Edited version of private advice

Authorisation Number: 1051890176389

Date of advice: 27 September 2021

Ruling

Subject: GST and out of court settlement

Questions

Question 1

Did Entity A make 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 Deed of Settlement and Release (Settlement Deed)?

Question 2

Was Entity A liable to pay GST on the Settlement Sum pursuant to the Settlement Deed?

Question 3

If the answer to 1) or 2) above is Yes, then what is the amount of GST that is payable by Entity A to the Australian Taxation Office in relation these items?

Question 4

If an amendment to the GST treatment is required, should this be processed as an adjustment note dated the current date (date of the issue of the adjustment note)?

Answers

Answer 1

No. Entity A did not make a taxable supply under section 9-5 of the GST Act in relation to the Settlement Deed.

Answer 2

No. However, under Division 142 of the GST Act, the assessed net amount of Entity A for the relevant tax period includes an amount of excess GST that was passed on to Entity B. This amount of excess GST remains payable by and on a taxable supply until they reimburse that amount of excess GST to Entity B.

Answer 3

The excess GST referred to in Answer 2 is $.

Answer 4

No, should Entity A reimburse Entity B for the amount of excess GST, an adjustment note is not required as there is no adjustment event. If Entity A first reimburses Entity B for the amount of excess GST, subject to the period of review, Entity A can apply to amend their assessment (for the tax period they remitted the GST amount) for a refund of the GST. Entity A does not need to hold or have issued an adjustment note or tax invoice in respect of the reimbursed excess GST.

Relevant facts and circumstances

Services Agreement

1. Entity B is an Australian holding company.

2. Entity C was a wholly owned subsidiary of Entity B.

3. Entity B and Entity C were members of a GST Group of which Entity B was the nominated representative of the GST Group. Entity B and Entity C are no longer members of the same GST Group.

4. Entity C retained the services of Entity A to provide services (Services agreement).

Dispute and Settlement

5. There was a dispute between the parties. It was settled via a Settlement Deed where Entity B paid an amount to Entity A.

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 Division 11

A New Tax System (Goods and Services Tax) Act 1999 Division 142

Taxation Administration Act 1953 (TAA) Division 155

Reasons for decision

Taxable supplies

Entities are liable for GST on any taxable supplies that they make.

Section 9-5 of the GST Act provides that you make a taxable supplyif:

(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 for GST.

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

In this case, in order to determine whether Entity A have made a taxable supply it is first necessary to establish whether Entity A made a supply in relation to the Deed of Settlement.

Supply

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. 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.

A supply related to an out-of-court settlement may have occurred prior to the settlement or it may be created by the terms of the settlement itself. There may be more than one supply that is related to a settlement and in addition, the subject of the dispute may not be a supply at all (damages claim).

Earlier supplies are supplies made prior to the out-of-court settlement where both the supplier and the recipient have some dispute regarding supplies.

Current supplies are supplies created by the terms of the settlement.

A discontinuance supply is, according to paragraph 54 of GSTR 2001/4:

(i) surrendering a right to pursue further legal action [paragraph 9-10(e)]; or

(ii) entering into an obligation to refrain from further legal action [paragraph 9-10(2)(g);

or

(iii) releasing another party from further obligations in relation to the dispute [paragraph 9-10(2)(g).

In finalising a dispute, a settlement will generally ensure no further legal action in relation to that dispute. Such a settlement could be the plaintiff releasing a defendant from some (or all) of the existing claims and from further claims and obligations in relation to the dispute. Therefore, a discontinuance supply could arise (paragraph 51 of GSTR 2001/4).

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

Further Entity B submits that it may be argued that the out-of-court settlement between Entity B, Entity C and Entity A is a supply for the termination of the existing Services Agreement pursuant to a clause in the Settlement Deed. In particular, it is explained that in effect, Entity A agreed to release Entity B from their current and existing obligation to use Entity A for future advisory services under the Services Agreement or the obligation to make payments to Entity A in lieu of not engaging Entity A to provide those services. Entity B therefore submits that Entity A has made a taxable supply in respect of the Settlement Sum that is payable under the Settlement Deed.

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

Paragraph 100 of GSTR 2001/4 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 B that they are not the recipients of a supply made by Entity A or another party of any services. Therefore, the payment by Entity B does not have the necessary connection with any earlier supply made to Entity B. Further there is no evidence to suggest that Entity B 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 B.

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 B to Entity A under the terms of the Settlement Deed is not consideration for a supply to Entity B.

As there is no supply there cannot be a taxable supply under section 9-5 of the GST Act.

As the Commissioner is of the view that the payment made by Entity B to Entity A under the Settlement Deed is a payment of damages, consideration needs to be given to the GST remitted by Entity A on that payment.

