Edited version of your private ruling

Authorisation Number: 1012498644081

Ruling

Subject: GST and settlement deed

Question 1

Is the payment under the Settlement Deed consideration for a taxable supply?

Answer

No, the payment is not consideration for a taxable supply

Relevant facts and circumstances

§ You are registered for goods and services tax (GST).

§ Another entity B is registered for GST.

§ You and B entered into a 'Joint Venture Agreement' (JVA) to acquire two properties and to build a commercial building on them.

§ Each party has a 50% interest in the JV.

§ Following the JVA, you and B registered for GST as a partnership.

The Settlement Deed

Later, the parties attended mediation and written agreement was reached. The Settlement Deed provided initially for monetary payment of $XXXX on a certain date.

The sum of $xxxx was paid by you to B on that day in exchange for the delivery of:

1. Transfer of B's half interest in Property No 1; and

2. Transfer of B's interest in Property no 2; and

3. All plans, drawings and other documents, correspondence and other product of B's work.

4. the partnership terminated as consequent of the Settlement Deed.

Relevant legislative provisions

A New Tax System (Goods and services Tax) Act 1999

Section 9-5

Section 9-10

Subdivision 40-A

Division 11

Reasons for decision

Summary

The payment under the Deed is not made for a taxable supply. There is no GST included in the payment and therefore no entitlement for an input tax credit arising from the acquisition.

Detailed reasoning

Matters in dispute may be resolved either by the judgement of a court or by agreement between the parties (out-of-court settlement).

It is considered that an out-of-court settlement will include any form of dispute resolution in which the terms of the resolution are agreed between the parties including an agreement between the parties settling their differences before court action commences.

The views of the Commissioner of Taxation on the GST consequences resulting from out of court settlements are expressed in goods and services tax ruling GSTR 2001/4. This ruling explains how a payment (or act of forbearance) that is made in compliance with an out of court settlement constitutes consideration for a supply and if so, whether the supply is in the nature of taxable, GST-free or input taxed. Each and every such supply is subject to GST provided the supply is a taxable supply.

The supply under the Settlement Deed

Supply is defined in subsection 9-10(1) of the GST Act as any form of supply whatsoever. A supply is essentially something that passes from one entity to another. A supply under subsection 9-10(2) includes:

(a) a supply of goods;

...

(f) a financial supply;

(g) 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;

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

In GSTR 2001/4, the Commissioner is of the view the supplies for an out-of-court settlement fall within three categories:

1. Earlier supply - where the subject of the dispute is an earlier transaction in which the supply was made involving the parties.

2. Current supply - where a new supply is created by the terms of the settlement.

3. Discontinuance - supply where the terms of settlement, in finalising a dispute, create one or more new supplies to ensure that no further legal action in relation to the dispute.

Under the Settlement Deed a new supply is created by the terms of the settlement.

In essence, the Settlement Deed provided initially for payment of $xxxx on or before a certain date. The sum of $xxxx was paid by you to B on that day in exchange for the delivery of:

- the transfer of B's half interest in Property no 1; and

- the transfer of B's interest in Property no 2; and

- all plans, drawings and other documents, correspondence and other product of its work or that of its subcontractors, concerning or relating to the building contract.

- the partnership (joint venture agreement) terminated as consequence of the Settlement Deed.

The terms of the Settlement Deed indicates that you have acquired the interest of the other partner in the partnership. Goods and services tax ruling GSTR 2003/13 explains how the GST Act applies to transactions involving general tax law partnership.

It is considered that the terms of the Settlement Deed indicate an acquisition of the interest in the partnership by you. It is not disputed that the payment of $xxxx is the consideration for the supply. The issue is to determine the character of the supply, whether it is taxable, input taxed or GST-free.

Paragraphs 187 to 189 of GSTR 2003/13 provide the view of the Commissioner on the acquisition:

One partner acquires all the other interests in the partnership and continues as a single entity

187. Where one partner takes over the business of the partnership, this is usually achieved by the purchase of the other partners' interests in the partnership.

188. It makes no difference whether the sale or assignment of an interest in a partnership by an outgoing partner is to either an incoming or a continuing partner. Therefore, where one partner acquires the partnership interests of all the other partners, the outgoing partners make supplies of financial interests to the acquiring partner. The supplies by the outgoing partners, and the acquisition-supply by the acquiring partner, will be financial supplies if the requirements of Sub-regulation 40-5.09(1) are met.

189. By acquiring all of the other partnership interests, the acquiring partner effectively takes over all of the assets and liabilities of the partnership and carries on the enterprise in its own right.

Interest in a partnership

Upon a partnership coming into existence, its partners hold interests in the partnership. A partner's interest in the partnership may increase or decrease over time. A partner's interest is extinguished if the partner exits the partnership, unless the partner sells or assigns their interest to another entity.

For GST purposes, transactions involving the acquisition, disposal, or changes in the level of interests held in a partnership are considered in the context of financial supplies.

