Private ruling: GST and payment of out-of-court settlement
Date of advice: 24 October 2017
Published: March 2018

Ruling: Q1: Is the payment of $XXX received by you as a result of an out-of-court settlement, subject to goods and services tax? | A1: Yes. The payment of $XXX received by you as a result of an out-of-court settlement is subject to GST.

Relevant facts and circumstances: ● You are registered for goods and services tax (GST) and carry on an enterprise of leasing commercial property. ● You leased your commercial property to a tenant who was under liquidation. ● You made a claim for the unpaid lease payments and other costs against the guarantor of the tenant. ● According to the out-of-court settlement, the defendant (the guarantor) offered you an amount of $XXX in full satisfaction of the claim, interest and costs. ● You agreed to accept the sum in lieu of seeking judgement. ● You and the defendant agreed to mutually abandon any rights, entitlements or liabilities arising from this action.

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: Summary: Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if you make the supply for consideration; the supply is made in the course or furtherance of an enterprise that you carry on; the supply is connected with the indirect tax zone and 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. The term ‘supply’ is defined in subsection 9-10(1) of the GST Act as ‘any form of supply whatsoever’ and includes an entry into, or release from, an obligation to do anything; or to refrain from an act; or to tolerate an act or situation. (Paragraph 9-10(2)(g) of the GST Act) Goods and Services Tax Ruling GSTR 2001/4 deals with the GST consequences of court orders and out-of-court settlements and discusses the meaning of supply. Paragraph 22 of GSTR 2001/4 provides that a supply is essentially ‘something which passes from one entity to another’. The supply may be one of particular goods, services or something else. Further, paragraph 25 of GSTR 2001/4 states: 25. Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release. Therefore, the term ‘supply’ covers not only the subject of the transaction – the thing that passes – but also includes the action by which the thing passes from one entity to another. In addition, by use of the word ‘make’ in the phrase ‘you make the supply’ in paragraph 9-5(a) of the GST Act, there is a requirement for a supplier to take some action to cause a supply to be made. In this case, it is important to consider what has been supplied in relation to the components of the settlement sum agreed between the parties. In the context of an out-of-court settlement, a supply referred to under any of the paragraphs within subsection 9-10(2) could be related to an out-of-court settlement. 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. | Detailed Reasoning - Earlier supply: Paragraphs 45 and 46 of GSTR 2001/4 state: 45. Each and every supply is subject to GST provided the supply satisfies the requirements of a taxable supply. The GST Act does not prescribe any sequencing or hierarchy of supplies for taxing purposes. GST becomes payable on the relevant supply. 46. In these circumstances, 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’. In this case an amount of $XXX was paid to you as a result of the out-of-court settlement. You claimed an amount of $YYY in total for the outstanding lease payment by the tenant and other related cost incurred by you such as re-letting the premises and other losses. 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. 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. There are two elements to the definition of consideration. The first is the payment by one entity to another and the second is the nexus that must be established between the payment and a supply. According to the out-of-court settlement, the amount of $XXX was paid to you in full satisfaction of the claim, interest and costs. The payment was made for the outstanding lease including other outgoings which the tenant did not pay in relation to the lease. It was the consideration for the earlier supply of lease by you. Therefore, there is a nexus between the supply of lease by you and the payment made to you as a result of the out-of-court settlement. | Detailed Reasoning - Consideration made by a third party: In this case you made the claim against the guarantor for the outstanding lease payments and other costs as the tenant was liquidated. You received the payment from the guarantor who was not the recipient of the supply of lease of commercial premises. Subsection 9-15(2) of the GST Act provides that the payment does not have to come from the recipient of the supply. Furthermore, paragraphs 177 to 179 of GSTR 2006/9 explain that a third party may pay for a supply but not be the recipient of the supply. GSTR 2006/1 explains how guarantees and indemnities are treated under the GST legislation. Paragraph 80 of GSTR 2006/1 provides that where a creditor has made a supply to the principal, payment for which is guaranteed by the surety, a payment by the surety is third-party consideration for that supply. Example 1 of GSTR 2006/1 has been reproduced below: 82. Tarot Corporation (Tarot) agrees to guarantee the lease payments of its subsidiary, Channel Limited (Channel), if Highrise Unit Trust (Highrise) enters into a two year lease with Channel. 83. Channel fails to make the lease payments and Tarot pays the amount owing to Highrise. The payment is consideration for the supply by way of the lease by Highrise. The payment is third party consideration by Tarot. 84. Tarot has a right of indemnity against Channel for the amount it paid Highrise. 85. In the case of an indemnity, the payment may exceed the actual consideration for the supply made to the principal, the surety being called upon to make good the loss of the creditor in full. If this is the case, the GST treatment of the payment will depend upon what the payment to the creditor is for. As explained above, in this case, there is a nexus between the payment of $xxx received by you as a result of the out-of-court settlement and an earlier supply. Therefore you are required to remit GST on the payment.

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