Edited version of your written advice

Authorisation Number: 1051513553299

Date of advice: 20 May 2019

Ruling

Subject: Goods and services tax (GST) on a claim made for additional costs incurred due to termination of a subcontract.

Questions

1. Does the claim made by Entity A to Entity B under the particular Article of the subcontract to allow for them to seek reimbursement of additional costs and expenses reasonably incurred above the Subcontract Price due to termination of the subcontract, represent a claim for damages and therefore does not constitute a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

2. Is Entity A required to attribute GST under section 29-5 of the GST Act in respect of the claim made under the subcontract?

Answers

1. On the basis that the claim made by Entity A to Entity B under the particular Article of the subcontract relates solely to additional costs and expenses incurred by Entity A as a result of Entity B’s obligations under the contract not being completed, and not to any earlier or current supplies made by Entity A, then it is considered that the claim is in the nature of damages and therefore does not constitute a taxable supply under section 9-5 of the GST Act.

2. If the claim made by Entity A under the particular provision of the subcontract is in the nature of damages and does not relate to any taxable supply, Entity A is not required to attribute GST under section 29-5 of the GST Act in relation to the claim.

Relevant facts and circumstances

● Entity A is registered for GST. Entity A accounts for GST on a non-cash basis.

● As part of a project, Entity A and Entity B were operating as part of a consortium with a third entity where Entity A and Entity B were obliged to carry out certain works.

● Entity A and Entity B entered into a subcontract where Entity B agreed to perform some of the work allocated to Entity A by the Consortium Agreement, as Entity A’s subcontractor.

● Entity B undertook some works as part of the subcontract, but after a period of time Entity B abandoned the project. As a result of this Entity A purported to terminate the subcontract.

● Under the subcontract there were provisions which came into effect in the event of a termination of the subcontract. A particular Article allows for the Contractor to seek reimbursement of additional costs and expenses reasonably incurred above the Subcontract Price in completing the uncompleted works due to termination or takeover of the subcontract. Following Entity B abandoning the project, Entity A engaged other subcontractors and incurred additional costs to complete Entity B’s remaining scope of work under the Subcontract.

● Entity A was not required to make, and will not make, any supplies to Entity B under the subcontract.

● Entity A issued a tax invoice to Entity B under the provision to seek reimbursement for additional costs and expenses due to termination of the subcontract.

● Entity A advise that an error occurred and the invoice should not have been issued as a tax invoice. The invoice should not have stated that there was a GST component.

● Entity A has not attributed the GST payable (that is they have not included it in their BAS) for the relevant period. This has resulted in Entity A not taking any GST payable on this supply into account in determining their net amount for the relevant period.

● Entity A seeks assurance that there is no taxable supply in connection with making a claim under the particular Article to seek reimbursement of additional costs and expenses incurred by them to complete the works.

Assumptions

As the dispute between Entity A and Entity B not been resolved at this time, the following assumptions are made:

● Entity A was validly entitled to terminate the contract and issue an invoice for reimbursement of additional costs incurred pursuant to the particular Article of the subcontract allowing them to seek reimbursement of additional costs and expenses reasonably incurred to complete the works.

● The claim relates only to amounts that can be recovered as reimbursement of additional costs under this particular Article of the subcontract.

● The claim does not include costs that relate to any other supplies made by Entity A, whether under the subcontract or otherwise in connection with the project.

● Entity A was not required to make, and will not make, any supplies to Entity B under the subcontract.

● No discontinuance supply is made by Entity A under the subcontract if payment of the claim by Entity B is made.

● Entity A will amend the original invoice issued and advise Entity B that this change has been made.

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 subsection 9-10(1)

A New Tax System (Goods and Services Tax) Act 1999 section 29-5

Reasons for decision

Summary

On the basis that the claim made by Entity A to Entity B under the particular Article of the subcontract relates solely to additional costs and expenses incurred by Entity A as a result of Entity B’s obligations under the contract not being completed, and not to any earlier or current supplies made by Entity A, then it is considered that the claim is in the nature of damages and therefore does not relate to a taxable supply under section 9-5 of the GST Act.

Detailed reasoning

Under section 9-5 of the GST Act you make a taxable supply if:

(a) you make the supply for consideration;

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

(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.

For there to be a supply for consideration, three fundamental criteria must be met:

(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.

The issue in this case is whether the claim made by Entity A to Entity B under the particular Article of the subcontract is consideration for a taxable supply under section 9-5 of the GST Act.

The meaning of supply is set out in section 9-10 of the GST Act. Subsection 9-10(1) of the GST Act provides that a supply is any form of supply whatsoever.

GSTR 2006/9 Goods and services tax: supplies, provides that:

71. An entity will make a supply whenever that entity (the supplier) provides something of value to another entity (the recipient). This is consistent with the ordinary meaning of ‘supply’ being to furnish or provide.

GSTR 2001/4 discusses the GST consequences of court orders and out-of-court settlements. Under the ruling, an agreement between the parties is referred to as an out-of-court settlement. This will include any form of dispute resolution in which the terms of the resolution are agreed between the parties rather than imposed by the court.

In the current circumstances the particular Article has not established an out-of-court settlement. Our view below follows the principles in GSTR 2001/4.

GSTR 2001/4 sets out some examples of when the subject of a claim is not a supply. It provides:

Where the subject of a claim is not a supply

71. Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury.

72. When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation.

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. …

Damages

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 whether there is an identifiable discontinuance supply under the settlement.

Based on the information provided and the assumptions which underlie this ruling, we consider that:

● a payment made to Entity A by Entity B pursuant to the claim made under the particular Article of the subcontract is in the nature of damages. This is because the clause only enables Entity A to invoice Entity B for additional costs it incurred above the price it agreed to pay Entity B. In effect it is putting Entity A back in the position it would have been in had the works been completed under the contract as agreed.

● the payment does not relate to any earlier or current supplies made by Entity A. The payment relates solely to damages claimed by Entity A.

● in accordance with the view expressed in GSTR 2001/4 relating to damages, we consider that any payment made in relation to the claim will not be consideration for a taxable supply. This means that entity A will not have made a supply by making the claim.

To the extent that the claim relates solely to damages, we consider that Entity A will not have made a supply. However, to the extent that the claim is made up of other components (such as a reimbursement of expenses previously outlaid) then there may have additional GST implications. For example, if any payment received relates to the reimbursement of an overpayment made by Entity A then an adjustment may need to be made to the GST return in which the original claim was made.

We also note that this private ruling has been provided on the basis of the facts and assumptions set out above. If the facts and assumptions outlined in this private ruling do not reflect what actually occurs, or material facts have been omitted or misleadingly or inaccurately stated then this private ruling will not bind the Commissioner.