Edited version of your written advice

Authorisation Number: 1013006598564

Date of advice: 4 May 2016

Ruling

Subject: GST and out of court settlement

Question 1

Are the amounts of $xx and $xx consideration for a supply under paragraph 9-5 (a) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No.

Relevant facts and circumstances

You entered into a contract with the vendor for the purchase of a business.

You also took over the lease of the property for the business.

The supply was treated as GST-free supply of a going concern.

A dispute later arose with you claiming that the vendor had breached the sale of business contract. In particular, that they had contravened clause that covered restraint of trade in carrying on business in the same industry.

You took action against the vendor and claimed damages due to the breach of contract as a result of the restraint in trade clause being contravened.

The parties to the dispute later settled and entered into a settlement deed (Deed).

The relevant clauses of the Deed are as follows:

• Clause X provided that in consideration of the parties entering into the terms of settlement, the parties mutually release and discharge each other from all further claims, demands, suits and costs of whatever nature, however arising out of or connected with the subject matter of the dispute.

• Clause X provides that the injunction be lifted.

• Clause X provides that the vendor is free to trade regardless of location and the clause of the sale of business contract relating to the restraint of trade clause will no longer apply.

• Clause X and X provided that two of the assets purchased as part of the business were to be sold with the sale of the proceeds going to you.

• Clause X and X provide that the vendor will pay two amounts being $xx and $xx at a time specified in the Deed. These amounts are inclusive of costs ordered by the Judge.

Further information provided by you explained that the two assets to be sold are part of your business assets and you will be selling them as part of your business with the business keeping the proceeds.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5, and

A New Tax System (Goods and Services Tax) Act 1999 section 9-10.

Reasons for decision

Matters in dispute may be resolved either by the judgment of a court, or (at a time prior to the court delivering its judgment) by agreement between the parties. We refer to an agreement between the parties as an out-of-court settlement. Out-of-court settlements will include any form of dispute resolution in which the terms of the resolution are agreed between the parties, rather than imposed by the court. As in your situation where the parties obtain a consent order, the draft of which has been agreed to in a settlement deed.

The GST consequences of an out-of-court settlement will depend on a number of matters, including whether a payment made under the settlement constitutes consideration for a supply and whether the supply is taxable.

Section 9-5 sets out the requirements of a taxable supply and provides:

You make a taxable supply if:

(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 the indirect tax zone; 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.

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

(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.

Essentially, a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

'Supply' is defined in subsection 9-10(1) as 'any form of supply whatsoever'.

Without limiting these general meanings, subsection 9-10(2) provides a non-exhaustive list of activities or occurrences that are included within the meaning of supply. The list is as follows:

(a) a supply of goods;

(b) a supply of services;

(c) a provision of advice or information;

(d) a grant, assignment, or surrender of real property;

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

(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).

Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release.

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), or it may be created by the terms of the settlement itself. 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.

Supplies that are related to an out-of-court settlement fall within the three categories of supply being earlier supply, current supply and discontinuance supply. This characterisation assists in the subsequent analysis of consideration for a supply. 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.

An earlier supply is where the subject of the dispute is an earlier transaction in which a supply was made involving the parties. A current supply is a new supply created by the terms of the settlement. A discontinuance supply relates to discontinuance of action in finalising a dispute, ensures no further legal action in relation to the dispute provided that the terms of the settlement are complied with.

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, or

(ii) entering into an obligation to refrain from further legal action, or

(iii) releasing another party from further obligations in relation to the dispute.

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.

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.

In your circumstances the identified supplies are as follows:

• a current supply of a release from an obligation (subparagraph 9-10(2)(g)(ii) of the GST Act) from you to the vendor due to the lifting of the restraint of trade Clause 13 of the sale of business contract, and

• the discontinuance supply (subparagraph 9-10(2) (e) and (g) of the GST Act) provided for under clause 1 of the Deed.

We now need to determine if the payments under clause 5 and 6 to you from the Vendor have a sufficient nexus to the supplies mentioned.

In this situation we believe the payments are being provided due to settlement of a damages claim for a contractual breach and do not have a sufficient nexus to the current supply of a release from an obligation due to the lifting of the restraint of trade clause created under the Deed.

Furthermore, we also do not believe the payments have a sufficient nexus to any discontinuance supply and they are in fact a term of the settlement rather than being the subject of the settlement.

As there is no supply for consideration paragraph 9-5(a) of the GST Act will not be satisfied and as a result there will be no GST on the amounts paid to you.