Edited version of your written advice

Authorisation Number: 1051292745186

Date of advice: 11 October 2017

Ruling

Subject: GST and Out-of-court Settlement Amount

Question

Is the out-of-court settlement amount the Entity received subject to goods and services tax (GST)?

Answer

No, the out-of-court settlement amount the Entity received is not subject to GST.

Relevant facts and circumstances

The entity entered into a Business Finance Arrangement with a bank (the Bank) pursuant to which the Bank loaned the Entity funds. The Entity and the Bank also entered into an international Swaps and Derivatives Association Agreement and an interest rate swap transaction.

A dispute arose between the Entity and the Bank in relation to the terms and operations of the above agreements and swap transaction and you proceeded to take legal action against the Bank to recover alleged financial losses suffered due to the Bank’s conduct in respect of the above agreements and swap transaction.

The legal matter was settled during a mediation process and the Bank agreed, without admission of liability, to pay an out of court settlement amount to the Entity.

In terms of the settlement Agreement, the Entity released the Bank from all claims and actions, present and future, in relation to the above legal matter among other conditions, and vice versa.

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 9-15

Reasons for decision

Taxable supply

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if you make the supply for consideration; the supply is made in the course or furtherance of an enterprise that you carry on; the supply is connected with the indirect tax zone; and 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.

The term ‘supply’ is defined in subsection 9-10(1) of the GST Act as ‘any form of supply whatsoever’ and includes an entry into, or release from, an obligation to do anything; or to refrain from an act; or to tolerate an act or situation (Paragraph 9-10(2)(g) of the GST Act).

Possible Supplies in out-of-court settlements

Goods and Services Tax Ruling GSTR 2001/4 deals with the GST consequences of court orders and out-of-court settlements and discusses the meaning of supply. According to GSTR 2001/4, a supply related to an out-of-court settlement may have occurred prior to the settlement 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 and in addition, the subject of the dispute may not be a supply at all (damages claim).

In particular, GSTR 2001/4 explains that supplies related to out-of-court settlements fall into three types. These are:

• earlier supply

• current supply

• discontinuance supply.

Earlier supplies are supplies made prior to the out-of-court settlement where both the supplier and the recipient have some dispute regarding supplies.

Current supplies are supplies created by the terms of the out-of-court settlement.

A discontinuance supply is, according to paragraph 54 of GSTR 2001/4:

(i) surrendering a right to pursue further legal action

(ii) or

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

In finalising a dispute, a settlement will generally ensure no further legal action in relation to that dispute. Such a settlement could be the plaintiff releasing a defendant from some (or all) of the existing claims and from further claims and obligations in relation to the dispute. Therefore, a discontinuance supply could arise.

The earlier supply

Prior to the settlement, the Entity had entered into a Business Finance Agreement, an International Swaps and Derivative Association Agreement and an interest swap transaction with the Bank. The dispute between the Entity and the Bank is related to these agreements and the transaction.

In entering into these arrangements, potentially the Entity could be making financial supplies according to Regulation 40-5.09 of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations). Such supplies would be the earlier supplies related to the out-of-court settlement because the dispute that led to the settlement arose from these agreements and the transaction. However, any financial supplies the Entity made as part of entering into these agreements and the transaction would be input taxed (section 40-5 of the GST Act). As the earlier financial supplies (if any) would not change the GST outcome of the present case, it is not necessary to analyse the potential financial supplies.

The discontinuance supply

According to paragraph 109 of the GSTR 2001/4, the payment made under a settlement agreement 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.

Although both parties agreed to release each other from all claims and actions subject to the payment of settlement amount, based on the facts provided, we do not consider that the payment of the settlement amount is made for the discontinuance supply.

The current supply

There is no current supply identified from the terms of the Settlement Agreement.

The damages claim

Based on the facts provided, the Entity has made a claim to recover alleged financial losses suffered due to the Bank’s conduct in respect of the agreements and the interest rate swap transaction.

Paragraphs 73 and 110 of GSTR 2001/4 state:

73. 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.

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply. 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.

It is therefore concluded that the damages claim is not a supply for GST purposes.

Supply for consideration

Section 9-15 of the GST Act provides that a payment will be consideration for a supply if the payment is ‘in connection with’ a supply and ‘in response to’ or ‘for the inducement’ of a supply.

As discussed above, there is no current supply or discontinuance supply for which the settlement amount can have a sufficient nexus with. As such, the settlement amount can only link to the earlier supply and the damages claim.

Given that the damages claim is not a supply for GST purposes and the input taxed status of the potential earlier supplies to which the settlement amount relates to, the settlement amount is not subject to GST.