Edited version of your written advice

Authorisation Number: 1051208972673

Date of advice: 13 April 2017

Ruling

Subject: GST and input tax credit and out of court settlement

Question 1

Is the Licence Fee paid by you to the Owners under a Deed of Settlement (Deed) consideration for a creditable acquisition under section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes, on the facts provided, the Licence Fee paid by you to the Owners under the Deed was consideration for a creditable acquisition of a licence under section 11-5 of the GST Act for which an entitlement to an input tax credit arose.

Relevant facts and circumstances

You are registered for goods and services tax (GST) and carry on an enterprise which involves providing services.

You released a mobile device application (MD App).

A dispute arose between you and the registered owners (Owners) of the Australian Patents (Patents). The dispute concerned an allegation by the Owners that your MD App infringed the Owners' intellectual property rights in the Patents.

The Owners commenced proceedings in the Courts (Proceedings). The parties to the Proceedings agreed to settle the claim on the terms set out in the Deed.

You provided an executed copy of the Deed which provides that the Owners grant you a licence to use and adapt the information…described in the Patents.

You agreed to pay a once only Licence Fee to the Owners.

Under the terms of the Deed the Owners agreed that on the payment of the Licence Fee to:

● forever release and discharge you from all Claims of any nature…

● not to make any Claims against you...

● indemnify you and keep you indemnified in relation to all Claims of any nature…

The parties agreed that on the payment of the Licence Fee to discontinue the Proceedings with no order as to cost and each party bear their own costs of the Proceedings and the parties will take any steps to discontinue the Proceedings.

The parties expressly agreed that the Licence Fee was inclusive of GST.

The Deed makes no reference to the GST registration of any of the parties. The Owners were not registered for GST at the time the Deed was executed and the payment made. However you contend that on the facts the Owners were required to be registered for GST.

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 section 9-10

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

A New Tax System (Goods and Services Tax) Act 1999 section 11-5

A New Tax System (Goods and Services Tax) Act 1999 section 11-10

A New Tax System (Goods and Services Tax) Act 1999 section 11-20

A New Tax System (Goods and Services Tax) Act 1999 section 23-5

A New Tax System (Goods and Services Tax) Act 1999 section 188-10(1)

Reasons for decision

Creditable acquisition

Section 11-20 of the GST Act provides that you are entitled to an input tax credit (ITC) for any creditable acquisition you make. You make a creditable acquisition under section 11-5 of the GST Act if:

● you acquire anything solely or partly for a creditable purpose

● the supply of the thing to you is a taxable supply

● you provide, or are liable to provide, consideration for the supply, and

● you are registered, or required to be registered for GST.

You make an acquisition for a creditable purpose to the extent that you acquire a thing in carrying on your enterprise unless the acquisition relates to making supplies that would be input taxed or the acquisition is of a private or domestic nature.

On the facts, you are registered for GST, any acquisition made by you pursuant to the Deed would have been for a creditable purpose and you provided consideration (Licence Fee).

The issues under section 11-5 of the GST Act that arise are:

● whether the settlement gives rise to a supply and corresponding acquisition for which the Licence Fee is consideration and if so

● whether that supply was a taxable supply made to you.

The Owners would have made a taxable supply to you under section 9-5 of the GST Act, if:

● they made the supply for consideration

● the supply was made in the course or furtherance of an enterprise that they carried on

● the supply was connected with the indirect tax zone and

● they were 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. The supplies contemplated by the Deed were not GST-free or input taxed.

The GST consequences of out of court settlements are discussed in Goods and Services Tax Ruling GSTR 2001/4. That ruling focuses on the first requirement of a taxable supply that there is a 'supply for consideration' in relation to the out-of-court settlement.

GSTR 2001/4 outlines three categories of supplies that may relate to out-of-court settlements including an earlier supply, a current supply and a discontinuance supply. However, where damages are the substance of the dispute, damages cannot of themselves be characterised as a supply under section 9-10 of the GST Act made by the aggrieved party (paragraphs 71 to 73 of GSTR 2001/4).

Therefore the first step is to identify whether any supplies were made on settlement.

Is there a supply

The Deed provides for the grant by the Owners of a perpetual licence to use and adapt the information described in the Patents. That licence answers the statutory definition of a supply under section 9-10 of the GST Act.

