Edited version of your written advice

Authorisation Number: 1051478433503

Date of advice: 5 February 2019

Ruling

Subject: GST implications of an out of court settlement.

Question 1

Was the payment of the $X Amount by A to B consideration for a taxable supply pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)? If so, who made the taxable supply?

Answer 1

Yes. B

Question 2

If the answer to Question 1 is yes, did A make a creditable acquisition pursuant to section 11-5 of the GST Act?

Answer 2

Yes

Question 3

Was the payment of the Interest by A to B consideration for a taxable supply pursuant to section 9-5 of the GST Act?

Answer 3

No. The payment of the Interest is consideration for the acquisition of an interest in a credit arrangement and is not subject to GST.

Question 4

Was the Settlement Payment (or any amount payable between the parties which was set-off to determine the net Settlement Amount) consideration for a taxable supply by either A or B pursuant to section 9-5 of the GST Act?

Answer 4

See detailed reasoning.

This ruling applies for the following period:

XXYY to XXYY

Relevant facts and circumstances

You provided the following documents in support of your ruling application:

● the Contract;

● the Deed;

● the Contract;

● the Judgement; and

● the Settlement Deed.

A and B are currently registered for GST. B has been continuously registered for GST since XXYY as a partnership for GST purposes. A has been continuously registered for GST since XXYY.

A and B entered into a Contract for the construction of the C in XXYY (“Export Contract”).

The Contract required B to provide various works to A in return for payment (“Works”). The Works provided by B included the design, engineering, procuring and constructing of C. All of the Works were performed in Australia.

A dispute arose between the parties to the Contract, resulting in B making a number of claims against A. Those claims were ultimately the subject of arbitration (“Arbitration”). A request for Arbitration was made by B to a Court on XXYY. The Arbitration commenced in XXYY and the Court handed down its decision on XXYY.

B advanced the following two alternate claims in the Arbitration:

(1) a claim for quantum meruit by reason of A’s repudiation of the Contract; and

(2) in the alternative, compensation for claims under the Contract arising from numerous disputed claims.

The Court ultimately found against B with respect to the quantum meruit claim.

As to B’s claim for compensation for claims arising under the Contract, as set out in the decision, B claimed against A that it was entitled to payment for:

(1) Variation proposals (“VPs) issued by Bunder the Contract; and

(2) Variation Orders (“VOs”) issued by A under the Contract.

B’s claims in respect of the VPs were for ‘Variations’ under the Contract. ‘Variation’ is defined under the Contract as follows:

Variation means any addition, deletion or change in the Works or the timing and sequence of the Works or other matters as described in clauses X (Verification of the Company Provided Information), X (the Company Provided Items) and X(a)(i) to X(a)(v) (Right of the Company to issue a Variation Order (inclusive);

B’s claims in respect of the VOs were in respect of negative Variation Orders under the Contract. “Variation Order’ is defined under the Contract as follows:

Variation Order means the document issued by the Company to the Contractor authorising a Variation or any other matter described in clause X (Variations) and in the form in Exhibit E (Administrative Procedures);

The Court ultimately decided that some of the VP/VO claims were successful in whole or part.

The VP/VO claims that were successful in whole or in part were claims for payment for Works previously performed under or in connection with the Contract.

Per the Final Award, the total amount awarded to B for its Variation claims was $X (“Variation Award Amount”). Interest of $Y on the Variation Award Amount was also awarded to B (“Variation Award Interest”).

The parties subsequently identified errors (“Errors”) in the calculation of the Variation Award Amount and the Variation Award Interest. The final agreed amounts are as follows:

(1) Variation Award Amount: $X

(2) Variation Award Interest: $Y

The above amounts include adjustments that were made under the settlement deed dated XXYY (“Settlement Deed”).

All of the above amounts are expressed on a GST-exclusive basis. You have advised that all, or substantially all, of the above payments have been made to B.

