Edited version of your written advice

Authorisation Number: 1012707998529

Ruling

Subject: GST and out-of-court settlements

Question

Is payment of the settlement sum from Entity A consideration for a taxable supply that you made?

Answer

Yes

Relevant facts and circumstances

You are the trustee for the Trust.

Around ddmmyyyy, you and Entity A entered into a Contract whereby you agreed to complete alterations and additions to Entity A 's property.

A dispute arose over payment of your invoices and you submitted the dispute to arbitration, pursuant to the provisions of the Contract.

The parties settled the dispute on the basis that Entity A would pay you a settlement sum of $xxx plus legal costs of $xx and the parties entered into a Deed of Settlement and Release dated ddmmyyyy.

You supplied a copy of the Deed of Settlement and Release:

Under a clause 1X

• the amount for legal costs of $xx is inclusive of GST.

• settlement sum means the sum of $xxx

Clause 3X states:

The Parties unconditionally and irrevocably release and discharge each other from all Claims in respect of the Released Matters, which but for this document would, could or might at any future time have or have had against each other.

Clause XX states:

If any payment made by one party to any party under or relating to this document constitutes consideration for a taxable supply for the purposes of GST or any similar tax, the amount to be paid for the supply will be increased so that the net amount retained by the supplier after payment of that GST is the same as if the supplier was not liable to pay GST in respect of that supply. This provision is subject to any other agreement regarding the payment of GST on specific supplies, and includes payments for supplies relating to the breach or termination of, and indemnities arising from, this document.

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 subsection 9-10(2)

A New Tax System (Goods and Services Tax) Act 1999 section 9-75

A New Tax System (Goods and Services Tax) Act 1999 section 9-70

Reasons for decision

Note: In this ruling, unless otherwise stated,

• all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

• all reference materials referred to are available at www.ato.gov.au

• all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act

Under section 9-5, an entity makes a taxable supply if:

• it makes a supply for consideration; and

• the supply is in the course or furtherance of an enterprise that it carries on;

• the supply is connected with Australia; and

• the entity is registered or required to be registered for GST.

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

Subsection 9-10(2) provides a non-exhaustive list of activities or occurrences that are included within the meaning of supply. The list includes the following items of relevance in this instance:

(b) a supply of services;

(e) a creation, grant, transfer, assignment or surrender of any right;

(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;

Paragraph 21 of Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 201/4), explains that for there to be a supply for consideration, three criteria must be met:

• there must be a supply;

• there must be a payment; and

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

Supply

Paragraph 22 of GSTR 2001/4 explains that a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

Paragraph 43 of GSTR 2001/4 explains that 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).

The ruling identifies three types of supplies: earlier supply, current supply and discontinuance supply.

Paragraph 46 of GSTR 2001/4 explains that, where the subject of the dispute is an earlier transaction in which a supply was made involving the parties, that supply is referred to as an earlier supply.

Paragraph 47 of GSTR 2001/4 gives an example of an 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.

You contracted with and supplied services to Entity A. A dispute arose over payment of your invoices. The matter has been resolved through an out-of-court settlement. Your supply of services is an earlier supply because, as in the example above, it occurred before the dispute arose.

Supplies related to discontinuance of action are discussed at paragraphs 50-55 of GSTR 2001/4.

50. Even where there is no earlier or current supply, the very wide range of things that can constitute a 'supply' means that one or more new supplies will probably crystallise on an out-of-court settlement being reached.

51. 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.

52. 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.

53. 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.

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.

In your instance there are potentially two identifiable supplies, being the earlier supply of services and the discontinuance supplies in the form of the agreement under clause 3X of the Deed of Settlement and Release.

Payment

There has been a payment of $xxx.

Nexus

Whilst the nexus between the payment and the earlier supply of services is clear, it is also necessary to examine whether there is a nexus between the payment and any discontinuance supplies.

Paragraphs 106,107 and 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.

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.

On the facts provided, there is no evidence that your claim was so lacking in substance that the payment could only have been made for the discontinuance supply. Clause 3X is considered to be a condition of the settlement and not the subject of the settlement. As explained in paragraph 107 above, it is merely an inherent part of the legal machinery to add finality to the dispute. Therefore, the payment from Entity A relates solely to your earlier supply of services and is consideration for that supply.

In reviewing the requirements under section 9-5

• you made a supply for consideration;

• your supply was in the course or furtherance of an enterprise that you carry on;

• your supply was connected with Australia; and

• you are registered or required to be registered for GST.

Your supply meets the requirement of a taxable supply, and, in the circumstances described, there is no provision of the GST Act that would make your supply GST-free or input taxed.

Therefore, the payment of the settlement sum from Entity A constitutes the receipt of consideration for your earlier taxable supply of services.

In accordance with sections 9-75 and 9-70, the price of your supply was $xxxx including GST payable of $yy.