Edited version of private advice

Authorisation Number: 5010078907787

Date of advice: 29 October 2021

Ruling

Subject: GST and out of court settlement

Issue 1

Question 1&2

Is the out-of-court settlement amount paid by xxxx to xxx under the Deed a taxable supply under section 9-5 of a New Tax System (Goods and Services Tax) Act 1999 ("GST Act")?

Are the legal fees included in the out-of-court settlement subject to GST?

Summary

The amounts paid under the Deed of settlement is not consideration for a taxable supply. As such, there is no GST in the legal fees.

This ruling applies for the following periods:

xxxx to xxxx - Year 1

xxxx to xxxx - Year 2

The scheme commences on:

xxxx

Relevant facts and circumstances

Entity A (The Plaintiff) is registered in Australia and has been for Goods and services tax (GST) since xxxx.

Entity B Limited is a business registered in xx which is a branch of the Plaintiff.

Entity C (the First Defendant) is a business registered in xx who is a supplier of products.

Entity D (the Second Defendant) is a business registered in Australia which is a branch of the First Defendant.

Entity D has been registered for GST since xxxx.

In xxxx, Entity A and Entity C entered into an agreement (the First Agreement) whereby Entity C agreed to supply xxx products to Entity A which Entity A would in turn supply to Australian supermarkets.

In xxxx, Entity A and Entity C varied the First Agreement where they agreed that Entity A will be the official distributor of products to Australian supermarkets.

Since at least xxxx, Entity A, as part of maintaining its supply relationship with the Australian supermarkets, was required to, and did, make regular commitments to the supermarkets to undertake the following:

•         a six month promotional cycle in relation to all products the it would be supplying in advance or the commencement of the relevant six- month promotional cycle;

•         provide a certain level of promotional funding in relation to the products it supplied; and

•         provide an assurance of consistent and timely supply of the products.

In xxxx, Entity A and Entity C and Entity D entered into a new agreement (Second Agreement) which included the following terms:

•         Entity A, from xxxx, would place all purchase orders for products with Entity D for which Entity D would invoice Entity A as per the purchase orders;

•         Entity C would ship the products to Entity D in Australia;

•         Entity D would deliver the products to Entity's A warehouse within x weeks from them placing the order;

•         Entity A would pay Entity D within x days after delivery of the products to their warehouse; and

•         The terms of the First Agreement would also apply to the Second Agreement.

Entity A insisted that Entity C and Entity D were aware that, as part of Entity A ongoing supply relationships with the supermarkets, it was required to, and did, make regular commitments to s the supermarkets as outlined in item number 8, above.

Entity A insisted that on or about xxxx and onwards, Entity C and/or Entity D breached the Second Agreement as follows:

•         Between xxxx and xxxx, failed to deliver products to the Entity A's warehouse within x weeks of them placing the purchase orders;

•         From xxxx, appointed xx to supply the products directly to the Supermarket ;

•         On xxxx, gave notice of termination of the Second Agreement to Entity A, effective xxxx (which is less than the agreed 12 months' notice.)

As a result of the breach by Entity C and/or Entity D, Entity A's has suffered loss and damage as follows:

•         Entity A insisted that it led to their failure to provide consistent and timely supply of products to Supermarket B and as a consequence, in or about xxxx, the supermarket deleted all xxx products from its range; and

•         Entity A insisted that the loss of the profit it would otherwise have received had the supermarket not deleted xx products from its product range for the period xxxx to xxxx, being $xx.

From xxxx to at least xxxx, Entity C and Entity D have mispresented Entity A by labelling their products supplied to the Australian supermarkets as being distributed by Entity A when in fact these are distributed by another distributor.

In xxxx, Entity A commenced proceedings in the Supreme Court of xx against Entity C and/or Entity D for alleged breach of the agreement and in contravention of Section 18 Australian Consumer Law (Schedule 2 to CCA) and/or Section 8 of the Australian Consumer Law and Fair Trading Act 2012 (VIC).

Entity C and/or Entity D had filed a counterclaim against Entity A's for alleged breach of the agreement.

In xxxx, Entity A, Entity C and Entity D (the Parties) agreed to settle the dispute out of court. As part of the out-of-court settlement, the Parties agree:

a.    to terminate their agreement for the distribution of the xx products by Entity A and/or Entity B;

b.    xx Ltd shall settle Entity's A claim for damages and legal costs by paying a Settlement Sum:

                                                          i.        $xx on or before xxxx; and

                                                         ii.        $xx on or before xxxx.

c.     Upon the final payment on xxxx, the parties shall take all steps necessary to withdraw their claim and counterclaim by filing minutes of consent orders with the Supreme Court of xx in the form set out in xx of the Deed of Settlement and Release document provided along with the private ruling application.

d.    To release and forever discharge each other from any and all claims against each other in relation to dispute.

e.    To release and forever discharge each other in relation to any interlocutory costs orders made in the Proceeding.

Entity D's tax representative provided us the "Writ and Statement of Claim" in xxxx and advised that there is no dissection or itemisation of the settlement sum.

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 section 9-15

Reasons for decision

Section 9-40 of the GST Act provides that you must pay the GST on any taxable supply that you make.

Section 9-5 of the GST Act states:

You make a taxable supply if:

(a)  you make the supply for *consideration; and

(b)  the supply is made in the course or furtherance of an *enterprise that you *carry on; and

(c)   the supply is *connected with Australia; and

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

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

(* denotes a term defined in section 195-1 of the GST Act)

All the criteria in section 9-5 of the GST Act must be met for there to be a taxable supply.

'Supply' is defined in section 9-10 of the GST Act.

The GST consequences of an out-of-court settlement will depend on whether the payment made under a settlement constitutes consideration for a supply and, if so, whether the supply is a taxable supply.

Goods and Services Tax Ruling GSTR 2001/4 (GSTR 2001/4) deals with the GST consequences of court orders and out-of-court settlements and discusses the meaning of supply.

Paragraph 21 of GSTR 2001/4 provides, for there to be a supply for consideration, three fundamental criteria must be met:

(a)  there must be a supply

(b)  there must be a payment and

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

GSTR 2001/4 explains that supplies related to out-of-court settlements fall within one of the three categories. These categories are:

(a)  earlier supply

(b)  current supply

(c)   discontinuance supply

An earlier supply is a supply that occurred before the dispute arose, and which is the subject of the dispute.

A current supply is one that may be created by the terms of the court order or out-of-court settlement.

A discontinuance supply may be characterised as:

(a)  surrendering a right to pursue further legal action

(b)  entering into an obligation to refrain from further legal action

(c)   releasing another party from further obligations in relation to the dispute.

However, whether any of these supplies would be a taxable supply would then depend on the requirements of section 9-5 of the GST Act being met in relation to that supply.

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.

The damages claim

Based on the facts provided, xxx paid a settlement amount to xxx for its claim to recover alleged financial losses incurred due to the breach of contract.

Paragraphs 73,110 and 111 of GSTR 2001/4 state:

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.

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply. 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.

It is therefore concluded that the damages claim is not a supply for GST purposesand therefore the amounts paid are not consideration for a taxable supply. As such, legal fees will also not attract GST.