Settlement Deed - Background

The Settlement Deed deals with a number of claims, disputes and amounts alleged to be owing between B and A.

The Settlement Deed addresses:

(1) The Errors contained in the Final Award. B and A agreed that there were Errors in the Final Award, but differed as to the quantum owing to each other as a result of such errors.

(2) The dispute arising from the Contract for the Construction of the C entered into between B and A in XXYY. This dispute had been referred to arbitration under the X Rules (“the Dispute”).

(3) Costs and interests claimed to be owing by A to B in respect of the Dispute.

(4) An amount said to be owing by A to B under the Deed dated on or around XXYY (“the Deed”), being a milestone payment (referred to as the Incentive Milestone Payment) for the provision of Works by B to A under the Contract.

(5) Costs for the first arbitration and costs relating to the appeal to the Court of with respect to the first arbitral award said to be owing by B to A under an order made by the Tribunal in the first arbitration dated XXYY that B pay A’s “costs of and incidental to the arbitration” to be assessed on a standard basis in accordance with the Uniform Civil Rules. The assessment of costs, required pursuant to section X of the Commercial Arbitration Act, and contemplated by the Tribunal’s order dated XXYY, was not carried out prior to the Settlement Deed.

(6) A’s claim that B owes A an amount of Rectification for Defects under both the Contract and another contract. The Rectification Costs (per the definition in clause X of the Settlement Deed) are ‘those costs incurred or which will be incurred by B to rectify the defects to the Works undertaken by the Contractor pursuant to the Contract and another contract…’

Clause X of the Settlement Deed provides that W must pay $X to B within 14 days of the Settlement Date (“Settlement Payment”). Per clause X of the Settlement Deed, the parties agree that “all outstanding Claims and Disputes are settled for the amounts payable under this Deed, with such payments being solely in respect of a claim for loss or damage.’

Role of W

W is a party to the Settlement Deed. W is a member of the V Group and was previously the owner of A. W sold A to the A Group in XXYY, hence the name change of A from K to A in XXYY.

As part of that sale, W and A Group agreed that W would indemnify A Group for certain matters, including liability for those claims that were the subject of Arbitration and the Settlement Deed.

Accordingly, W bears the ultimate cost of A’s liability under both the Arbitration and the Settlement Deed. W does not have any direct liability to B. W’s involvement in the negotiation of the Settlement Deed is solely as a result of private arrangements between it and the A Group.

Clause Z of the Settlement Deed required W to pay B $X within 14 days of the Settlement Date.

B did not issue an invoice for the net payment of $X under the Settlement Deed.

W paid $X to B for and on behalf of A within 14 days of the Settlement Date. The payment was made to give finality to the dispute.

Calculation of net payment under the Settlement Deed

While the Settlement Deed does not specifically outline what the Settlement Payment is for, or how it is calculated, the payment is a net amount determined by reference to the various disputes and claims set out in the Background of the Settlement Deed.

The Settlement was loosely determined as follows:

While the above amounts were used as an indicative guide to determining the Settlement Payment, the parties never specifically agreed to these amounts under the terms of the Settlement Deed or under any other formal agreement.

All of the above amounts are expressed on a GST exclusive basis.

B sought interest in respect of its various claims. B did not specifically plead the basis on which it sought interest or the interest rate to be applied.

The Court looked to the Contract and found that clause X applied to Variation Orders and Variation Proposals. Clause X provides:

If payment of any sum payable under clause X is delayed, the Contractor shall be entitled to receive interest on the amount unpaid during the period of the delay. The interest shall be the Default Interest Rate.

The Court ultimately awarded interest (being the Variation Award Interest) in accordance with clause X of the Contract.

The Settlement Deed requires the payment of an undissected lump sum (being the Settlement Payment). While the Settlement Deed expressly requires W to pay the Settlement Payment, this was due to the peculiarity of the arrangements between the parties.

