Edited version of private advice

Authorisation Number: 1051625233773

Date of advice: 06 July 2020

Ruling

Subject: GST and out-of-court settlement/orders

Question

Was the amount of $X you received, consideration for a taxable supply made by you under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act)?

Answer

Yes.

Relevant facts and circumstances

You are registered for GST and report GST on a quarterly basis.

You were engaged by Entity A to be the project manager for two property developments:

·   Project 1

·   Project 2.

On ddmmyyyy you presented a proposal letter to Entity A for Project 1. You set out the details of the work you would complete for the stages of the project and proposed that you would be paid specified amounts for each stage. Where additional work was completed you proposed that you be paid $X per hour plus GST. All the fees associated with Project 1 were paid.

On ddmmyyyy you presented a proposal letter to Entity A for Project 2. You set out the details of the work you would complete for the stages of the project. You proposed that you would be paid specified amounts for each stage discounted from those for Project 1 in lieu of a share of profit in addition to these fees.

You and Entity A entered into a dispute in relation to your share of profit on Project 2.

On ddmmyyyy you entered into a Deed of Settlement and Release with Entity A and settled on a final sum for the share of profit.

You have not reported any GST payable on the receipt of the share of profit as you believed it was not consideration for any taxable supply.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 9-5

A New Tax System (Goods and Services Tax) Act 1999 9-40

Reasons for decision

In this reasoning, please note:

·   all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

·   all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act

·   all reference materials referred to are available on the Australian Taxation Office (ATO) website ato.gov.au

You are liable for GST on any taxable supplies that you make.

Section 9-5 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 for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements explains how a payment that is made in compliance with an out-of-court settlement should be treated for the purposes of the GST Act.

Out-of-court settlements 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. This includes, as in this case, the parties obtaining a consent order, the draft of which has been agreed to in a settlement deed.

The GST consequences of an out-of-court settlement will depend on a number of matters, including whether a payment made under the order or settlement constitutes consideration for a supply.

GSTR 2001/4 focusses on the 'supply for consideration' requirement. However, the remaining elements of section 9-5 must also be satisfied for there to be a taxable supply.

Paragraph 21 of GSTR 2001/4 states:

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 (see paragraph 22 onwards);

(ii) there must be a payment (see paragraph 74 onwards); and

(iii) there must be a sufficient nexus between the supply and the payment for it to be a supply for consideration (see paragraph 100 onwards).

Supplies related to an out-of-court settlement fall within three categories of supply:

1.    earlier supply - subject of the dispute is an earlier transaction in which a supply was made involving the parties

2.    current supply - new supply created by the terms of the settlement

3.    supply related to discontinuance of action, for example:

-      surrendering a right to pursue further legal action

-      entering into an obligation to refrain from further legal action

-      releasing another party from further obligations.

In addition, disputes often arise over incidents that do not relate to a supply. Where such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. The most common form of remedy is a claim for damages arising out of the termination or breach of contract or for some wrong or injury suffered. The 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. In your case, we do not consider that the payment you received is for damages.

In this case, the dispute did not arise due to any current supplies but arose in relation to your claim to a share of profit. Under the agreement you were to receive fees and a share of profit in lieu of higher fee charges. That is, instead of charging flat fees, as you did for Project 1, you negotiated a fee structure for Project 2 which comprised lower fees in lieu of a share of any profits from the venture. The 'profit share' component was a method of calculating part of your fees for your service. This meant that if the project went well as a result of your services you would receive more and if not you would receive less.

When the Property was sold prior to the development being completed, your profit share changed from X% of the value of the completed project to Y% of net profit on the sale of the Property less any fees paid already. This profit sharing was part of the method of calculating how much you would receive for your services.

In addition, we note that although there were discontinuance clauses the amount of $X was not paid in relation to these clauses but for the fee calculated with reference to the profit share.

Conclusion

We consider that the payments received by you relate to the earlier supply of your project management services to Entity A for Project 2.

The earlier supply of project management services meets all the requirements of a taxable supply under section 9-5 and there are no provisions whereby the supply would be GST-free or input taxed. Therefore, you are required to report GST on the receipt of the profit share component of $X.