Edited version of your private ruling

Authorisation Number: 1012633369149

Ruling

Subject: GST and out of court settlement

Question:

Is an Australian company (you) liable for goods and services tax (GST) on the annual amount of $XXX received from a non-resident company (NRCo) in accordance with a deed of settlement and release (Deed), for the transfer of its business and the related surrender of rights under a licence agreement with NRCo?

Answer:

Yes, you are liable for GST on the annual amount of $XXX received from NRCo in accordance with the Deed with NRCo.

Relevant facts and circumstances:

An Australian company (you) is registered for goods and services tax (GST).

You had entered into a licence agreement (Agreement) with a non-resident company (NRCo).

NRCo also controls a company in Australia (AusCo). AusCo is registered for GST.

You and NRCo entered into a deed of settlement and release (Deed). You advise that you will surrender your rights under the Agreement and in accordance with the Deed will receive an annual amount of $XXX (exclusive of GST).

The Deed was executed in Australia. A copy of the Deed is provided.

The Deed provides (amongst other things) that:

• You are an Australian company controlled by A.

• NRCo is a non-resident company of which B is a director.

• AusCo is an Australian company controlled by NRCo.

• The System is owned by NRCo.

• In X {date}, you and NRCo entered into the Agreement. NRCo granted you an exclusive licence to exploit the System in Australia on certain terms and conditions.

• NRCo issued termination notices to you, and you also commenced proceedings against NRCo.

• On X {date} the parties entered into the terms of settlement. The parties to this Deed have agreed to resolve any and all issues which relate to or arise out of the Agreement, the termination notices and the proceedings.

Definitions:

• 'Annual Amount' means $XXX exclusive of GST, if any, per annum.

• 'Business' means the business currently conducted by you under the terms of the Agreement and includes all agreements and arrangements for the provision of services in relation to the System, but does not include the Agreement itself.

• 'System' means the intellectual property owned by NRCo and licensed to you under the Agreement.

• 'AusCo Business' means the business to be conducted by AusCo in relation to the System in Australia as a consequence of the transfer of the Business to it and includes all agreements and arrangements made for the provision of services in relation to the System by AusCo.

• 'Reactivation of the Agreement' means that the Agreement will from the date of a relevant termination election continue in full force and effect as though it had never been suspended under the Deed.

Clause X Suspension of Agreement

• You will conduct the Business in the ordinary course of business until the effective date.

• On the effective date the Agreement will be suspended in full in its operation and it will only, if at all, be reactivated in accordance with the terms of this Deed.

• On the effective date, you will cause the benefit of the Business to be transferred to AusCo, including the following steps:

• assign any existing contracts to AusCo, including completing an assignment notice form for each client contract;

• deliver to AusCo the client data;

• all documents or other material necessary to be provided by you to AusCo to transfer the Business shall be delivered to a specified address in Australia;

• Within X days of the effective date, you will deliver to AusCo all documents containing the intellectual property of NRCo, including the System, and delete any electronic copy thereof and confirm the deletion in writing to AusCo.

• While the Agreement is suspended:

• NRCo will not terminate or purport to terminate the Agreement;

• You will not operate or purport to operate the Business;

• AusCo will not assign, sell or otherwise dispose of AusCo's Business or any part of it without your prior written consent.

• Reactivation of the Agreement (to you) is covered in clause X.

Clause X Payment of Annual Amount

• NRCo will pay to you the Annual Amount for the duration of the remaining term.

• You are not required to remit any royalty under the Agreement to NRCo in relation to the Annual Amount.

Clause X Consulting work - AusCo may make a consulting work offer to A in relation to AusCo's business. A shall be engaged as an independent contractor.

Clause X Release and indemnity

• You and A agree, other than in respect of obligations which arise under this Deed or fraud: to forever release and discharge; not to make any claims against; and to indemnify and keep indemnified, NRCo, B and AusCo from claims which you and A now have or in the future may have against NRCo, B and AusCo arising from (i) the Agreement before the effective date and the (ii) the proceedings.

• NRCo, B and AusCo agree, other than in respect of obligations which arise under this Deed or fraud: to forever release and discharge; not to make any claims against; and to indemnify and keep indemnified, you and A from claims which you and A now have or in the future may have against NRCo, B and AusCo arising from (i) the Agreement before the effective date and the (ii) the proceedings.

