Edited version of your private ruling

Authorisation Number: 1012482557446

Ruling

Subject: GST and dispute settlement

Question 1

Is Goods and Service Tax (GST) payable by you in respect of the convey and transfer of the Selected Clients?

Answer

There are no GST implications for you in respect to the convey and transfer of the Selected Clients.

Question 2

Is GST payable by you in respect of the Settlement Amount?

Answer

There are no GST implications for you in respect of the Settlement Amount.

Relevant facts and circumstances

You are registered for GST.

The other party conducted an accounting practice as a sole trader and was registered for GST.

The other party and you entered into a deed titled "Deed of Agreement for sale of Practice" (Sale Agreement) pursuant to which the other party agreed to sell his/her right, title and interest in the Practice to you for consideration.

The parties further entered into an agreement (Employment Agreement) pursuant to which the other party agreed to provide services in consideration of payment of salary and superannuation benefits by you. Pursuant to the Employment Agreement, you were required to pay certain amounts.

You advised that the sale of the Practice to you met the requirements of section 38-325 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) and therefore was a GST-free supply of a going concern and to the best of your knowledge you did not claim any input tax credits at any time in relation to its purchase of the Practice.

A dispute arose between the other party and you; which led to court hearings.

At the time of the dispute an amount of money remained unpaid by you in relation to the Sale Agreement and the Employment Agreement.

The other party claimed damages for breach of contracts in the proceedings. You sought a Cross Claim for damages against the other party.

On the fourth day of the proceedings, the parties reached an out-of-court settlement which was formalised by way of a deed (the Deed).

The parties settled the Deed. The other party received title of the Selected Clients and a bank cheque in full and final settlement of the Deed.

Taxpayer's submissions

You are of the view that the transfer and conveyance of the Selected Clients, plus the amount of money is not a taxable supply as consideration did not pass.

You consider that if a payment is made as 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.

Alternatively, the nature of the terms of the Deed would be:

(a) A discontinuance supply;

(b) A payment, by way of transfer of clients and monies, for damages;

(c) The court orders reflected Judgment could have been entered into at any time if the Defendants failed to comply with the Deed.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Section 7-1, section 9-5, subsection 9-10(2), and section 38-325.

Reasons for decision

Question 1

Detailed reasoning

Subsection 7-1(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that GST is payable on taxable supplies and taxable importations.

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.

Items marked with an asterisk (*) are defined in the Dictionary at section 195-1 of the GST Act.

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) provide guidance on the GST consequences resulting from court orders and out-of-court settlements.

Paragraph 17 of GSTR 2001/4 states:

17. The GST consequences of a court order or out-of-court settlement will depend on a number of matters, including whether a payment made under the order or settlement constitutes consideration for a supply and, if so, whether the supply is in the nature of a taxable, input taxed, or GST-free supply. These consequences are discussed more fully at paragraphs 126 to 136.

Paragraph 21 of GSTR 2001/4 provides that 'a supply for consideration' is the first step towards there being a taxable supply and three fundamental criteria need to be met as follows:

· there must be a supply;

· there must be a payment; and

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

Supply is defined by subsection 9-10(2) of the GST Act as:

· a supply of goods;

· a supply of services;

· a provision of advice or information;

· a grant, assignment, or surrender of real property;

· a creation, grant, transfer, assignment or surrender of any right;

· a financial supply;

· an entry into, or release from an obligation:

(i ) to do anything; or

(ii ) to refrain from an act; or

(iii ) to tolerate an act or situation;

· any combination of any 2 or more of the matters referred to in paragraphs (a) to (g).

This definition of supply is broad and with respect to an out-of-court settlement could include any of the supplies referred to in the subsection 9-10(2) of the GST Act. A supply related to an out-of-court settlement may have occurred prior to the settlement or it may be created by the terms of the settlement itself. There may be more than one supply that is related to a settlement or alternatively the subject of a dispute may not be a supply at all.

Paragraph 44 of GSTR 2001/4 state:

44. For the purposes of this Ruling, supplies that are related to an out-of-court settlement fall within the three categories of supply described below. This characterisation assists in the subsequent analysis of consideration for a supply, which commences at paragraph 100. The existence of a particular supply in relation to a given settlement will not necessarily mean a sufficient nexus exists between that supply and a payment made under the settlement.

