Edited version of your written advice

Authorisation Number: 1013074810777

Date of advice: 6 October 2016

Ruling

Subject: GST and out-of-court settlement

Question

Do you make a creditable acquisition under section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) when you make a payment pursuant to the Deed?

Answer

No, you are not making a creditable acquisition under section 11-5 of the GST Act when you make a payment pursuant to the Deed as there is no supply for consideration.

Relevant facts and circumstances

The following description of the scheme is based on information provided by you and information gathered from a court judgment.

You are registered for GST.

You and the payee were parties to a number of legal proceedings.

There were negotiations with respect to the payment of the court awarded costs by you to the payee.

You entered into an out-of-court settlement deed. The deed sets out an amount you will pay to the payee. The deed is an agreement between you and payee to agree to resolve all matters in dispute in relation to court costs, the summonses and court proceedings.

Reasons for decision

Unless otherwise stated, all legislative references in this Ruling are to the A New Tax System (Goods and Services Tax) Act 1999.

Section 11-5 provides that you make a creditable acquisition if:

• you acquire anything solely or partly for a *creditable purpose; and

• the supply of the thing to you is a *taxable supply; and

• you provide, or are liable to provide, *consideration for the supply; and

• you are registered, or required to be registered.

(The asterisks in this ruling indicate terms defined under section 195-1 of the GST Act)

Subsections 11-15(1) and 11-15(2) provide that you acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise and it is not acquired for making input taxed supplies or for a private or domestic purpose.

To decide whether the payment you make is for a creditable acquisition made by you, the remaining requirement to be determined is whether the supply to you is a taxable supply.

TAXABLE SUPPLY

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

(a) it makes a supply for *consideration; and

(b) the supply is made in the course or furtherance of an *enterprise that it carries on; and

(c) the supply is *connected with the indirect tax zone; and

(d) the entity is *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 relation to your case, we consider that the terms of the Deed amount to an out-of-court settlement. An out-of-court settlement includes any form of dispute in which the terms of the resolution are agreed between the parties, rather than imposed by the court.

Goods and Services Tax Ruling GSTR 2001/4 (GSTR 2001/4) considers the GST consequences resulting from court orders and out-of-court settlements. Relevantly, it explains how a payment (or act or forbearance) that is made in compliance with an out-of-court settlement should be treated for the purposes of the GST Act.

Paragraphs 19-21 of GSTR 2001/4 provide that in considering the GST consequences of out-of-court settlements, the focus is on the 'supply for consideration' requirement. This requirement is the first step in determining whether there is a taxable supply. For there to be a 'supply for consideration', three fundamental criteria must be met:

1) there must be a supply;

2) there must be a payment; and

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

Supply

Supply is defined broadly in subsection 9-10(1) as 'any form of supply whatsoever'. Subsection 9-10(2) provides a non-exhaustive list of activities or occurrences that are included within the meaning of supply. Essentially, a supply is something which passes from one entity to another and may be goods, services or something else. In the context of an out-of-court settlement, a supply referred to under any of the paragraphs in subsection 9-10(2) could be related to an out-of-court settlement.

Paragraph 43 of GSTR 2001/4 provides that a supply related to an out-of-court settlement may have occurred prior to settlement (and in fact have been the subject of the dispute in the first place), or it may have been created by the terms of the settlement itself. There may be more than one supply that is related to a settlement or the subject of the dispute may not be a supply at all.

However, 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.

Paragraph 44 of GSTR 2001/4 explains that there are three different categories of supplies relating to out-of-court settlements and these are:

a) Earlier supply

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'.

b) Current supply

A new supply which is created by the terms of the settlement is referred to as a current supply.

c) Supply related to discontinuance of action

Paragraph 50 of GSTR 2001/4 explains that even where there is no earlier or current supply, the broad 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.

Paragraphs 51 and 52 of GSTR 2001/4 provide that, generally, 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. 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.

These conditions of settlement can create discontinuance supplies which, according to paragraph 54 of GSTR 2001/4, 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.

However, for the discontinuance supplies to be taxable supplies depends on whether the requirements of section 9-5 are satisfied, as set out above.

Paragraph 107 of GSTR 2001/4 states in relation to discontinuance supplies, that 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 settlement rather than being the subject of the settlement.

Further, paragraph 109 of GSTR 2001/4 states that the Commissioner considers 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.

Where the subject of a claim is not a supply

GSTR 2001/4 at paragraphs 71 to 73 explains that disputes can arise over incidents that do not relate to a supply such as claims for damages arising out of property damage, negligence causing loss of profits, personal injury, etc. 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.

Paragraph 111 of GSTR 2001/4 discusses the GST consequences of damages in the context of an out-of-court settlement. It states that if a payment is made 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.

Costs

Paragraphs 142 to 149 of GSTR 2001/4 discuss the GST treatment of costs relating to the finalisation of a dispute. The unsuccessful party in the action may be required to pay the costs or part of the costs that have been incurred by the successful party in bringing or defending the claim.

Paragraph 148 of GSTR 2001/4 states that in the instance of the payment of costs under the court order or settlement there is no supply for consideration from the successful party to the unsuccessful party. This is essentially paying compensation for costs or losses incurred in the dispute and will be treated in the same manner as damages under paragraphs 110 (court order) and 111 (out-of-court settlement).

Accordingly, GSTR 2001/4 states at paragraph 149, that the payment of court ordered costs or costs negotiated in a settlement in the circumstances described will not be consideration for an earlier or current supply.

In your case, the payments you will be making are pursuant to the Deed, which is an agreement between you and payee to agree to resolve all matters in dispute in relation to court costs, the summonses for taxation and court proceedings.

Based on the facts provided, including an examination of the deed, it is considered that the payment is for payment of the outstanding costs arising from the various court proceedings. That is, the deed is a negotiated out-of-court settlement relating to the matter of payment of the outstanding court ordered costs.

As outlined above, paragraph 148 of GSTR 2001/4 sets out that for payments of costs under a settlement, there is no supply for consideration from the successful party to the unsuccessful party. Further, paragraph 149 of GSTR 2001/4 provides that these types of payments for costs negotiated in a settlement will not be consideration for an earlier or current supply.

We consider that the terms of your out-of-court settlement as set out in the deed create discontinuance supplies. However, our view is that the payment has no nexus with the discontinuance supplies arising under the deed.

In line with the Commissioner's view in paragraph 107 of GSTR 2001/4, the discontinuance supplies arising under the deed do not have separately ascribed values and merely add finality to the dispute without giving rise to payment in its own right. They are in the nature of a term or condition of settlement rather than being the subject of the settlement.

Accordingly, the payment you will be making to the payee is not for a supply made by the payee to you. The payment is akin to damages, whereby the payee is seeking payment of their court-ordered costs incurred in prior legal proceedings which were awarded by the court to essentially compensate the payee. As there is no supply for consideration, there is no taxable supply made to you by the payee under the deed. As the requirements in section 11-5 are not met, you are not making a creditable acquisition when you make a payment to the payee pursuant to the deed.