Edited version of your written advice

Authorisation Number: 1012669584952

Ruling

Subject: GST and out of court settlement

Question:

Is the payment received by an Australian company (you) from another Australian company (CoA) in relation to an out of court settlement subject to goods and services taxes (GST)?

Answer:

No, the out-of-court settlement payment does not constitute consideration for a taxable supply made by you, and will not be subject to GST.

Relevant facts:

You are a company in Australia that is registered for goods and services tax (GST).

You will receive a payment of $XXX from another Australian company ('CoA') in relation to an out of court settlement. CoA is registered for GST.

You, CoA, and two other companies (CoB and CoC) are named as parties to a Deed of Settlement and Release (Deed).

You have provided a copy of a draft Deed which provides (amongst other things) that:

• CoA is the registered owner of certain intellectual property rights (rights).

• The parties filed notices of opposition to the rights (the Proceedings).

• Following negotiations between the parties, the parties have agreed to resolve all matters in dispute between them, including the Proceedings, and certain other matters in accordance with the terms of this deed.

• The parties must do all things and execute all documents necessary to ensure that the Proceedings are withdrawn.

• CoA must pay the Settlement Amount (of $XX) to you.

• You have sought and CoA has agreed to grant you a limited licence for a period of time. The use of the licence is treated separately.

• 'Undertakings' by you, CoB, and CoC are outlined:

• The parties undertake to cease certain activities (without the licence of CoA) that would fall within the scope of any of the claims of CoA's rights.

• You (and CoB) undertakes that you (and CoB) will not: oppose or maintain any opposition to any application for, or seek the re-examination or revocation of, or otherwise challenge the validity or ownership of, any of CoA's rights; or provide any assistance to any party seeking to oppose, re-examine or revoke any of CoA's rights or otherwise invalidate any of the claims of any of CoA's rights.

• CoC also agrees to cease pursuing any opposition to any application for, re-examination or revocation of, or otherwise challenge the validity or ownership of any of CoA's rights; and withdraw the Proceedings in relation to CoA's rights.

• Releases by the parties are outlined:

• CoA will release you, CoB and CoC from all claims in relation to the infringement of CoA's rights.

• You, CoB and CoC agree to release CoA from all claims arising out of any allegations and claims of infringement of CoA's rights.

You also provided the following additional information:

CoA is the registered owner of the intellectual property rights. You allege that the rights were invalid and opposed these rights. You believe the rights were manipulated by CoA. You and CoA reached a settlement where you will not oppose (you will withdraw your opposition against) the rights, in return CoA will not proceed with claims of any breach of the rights and will also pay you the settlement amount of $XX.

You clarified that there are essentially two components to the Deed: The transaction relating to the out of court settlement and the payment of $XX for you to not oppose (you will withdraw your opposition to) CoA's rights; and the transaction relating to any royalties for certain undertakings (that is, on the sales of the products which falls within the rights). You state that there is no transfer of any goods, services or rights between the parties in return for the 'settlement amount' of $XX paid to you.

You confirmed that the settlement amount of $XX will only be paid to you (and not to CoB or CoC). You, CoB, and CoC share common directors but operate separately.

You explain that the Deed only refers to the other parties because at some stage the products were traded through the various entities. CoC was involved in the initial proceedings, however you are the actual party involved with reaching the current out of court settlement with CoA and you will be the only entity receiving the settlement amount of $XX. The other parties are named (as they have traded the products at some stage) but the out of court settlement and the settlement payment is between you and CoA.

You clarified that some of the clauses in the Deed relate to the royalties for certain undertakings (that is, on the sales of the products which falls within the rights). The royalties are paid separately from the settlement amount and that you do not need a ruling in relation to this transaction.

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 section 9-10

A New Tax System (Goods and Services Tax) Act 1999 section 9-15

Reasons for decision

GST is payable on a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). One of the requirements for a taxable supply is that you make 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.

Paragraphs 71 to 73 of GSTR 2001/4 discuss 'where the subject of a claim is not a supply', and 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.

CoA is the registered owner of the intellectual property rights. You allege that the rights were invalid and opposed these rights. You claim that the rights were manipulated by CoA. You reached a settlement with CoA whereby you will not oppose (you will withdraw your opposition against) the rights (that is, the Deed indicates that you will not oppose to, or seek the re-examination or revocation of, or challenge the validity or ownership of, any CoA's rights'), and CoA agrees to pay you a settlement amount of $XX (and CoA will also not proceed with claims of any breach of the rights). We consider that the subject of the dispute/claim, being the validity (or ownership) of the rights, is not a supply for GST purposes.

In addition, paragraphs 44 to 55 of GSTR 2001/4 discuss supplies that are related to an
out-of-court settlement, which may fall within three categories of supply: earlier supply, current supply and discontinuance supply.

The facts indicate that the subject of the dispute relates to the validity (or ownership) of the rights. In finalising the dispute between the parties, you will not oppose to, or seek the re-examination or revocation of, or challenge the validity or ownership of, any CoA's rights. Each party also agrees to release the other party (or parties) from all claims arising out of the allegations and claims of infringement of CoA's rights, including unjustified treats of infringement and so on.

We do not consider that there is an earlier or current supply on the basis of the information provided.

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. The supplies may be characterised as: surrendering a right to pursue further legal action; or entering into an obligation to refrain from further legal action; or releasing another party from further obligations in relation to the dispute (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.

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.

You allege that the rights were invalid and opposed these rights. You reached a settlement with CoA whereby you will not oppose (you will withdraw your opposition against) the rights (that is, the Deed indicates that you will not oppose to, or seek the re-examination or revocation of, or challenge the validity or ownership of, any CoA's rights). In finalising the dispute, you will ensure no further action in relation to that dispute, provided that the terms of the settlement are complied with.

On the information provided, there is nothing to suggest that the subject of the dispute/claim (being the validity of the rights) is so lacking in substance to the extent that it can be construed that the settlement payment is only made for a discontinuance supply. 

As a sufficient nexus cannot be established between a discontinuance supply and the settlement payment, it is not considered that the settlement amount payable under the Deed is in response to a discontinuance supply. The settlement payment received from CoA is not consideration for a supply, and therefore is not subject to GST.