Edited version of private advice

Authorisation Number: 1051631993244

Date of advice: 5 February 2020

Ruling

Subject: GST and out-of-court settlements

Question 1

Are you liable for goods and service tax (GST) pursuant to section 9-40 of the A New Tax System (Goods and Service Tax) Act 1999 (GST Act) on the out-of-court settlement sum of $X you received?

Answer

Yes, in part.

You are liable for GST on the portion of the $X that relates to your earlier supply of:

·                 commercial premises for which you did not receive the rent or receive the full amount of rent, and

·                 insurance for which you were not reimbursed.

Question

Are you entitled to input tax credits pursuant to section 11-20 of the GST Act on the costs incurred for legal representation?

Answer

Yes, you are entitled to input tax credits on the costs that you incurred from:

·                 the specialist legal parties for which you or your agent holds the four tax invoices

·                 Entity C for which you hold the tax invoice except for the court filing fee.

Relevant facts and circumstances

Entity A (You) are registered for GST and carry on a commercial leasing enterprise. You report GST quarterly and account on a cash basis.

In YYYY you purchased the Property and entered into a lease with Entity B (the Lessee).

A new lease agreement between you and the Lessee was to commence from DDMMYYYY. The Lessee did not sign the new agreement but commenced paying the monthly rental amount as specified in the new lease agreement.

You do not have a copy of the original lease however you were able to provide a copy of the unsigned lease. The terms and conditions were the same.

Between DDMMYYYY and DDMMYYYY you engaged a legal firm, Entity C to provide you with services associated with the lease of the premises and disputes with the Lessee. No invoices were issued for those services nor monies paid until the current time when your disputes with the Lessee were settled.

You have provided a copy of the unsigned new lease agreement.

In MMYYYY the Lessee vacated the Property without:

1.               Providing written notice of their intention to terminate.

2.               Returning the keys.

3.               Paying one month's rental (not related to the notice period) and in addition the Lessee had failed to pay the annual CPI increases in rent from DDMMYYYY until the date of departure.

4.               Having reimbursed insurance up to the date of departure.

Following departure an inspection of the Property also identified damage to the Property walls and floor caused by the Lessee when removing equipment, and broken glass in a window.

You contacted the Lessee to obtain restitution for these various breaches to the lease agreement but were unsuccessful.

You engaged Entity C as your legal representative in relation to this dispute. In addition Entity C engaged specialist legal parties on your behalf. You have provided a copy of the engagement letter with Entity C.

You intended to proceed to court and in YYYY court filing fees were paid to the Court.

In YYYY you and the Lessee came to an out-of-court settlement, signed a Deed of Settlement and Release (Deed) and you received a settlement sum of $X. You have provided a copy of the Deed.

You incurred various costs for legal representation relating to the court proceedings and out-of-court settlement.

You have provided a copy of four invoices from specialist legal parties. You were required to transfer amounts into a Trust Account set up by Entity C (the trust account) to pay for these invoices. Entity C have confirmed to you that they did not claim the GST on the invoices received from the specialist legal parties.

You have provided a copy of the single tax invoice from Entity C dated DDMMYYYY for legal services supplied between DDMMYYYY and DDMMYYYY.

The tax invoice contains an itemisation of professional costs on a time spent basis for the period DDMMYYYY to DDMMYYYY. The professional costs prior to the Lessees departure in MMYYYY relate to negotiations regarding the lease agreement between the Lessor and Lessee, which remained unsigned as at the date of departure by the Lessee. You were not issued with any previous tax invoices nor had you paid for any of the earlier fees.

The list of taxable disbursements in the tax invoice included a court filing fee. You have provided a copy of the receipt/tax invoice from the Court.

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 9-40

A New Tax System (Goods and Services) Tax Act 1999 Section 11-5

A New Tax System (Goods and Services) Tax Act 1999 Section 11-20

A New Tax System (Goods and Services) Tax Act 1999 Subdivision 153-A

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

Question 1

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 this case, the dispute arose in relation to restitution sought by you from the Lessee in relation to matters you considered to be various breaches of the Lease.