W was not directly liable for any of the claims or disputes that were the subject of the Settlement Deed.

Clause T of the Settlement Deed provides that the Settlement Payment is ‘solely in respect of a claim for loss or damage.’

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999, section 9;

A New Tax System (Goods and Services Tax) Act 1999, section 11;

A New Tax System (Goods and Services Tax) Act 1999, section 19-50;

A New Tax System (Goods and Services Tax) Act 1999, section 19-85.

Reasons for decision

Section 9-5 of the GST Act provides that you make a taxable supply if:

(a) you make the supply for consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

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

(d) 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.

In your case, the relevant issue is whether there is a supply by B to A for consideration and if so, whether that supply is a taxable supply

Paragraph 21 of Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements), explains that for there to be a supply for consideration, three criteria must be met:

● there must be a supply;

● there must be a payment; and

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

Supply

Paragraph 22 of GSTR 2001/4 explains that a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else. In your case the supply was earlier construction services provided by B to A.

Paragraph 43 of GSTR 2001/4 explains that 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).

The ruling identifies three categories of supply: earlier supply, current supply and discontinuance supply.

Paragraph 46 of GSTR 2001/4 explains that, 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. Each and every supply is subject to GST provided the supply satisfies the requirements of a taxable supply.

Paragraph 47 of GSTR 2001/4 gives an example of an earlier supply:

47. Widget Company supplies toys to a retailer. A dispute between the parties over payment for the toys is subsequently resolved through an out-of-court settlement, with the retailer paying all monies owed. The supply of the toys, that is the subject of the dispute, is an earlier supply because it occurred before the dispute arose.

In this case, B and A entered into a Contract for the construction of C (“Contract”). The Contract required B to provide various works to A in return for payment (“Works”). The Works provided by B included the design, engineering, procuring and constructing of C. From time to time, changes were necessary to the Works for the successful progression of the project. These occurred by way of:

● Variation Proposals – a means by which B would put to A the need for a change to originally planned Works (“VO”); and

● Variation Orders – a document issued by A to B authorising a variation (“VP”).

Payment

Pursuant to a request for Arbitration made by B to the Court of Arbitration on XXYY, the Tribunal, in its final award dated XXYY (“the Award”) awarded B $X (“Variation Award Amount”) for various VO/VP claims which were wholly or partially successful. Those claims related to the earlier Works performed by A for B relating to construction of the C. Interest of $Y was also awarded to B (“Variation Award Interest”).

In your case, the payment of the Variation Award Amount by A to B was part of the terms of an out-of-court settlement. Both parties subsequently identified errors in the Variation Award Amount and the final amounts were agreed under the Settlement Deed:

● Variation Award Amount: $X

● Variation Award Interest: $Y

Nexus

A payment will be consideration for a supply if the payment is ‘in connection with’, ‘in response to’ or ‘for the inducement of a supply. In your case, the declarations made in the Final Award confirm the nexus between the VO/VP claims and the earlier Works performed by B for A in relation to construction of the C.¹

Paragraph 93 of GSTR 2001/4 states:

93. In determining whether a payment satisfies the requirements of subsection 9-15(1), the test is whether there is a sufficient nexus between the supply and the payment made.

Paragraph 96 of GSTR 2001/4 states further:

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.

Subsection 9-15(2A) makes it clear that the fact that a payment is made in compliance either with a court order, or with a settlement relating to proceedings before a court will not, without more, prevent it from being consideration for a supply. It states:

(2A)

It does not matter:

(a) whether the payment, act or forbearance was in compliance with an order of a court, or of a tribunal or other body that has the power to make orders; or

(b) whether the payment, act or forbearance was in compliance with a settlement relating to proceedings before a court, or before a tribunal or other body that has the power to make orders.

This provision negates any argument that the characterisation of a payment according to section

9-15 either as consideration for a supply or otherwise could be affected by the payment being made in compliance with a court order or settlement relating to proceedings before a court.

