Edited version of private advice

Authorisation Number: 5010079216718

Date of advice: 29 November 2021

Ruling

Subject: GST and out of court settlement

Question

Did the Landholders make a taxable supply to Entity A under the Deed in return for the Settlement Sum as consideration for the supply under section 9-5 of A New Tax System (Goods and Services Tax) Act 1999 ("GST Act")?

Answer

No, the Landholders did not make a taxable supply to Entity A in return for the Settlement Sum as consideration for the supply. Therefore, the Landholders will need to refund the GST component to Entity A.

This ruling applies for the following period:

xxx

The scheme commences on:

xx

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Entity A is the registered proprietor of the xx Land which it holds subject to an Easement ("the Easement").

xx Trust is the registered proprietor of xx Land which it holds together with rights under the subject to Easement.

xx Trust is the registered proprietor of xx Land, which it holds together with rights under the Easement.

Xx Trust and xx Trust will together be referred to as the "Landholders". Both are registered for GST.

Entity A had constructed a building on their Land. The building construction has encroached the Easement.

A dispute ("the Dispute") has arisen between Entity A and the Landholders (the Parties) regarding the encroachment of the Easement.

Entity A has made an application (the Application) with the xx Land Titles Office to vary the position of the Easement in respect of, amongst others, their land and the Landholders' lands.

The Landholders objected to the Application.

The Landholders claimed that the encroachment, and the variation of the Easement sought in the Application has devalued and will continue to devalue each of their properties.

The Landholders have claimed compensation from Entity A for the devaluation of your properties but was denied by Entity A.

The Parties have settled the dispute, out-of-court, by executing a Deed of Settlement and Release with the following terms:

a)    The Landholders will withdraw their objections, and provide consent, to the Application;

b)    Entity A will indemnify the Landholders in the amount of $xx (the Settlement Sum) for the loss arising from the devaluation of their properties; and

c)    The Parties will unconditionally release and forever discharge each other from all claims each may have against each other in relation to the Dispute, Entity A Land and the development that has taken place on the Entity A Land.

To give effect to the settlement, Entity A paid the Settlement Sum of xxxx, which included a GST of $xxx, to the Landholders which was evidenced by a tax invoice dated xx.

In a telephone discussion with your tax and legal representative in regards to the GST-treatment, xx stated that should the Commissioner accept a taxable supply was not made the GST amount of $750,000 would be refunded to Entity A.

The Landholders advised that:

•         They held the rights to the Easement prior to the variation.

•         There was no change in legal titles as a result of the variation

•         The building was already built when the dispute and application for change of Easement commenced.

•         The final Settlement Sum was agreed without taking any specific facts into account by both parties. The sum was simply arrived by both parties putting forward an amount that they thought the other party would accept to settle on.

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

Issue 1

Question 1

Did the Landholders make a taxable supply to Entity A under the Deed in return for the Settlement Sum as consideration for the supply under section 9-5 of A New Tax System (Goods and Services Tax) Act 1999 ("GST Act")?

Summary

No, the Landholders did not make a taxable supply to Entity A in return for the Settlement Sum as consideration for the supply. Therefore, the Landholders will need to refund the GST component to Entity A.

Detailed reasoning

For the receipt of compensation amounts to give rise to a GST liability there has to be a taxable supply made.

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.

The Landholders did not satisfy section 9-5 of the GST Act because they did not make a supply for consideration.

Whether a supply for consideration is made in the context of an out-of-court settlement is the subject of GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements ("the Ruling").

Supply

'Supply' is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever'. The statutory definition of 'supply' is very broad. Essentially, a supply is something which passes from one entity to another, and may be one of goods, services or something else.

Paragraphs 44 to 55 of the Ruling explain that supplies that are related to an out-of-court settlement fall within the three categories of supply: earlier supply, current supply, and discontinuance supply.

An earlier supply is one where the subject of the dispute is an earlier transaction in which a supply was made involving the parties, that supply is referred to in this ruling as an 'earlier supply'. An example is provided in the Ruling as follows:

Widget Company supplies toys to a retailer. A dispute between the parties over payment for the toys is subsequently resolved through an out-of-court settlement, with the retailer paying all monies owed. The supply of the toys, that is the subject of the dispute, is an earlier supply because it occurred before the dispute arose.