Other supplies

The Deed contains discontinuance supplies of the kind described in paragraph 51 to 55 of GSTR 2001/4. In these circumstances, the dispute has reached finality with parties surrendering rights to discontinue further legal action and releasing other parties from obligations in relation to the dispute etc. These actions are also supplies for GST purposes.

It follows that the settlement gave rise to a number of things which satisfy the statutory definition of a supply namely the current supply of the licence and the discontinuance supply.

Sufficient nexus

Under subsection 9-15(1) of the GST Act consideration includes any payment, or any act or forbearance, in connection with, or in response to or for the inducement of a supply of anything and would include the Licence Fee (paragraph 9-15(2A)(b) of the GST Act) paid by you to the Owners.

Which supply has a nexus with the Licence Fee?

A sufficient nexus between the payment made under Deed and a supply must exist to create the 'supply for consideration' relationship under paragraph 9-5(a) of the GST Act. The test is an objective one.

The Commissioner explains in paragraph 96 of GSTR 2001/4:

96. 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.

Having regard to the Deed and the statement of claim and cross claim and the true character of the transaction it is reasonable to conclude that there is a sufficient nexus between the Licence Fee and the current supply of a licence made under the Deed for the Licence Fee to constitute consideration for that current supply of the licence.

Discontinuance supply

Discontinuance supplies are discussed in paragraphs 106 to 109 of GSTR 2001/4. Paragraph 109 of GSTR 2001/4 states:

109. We consider that a payment 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 substances that the payment could only be for the discontinuance supply

In the present case there is no overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment can only be for the discontinuance supply.

Although it cannot be dismissed that some of the Licence Fee may be consideration for the discontinuance supplies or the damages claim the better view (based on the reasoning above) is that the settlement sum has a nexus with the current supply of the licence. Under the terms of the Deed the discontinuance supplies do not have a separately ascribed value and are merely an inherent part of the legal machinery to add finality to the disputes and as such, do not give rise to an additional payment of its own. Therefore, none of the Licence Fee has a nexus with the discontinuance supplies.

Other requirements of section 9-5 of the GST Act

On the facts, the Owners were not registered for GST. Section 23-5 of the GST Act provides that you are required to be registered for GST if:

● you are carrying on an enterprise and

● your GST turnover meets the registration turnover threshold

The term 'enterprise' is relevantly defined in subsection 9-20(1) of the GST Act and includes, amongst other things, an activity, or series of activities, done on a regular or continuous basis, in the form of a lease, license or other grant of an interest in property. However, an enterprise does not include an activity or series of activities by an individual or a partnership (all or most of those members of which are individuals) without a reasonable expectation of profit or gain.

In Miscellaneous Taxation Ruling MT 2006/1 the Commissioner considers the meaning of certain key words and phrases used to define an enterprise.

According to MT 2006/1 the term 'property' cover's all types of property including intangible assets such as patents. The terms 'lease, licence or other grant of an interest in property' encompass all activities that are directed to the exploitation of property rights.

The grant of the licence need not be done on both a regular and continuous basis. An activity will be continuous if there is no significant cessation or interruption to the activity and regular if it is repeated at reasonable proximate intervals.

Paragraph 306A of MT 2006/1 states:

306A. In Commissioner of Taxation v MBI Properties Pty Ltd [2014] HCA 49; 2014 ATC 20-474 (MBI Case) at [37], the High Court noted that in observing and continuing to observe the obligation to provide quiet enjoyment under a lease, a lessor is appropriately regarded as engaging in an activity done on a regular or continuous basis in the form of a lease.

The Owners intellectual property is an intangible asset capable of being licenced and according to the Deed the Owners granted a licence for which they were paid the Licence Fee.

Registration turnover threshold

You have a GST turnover that meets a particular turnover threshold under subsection 188-10(1) of the GST Act if:

● your current GST turnover is at or above the turnover threshold and the Commissioner is not satisfied that your projected GST turnover is below the turnover threshold; or

● your projected GST turnover is at or above the turnover threshold.

The value of the supply of the licence (Licence Fee) under the Deed indicates that the Owners GST turnover met the GST registration turnover threshold.

On the facts available to the Commissioner it is reasonable to conclude that all the requirements of a creditable acquisition were satisfied including that a taxable supply under section 9-5 of the GST Act was made to you by the Owners under the terms of the Deed and as such you are entitled to an ITC in relation to the creditable acquisition of the licence.