Edited version of private advice

Authorisation Number: 1051570591226

Date of advice: 22 August 2019

Ruling

Subject: GST and income tax

Question 1

Is there a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) in relation to the out-of-court settlement amount?

Answer

No

Question 2

Can the individuals claim an input tax credit in relation to the out-of-court settlement amount under section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999?

Answer

No

Question 3

Can the Company claim an input tax credit in relation to the out-of-court settlement amount under section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999?

Answer

No

Question 4

Can the individuals claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the out-of-court settlement payment?

Answer

Yes

Question 5

Can the Company claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the out-of-court settlement payment?

This ruling applies for the following periods

1 July 20xx to 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Building business was carried on through a partnership which was registered for GST.

A contract was signed for a house to be built by the partnership.

The partnership ceased trading, cancelling its ABN and ceased to be registered for GST.

The clients are not registered for GST.

Later, an entity was registered as a Company and it was also registered for GST.

Later, defects in the house became apparent.

A Statement of Claim was filed in a court by the clients (plaintiffs) and a Defence and Counter Claim was filed by the individuals (defendants).

An out-of-court settlement was reached for $ sum. The Company paid this amount in $ monthly instalments on behalf of the individual (defendants). The $ sum has been recorded in the Company accounts as a loan to the individual (defendants).

Legal expenses incurred by the clients were included in the $ sum claimed.

The first payment in relation to the out-of-court settlement was made in November 20xx and the last payment was made in May 20XX.

It was confirmed that no consent orders were issued by the Court and that a written record between the lawyers for both parties is the record of the final settlement agreement.

Relevant legislative provisions

Section 9-5 of the GST Act 1999

Section 11-20 of the GST Act 1999

Section 8-1 of the ITAA 1997

Reasons for decision

1. GST

Goods and Services Tax Ruling GSTR 2001/4 provides the ATO view on the GST consequences of out-of-court settlements. 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. In particular, paragraphs 21 and 22 of GSTR 2001/4 state:

21.      A supply for consideration is the first step towards there being a taxable supply. However, 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

22.      Essentially, a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

Further, 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:

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 (Australia), and

d)    you are registered, or required to be registered.

...

You are entitled to input tax credits for your creditable acquisitions. Section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that 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.

Application to the facts

No GST payable

The supply in relation to the out-of-court settlement was made by the owners of the property. As the owners of the property are not registered for GST the supply is not a taxable supply under section 9-5 of the GST Act. Therefore, there is no GST consequence for the individual defendants.

The Company was not a party to the court proceedings and there is insufficient nexus between the payment in relation to the out-of-court settlement, made by the individual defendants, and the Company. There is no GST consequence for the Company.

Individuals cannot claim input tax credits

The individuals cannot claim an input tax credit because they have not made a creditable acquisition, as there is no taxable supply as required by paragraph 11-5(b) of the GST Act.

Individuals cannot claim a decreasing adjustment

The out-of-court settlement payment by the individuals does not give rise to a decreasing adjustment as there is no adjustment event as required by section 19-10 and 19-40 of the GST Act. The original supply of the building services is complete and the payment does not have the effect of changing the consideration for these services.

2. Deduction

Section 8-1 of the Income Tax Assessment Act 1997 states that:

You can deduct from your assessable income any loss or outgoing to the extent that:

·         it is incurred in gaining or producing your assessable income; or

·         it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

However, you cannot deduct a loss or outgoing under this section to the extent that:

·         it is a loss or outgoing of capital, or of a capital nature; or

·         it is a loss or outgoing of a private or domestic nature; or

·         it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

·         a provision of this act (the ITAA 1997) prevents you from deducting it.

Application to the facts

The out-of-court settlement payment is an expense incurred by the individuals in gaining or producing assessable income.

Payments for losses or outgoings that arise after the business has ceased, but relate to the business's activities will be an allowable deduction under section 8-1 of the ITAA 1997.

The case of Evenden v. FC of T 99 ATC 2297, found that, the decision in AGC (Advances) Ltd v FC of T 75 ATC 4057; (1975) 132 CLR 175, established the following proposition:

that provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally, the fact that that outgoing was incurred in a year later than the year in which the income was incurred and the fact that in the meantime business in the ordinary sense may have ceased will not determine the issue of deductibility.

The individuals are entitled to claim a deduction for the out-of-court settlement expense in the year it was incurred irrespective of the partnership business having ceased. Thus, the deduction can be claimed by the individuals in the 2018/2019 income year.