Edited version of private advice

Authorisation Number: 1051809852581

Date of advice: 26 February 2021

Ruling

Subject: GST and payments under a settlement deed

Question

Is Entity A entitled to an input tax credit under section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) on the Settlement Sum paid to Entity C under Deed of settlement and release (Settlement Deed)?

Answer

No

This ruling applies for the following period:

XX November 20XX till quarter ending 31 March 20XX

The scheme commences on:

XX November 20XX

Relevant facts and circumstances

The description of the scheme is based on information provided by Entity X as part of their private ruling request in the following documents, which are to be read in conjunction with the facts as set out below:

•   The agreement between Entity B and Entity C and Entity D (Services Agreement)

•   The Deed of settlement and release between Entity A, Entity B and Entity C (Settlement Deed)

Entity A is an Australian company carrying on an enterprise and is registered for GST

Entity B is a wholly owned subsidiary of Entity A.

Entity B retained the services of Entity C and Entity D for the provision of advice under a Services Agreement (Services Agreement).

Entity B used Entity C and Entity D for advisory services pursuant to the Services Agreement and provided consideration for the services rendered.

Dispute and Settlement

Entity A engaged in negotiations with Entity X to undertake a series of transactions which involved the sale of Entity A's product (the Transaction).

Entity A did not utilise or engage the services of Entity C or Entity D to acquire advice. Rather Entity A appointed another advisor, Entity Y, to provide advice with regards to the Transaction.

Entity C and Entity D claimed that pursuant to the Services Agreement, Entity A was required to pay Entity C and Entity D a fee in respect of the Transaction, regardless of the fact that Entity A appointed Entity Y to provide services in respect of the Transaction.

Entity A and Entity B disputed Entity C's claim and alleged that a fee was not payable.

To avoid the costs, inconvenience and uncertainty of litigation, Entity A, Entity B and Entity C agreed to settle the dispute by entering into the Settlement Deed.

The Settlement Deed provides that:

•   subject to payment of the Settlement Sum, Entity A, Entity B and Entity C agree that the Services Agreement is terminated and will be of no further force or effect and

•   Entity A will pay the Settlement Sum to Entity C in settlement of the dispute

Pursuant to the Settlement Deed, if the Settlement Sum was deemed to be consideration for a taxable supply, then it would be increased by 10% for GST.

Under the Settlement Deed, the parties to the deed irrevocably and unconditionally released and forever discharged each other any claims arising from:

•   the matters the subject of the Dispute;

•   matters under or pursuant to the Services Agreement; and

•   the termination of the Services Agreement.

Entity A paid the Settlement Sum to Entity C.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Division 11

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

Reasons for decision

Section 11-20 of the GST Act provides that an entity is entitled to an input tax credit on a creditable acquisition it makes. Section 11-5 provides the meaning of creditable acquisition and states:

11-5 What is a creditable acquisition?

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.

In this case Entity A is registered for GST, therefore it is necessary to consider whether Entity A has made an acquisition under the Settlement Deed such that it meets the requirement set out in (a) to (c) above.

Goods and services tax ruling, GSTR 2006/9: supplies (GSTR 2006/9) provides discussion regarding the meaning of supply and sets out at a number of propositions. In particular paragraph 22 of GSTR 2006/9 provides that for every supply there is a supplier (Proposition 1) and generally, for every supply there is a recipient and an acquisition (Proposition 2). Further paragraph 23 of GSTR 2006/9 explains that the agreement is the logical starting point when working out the entity making the supply and the recipient of that supply (Proposition 11).

As Entity A is not party to the Services Agreement, Entity A is not considered the recipient of the supplies made under this agreement. Further, as they are not party to the Services Agreement Entity A is not considered the recipient of any termination supply that may exist under the Services Agreement and/or the Settlement Deed. However, Entity A has entered into a Settlement Deed to resolve matters in dispute in respect of the Services Agreement.

GSTR 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) considers the GST consequences resulting from out of court settlement. Relevantly this ruling explains where and if, a sufficient nexus exists between a payment and a supply.

The view outlined in paragraphs 100 to 109 of GSTR 2001/4 explains that in determining whether there is a nexus between a payment and a supply requires consideration of whether the payment has a connection to any earlier supply, current supply or discontinuance supply.

Entity A has submitted that the out-of-court settlement was reached in relation to an earlier supply. Relevantly pursuant to the Settlement Deed, the parties agreed to settle the dispute, provided that the Services Agreement was terminated, and Entity A pays Entity C the Settlement Sum. Under the original Services Agreement, Entity C and Entity D had agreed to provide advisory services to Entity B, which were established to be taxable supplies and was an ongoing obligation.

Entity A has also submitted that it may be argued that the out-of-court settlement between Entity A, Entity B and Entity C is a supply for the termination of the existing Services Agreement pursuant to the terms of the Settlement Deed. In particular it is explained that in effect, Entity C agreed to release Entity A from their current and existing obligation to use Entity C for future advisory services under the Services Agreement.

The Commissioner does not agree with either submission. Relevantly paragraph 109 explains that a sufficient nexus between a payment made under a court order or out-of-court settlement and a supply must exist to create the 'supply for consideration' relationship. However, in this case it has been acknowledged by Entity A that they are not the recipients of a supply made by Entity C and/or Entity D of any services. Therefore, the payment by Entity A does not have the necessary connection with any earlier supply made to Entity A. Further there is no evidence to suggest that Entity A is in the position to terminate the Services Agreement as they are not party to the contract such that under the Settlement Deed there can be a termination supply to Entity A.

In paragraphs 110 and 111 of GSTR 2001/4 it states:

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.

In this case the Commissioner considers the character of the payment is that of damages. As such the payment of the Settlement Sum by Entity A to Entity C under the terms of the Settlement Deed is not consideration for a supply to Entity A.

As the payment is not consideration for a supply to Entity A there is no entitlement to any input tax credit.