Clause X covers the discontinuation of proceedings and the bar to further proceedings.

The Deed does not cover any GST-free supply of a going concern.

Additional information provided:

You confirmed that as a result of the Deed, the Agreement will be suspended and you will no longer make any payments to NRCo in relation to the original licence to you.

NRCo and AusCo are related entities, and on suspension of the Agreement the business currently conducted by you under the terms of the Agreement will be transferred and conducted by AusCo as a result of the arrangements under the Deed.

Your understanding is that NRCo is not registered for GST in Australia. NRCo carries on its business (or business activities) through AusCo in Australia. AusCo conducts a business of marketing and implementing the System of NRCo (which is the parent company).

Under the Deed, AusCo can make a consulting work offer to A. The consulting work is a separate transaction and the consideration for this consulting work is not included as part of the annual amount of $XXX under the Deed.

You do not have a separate agreement with AusCo in relating to the transfer of the business to AusCo.

You provided a copy of the Agreement between you and NRCo in relation to the granting of the licence to use the System in Australia. The termination clause in the Agreement does not address NRCo's own decision or actions to terminate the Agreement, other than termination as a result of your (the licensee's) actions.

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, Paragraph 9-5(a)

A New Tax System (Goods and Services Tax) Act 1999, Section 38-190

Reasons for decision

GST is payable on a taxable supply. You make a taxable supply if all the requirements of section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) are satisfied as follows:

(a) you make the supply for consideration;

(b) the supply is made in the course or furtherance of an enterprise that you carry on;

(c) the supply is connected with Australia; and

(d) you are registered or required to be registered.

However, a supply is not a taxable supply to the extent that it is GST-free or input taxed.  

The facts indicate that the supply (or supplies) is made in the course of an enterprise (business) that you carry on (which includes the commencement and termination of an enterprise); the supply is connected with Australia (as the supply is either done in Australia or made through an enterprise in Australia); and you are registered for GST. Therefore, you have satisfied the requirements of paragraphs 9-5(b) to 9-5(d) of the GST Act. What remains to be determined is whether you make a supply for consideration, and if so, whether the supply is GST-free or input taxed.

Supply for consideration

To be a taxable supply, there must be a 'supply for consideration'.

Goods and Services Tax Ruling GSTR 2001/4 provides guidance on court and out-of-court settlements.  In particular, paragraph 21 of the GSTR 2001/4 sets out the fundamental criteria that must be satisfied for there to be a 'supply for consideration', namely: 

(i) there must be a supply

(ii) there must be a payment, and

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

The term 'supply' is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever' and includes 'a creation, grant, transfer, assignment or surrender of any right', and 'an entry into, or release from an obligation: to do anything, or to refrain from an act, or to tolerate an act or situation'. Paragraph 22 of GSTR 2001/4 provides that a supply is essentially 'something which passes from one entity to another'.

A supply related to an out-of-court settlement may have occurred prior to the settlement (and in fact have been the subject of the dispute in the first place) - referred to as the earlier supply; or it may be created by the terms of the settlement itself - referred to as the current supply. There may be more than one supply that is related to a settlement. In addition, the subject of the dispute may not be a supply at all. We also note that 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.

As outlined in paragraphs 44 to 55 of GSTR 2001/4, the supplies that are related to an out-of-court settlement fall within three categories of supply: earlier supply, current supply and discontinuance supply, which are discussed below.

Earlier supply

In relation to an 'earlier supply', paragraphs 45 and 46 of GSTR 2001/4 state:

45. Each and every supply is subject to GST provided the supply satisfies the requirements of a taxable supply. The GST Act does not prescribe any sequencing or hierarchy of supplies for taxing purposes. GST becomes payable on the relevant supply.

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'

The facts indicate that in X {date}, you and NRCo entered into the Agreement which grants you an exclusive licence to exploit the System in Australia. As a result of the Deed, the Agreement will be suspended (but not terminated) and you will no longer make any payments to NRCo in relation to the original licence granted to you. This is confirmed under clause X of the Deed which states that you are not required to remit any royalty under the Agreement to NRCo in relation to the annual amount of $XXX. The subject of the dispute is not in relation to an earlier transaction (that is, a supply of the licence that occurred before the dispute arose), and therefore there is no earlier supply in relation to this settlement.

