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Ruling
Subject: GST and out of court settlements
Question
What is your goods and services tax (GST) liability on the out of court settlement reached between you and the owner of the commercial premises?
Decision
The owner incurred a GST liability equal to 1/11th of the settlement sum paid by you under the deed of settlement and release reached between the parties. If you hold a valid tax invoice from the owner and satisfy the other requirements of the GST Act for claiming input tax credits, you could be entitled to an input tax credit equal to 1/11th of the consideration paid under the out of court settlement.
Relevant facts and circumstances
• You operated a shop at a shopping centre owned by the owner. As a result of a failure to pay the commercial lease and other outgoings, the owner took legal actions against you to recover the outstanding amounts, legal fees etc.
• A judgment was awarded against you for $X for unpaid lease and other outgoings, $Y for damages including interest and $Z for owner's legal fees.
• After the court order, you and the owner reached an out of court settlement. As per the deed of settlement and release, you agreed to pay a GST inclusive amount of $M to the owner.
Relevant legislative provisions
A New Tax System (Goods and Services Tax) Act 1999 (GST Act) - section 9-5
Reasons for the decision
Section 9-5 of the GST Act provides that 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.
In considering the GST consequences of court orders or out of court settlements, it is necessary to ascertain whether the owner made any taxable supply to you. In this respect Goods and Services Tax Ruling GSTR 2001/4 (GSTR 2001/4 or ruling) refers to GST consequences of court orders and out of court settlements.
Paragraph 21 of the ruling provides that:
21. A 'supply for consideration' is the first step towards there being a taxable supply. However, for there to be a supply for consideration, three fundamental criteria must be met:
(i) there must be a supply (see paragraph 22 onwards);
(ii) there must be a payment (see paragraph 74 onwards); and
(iii) there must be a sufficient nexus between the supply and the payment for it to be a supply for consideration (see paragraph 100 onwards).
Supplies related to an out of court settlement
Paragraphs 45-47 of the ruling refer to 'earlier supply' and they are quoted below.
Earlier supply
45. Each and every supply is subject to GST provided the supply satisfies the requirements of a taxable supplyF26. 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'.
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.
Paragraphs 97-99 of the ruling refers to whether a settlement or court awarded payment be consideration and are quoted below.
Can a settlement or court awarded payment be consideration?
97. Subsection 9-15(2A) makes it clear that the fact that a payment is made in compliance either with a court order, or with a settlement relating to proceedings before a court will not, without more, prevent it from being consideration for a supply.
98. Subsection 9-15(2A) states:
(2A) It does not matter:
(a) whether the payment, act or forbearance was in compliance with an order of a court, or of a tribunal or other body that has the power to make orders; or
(b) whether the payment, act or forbearance was in compliance with a settlement relating to proceedings before a court, or before a tribunal or other body that has the power to make orders.
99. This provision negates any argument that the characterisation of a payment according to section 9-15 either as consideration for a supply or otherwise could be affected by the payment being made in compliance with a court order or settlement relating to proceedings before a court.
Nexus with the consideration
Paragraphs 100-102 of the ruling refer to which supply has the nexus with the consideration and they are quoted below.
Which supply has the nexus with the consideration?
100. As discussed above, a sufficient nexus between a payment made under a court order or out-of-court settlement and a supply must exist to create the 'supply for consideration' relationship. Our views on where such a relationship exists are set out below.
Earlier supply
101. Where the only supply (other than a 'discontinuance' supplyF61) 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.
We consider that the out of court settlement was related to the supply by the owner of the premises within the shopping centre to you under a commercial lease agreement. It is the earlier supply. The dispute originated from the default of the lease payments and other related outgoings on this earlier supply. We consider that sufficient nexus exists between the consideration paid under the out of court settlement and the earlier supply of the commercial premises under a lease. Therefore, paragraph 9-5(a) of the GST Act was satisfied.
The owner supplied the premises to you in the course or furtherance of their enterprise of commercial leasing of premises within the shopping centre and therefore, paragraph 9-5(b) of the GST Act was satisfied.
The supply was connected with Australia as the shopping centre was located in Australia and paragraph 9-5(c) was satisfied.
The owner was registered or required to be registered for GST and therefore, paragraph 9-5(d) was satisfied.
Accordingly, the earlier supply of the commercial premises by the owner to you under a lease satisfied the requirements of section 9-5 of the GST Act as a taxable supply. As per the deed of settlement and release, the settlement sum payable was a GST inclusive amount. Accordingly, the owner incurred a GST liability equal to 1/11th of the consideration paid by you.
If you hold a valid tax invoice from the owner and satisfy the other requirements of the GST Act for claiming input tax credits, you could be entitled to an input tax credit equal to 1/11th of the consideration paid under the out of court settlement.