A current supply is a new supply that is created by virtue of the settlement. An example is also provided in the Ruling, as follows:

A dispute arises over a claim by Beaut Enterprises Pty Ltd that Plagiariser Pty Ltd is using their trade name. Negotiations between the parties follow, resulting in Beaut entering into an agreement with Plagiariser that allows Plagiariser to use its trade name in the future. This would constitute the supply of a right under the agreement between Beaut and Plagiariser that amounts to a 'current' supply.

A discontinuance supply is one that is also created because of the terms of the settlement that usually exhibits the following characteristics:

      i.        surrendering a right to pursue further legal action [paragraph 9-10(2)(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)].

However, note that the Ruling also explains in paragraphs 71 to 73 that disputes may 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.

The Ruling further explains in paragraph 110 that disputes over a damages claim will not constitute a supply made by the aggrieved party.

Based on the facts of the case, it is the Commissioner's view that the dispute did not arise from an earlier supply. The settlement of the dispute did not also create a current supply but it did create a discontinuance supply by the Landholders giving up their right to further claims against Entity A, amongst others, in return for the compensation payment by entity A. The compensation/damages claim by the Landholders for the devaluation and/or potential devaluation of their lands does not constitute a supply by them to Entity A.

Aside from the discontinuance supply discussed above, the Landholders did not provide Entity A with any other supply in return for the compensation amounts as there has no change in the land title due to the variation of the land.

Consideration

Section 9-15 of the GST Act provides that a payment will be consideration for a supply if the payment is 'in connection with' a supply and 'in response to' or 'for the inducement' of a supply. Thus, there must be a sufficient nexus between a particular supply and a particular payment, which is provided for that supply, for there to be a supply for consideration.

Sufficient nexus

In this case, a sufficient nexus will be established if the compensation paid was in connection with, or in response to, or for the inducement of, the discontinuance supply, that is, the Landholders giving up their right to further claims against Entity A.

It is the Commissioner's view, as expressed in paragraphs 106 to 109 of the Ruling, that there is no sufficient nexus between the discontinuance supply that was made by the Landholders and the compensation they received:

106. Where the only supply in relation to an out-of-court settlement is a 'discontinuance' supply, it will typically be because the subject of the dispute is a damages claim. In such a case, the payment under the settlement would be in respect of that claim and not have a sufficient nexus with the discontinuance supply.

107. In most instances, a 'discontinuance' supply will not have a separately ascribed value and will merely be an inherent part of the legal machinery to add finality to a dispute which does not give rise to additional payment in its own right. They are in the nature of a term or condition of the settlement, rather than being the subject of the settlement.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

The Ruling further explains in paragraph 110 that disputes over a damages claim will not constitute a supply made by the aggrieved party. It goes on to explain in paragraph 111 that 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.

The process of Entity A varying the position of the Easement has led to the potential and continual devaluation of the Landholders' lands, for which they claimed compensation for. The Landholders received the amounts as compensation for any economic loss, hardship and inconvenience as a result of the encroachment by Entity A. It is compensation in respect of any damage caused or likely to be caused to the land and any inconvenience suffered by the Landholders as a consequence of the authorised activities they may carry out on the Land.

Upon receipt of the compensation amounts under the Agreement, the Landholders accept that they give up their right to pursue further claims against Entity A.

Although the Landholders' giving up their right for further claims against Entity A is a discontinuance supply it will not have a separately ascribed value and will merely be an inherent part of the legal machinery to bring finality to the amount of compensation paid to the Landholders.

Therefore, the receipt of the settlement amount by the Landholder from Entity A is not a consideration for the discontinuance supply. As a result, not all the elements of section 9-5 of the GST Act have been satisfied. Therefore, the settlement amount is not a consideration for a taxable supply made by the Landholders. As the settlement amount included GST, the Landholders will need to return the GST component to Entity A.