Current supply

In relation to a 'current supply', paragraph 48 of GSTR 2001/4 state:

48. A new supply may be created by the terms of the settlement. In this Ruling, such a supply is referred to as a 'current supply'.

The facts indicate that in accordance with the Deed, the Agreement will be suspended and you are not required to remit any royalty under the Agreement to NRCo in relation to the annual amount. On suspension of the Agreement, you will cause the benefit of the 'Business' to be transferred to AusCo. This also involves assigning any existing contracts to AusCo and delivering to AusCo the client data and other documents or materials necessary to transfer the 'Business'. The 'Business' as defined in the Deed is the business currently conducted by you under the terms of the Agreement and includes all agreements and arrangements for the provision of services in relation to the System, but does not include the Agreement itself.

There is a new supply that has been created by the terms of settlement under the Deed, which is referred to as the 'current supply'. The current supply is for the business and the related surrender of rights.

Furthermore, in accordance with the Deed, NRCo will pay you the annual amount of $XXX for the remaining term. There is a sufficient nexus between the current supply and the payment, and therefore the requirement that there is a supply for consideration under paragraph 9-5(a) of the GST Act is satisfied.

The current supply is not an input taxed supply under the GST legislation. We consider the GST-free provisions.

GST-free

In accordance with the Deed, you will make a supply of the 'Business' and related surrender of rights under the Agreement to NRCo, which is provided to AusCo. This is outlined in the Deed which states that you will cause the benefit of the business to be transferred to AusCo. 'AusCo Business' is the business to be conducted by AusCo in relation to the System in Australia as a consequence of the transfer of the business to it and includes all agreements and arrangements made for the provision of services in relation to the System by AusCo.

Section 38-190 of the GST Act specifies the circumstances where the supply of things other than goods or real property for consumption outside Australia is
GST-free. Of relevance to a supply made to NRCo (a non-resident entity) is item 2 in the table in subsection 38-190(1) of the GST Act (Item 2).

Under Item 2, a supply is GST-free where it is:

a supply that is made to a *non-resident who is not in Australia when the thing supplied is done; and

(a) the supply is neither a supply of work physically performed on goods situated in Australia when the work is done nor a supply directly connected with *real property situated in Australia; or

(b) the *non-resident acquires the thing in *carrying on the non-residents *enterprise, but is not *registered or *required to be registered.

(*denotes a defined term in section 195-1 of the GST Act).

Precondition - Not in Australia when the thing supplied is done

For the current supply to be GST-free under Item 2, NRCo must not be in Australia when the thing supplied is done. Paragraphs 31 and 37 of Goods and Services Tax Ruling GSTR 2004/7 state:

31. The requirement that the non-resident in item 2, or the recipient in item 3, is not in Australia when the thing supplied is done is a requirement, in our view, that the non-resident or recipient is not in Australia in relation to the supply when the thing supplied is done.

37. A non-resident company is in Australia if that company carries on business (or in the case of a company that does not carry on business, carries on its activities) in Australia:

a) at or through a fixed and definite place of its own for a sufficiently substantial period of time; or

b) through an agent at a fixed and definite place for a sufficiently substantial period of time.

We consider that if a non-resident company carries on business at or through a fixed and definite place of its own in Australia and it had carried on, or intends to carry on, its business from such premises by its servants or agents for a sufficiently substantial period of time, that company is in Australia (paragraph 250 of GSTR 2004/7).

Further, paragraphs 277 and 278 of GSTR 2004/7 provide that if a non-resident company has no fixed and definite place of its own in Australia, it may still carry on business in Australia through an agent from some fixed and definite place. The key issue in this kind of situation is whether the non-resident company is itself carrying on business in Australia through a duly appointed agent, or whether the business being conducted is the agent's own business, the non-resident company merely being one of its customers. A list of factors to assist in determining whether a non-resident company can properly be regarded as carrying on business in Australia through an agent is provided in paragraph 281 of GSTR 2004/7.

In addition, if a non-resident company is determined to be in Australia on the basis of the above test, it is necessary to determine if the company is in Australia in relation to the supply, when the supply is done.

Paragraphs 41 and 65 of GSTR 2004/7 provide that a (non-resident) company is in Australia in relation to the supply if the supply is solely or partly for the purposes of the Australian presence, for example, its Australian branch, representative office or agent if it is a non-resident company or the Australian head office if it is an Australian incorporated company. If the supply is not for the purposes of the Australian presence but that Australian presence is involved in the supply, the company is in Australia in relation to the supply, except where the only involvement is minor.