Paragraph 174 of GSTR 2003/13 states:

A sale or assignment of an interest in a partnership may be made by a continuing partner to an incoming partner or by an outgoing partner to either a continuing or an incoming partner. The supply is a partner-to-partner transaction and does not involve the creation or supply of any new interest by the partnership. Such a sale or assignment is a supply by the partner of a financial interest, and is a financial supply if the requirements of Sub-regulation 40-5.09(1) are satisfied. If the partner making the supply is unregistered, or the supply is not made in the course or furtherance of an enterprise carried on by the partner, no GST consequence arises in relation to the supply.108

Financial supplies

Section 40-5 of the GST Act provides that financial supplies are input taxed and that their meaning is given by the GST regulations. Subdivision 40-A of the GST regulations is about financial supplies. Under Sub-regulation 40-5.09(1), the provision, acquisition or disposal of an interest in or under securities, including the capital of a partnership, is a financial supply if:

(a) the provision, acquisition or disposal is:

(i) for consideration;

(ii) in the course or furtherance of an enterprise; and

(iii) connected with Australia.

(b) the supplier is:

(i) registered or required to be registered; and

(ii) a financial supply provider in relation to supply of the interest.

For GST purposes, an 'interest' is anything that is recognised at law or in equity as property in any form.

Goods and Services Tax Ruling GSTR 2002/2, dealing with the GST treatment of financial supplies and related supplies and acquisitions, explains and clarifies when something is a financial supply. GSTR 2002 uses the term 'financial interest' to describe a supply that may be a financial supply because it is mentioned in an item in the table in Sub-regulation 40-5.09(3) and is capable of satisfying the tests in Sub-regulation 40-5.09(1).

Item 10 in the table in Sub-regulation 40-5.09(3) (item 10) includes as securities 'the capital of a partnership or trust'. Part 8 of Schedule 7 to the GST regulations includes 'interests in a partnership' within its list of examples for item 10.

Paragraph 53 of GSTR 2002/2 provides that an interest in a partnership is a financial interest under Sub-regulation 40-5.09(3). It will be a financial supply if the requirements of Sub-regulation 40-5.09(1) are met.

In your circumstances:

§ The supplier is registered for GST

§ Paragraph 104 of GSTR 2002/2 provides the meaning of the term 'financial supply provider':

An entity is the financial supply provider of an interest if:

o the interest was the entity's property immediately before the supply (for example, an entity sells a debenture that it owns);

o …

The interest in the partnership was B's property immediately before the supply. This requirement is met.

§ The provision of the interest is made for consideration (of $xxxx).

§ Paragraph 61 of GSTR 2002/2 provides that

Where the supply is the provision, acquisition or disposal of a financial interest, the connection with Australia turns on whether the interest is provided, acquired, or disposed of in Australia. Whether an interest is provided, acquired or disposed of in Australia will depend on how, the provision, acquisition or disposal is effected. For example, if the interest is created, issued or transferred by the execution of a written contract, the creation, issue or transfer of that interest is done in Australia if that contract is made in Australia.

As the Settlement Deed was done in Australia, the supply is connected with Australia.

§ in the course or furtherance of an enterprise

Generally, it is considered that the partners are unlikely to be carrying on an enterprise in dealing with the partnership interest (foot note 108 in GSTR 2003/13). Then, the supply has no GST consequence (no GST payable on the supply and no input tax credit arising from the acquisition of the supply).

However, where the provision of the interest is considered to be made in the course or furtherance of the enterprise of the other partner, all of the requirements under Sub- regulation 40-5.09(1) are met. The supply of the interest in the partnership is a financial supply. Under section 40-5 of the GST Act a financial supply is input taxed. Section 40-1 of the GST Act provides that if a supply is input taxed, no GST is payable on the supply and there is no entitlement to an input tax credit for anything acquired to make the supply.

In either scenario (input taxed supply or not in the course or furtherance of an enterprise), there is neither GST payable nor input tax credit arising from the supply.

Change in the legal ownership of property upon a transfer of a partnership interest

A supply of an interest in a partnership by a partner may require the outgoing partner to effect a change in legal title or interest in partnership assets. The acquiring partner acquires the beneficial and legal interests under the supply of the interests in the partnership. For GST purposes, the transfer of the legal interest does not involve any separate supply by the outgoing partner.

Discontinuance supply

In relation to the terms of the Settlement Deed where parties release each other from legal actions, paragraphs 54 and 55 of GSTR 2001/4 provide that:

54. We consider that these conditions of settlement can create supplies for GST purposes. The supplies may be characterised as:

(i) surrendering a right to pursue further legal action [paragraph 9-10(2)(e)]; or

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

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

55. In this Ruling, we refer to supplies of these kinds as 'discontinuance supplies'. However, whether a discontinuance supply would be a taxable supply would then depend on the requirements of section 9-5 being met in relation to that supply.

It is considered that the discontinue supply will have no ascribed value and will merely be an inherent part of the legal machinery to add finality to the dispute. The view of the Commissioner is that a discontinuance supply is in the nature of a term or condition of the settlement rather than the subject of the settlement. In this context, every settlement agreement will contain a discontinuance supply.

In conclusion, the payment under the Settlement Deed is not made for a taxable supply and therefore there is no GST payable or input tax credit arising from the supply/acquisition.