GSTR 2001/4 provides that supplies related to out-of-court settlements are characterised according to the following categories:

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

· a current supply - a new supply created by the terms of settlement; or

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

Paragraphs 46, 47, 101 and 102 state:

46. In these circumstances, where the subject of the dispute is an earlier transaction in which a supply was made involving the parties, that supply is referred to in this ruling as an 'earlier supply'.

Example - Earlier supply

47. Widget Company supplies toys to a retailer. A dispute between the parties over payment for the toys is subsequently resolved through an out-of-court settlement, with the retailer paying all monies owed. The supply of the toys, that is the subject of the dispute, is an earlier supply because it occurred before the dispute arose.

101. Where the only supply (other than a 'discontinuance' supply) in relation to a court order or out-of-court settlement is an earlier supply and a sufficient nexus exists between the payment made under that order or settlement and the earlier supply, the payment will be consideration for that supply.

Example - payment for an earlier supply

102. In the Widget Company example at paragraph 47, the out-of-court settlement reached with the retailer provides for the retailer to make payment in full to Widget for the toys. The supply of the toys is an earlier supply and there is a sufficient nexus between it and the payment. The payment is consideration for that supply.

As such, an earlier supply is where the subject of the dispute is an earlier transaction in which a supply was made involving the parties.

The dispute that arose between the other party and you was in relation to amounts remaining unpaid for the sale of the Practice. At the time of the dispute, a certain amount remained unpaid by you. As such the subject of the dispute is an earlier supply involving the sale of the Practice by the other party to you.

In settling the dispute the Deed required the transfer of 'Selected Clients', who together in aggregate have a Prescribed Value inclusive of GST, from you to the other party. The actual value of clients transferred by you amounted to a slightly higher sum. The Deed also required the further payment of a Settlement Amount (which will be dealt with in Question 2 below).

Given the above, we consider the sale of the Practice to be the earlier supply and that there is sufficient nexus between it and the payments required under the Deed for these payments to be consideration for that earlier supply. That is, the transfer of the Selected Clients from you to the other party is consideration for the sale of the Practice.

You have advised that the sale of the Practice met the requirements of section 38-325 of the GST Act and as such was a GST-free supply of a going concern to you and consequently no input tax credits were claimed by you in relation to this acquisition. Accordingly, the transfer of the Selected Clients by you to the other party will have no GST implications for you.

Question 2

Detailed reasoning

Generally, the terms of an out-of-court settlement will ensure no further legal action is taken in relation to that dispute provided that the terms of the settlement are complied with. This often takes the form of a release from some or all of the existing claims and from further claims and obligations in relation to that dispute.

Where a dispute involves counter-claims, the terms of the settlement may provide for each party to release the other from all claims and obligations. Paragraph 54 of GSTR 2001/4 provides that these terms of settlement can create supplies for GST purposes. The supplies may be characterised as:

(i ) surrendering a right to pursue further legal action (section 9-10(2)(e));

(ii ) entering into an obligation to refrain from further legal action (section 9-10(2)(g)); or

(iii ) releasing another party from further obligations in relation to the dispute (section 9-10(2)(g)).

These supplies are referred to as discontinuance supplies. Whether a discontinuance supply is a taxable supply depends on whether the requirements of section 9-5 as set out above are met in relation to that supply.

The existence of a particular supply in relation to a given settlement will not necessarily mean a sufficient nexus exists between that supply and a payment made under the settlement.

Paragraphs 107 and 109 of GSTR 2001/4 state:

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.

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 payment could only have been made for the discontinuance supply.

We do not consider that there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payments made under the Deed could only have been made for a discontinuance supply. In fact, as discussed in Question 1, we consider the payments made under the Deed to be consideration for the earlier supply being the supply of the GST-free going concern of the Practice.

The discontinuance supply that is made does not have a separately ascribed value. It is merely part of the mechanism to finalise the dispute. Therefore, the payment of the Settlement Amount is for the earlier supply and the agreement to refrain from further legal action is merely part of the process of finalising the dispute.

Given the earlier supply is a supply of a GST-free going concern, the payment of the Settlement Amount will have no GST implications for you.