We consider that the settlement payment received by you relates to the following earlier supplies:

·                 A supply of the Premises for which a month's rental was unpaid.

·                 A supply of the Premises from DDMMYYYY for which the annual CPI increases to the rental were unpaid.

·                 A supply of insurance up to the date of departure for which you were not reimbursed.

These earlier supplies meet all the requirements of a taxable supply under section 9-5 and there are no provisions whereby the supplies would be GST-free or input taxed.

As such some of the $X settlement payment will be consideration for your earlier taxable supply of the commercial premises by rental and earlier taxable supply of insurance.

We do not consider that the settlement payment has a nexus with a discontinuance supply or that the terms of the settlement have resulted in a current supply.

Therefore, the balance of the $X settlement payment is not considered to relate to a supply but a claim for damages for failure by the lessee of obligations pursuant to the Lease to make good damage caused to walls and floor of the Premises and repair the broken glass in a window.

As the Deed does not dissect/itemise the $X settlement payment into the individual supplies and items of damages it is necessary for you to divide the settlement payment between the earlier taxable supplies (for which you know the quantum) and the balance being damages in order to achieve the correct GST consequences.

You are liable for GST pursuant to section 9-40 on the portion of the $X that relates to your earlier supply of:

·                 commercial premises for which you did not receive the rent or receive the full amount of rent

·                 insurance for which you were not reimbursed.

Question 2

You are entitled to the input tax credit for any creditable acquisition that you make.

Section 11-5 provides that you make a creditable acquisition if:

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

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

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

(d) you are registered, or required to be registered for GST.

You acquired the things for a creditable purpose in that you incurred the various legal costs in the course of carrying out your commercial leasing enterprise and you paid the consideration while registered for GST therefore where they were taxable supplies to you they would be creditable acquisitions.

Specifically, you have submitted the following invoices relating to these costs:

·                 Four separate invoices from specialist legal parties.

·                 A single invoice from Entity C.

Invoices issued to Entity C

The invoices from the specialist legal parties are issued to Entity C and not to you. It is necessary to know the contractual arrangement between you and Entity C.

The engagement letter with Entity C outlines that they may incur disbursements (being money they pay or are liable to pay on your behalf) including barrister's fees. Further, you have authorised Entity C to pay disbursements. In addition Entity C did not claim an ITC on four separate invoices from the specialist legal parties.

Goods and Services Tax Ruling GSTR 2000/37 Goods and services tax: agency relationships and the application of the law explains the special rules that apply under subdivision 153-A to agents. Paragraph 48 of GSTR 2000/37 provides the following about disbursements:

Agency relationship and disbursements

48. Agents may incur expenses on a client matter both as an agent of the client and as a principal in the ordinary course of providing their services to the client. For example, in most cases, even though agreements between solicitors and clients may not use the term agent or agency, it is clear that the clients have authorised the solicitors to act on their behalf in the particular matter. When the solicitor acts as an agent for the client, the general law of agency applies so that the solicitor is 'standing in the shoes' of the client.

On the facts submitted we consider that payments to the specialist legal parties were made by Entity C as a paying agent for you from your monies in the Trust Account. As such you are entitled to ITC's on your acquisitions from these parties as outlined in the four separate tax invoices.

Tax Invoice for legal services between DDMMYYYY and DDMMYYYY

You have been issued a single tax invoice dated DDMMYYYY from Entity C for all of the legal services you have acquired from them. You paid the legal services on DDMMYYYY when the full amount was transferred from the Trust Account to Entity C.

You are entitled to an ITC on your acquisition of these services from Entity C as outlined on the tax invoice except for the court filing fee listed under Taxable Disbursements. Paragraph 50 of GSTR 2000/37 provides examples of common fees for which a client is liable that may be paid for by a solicitor as a paying agent of the client, including court fees. If the solicitor makes the payment, GST is not payable on the subsequent reimbursement by the client to the solicitor.

In summary, you are entitled to input tax credits on the costs that you incurred from:

·                 the specialist legal parties for which you or your agent holds the four tax invoices

·                 Entity C for which you hold the tax invoice except for the court filing fee.