Edited version of your private ruling

Authorisation Number: 1012491352220

Ruling

Subject: GST and out-of-court settlements

Question 1

Is the payment of $, negotiated in an out-of-court settlement for the alleged breach of contract, subject to Goods & Services Tax (GST)?

Answer

No. See Reasons for Decision.

Question 2

Does GSTR 2001/4 apply to this particular case?

Answer

Yes. GSTR 2001/4 applies to this case.

See Reasons for Decision in relation to Question 1.

Relevant facts and circumstances

You are registered for GST.

You entered into a contract which was executed by you and the other party. A copy of the contract was supplied with this application for a private binding ruling.

You made a claim for damages suffered by you as a result of an alleged breach of the contract.

Your damages claim was split up into a number of components.

Your claim for damages was amended to a claim for loss of profits only which was the claim that was ultimately settled.

The parties reached a settlement of all claims and disputes which was embodied in a Deed of Settlement (Deed). Copies of this settlement Deed were supplied with this application for a private binding ruling.

The settlement sum to be paid under the Deed is $ to resolve the aspects of the dispute.

Relevant legislative provisions

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

Subsection 7-1(1)

Section 9-5

Reasons for decision

Question 1

Subsection 7-1(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) states:

(1) GST is payable on *taxable supplies …

Note that the asterisk denotes a defined term in the GST Act.

Section 9-5 of the GST Act also provides the requirements necessary for a supply to be taxable and 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.

It is therefore necessary in the first instance, given the above definition of a taxable supply, to determine whether there is a supply made by you to the recipient in relation to the money received.

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) provides the Commissioner of Taxation (Commissioner) view on the GST consequences resulting from court orders and out-of-court settlements. In GSTR 2001/4, the Commissioner states that the subject of the dispute may not give rise to a supply at all. Paragraphs 71 to 73 of GSTR 2001/4 state:

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.

Relevantly, the Commissioner's further view on damages is stated in paragraphs 110 and 111 of GSTR 2001/4:

Damages

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 your case the dispute arose in relation to the alleged breach of the contract by the other party. The dispute was settled under the terms of the Deed where the settlement sum of $ was dissected into two components to resolve the aspects of the dispute.

The payment of one component is regarded as payment of a damages claim, in accordance with paragraph 111 of GSTR 2001/4. Further, as provided by paragraph 73 of GSTR 2001/4, damages, being the substance of the dispute, cannot in itself be characterised as a supply made by you.

Consequently, as no supply is made by you to the other party in return for one component, paragraph 9-5(a) of the GST Act is not satisfied. Accordingly, there is no taxable supply and therefore the payment of one component is not subject to GST, in accordance with subsection 7-1(1) of the GST Act.

The Commissioner's view on the payment of costs is stated in paragraphs 145 to 148 of GSTR 2001/4. Relevantly, paragraphs 145 and 148 state:

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.

…

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.

Therefore, the payment of the other component negotiated in your settlement, as contribution towards your legal cost, will not be consideration for a supply; rather, it is compensation for your costs or losses incurred in the dispute. Consequently, as no supply is made by you to the other party in return for the other component, paragraph 9-5(a) of the GST Act is not satisfied. Accordingly, there is no taxable supply and therefore the payment of the other component is not subject to GST, in accordance with subsection 7-1(1) of the GST Act.

Question 2

GSTR 2001/4 provides the Commissioner's view on the GST consequences resulting from court orders and out-of-court settlements. As the out-of-court settlement in your case is accepted as a component for damages and a component for legal costs incurred, both of these outcomes are discussed in GSTR 2001/4. Consequently the views of the Commissioner, as expressed in GSTR 2001/4, are relevant in relation to your case.