Paragraph 101 of GSTR 2001/4 provides that where the only supply in relation to a court order or out-of-court settlement is an earlier supply and a sufficient nexus exists between the payment made under that order or settlement and the earlier supply, the payment will be consideration for that supply.

In this case (and as outlined in the Final Award), because the payment of the Variation Award Amount by A to B was directly related to the earlier supply of construction services to it by B, sufficient nexus exists between the provision of consideration and the earlier supply. The consideration is the payment A made to B pursuant to the Settlement Deed.

The following 3 elements referred to in paragraph 21 of GSTR 2001/4 have therefore been fulfilled:

● there has been an earlier supply of construction services;

● there has been payment for that earlier supply by payment of the Variation Award Amount from A to B; and

● there is sufficient nexus between payment of the Variation Award Amount and the earlier services provided by B to A.

Taking all of the above into account, the payment of the Variation Award Amount from A to B pursuant to an out-of-court settlement fulfils all the elements of section 9-5 of the GST Act for the following reasons:

● the supply of the construction services was made for consideration (being the Variation Award Amount).

● the supply of the construction services was made in the course or furtherance of an enterprise carried on by B;

● the supply was connected with the indirect tax zone (as the works were performed in Australia);

● A is registered for GST, and has been registered for GST at all material times; and

● the supply is neither GST-free or input taxed.

Question 2

If the answer to Question 1 is yes, did A make a creditable acquisition pursuant to section 11-5 of the GST Act?

Section 11-5 states:

You make a creditable acquisition if:

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

(b) the supply of the thing to you is a *taxable supply; and

(c) you provide, or are liable to provide,*consideration for the supply; and

(d) you are *registered, or *required to be registered

For the purpose of paragraph 11-5(a), A is carrying on an enterprise for which the acquisitions of the Works from A were made. That enterprise is the construction of infrastructure.

Section 11-15 provides the meaning of “creditable purpose”. Relevantly, subsection (1) states:

(1) You acquire a thing for a creditable purpose to the extent that you acquire it in *carrying on your enterprise.

The services acquired by A from B through their entry into the Contract were integral to A’s construction enterprise. Therefore, subparagraph 11-5(a) is fulfilled.

Applying the rationale used in answering Question 1 above, it has been established that the supply of the Works from B was a taxable supply. Therefore, subparagraph 11-5(b) is fulfilled.

Applying the rationale used in answering Question 1, the consideration for the taxable supply of the Works was the payment made by A to B pursuant to the Settlement Deed. That payment was for the earlier supply of the Works from B to A under the Contract. As confirmed by the judgement and declarations in the Final Award, sufficient nexus exists between the payment made by A to B and the earlier Works. In relation to the third party payment by W for and on behalf of A paragraph 74 of GSTR 2001/4, in discussing consideration, in part states:

It may include payments made voluntarily, and payments made by persons other than the recipient of the supply.

As consideration passed for the earlier supply, subparagraph 11-5(c) is fulfilled.

As both parties were registered for GST at all material times, subparagraph 11-5(d) is fulfilled.

As all elements of section 11-5 have been fulfilled, A is entitled to input tax credits on the creditable acquisitions it has made from B under the Project. To be entitled to claim that creditable acquisition, A must be in possession of a valid tax invoice.

Question 3

Was the payment of the Variation Award Interest by A to B consideration for a taxable supply pursuant to section 9-5 of the GST Act?

As the Contract specifically contemplated and provided for the payment of interest, the payment of the Variation Award Interest is consideration for the acquisition of an interest in a credit arrangement and is not subject to GST. The Variation Award Interest is consideration for a financial supply.

