Edited version of your written advice

Authorisation Number: 1013140951252

Date of advice: 20 December 2016

Ruling

Subject: GST and out-of-court settlement

Question

Is the settlement amount you paid consideration for a supply?

Answer

Yes. The settlement amount you paid is consideration for a supply except to the extent that it relates to the court ordered costs. The parties need to apportion the settlement amount on a reasonable basis to determine the amount that is consideration for a supply and the amount that is not consideration for a supply.

Relevant facts and circumstances

● You entered into a contract with another entity for an initial term (the Agreement). The Agreement contained a provision for a possible further term (the option term).

● The parties are in dispute in relation to the proper interpretation of the term in the Agreement relating to the option term. The dispute was whether both parties were, in the events which occurred, obliged to enter into an agreement for the option term.

● In proceedings before the Supreme Court of XXX, the Court declared that the parties are bound to enter into an agreement upon substantially the same terms as the Agreement.

● You appealed the decision to the Court of Appeal and the Court dismissed your appeal.

● As the unsuccessful party in both of the above proceedings (the Previous Proceedings), you are liable to pay the other entity's costs (the Court ordered costs).

● The other entity lodged a statement of claim against you before the Supreme Court of XXX (the Proceeding).

● While the dispute was ongoing, the other entity invoiced you for certain monthly charges. You did not pay any of these invoices.

● On X occasions, the other entity provided you with proposed agreements for the option term (the Proposed Agreements).

● In a settlement deed, you and the other entity agreed to settle your differences. You agreed to pay a settlement amount.

● The settlement deed provides that:

● the other entity releases you from any liability for the Court ordered costs in the Previous Proceedings

● both parties release each other from any claim referred to in, arising from or connected with the Proceeding, the Previous Proceedings and the Proposed Agreements.

● In an adjustment note, the other entity credited to your account an amount equal to their invoices that you did not pay.

Relevant legislative provisions

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

Reasons for decision

Relevant legislation and ATO view

In order for a payment to be consideration for a supply, there needs to be a nexus between the consideration and the supply. It is not sufficient for there to be a supply and a consideration. The consideration must be for the supply that is made.

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

The term 'supply' is defined very broadly in section 9-10 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) as 'any form of supply whatsoever'. Given the broadness of the term 'supply', an out-of-court settlement may relate to a supply.

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 described below:

1. Earlier supply - the subject of the dispute is an earlier transaction in which a supply was made involving the parties.

2. Current supply - a new supply created by the terms of the settlement.

3. Discontinuance supply - in finalising a dispute, the terms of a settlement will generally 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.

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.

The term 'consideration' is also very broadly defined in the GST Act. Consideration includes any payment, or any act or forbearance, in connection with, in response to or for the inducement of a supply of anything.

In terms of whether a payment pursuant to a settlement relating to proceedings before a court, paragraph 9-15(2A)(b) of the GST Act makes it clear that such payment does not prevent it from being consideration for a supply.

A sufficient nexus between a payment made under an out-of-court settlement and a supply must exist to create the 'supply for consideration' relationship.

In determining whether a sufficient nexus exists between supply and consideration, regard needs to be had to the true character of the transaction. An arrangement between parties will be characterised not merely by the description which parties give to the arrangement, but by looking at all of the transactions entered into and the circumstances in which the transactions are made.

Where a sufficient nexus exists between the payment made under a settlement and an earlier supply, a current supply or a discontinuance supply, the payment will be consideration for that supply.

In relation to a discontinuance supply, 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.

When a dispute is finalised, either by a court giving judgment or through negotiation of a settlement, 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.

In the instance of the payment of costs under a court order, 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.

Where the terms of an out-of-court settlement include a dissection and itemisation of the payment into the heads of claim, that itemisation will be accepted as representing the amounts of these relevant parts to the extent that it is made on a reasonable basis.

Where no dissection is made and the payment has sufficient nexus to a supply and an item of damages which is not a supply, the payment needs to be apportioned into amounts representing these relevant parts in order that the correct GST consequences result. The apportionment should be determined by the parties on a reasonable basis.

Application to your case

Under the Agreement, the other entity makes a supply to you for which you are liable to pay monthly charges.

The dispute which was the subject of the out-of-court settlement has its origin in the Agreement. The dispute was in relation to whether the parties are bound to enter into a new agreement for the Option term.

The Proceeding included a claim against you for the monthly charges.

Amongst other things, the settlement deed settled the dispute in relation to the monthly charges and the Court ordered costs.

We consider that there is an earlier supply relating to the monthly charges. To the extent that the settlement amount relates to this earlier supply, there was consideration for that supply. To the extent that the settlement amount was for the Court ordered costs, we consider that there is no supply for consideration.

As the settlement deed did not dissect the settlement amount, the parties need to apportion the amount on a reasonable basis.

Other information

Where there is no supply for consideration, it cannot result in a taxable supply. However, if an entity has passed on to another entity an amount for GST and the entity accounts for GST in an activity statement lodged with the Commissioner, the excess GST is taken to be payable until the entity reimburses the other entity for the passed-on GST (Division 142 of the GST Act).

While the excess GST is taken to be payable, paragraph 11-5(b) of the GST Act (about taxable supplies) is satisfied for the corresponding acquisition by the other entity.