Excess GST

The object of Division 142 of the GST Act is to ensure that excess GST is not refunded if this would give an entity a windfall gain. Generally, Division 142 of the GST Act operates so that a supplier is not entitled to a refund of an amount of excess GST where the supplier has passed on the GST to another entity (the recipient) and has not reimbursed that other entity for the passed-on GST.

GSTR 2015/1 Goods and services tax: the meaning of the terms 'passed on' and 'reimburse' for the purposes of Division 142 of the A New Tax System (Goods and Services Tax) Act 1999 sets out the Commissioner's views on the circumstances when excess GST may or may not have been passed on.

Paragraph 19 of GSTR 2015/1 provides:

19. If the excess GST arises because something that is not a supply is treated as a taxable supply, no adjustment event arises on reimbursement, and instead the supplier may, subject to the period of review, request an amendment to their assessment for the relevant tax period.14Any resulting refunds will be paid or applied in accordance with Divisions 3 and 3A of Part IIB of the TAA.15Where the recipient is registered (or required to be registered), any entitlement to input tax credits in relation to the excess GST will be reduced to nil.16 Registered recipients who have already claimed an input tax credit in relation to the excess GST will need to request an amendment to their assessment for the relevant tax period.17

In this case, we consider that no supply was made by Entity A under the Settlement Deed to Entity B.

Subsection 142-15(3) of the GST Act is relevant in cases where there is no supply. It provides that:

(3)             Treat section 142-10 as never having applied to the extent that:

(a)         you treated the excess GST as payable on a supply, but in fact there never was a supply: and

(b)         you reimburse the other entity for the passed-on GST.

The note under subsection 142-15(3) states: "If you reimburse the passed-on GST, you will be refunded an equivalent amount as described in section 155-75 in Schedule 1 to the Taxation Administration Act 1953."

Where subsection 142-15(3) of the GST Act applies, Note 1 under section 142-10 of the GST Act has no relevance. As there would be no adjustment event, there is no decreasing or increasing adjustment for either Entity A or Entity B.

Therefore, where Entity A firstly reimburses Entity B for the amount of passed-on GST, subject to the period of review, Entity A can then apply to amend their assessment for a refund of the GST remitted.

Reimbursement of excess GST by Entity A

In this case, should Entity A first reimburse Entity B for the excess GST, Entity A can then apply to amend the assessment for the tax period in which the overpayment was made or, if it chooses, can be corrected using Goods and Services Tax: Correcting GST Errors Determination 2013 (GSTE 2013/1). Entity A can correct the GST error on a later activity statement which starts within the four-year period of review of the assessed GST net amount for the earlier reporting period that contains the GST error.

Adjustment notes

Section 29-75(2) of the GST Act requires that an entity that made a taxable supply that is subject to an adjustment event that gives rise to an adjustment must issue an adjustment note within 28 days of the earlier of:

•         receiving a request for an adjustment note from the recipient of the supply, or

•         becoming aware of the adjustment, where the entity issued or was requested to issue a tax invoice for the supply.

Subsection 19-10(1) of the GST Act provides that:

(1) A adjustment event is any event which has the effect of:

(a) cancelling a supply or acquisition; or

(b) changing the *consideration for a supply or acquisition; or

(c) causing a supply or acquisition to become, or stop being, a *taxable supply or *creditable acquisition.

In this case there was no supply in the first place and should Entity A reimburse Entity B, this will not give rise to an event for the purposes of subsection 19-10(1). An adjustment event cannot arise when there is no supply in the first place.

This is confirmed by the Explanatory Memorandum to the Tax Laws Amendment (2014 Measures No. 1) Bill 2014 paragraph 2.52 which states:

2.52 In some cases a taxpayer may treat an arrangement as giving rise to a taxable supply, where there is no actual supply. In such cases, if the taxpayer subsequently discovers the mistake and reimburses the excess GST to the other entity, then that amount is treated as never having been payable or made in relation to a taxable supply. The taxpayer may seek a refund from the Commissioner by applying for an amendment of the relevant assessment or objecting to the relevant assessment. There is no adjustment event in these circumstances, because there is no supply to which Division 19 can apply.

In this case, since there was no supply, a reimbursement by Entity A to Entity B does not result in a Division 19 adjustment because adjustments under Division 19 of the GST Act require the presence of a supply. As there is no adjustment event there is no requirement for an adjustment note.

Should Entity A reimburse Entity B for the passed-on GST, it does not need to hold or issue an adjustment note or tax invoice in order to request an amendment to its assessment to obtain a refund of the reimbursed amount. It also does not need to cancel the original tax invoice despite this being issued in error.