Edited version of private advice

Authorisation Number: 1051901010447

Date of advice: 20 September 2021

Ruling

Subject: GST and payment of liquidated damages under a settlement agreement

Question

Is the supplier making a taxable supply of goods and services to the customer under a settlement agreement for liquidated damages?

Answer

No.

Relevant facts and circumstances

The supplier entered into a contract with the customer for the supply of vehicles.

The supplier delayed the delivery of the vehicles beyond the delivery date under the terms of the contract.

The customer has a right and is entitled to liquidated damages recoverable for the delayed delivery of the vehicles under the contract.

The customer subsequently made a damage claim under the terms of the contract and was entitled to liquidated damages.

The two parties to the contract agreed to settle the amount due under the liquidated damages claim by the supplier providing goods and services to the customer. The provision of these goods and services is ongoing.

The customer considers that the settlement of liquidated damages does not constitute a supply of goods and services and is therefore outside the scope of GST.

The supplier wished to confirm whether or not the provision of goods and services to the customer in satisfaction of the obligation to the customer represents a taxable supply of goods and services for GST purposes.

The customer's contention is that in order for a taxable supply to arise, there must be a sufficient nexus such that there is a "supply for consideration".

Under the settlement agreement the supplier and the customer agree that:

•         the liquidated damages amount will be recoverable by the customer as compensation in the form of:

                                     i.         an extension to the warranty period.

                                    ii.        supply of a training package.

                                   iii.        either or both a deduction by the customer from the payment of claims for goods and services under the contract or cash at the customer's discretion.

•         The warranty extension and the training package are incorporated into the supplies under the contract.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 - section 9-5, 9-10 & 9-15

Reasons for decision

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), sets out the requirements that must be met for an entity to make a taxable supply. Under paragraph 9-5(a) of the GST Act, the supply made by an entity must be for consideration.

Consideration is defined in section 9-15 of the GST Act to include any payment, act or forbearance, in connection with, in response to or for the inducement of a supply of anything.

Paragraph 21 of Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements), explains that for there to be a supply for consideration, three criteria must be met:

•         there must be a supply;

•         there must be a payment; and

•         there must be a sufficient nexus between the supply and the payment for it to be a supply for consideration.

The supplier entered into a contract with the customer for the supply of vehicles and delayed the

delivery of those vehicles. The customer is entitled to make a claim for compensation from the supplier as liquidated damages under the contract.

The right to receive compensation as liquidated damages is a right created by the contract entered into between the supplier and the customer.

To settle the liquidated damages, the supplier and the customer have entered into a settlement agreement and the customer has agreed to recover the liquidated damages in the form of goods and services and/or cash.

It should be determined whether the supplies made under the settlement agreement are for consideration, and there is a nexus between the supplies and any payments as consideration for those supplies.

GSTR 2001/4 discusses the GST treatment of claims for damages and states:

71. Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury.

72. When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation.

73. The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This 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 of the GST Act.

Under the settlement agreement, the customer has the option to recover the agreed liquidated damages amount by way of goods and services and/or cash. The customer has decided to receive most of the liquidated damages amount as goods and services rather than money.

The Goods and Services Tax Ruling GSTR 2001/6: non-monetary consideration explains the Commissioner's views in regard to what non-monetary 'consideration' is and states:

82. Whether a payment is consideration for a supply depends on the true character of the transaction. Consideration for a supply is something the supplier receives for making the supply. Although a non-monetary payment (and acts or forbearances) can form consideration, the character of the transaction will determine whether it forms part of the consideration received by the supplier for making the supply.

83. Many transactions involve exchanging various rights and obligations between the parties to the transaction. In particular, the true character of the transaction may characterise the payment as a condition of the contract rather than the provision of non-monetary consideration. For example, in many cases, agreeing to enter into a contract to receive a supply for a specific period of time is not non-monetary consideration for that supply.

84. Also, subject to the terms of the agreement, transactions will often involve a supply made only for monetary consideration. In these circumstances, obligations entered into as part of the transaction by the entity that is liable to provide the money will not be separate parts of the consideration for the supply. Similarly, where the transaction in substance involves a supply made for a thing that is non-monetary consideration, the obligations to provide that thing will not constitute separate parts of the consideration.

85. Non-monetary consideration needs to have a clearly independent identity. Obligations that are essentially another way of describing the consideration do not have a separate existence. For example, the obligation to pay money does not exist separately from the payment of money for the purposes of identifying the consideration. Also, in most cases, the use of a particular method of payment is not consideration. For example, where a supply is made for a lower price if a customer uses a credit card, the use of the credit card is not non-monetary consideration.

In this case, the customer is not making any separate supplies under the settlement agreement. They are not supplying any rights available to them under the original contract rather exercising their right to recover the loss due to the delay in supplying the vehicles by the supplier.

Generally, exercising a right that exists is not considered as 'the surrender of any right'. The context of section 9-10 of the GST Act in relation to supplies of rights is that a right must be passed from the supplier to a different entity. The contract between the supplier and the customer doesn't involve the transfer of anything by the customer to the supplier when the customer exercises their right to compensation.

GSTR 2001/4 explains that there may be an earlier supply, a current supply or a discontinuance supply in relation to a dispute between parties. The original contract between the supplier and the customer involves the supply of vehicles which is considered as earlier supply. The earlier supply of vehicles occurred under the original contract and consideration for these supplies was provided.

The liquidated damages amount payable by the supplier is compensation for genuine loss and detriment suffered by the customer as a result of supplier's failure to complete its contractual obligations. The payment of liquidated damages by the supplier is not consideration for any earlier supply. The payment of in-kind liquidated damages involves further supplies to the customer, but no further payment is provided by the customer.

Although the supplies of extended warranty and the training package have been included in the

original contract, the customer will not make any payments to the supplier when these supplies are made to the customer. It is our view that the compensation that is payable as liquidated damages and the fact that it is provided as goods and services or cash does not alter the position.

As per the settlement agreement, the customer has the choice to recover the liquidated damages either monetary payment or goods and services or both if and when the compensation is paid. When the goods and services are provided to the customer as per the Settlement Agreement, it will be considered as part of the liquidated damages and will not be a separate supply by the supplier.

Therefore, the supplies that will be made under the Settlement Agreement as liquidated damages are not considered as taxable supplies.