The above characterisation is consistent with paragraphs 30 and 31 of GSTR 2000/19 (Goods and services tax: making adjustments under Division 19 for adjustment events), which provides:

30. Where an amount is required to be paid by a specified date, but an additional charge becomes payable if the primary amount is not paid by the due date, the additional charge is consideration for the supply of an interest in a credit arrangement and, as such, is consideration for a financial supply. This is so whether the payment is in the nature of an accruing interest charge (for example, 10% per annum), a flat percentage of the amount due (for example, 10% of the amount due) or a fixed amount (for example, $20).

The key influencing factor in determining the GST treatment in your case is that the Contract specifically contemplates late payment, including the means by which interest is to be calculated (being the ‘Default Interest Rate’).

In relation to the GST treatment of pre-judgement interest, paragraph 13 of GSTD 2003/1 (Goods and Services Tax: Is the payment of judgment interest consideration for a supply?) provides:

The power to award pre-judgement interest exists irrespective of the cause of action, with the claim for interest considered to be separate and distinct from the underlying cause of action…We consider the awarding of pre-judgement interest is separate to the cause of action and has no connection to any supply which may be the basis of the cause of action.'

In relation to the GST treatment of post-judgement interest, paragraphs 18 and 19 of GSTD 2003/1 provide:

18. Post-judgement interest has no connection with the underlying cause of action. Once plaintiff has succeeded and judgement has been entered for a sum which may include pre-judgement interest, the cause of action which led to the judgement has merged in the judgement.

19. As post-judgement interest has no connection with the underlying cause of action, we consider that it is not connected with any earlier supply. In addition, as post judgement interest is interest on a sum awarded in judgement, the payment of the post-judgement interest is not consideration for any current supply.

Based on the above, the Variation Award Interest is not consideration for any identifiable supply.

Question 4

Was the Settlement Payment (or any amount payable between the parties which was set-off to determine the net Settlement Amount) consideration for a taxable supply by either A or B pursuant to section 9-5 of the GST Act?

Clause 3 of the Settlement Deed provides that the Settlement Payment is ‘solely in respect of a claim for loss or damage.’ Paragraph 111 of GSTR 2001/4 states:

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 whether there is an identifiable discontinuance supply under the settlement.

Even though clause 3 of the Settlement Deed states that the amounts payable under it are “…solely in respect of a claim for loss or damage”, based on the information you have provided we consider that not all of the amounts paid relate to damages. This is consistent with Commissioner’s espoused ‘substance and reality’ approach to the application of the GST Act in paragraph 42 of Saga Holidays v Commissioner of Taxation [2006] FCAFC 191. Some of the payments relate to earlier supplies and some relate to damages.

The Settlement Deed requires the payment of an undissected lump sum (being the Settlement Payment). Consistent with the apportionment principles in GSTR 2001/4, the Settlement Payment should be dissected (on a reasonable basis) in order to determine the GST implications.

GSTR 2001/4 relevantly provides:

115. Where payment made under a court order or out-of-court settlement has a sufficient nexus with more than one supply, with one or more being GST-free or input taxed, the payment will be for each of the relevant parts. This will also be the case where the payment where the payment is partly for an item of damages which is not a supply.

117. In the case of an out-of-court settlement, where the terms of the 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 is made on a reasonable basis.

118. Where no dissection is made, even though the payment has a sufficient nexus with more than one supply, or to a supply and an item of damages which is not a supply, the payment should be apportioned into amounts representing these relevant parts in order that the correct GST consequences result.

119. The apportionment should be determined by the parties on a reasonable basis. Where a payment is apportioned in a manner that cannot be justified in terms of reasonableness, the general ant-avoidance provisions of the GST Act may have application.

Paragraph 119 of GSTR 2001/4 provides:

119. The apportionment should be determined by the parties on a reasonable basis. Where a payment is apportioned in a manner that cannot be justified in terms of reasonableness, the general anti-avoidance provisions of the GST Act may have application.