You advise that AusCo is an Australian company controlled by NRCo. NRCo carries on its business (or business activities) through AusCo in Australia, where AusCo business involves marketing and implementing the System of NRCo (its parent company). In accordance with the Deed (which was executed in Australia) between you and NRCo, you will cause the benefit of the 'Business' to be transferred to AusCo. That is, the business currently conducted by you under the terms of the Agreement will be transferred and conducted by AusCo in Australia.

Further, NRCo and AusCo are related parties. AusCo is not conducting its own business with NRCo merely being one of its customers. The supply is for the purposes of the Australian presence, and AusCo involvement in relation to your current supply is not minor. In relation to the current supply, the business to be conducted by AusCo in relation to the System in Australia is as a consequence of the transfer of the 'Business' (that is, your business) to it and includes all agreements and arrangements made for the provision of services in relation to the System by AusCo. The business and related surrender of rights is provided to and used by AusCo in Australia. AusCo is at a fixed and definite place in Australia for a sufficiently substantial period of time.

Accordingly, we consider that NRCo is carrying on a business (or its activities) in Australia through AusCo at a fixed and definite place for a sufficiently substantial period of time, and is in Australia in relation to the current supply when it is done. Therefore, the precondition in Item 2 that the supply is made to a non-resident who is not in Australia when the thing supplied is done is not satisfied, and the current supply is not GST-free.

Alternatively, even if it is argued that NRCo does not carry on its business in Australia through AusCo, subsection 38-190(3) of the GST Act may be applicable to exclude the supply from being GST-free.

Subsection 38-190(3)

Subsection 38-190(3) of the GST Act states that a supply covered by Item 2 is not GST-free if it is a supply under an agreement entered into, directly or indirectly, with a non-resident and the supply is provided, or the agreement requires it to be provided, to another entity in Australia.

Goods and Services Tax Ruling GSTR 2006/9 considers multi-party transactions, commonly known as tripartite arrangements. As stated at paragraphs 131 and 132 of GSTR 2006/9:

131. 'Made' in the context of 'a supply made' takes its meaning from the definition of 'recipient' in section 195-1:

recipient, in relation to a supply, means the entity to which the supply was made.

132. 'Provide' is used to contrast with 'made' - it distinguishes between the contractual flow of the supply to the recipient (the entity to which the supply is made) and the actual flow of the supply to another entity (the entity to which the supply is provided).

Under a tripartite arrangement (involving three or more parties) it is possible that a supply is made to one entity under the terms of an agreement, but the supply is provided to another entity. It may be that the agreement, together with the surrounding circumstances, show that there is a binding obligation between the two parties making the arrangement for goods, services or anything else to be provided to a third party.

Goods and Services Tax Ruling GSTR 2005/6 also provides guidance on the application of subsection 38-190(3) of the GST Act. The term 'provided' is used in subsection 38-190(3) of the GST Act to contrast with the term 'made' in Item 2.

A supply is made to a recipient and provided to another entity if in the performance of the service or in the doing of something the actual flow of that supply is to an entity that is not the recipient entity with which the supplier made the agreement for the supply. That is, while the contractual flow of the supply is to the recipient entity, the actual flow of the supply is to another entity.

The facts indicate that you have entered into an agreement (being the Deed) with NRCo (a non-resident entity) for the current supply (being the supply of the 'Business' and related surrender of rights), but the current supply is provided (or there is an agreement to provide the supply) to AusCo. That is, the Deed provides that the benefit of the business (including agreements and arrangements in relation to the System in Australia) is to be transferred to AusCo, and AusCo will conduct the business in Australia.

Accordingly, the current supply made to NRCo, but provided to AusCo in Australia satisfies subsection 38-190(3) of the GST Act and is excluded from being GST-free under Item 2.

We note that as the precondition of Item 2 is not satisfied (and also subsection 38-190(3) of the GST Act applies to exclude the supply from being GST-free), there is no need to consider the other requirements of Item 2.

For completeness, we do not consider that your current supply (of the business and related surrender of rights used in Australia) which is made to NRCo, but provided to AusCo in Australia, would satisfy the other items in the table in subsection 38-190(1) of the GST Act (or any other GST-free provisions under the GST legislation), and therefore is not GST-free.

