Private ruling: Goods and services tax (GST) and out-of-court settlement payment
Published: July 2012

Ruling: Q1: Is GST payable by you where you received the out-of-court settlement payment? | A1: No. | Q2: Will the Commissioner of Taxation (Commissioner) exercise the discretion under section 105-65 of Schedule 1 to the Taxation Administration Act 1953 (TAA) to refund any GST remitted in relation to the proceeds received by you for the out of court settlement? | A2: Yes.

Relevant facts and circumstances: You are registered for GST. A supply was made to you via an agent from the entity (the agent firm). The agent firm is registered for GST. The supplier is registered for GST. You operate a business. You and the agent firm agreed that they would pay you an out-of-court settlement payment as a result of a certain agent from the agent firm allegedly acting fraudulently in respect of the original supply agreement. The calculation of the settlement payment was originally based on past and future expenses related to the supply that were payable under the supply agreement, to the supplier, but not disclosed to you by the relevant agent and legal fees you incurred in relation to your dispute with the agent firm. However, you stated that the settlement payment was an agreed amount that did not represent this total. The original compensation you sought was in the vicinity of a certain amount of money, but the parties to the settlement eventually agreed to a settlement amount of a certain amount of money. The settlement payment was made by the agent firm as full and final settlement of the claim and resulted in a release, discharge and indemnity being signed. When the settlement amount was being negotiated and the settlement deed was being drawn up, the parties to the settlement did not come to an agreement that the settlement payment would be subject to GST or that it would not be subject to GST. During those times, the parties did not consider GST at all in regards to the settlement. The settlement deed does not state that GST is payable or that GST is not payable. There was never any agreement between the parties to the settlement that the agent firm would not compensate you for the GST components of the relevant expenses that you incurred or would incur. You did not issue a tax invoice to the agent firm in respect of the settlement payment. You have treated the payment as being consideration for a taxable supply in your activity statement as a precautionary measure, and you have paid an amount of 'GST' to the ATO in respect of this payment. You have advised that you have not reimbursed the agent firm an amount corresponding to the GST you overpaid to the ATO. The legal firm you used in relation to the dispute is registered for GST.

Relevant legislative provisions: A New Tax System (Goods and Services Tax) Act 1999 subsection 7-1(1) | 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 subsection 9-10(1) | A New Tax System (Goods and Services Tax) Act 1999 subsection 9-15(1) | A New Tax System (Goods and Services Tax) Act 1999 section 9-40 | Taxation Administration Act 1953 section 105-65 of Schedule 1

