle the matter and agreed to settle their claims upon Entity B paying a sum of money.

· The terms of the settlement were executed in writing with both parties resolving to refrain from legal action and releasing each other from any further claims with regard to the dispute.

· Entity A has not remitted any GST because it considers that the sum received is to resolve a damages claim.

Relevant legislative provisions

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

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

Reasons for decision

Under subsection 7-1(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), GST is payable on taxable supplies.

Section 9-5 of the GST Act states:

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.

(*Asterisked items are defined in section 195-1 of the GST Act)

The GST consequences of a court order or an 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 the nature of a taxable supply.

Goods and Services Tax Ruling GSTR 2001/4 set out the Commissioner's view on the GST consequences of 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.

Paragraph 21 of GSTR 2001/4 relevantly states:

21. A 'supply for consideration' is the first step towards there being a taxable supply. However, for there to be a supply for consideration, three fundamental criteria must be met:

(i) there must be a supply…;

(ii) there must be a payment…; and

(i) 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' is defined in section 9-10 of the GST Act as follows:

(1) A supply is any form of supply whatsoever.

(2) Without limiting subsection (1), supply includes any of these:

…

(g) an entry into, or release from, an obligation:

(i) to do anything; or

(ii) to refrain from an act; or

…

The definition of supply is broad and with respect to an out-of-court settlement could include any of the supplies referred to in subsection 9-10(2) of the GST Act.

GSTR 2001/4 explains that supplies related to out-of-court settlements fall within one of the following three categories:

· earlier supply

· current supply, or

· discontinuance supply.

Paragraph 46 of GSTR 2001/4 provides that an 'earlier supply' is a supply that occurred before the dispute arose, and which is the subject of the dispute.

According to paragraph 48 of GSTR 2001/4, a 'current supply' is one that may be created by the terms of the settlement.

Paragraphs 51 and 54 of GSTR 2001/4 characterise a 'discontinuance supply' as:

· surrendering a right to pursue further legal action (paragraph 9-10(2)(e) of the GST Act)

· entering into an obligation to refrain from further legal action (paragraph
9-10(2)(g) of the GST Act), or

· releasing another party from further obligations in relation to the dispute (paragraph 9-10(2)(g) of the GST Act).

In this case, Entity A and Entity B agreed to settle the dispute at mediation upon Entity B paying a sum of money to Entity A. Both parties also resolved to refrain from legal action and were released from any further claims with regard to the dispute.

On the facts provided, there are no supplies which would come within the scope of an earlier or current supply. Rather, the dispute was finalised when Entity A surrendered its rights and entered into obligations to abide by the terms of the settlement. Therefore, the only supply arising from the settlement of the dispute is in the nature of a discontinuance supply.

Whether a discontinuance supply would be a taxable supply would depend on the requirements of section 9-5 of the GST Act being met in relation to that supply. The first requirement in section 9-5 of the GST Act is that the supply is made for consideration.

Therefore, it is necessary to establish whether there is a nexus between the payment of the sum of money by Entity B to Entity A as provided for under the terms of the settlement and a discontinuance supply.

With regard to a 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.

Further, the distinction between a damages claim and a discontinuance supply is explained at paragraphs 110 and 111 of GSTR 2001/4 which state:

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.

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.

In this case, there is no earlier or current supply. It is considered that the payment of money by Entity B is more in the nature of payment for damages rather than consideration for a discontinuance supply. That is, the payment was for loss and damage that Entity A suffered as a result of the breaches of the lease by Entity B and not for any supply that Entity A made to Entity B. Therefore, the payment does not have sufficient nexus with a discontinuance supply.

As such, in accordance with paragraph 111 of GSTR 2001/4, the payment of the money is not consideration for a supply and paragraph 9-5(a) of the GST Act is not satisfied.

Consequently, GST is not payable on receipt of the payment of money as a result of the out-of-court settlement.