On the information you have provided, the fact that the parties were in dispute and arrived at the dissected amounts listed in the table in paragraph X of the ruling application indicates they used sufficient diligence to identify the various components of the settlement. The parties would not have settled on those terms if they were disadvantaged by the apportionment method used. Analysing each dissected amount in turn:

Award Corrections

The payment from A to B on account of the ‘Award corrections’ arises from the Errors in calculating the Variation Award Amount under the Final Award.

The primary payment under the Final Award was for Variations to Works under the Contract, being an earlier taxable supply.

Accordingly, this payment is further consideration for the earlier taxable supply of the Variation Works and that:

(1) B either has a GST liability as a result of receiving the ‘Award corrections’ payment for its earlier taxable supply, or B has a GST increasing adjustment under section 19-50 of the GST Act; and

(2) A either made a creditable acquisition as a result of paying the ‘Award corrections’ payment, or has a decreasing adjustment under section 19-85 of the GST Act.

Claims and interest

The Dispute relates to a claim for payment by B against A in respect of Variations under the Contract.

The Contract required B to provide various works in return for payment (“Works”). The Works provided by B included the design, engineering, procuring and constructing of C. All of the Works were performed in Australia.

We concur with your submission that the primary claim component of the payment is consideration for an earlier supply by A and that B makes a corresponding creditable acquisition.

You have stated that “B’s claims were never sufficiently advanced to allow for a calculation of any interest component” and that “it is not practical or reasonable in the circumstances to artificially dissect the payment between the claims component and the interest component.” We accept your submission that, as the payment predominantly relates to B’s claims for Variation Works under the Contract, the entire payment should be treated as consideration for a taxable supply and corresponding creditable acquisition.

All other costs and interest

B claimed against A various amounts for costs and interest incurred in respect of the disputes arising from the Contract.

The treatment of costs is addressed by GSTR 2001/4, which provides:

145. When a dispute is finalised, either by a court giving judgement 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. These costs, referred to as party-party costs, could include barrister’s fees, solicitor’s costs, fees for various expert reports and court costs.

147. For the purposes of this Ruling, we are concerned with the subsequent stage when the successful party is able to able to recover costs wholly or partly through a court order for costs or by negotiation of an amount in a settlement.

148. As we have seen for supply to be a taxable supply the conditions under section 9-5 of the GST Act must be met. 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 and 111.

149. Accordingly, 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. It does not matter that the payment of the costs order or settled amount is made by an entity other than the unsuccessful party.

Based on the above, we concur with your submission that the costs payable by A to B are not consideration for any taxable supply. To the extent that any part of the payment relates to interest, we agree that the interest is either not consideration for a taxable supply or is consideration for an interest under a credit arrangement (being a financial supply and not subject to GST).

Incentive Milestone Payment

A claimed that it was entitled to a milestone payment for Works performed under the Contract. The entitlement was said to be owing under the terms of Y, which amended the Contract.

For the same reasons set out in response to Questions 1 and 2 above, we concur with your submission that this payment is further consideration for the taxable supply of Works by B to A under the Contract. The effective receipt of this payment causes B to have a GST liability and B to make a corresponding creditable acquisition. To be entitled to claim that creditable acquisition, A must be in possession of a valid tax invoice.

Costs first arbitration and appeals

A also claimed against B an amount in respect of the costs that it incurred in the first arbitration.

For the same reasons set out in our answer in relation to subheading ‘All other costs and interest’ above, the payment of those amounts is not consideration for any taxable supplies per paragraph 149 of GSTR 2001/4.

Rectification Costs

Part of the Settlement Deed related to a claim by A that B owed it an amount of Rectification Costs under the Contract. This was in substance a claim for loss or damage, being the loss or damage suffered by A as a result of the defects to the Works that were undertaken by A pursuant to the Contract.

As outlined at paragraph 111 of GSTR 2001/4, a claim for loss or damage as a result of a breach of contract or for some other wrong or injury suffered is not consideration for a taxable supply. We concur with your submission that that part of the Settlement Deed which relates to the Rectification Costs does not have any GST implications for either B or A.