Edited version of your written advice

Authorisation Number: 1051195420237

Date of Advice: 28 February 2017

Ruling

Subject: GST and out of court settlements

Question

Are you liable for GST pursuant to section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) on the receipt of the settlement sum?

Answer

No

Relevant facts and circumstances

Background

Entity A created a family Trust. Entity A was the Primary Beneficiary under the Trust Deed and the trustee of the Trust. Entity B was the Settlor.

The “Secondary Beneficiaries” are defined by reference to their relationship with Entity A. The main named Secondary Beneficiaries are:

Second Beneficiary 1 and

Second Beneficiary 2.

Second Beneficiary 2 is not a resident of Australia.

Entity A executed a will and pursuant to the terms of the Will, the Settlor was to be appointed as sole executor and trustee of the deceased's estate (“Estate”) upon the death of Entity A. Under the Will, the whole of the Estate was devised and bequeathed, in equal shares, to the Second Beneficiaries.

The Estate included the assets of the Family Trust.

Entity A died and the Settlor became the executor of the Estate and trustee of the Family Trust.

During the time when Settlor was acting as trustee of the Family Trust and as executor and administrator of the Estate, he, at the request of Second Beneficiary 1 and associates without the consent or knowledge of Second Beneficiary 2 pledged the assets of the Trust and the assets of the Estate as security for two loans which were used to acquire businesses.

Subsequently the Settlor disposed of some of the assets of the trust and paid out the lender.

The Settlors appointment as executor and trustee ceased when he was removed by a Court order and Entity C was appointed Administrator of the Estate of entity A and the trustee of the Family Trust.

Second Beneficiary 2 believed that the assets of the Trust and the Estate had been diminished by the amount of $X .

Entity C made an application to the Court for directions. The Court appointed Entity C as a separate trustee of property of the Trust and the Estate, but confined to the following issues:

The claims, rights, remedies and interests which may be available to the Trust and the Estate in consequence of the borrowings secured against assets of the Trust and the Estate;

The provision and application of the Proceeds; and

Any right of subrogation arising from repayments received by the third party lender out of the realisation of assets of the Trust and the Estate that secured the borrowings;

Ultimately, Second Beneficiary 1 and associates engaged in mediation with Second Beneficiary 2, ultimately leading to the resolution of their dispute in terms of a settlement sum to be paid over to Second Beneficiary under a Settlement Deed.

The settlement Deed was then sanctioned by order of the Court.

Relevant legislative provisions

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

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

Reasons for decision

In this reasoning, 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 on the Australian Taxation Office (ATO) website 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

Issue 1

Are you liable for GST pursuant to section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) on the receipt of the settlement sum of $1.8 million paid by Lynn and her associates?

The GST consequences of a court order or out-of-court settlement will depend on whether the payment made under an order or settlement constitutes consideration for a supply and, if so, whether the supply is in nature of a taxable supply.

The Commissioners views on the impacts of out of Court settlements are set out in Goods and Services Tax Ruling GSTR 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4).

It analyses, amongst other things, the concept of supply and the nexus that must exist between a payment and a supply in order to establish the relationship of a supply for consideration.

As explained in paragraph 21 of GSTR 2001/4, three fundamental criteria must be met for there to be a supply for consideration and these three criteria are:

(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.

The term supply under subsection 9-10(1) includes any form of supply whatsoever. GSTR 2001/4 explains that supplies related to out-of-court settlements fall within one of three categories which are:

Earlier supply;

Current supply;

Discontinuance supply.

An earlier supply is a supply that occurred before the dispute arose, and which is the subject of the dispute.

A current supply is one that may be created by the terms of the court order or out-of-court settlement.

A discontinuance supply may be characterised as:

Surrendering a right to pursue further legal action;

Entering into an obligation to refrain from further legal action;

Releasing another party from further obligations in relation to the dispute.

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 the supply.

Under the Deed of Settlement $X was to be paid to Second Beneficiary 2 as an out-of-court settlement representing compensation arising from the alleged misdealing that has diminished the assets of the trust. In addition, the terms in the Deed provide for discontinuance of the Proceeding.

In this instance, there is no earlier supply or current supply relating to the settlement amount and the Deed includes a discontinuance supply.

In regard to discontinuance supply, paragraphs 106 to 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.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

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.

Furthermore, the distinction between a damages claim and a discontinuance supply is explained at paragraphs 110 and 111 of GSTR 2001/4. They state:

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply made by the aggrieved party. If a payment made under a court order is wholly in respect of such a claim, the payment will not be consideration for a supply.

111. If a payment is made under an out-of-court settlement 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 where there is an identifiable discontinuance supply under the settlement.

In this case, there is no earlier or current supply and we consider the payments made under the Deed are more in the nature of payments for damages rather than consideration for the discontinuance supply. This is because the Deed does not give the discontinuance supply a separately ascribed value and the discontinuance supply is just a term or condition of the settlement. The payment under the settlement is in respect of the damages claim and therefore does not have a sufficient nexus with the discontinuance supply.

Accordingly, in line with paragraph 111 of GSTR 2001/4 the payment of the settlement sum is not consideration for a supply.

As all of the requirements for a taxable supply have not been met, you are not liable for GST on the receipt of the settlement sum paid by Second Beneficiary 1 and associates.