Reasons for decision: Summary: GST is not payable by you where you received the out-of-court settlement payment, as this payment was not consideration for any supply made by you. | Detailed Reasoning - Detailed reasoning: GST is payable by you where you make a taxable supply. You make a taxable supply where you satisfy the requirements of section 9-5 of the GST Act which states: You make a taxable supply if: · you make the supply for *consideration; and · the supply is made in the course or furtherance of an *enterprise that · you *carry on; and · the supply is *connected with Australia; 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. (*Denotes a term defined in section 195-1 of the GST Act) In order for a recipient of a payment to have a GST liability, the payment must be consideration for a supply. For there to be a supply for consideration, three criteria must be met, in accordance with paragraph 21 of Goods and Services Tax Ruling GSTR 2001/4. They are: · 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. 'Supply' is defined as 'any form of supply whatsoever' in subsection 9-10(1) of the GST Act. 'Supplies' related to an out-of-court settlement are considered in GSTR 2001/4. Paragraphs 71 to 73 of GSTR 2001/4 discuss where the subject of a claim is not a supply. They state: 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. Paragraphs 145 to 148 of GSTR 2001/4 discuss reimbursement of legal costs relating to a dispute. They state: 145. When a dispute is finalised, either by a court giving judgment or through negotiation of a settlement, the unsuccessful party in the action may be required to pay the costs or part of the costs that have been incurred by the successful party in bringing or defending the claim. These costs, referred to as party party costs, could include, barrister's fees, solicitor's costs, fees for various expert reports and court costs. 146. In any legal action the parties concerned are required to pay their legal advisers the solicitor client costs incurred and the supply of these legal services will attract GST and be GST inclusive sums to the extent that they are not GST-free. Both parties to a dispute, as recipients of a supply of legal representation respectively, may be entitled to an input tax credit for a creditable or partly creditable acquisition of these services. 147. For the purposes of this Ruling, we are concerned with the subsequent stage when the successful party is able to recover costs wholly or partly through a court order for costs or by negotiation of an amount in a settlement. 148. As we have seen for a supply to be a taxable supply the conditions under section 9-5 of the GST Act must be met. In the instance of the payment of costs under the court order or settlement there is no supply for consideration from the successful party to the unsuccessful party. This is essentially paying compensation for costs or losses incurred in the dispute and will be treated in the same manner as damages under paragraphs 110 and 111. A supply was made to you by an entity, via an agent from the agent firm. You and the agent firm agreed that they would pay you an out-of-court settlement payment as a result of the relevant agent from the agent firm allegedly acting fraudulently in respect of the original supply agreement. The calculation of the settlement payment was originally based on past and future expenses relating to the supply that were payable under the supply agreement, to the supplier, but not disclosed to you by the relevant agent and legal fees you incurred in relation to your dispute with the agent firm. However, you stated that the settlement payment was an agreed amount that did not represent this total. The settlement payment you received was an out-of-court-settlement. The substance of the dispute is losses you have suffered and will suffer relating to the supply (certain sorts of expenses) and these losses cannot themselves be characterised as a supply under section 9-10 of the GST Act made by you - the aggrieved party (in accordance with paragraph 73 of GSTR 2001/4). The settlement payment is partly compensation for the legal costs you incurred in relation to the dispute, and these legal costs did not constitute a supply made by you (in accordance with paragraph 148 of GSTR 2001/4). Therefore, the settlement payment is not consideration for any supply made by you. Hence, you have not satisfied the requirement of paragraph 9-5(a) of the GST Act. Therefore, GST is not payable by you where you received the settlement payment. | Detailed Reasoning - Question 2: Under the general rules the Commissioner is required to give a refund or apply that amount in accordance with the running balance account provisions in Divisions 3 and 3A of Part IIB of the Taxation Administration Act 1953 (TAA). However, the requirement to give a refund of overpaid GST is subject to section 105-65 of Schedule 1 to the TAA which modifies the general rules so that the Commissioner need not give a refund or apply that amount if an entity overpaid its net amount or an amount of GST where the requirements of the section are satisfied. Where an entity overpays GST to the ATO because an arrangement was treated by the entity as giving rise to a taxable supply, we need to consider the rules in section 105-65 of Schedule 1 to the TAA in determining whether to refund the taxpayer the relevant amount. Section 105-65 of Schedule 1 to the TAA states: (1) The Commissioner need not give you a refund of an amount to which this section applies, or apply (under Division 3 or 3A of Part IIB) an amount to which this section applies, if: (a) you overpaid the amount, or the amount was not refunded to you, because a *supply was treated as a *taxable supply, or an *arrangement was treated as giving rise to a taxable supply, to any extent; and (b) the supply is not a taxable supply, or the arrangement does not give rise to a taxable supply, to that extent (for example, because it is *GST-free); and (c) one of the following applies: (i) the Commissioner is not satisfied that you have reimbursed a corresponding amount to the recipient of the supply or (in the case of an arrangement treated as giving rise to a taxable supply) to an entity treated as the recipient; (ii) the recipient of the supply, or (in the case of an arrangement treated as giving rise to a taxable supply) the entity treated as the recipient, is registered or *required to be registered. | Detailed Reasoning - Whether subsection 105-65(1) of Schedule 1 to the TAA applies to your circumstances: The restriction on refunds of overpaid GST under section 105-65 of Schedule 1 to the TAA will apply if all three of the following conditions are satisfied: · there was an overpayment of GST · a supply was treated as a taxable supply when it was not a taxable supply or was taxable to a lesser extent, and · either the recipient has not been reimbursed a corresponding amount of the overpaid GST and/or the recipient of the supply is registered or