Discontinuance supply

Generally (it is suggested in most if not all cases), the terms of a settlement, in finalising a dispute, will ensure no further legal action in relation to that dispute, provided that the terms of the settlement are complied with. This often takes the form of a plaintiff releasing a defendant from some (or all) of the existing claims and from further claims and obligations in relation to that dispute. Sometimes, where a dispute involves counter claims, the terms of the settlement may provide for each party to release the other from such claims and obligations. Where court proceedings have commenced, the filing of a notice of discontinuance pursuant to the relevant court rules may also be required to ensure the court is advised that a particular action will not proceed. We consider that these conditions of settlement can create supplies for GST purposes (paragraphs 51 to 54 of GSTR 2001/4).

We refer to supplies of these kinds as 'discontinuance supplies'. However, whether a discontinuance supply is a taxable supply will then depend on the requirements of section 9-5 of the GST Act being met in relation to that supply.

Under the Deed, clause X addresses the 'release and indemnity' between the parties. You and A agree to forever release and discharge, not make any claims against, and to indemnify, NRCo, B and AusCo from claims which you and A now have or in the future may have against NRCo, B and AusCo arising from the Agreement before the effective date (of the Deed) and the proceedings. NRCo, B and AusCo also agree to the same conditions in relation to you and A. Clause X of the Deed also covers the discontinuation of the proceedings and the barring from further proceedings.

In relation to the GST treatment of discontinuance supplies and damages, paragraphs 106 to 108 and 111 of GSTR 2001/4 further state:

Discontinuance supply

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.

…

Damages

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.

As outlined above, there is a 'current supply' made by you to NRCo (which is provided to AusCo) in accordance with the Deed. The payment of the annual amount of $XXX is not solely for a discontinuance supply or for damages.

The facts indicate that the business currently conducted by you under the terms of the Agreement will be transferred and conducted by AusCo in Australia as a result of the arrangements under the Deed. This includes assigning any existing contracts to AusCo, and delivering the client data and other documents or material necessary to transfer the 'Business' to AusCo. AusCo can also make a consulting work offer to A (who currently controls you). The business is transferred to AusCo, but not the Agreement itself. It is noted that while the Agreement is suspended AusCo can not assign, sell or otherwise dispose of AusCo's business or any part of it without your prior written consent. The Agreement with you is suspended (but not terminated) and may be reactivated as if it had never been suspended.

Goods and Services Tax Ruling GSTR 2003/11 covers payment on early termination of a lease, and the principles from paragraph 25 indicate that in determining the GST consequences of a payment made on early termination of a lease (in this case a contractual agreement), regard needs to be had to the true character of the transaction. An arrangement between the parties will be characterised not merely by the description the parties give to the arrangement, but by examining the transactions entered into and the circumstances in which the transactions are made.

Further as provided in paragraphs 38 to 41 of GSTR 2003/11, early termination under a separate agreement between the parties may occur where it is not provided for in the original terms of the agreement. For example, if a lessor agrees to terminate a lease early, provided the lessee pays an agreed amount to the lessor. In these circumstances, the payment is consideration for a supply by the lessor. The supply is separate to the original supply and is subject to GST where the other requirements of a taxable supply are met. However, a payment on early termination under a separate agreement may consist of a number of components with different characterisations. This depends on the agreement reached and implemented by the parties.

On the basis of the facts available and outlined above, we consider that the annual amount of $XXX is for the current supply of the business and the related surrender of rights to NRCo (but provided to and used by AusCo in Australia), rather than a discontinuance supply where the subject of the dispute is a damages claim or for damages. Further, you informed that you had surrendered your rights under the Agreement and in consideration for this surrender NRCo paid you the annual amount of $XXX (exclusive of GST). There is no evidence provided to indicate that part of the $XXX is for a damages claim.

Summary

In summary, you are making a current supply of the business and the related surrender of rights to NRCo (which is provided to and used by AusCo in Australia) in return for the annual amount (consideration). Paragraph 9-5(a) of the GST Act is satisfied as there is a sufficient nexus between the current supply and the consideration, being the annual amount of $XXX. The current supply made to NRCo but provided to AusCo in Australia is not GST-free. Therefore, all the requirements of section 9-5 of the GST Act are satisfied and you are liable for GST on the annual amount of $XXX received from NRCo in accordance with the Deed with NRCo.