required to be registered for GST. Miscellaneous Tax Ruling MT 2010/1 provides the view of the Commissioner on section 105-65 of Schedule 1 to the TAA. Paragraph 20 of MT 2010/1 explains the meaning of "overpaid". In the context of section 105-65 "overpaid" means the amount that has been remitted must be in excess of what was legally payable on the particular supply in the relevant tax period prior to taking into account or applying section 105-65 of Schedule 1 to the TAA. You have treated the payment as being consideration for a taxable supply in your activity statement as a precautionary measure, and you have paid an amount of 'GST' to the ATO in respect of this payment although this payment was in fact not subject to GST. It follows that you remitted more GST than was legally payable and that there has been an overpayment of GST to the ATO. Paragraph 21 of MT 2010/1 explains the meaning of 'treated' as a taxable supply. You treated the out of court settlement as being subject to GST when you mischaracterised the supply as taxable and remitted GST to the Commissioner when the supply was in fact not subject to GST. You have advised that you have not reimbursed the recipient any amount corresponding to the GST overpaid. As the three conditions are satisfied, section 105-65 of Schedule 1 to the TAA applies and the Commissioner has no obligation to pay a refund that would otherwise be payable under section 8AAZLF of the TAA. However, it is the view of the ATO in paragraph 27 of MT 2010/1 that the Commissioner may choose to pay a refund even though the conditions in paragraphs 105-65(1)(a), (b) and (c) of Schedule 1 to the TAA are satisfied. Paragraphs 116 and 117 of MT 2010/1 state: 116.The operation of section 105-65 to deny the requirement to pay refunds that would otherwise be payable is not discretionary. The words of the provision say that where the section applies the Commissioner need not give you a refund of the amount or apply the amount under the relevant RBA provisions…. 117. The commissioner considers that the words "need not", in the context of section 105-65, do not prohibit the giving of a refund and accordingly the Commissioner has a discretion to pay a refund in appropriate circumstances…. This view is supported by the decision in Luxottica Retail Australia Pty Ltd v FC of T 2010 ATC 10-119 at 57 when the AAT referred to "residual discretion". The question then becomes whether, in these circumstances, the discretion to pay the refund to the applicant should be exercised. Paragraph 128 of MT 2010/1 provides some guiding principles to consider when exercising the discretion. It states: 128. Section 105-65 does not specify what factors are relevant to the exercise of this discretion. In exercising the discretion, the Commissioner will have regard to the following guiding principles: (a) The Commissioner must consider each case based on all the relevant facts and circumstances. (b) The Commissioner needs to follow administrative law principles such as not fettering the discretion or taking into account irrelevant considerations. (c) The Commissioner must have regard to the subject matter, scope and purpose of section 105-65. As explained in paragraph 127 of this Ruling, it clear from the scope and purpose that section 105-65 is designed to prevent windfall gains to suppliers and to maintain the inherent symmetry in the GST system and is based on the underlying design feature and presumption of the GST system that the cost of the GST is ultimately borne by the non registered end consumer. (d) The discretion should be exercised where it is fair and reasonable to do so and must not be exercised arbitrarily. The circumstances in which the Commissioner considers it may be fair and reasonable to exercise the discretion include, but are not limited to, the following: (i) The overpayment of GST occurs as a result of an arithmetic or recording error made by the supplier. For instance, an entity correctly treated its supply as GST-free when making the supply to the customer. However, when filling out its activity statement the entity incorrectly included the supply as a taxable supply in the calculation of the net amount returned on the activity statement. In such circumstances it would not be necessary for the supplier to refund the recipient of the supply whether the recipient is registered or unregistered. … Of relevance to your circumstances is the guiding principle that the Commissioner must have regard to the subject matter, scope and purpose of section 105-65 of Schedule 1 to the TAA which is explained in paragraph 127 of MT 2010/1 as follows: the provision is designed to prevent windfall gains to suppliers and to require the supplier to ensure that any refund ultimately compensates the person or entity who ultimately bore the cost. In relation to a refund of overpaid GST, the potential or otherwise for a windfall gain, the requirement to ensure the refund compensates the person or entity that ultimately bore the cost and the potential to disturb the symmetry envisaged by the GST system, are factors that must be taken into account in relation to the exercise of the discretion. It follows from the above that it is important when exercising the discretion to determine who has borne the burden of the GST. That is, whether the supplier has passed on the GST to the recipient of the supply. On balance it is accepted that you set the out-of-court settlement amount without taking GST into account and made a later decision to treat it as being consideration for a taxable supply. In the circumstances the out-of-court settlement proceeds did not include a GST component. It follows that the overpaid GST was not passed onto the recipient and the burden of the GST was borne by you. It follows that if the proceeds from the out-of-court settlement were not reported on your activity statement, the price the recipient paid would be the same as the settlement amount that did not factor in any GST. Therefore, a refund of the overpaid GST to you will not result in a windfall gain to you at the expense of the recipient. In your circumstances the Commissioner will exercise the discretion under section 105-65 of Schedule 1 to the TAA to refund any incorrectly remitted GST by you. Therefore, you can claim a refund of this amount. You need not pay a corresponding amount to the agent firm in order to claim this refund. You can claim the refund by obtaining a revised activity statement for the quarter you attributed the 'GST' to (ring 13 28 66 to request a blank revised activity statement form) and report the correct GST liability total at label 1A of that activity statement. Alternatively, you might be able to correct the error by reducing the label 1A figure in your next activity statement by the amount of the error (subject to the correction limits set out in the ATO fact sheet 'Correcting GST mistakes', which can be found on the ATO website www.ato.gov.au).

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