Issue
Is entity A, a business operator, making a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), when it: • enters into a termination agreement to terminate its service agreement with entity B, another business operator, rather than relying on the termination clause in the service agreement; and • receives payment from entity B for the early termination?
Decision
Yes, entity A is making a taxable supply, under section 9-5 of the GST Act, when it: • enters into a termination agreement to terminate its service agreement with entity B, another business operator, rather than relying on the termination clause in the service agreement; and • receives payment from entity B for the early termination.
Facts
Entity A is a business operator. Entity A receives a payment for the early termination of a service agreement.
Entity A entered into the service agreement with entity B to provide services to entity B for a specified period. The service agreement contained a termination clause which allows entity B to terminate all or part of the service agreement on the happening of a specified event. The service agreement also provided for a payment to be made to entity A if the agreement was terminated pursuant to the termination clause.
The specified event occurred and entity B advised entity A that it wished to terminate the service agreement.
The parties entered into a separate termination agreement which contained a clause stating that the service agreement was being terminated in accordance with the termination agreement and not pursuant to the termination clause in the service agreement.
Entity A is registered for goods and services tax (GST). The supplies it makes are in the course or furtherance of its enterprise and are connected with Australia.
Reasons for Decision
Under section 9-5 of the GST Act, an entity makes a taxable supply if: • it makes a supply for consideration; and • the supply is made in the course or furtherance of an enterprise that it carries on; and • the supply is connected with Australia; and • the entity is registered or required to be registered for GST.
However, a supply is not taxable to the extent that it is GST-free or input taxed.
Section 9-10 of the GST Act defines a supply to include the creation or grant of any right, or the entry into, or release from, an obligation (paragraphs 9-10(2)(e) and 9-10(2)(g) of the GST Act). These are the only supplies that may be of relevance to entity A's situation.
The service agreement contained a termination clause that allowed entity B to terminate all or part of the service agreement on the happening of a certain event. The service agreement also provided for an amount to be paid to entity A in the event that the service agreement was terminated by entity B pursuant to this termination clause. Had entity B terminated the agreement pursuant to this clause, it would have been merely exercising a right under the service agreement and entity A would not have made a supply. (See ATO ID 2002/1078 )
However, entity B is not exercising this right. The termination agreement specifically stated that the service agreement was being terminated in accordance with the termination agreement and not pursuant to the termination clause in the service agreement.
By terminating the service agreement in accordance with the termination agreement, entity A is making a supply to entity B. Entity A is releasing entity B from its obligations under the service agreement. This is a supply by virtue of paragraph 9-10(2)(g) of the GST Act.
Entity A is receiving consideration for that supply, when it receives the payment for the early termination of the service agreement. As such, entity A is making a supply for consideration and the first requirement in section 9-5 of the GST Act is met.
In addition, entity A is registered for GST, supplies it makes are in the course or furtherance of its enterprise and are connected with Australia. Therefore, the remaining the positive requirements in section 9-5 of the GST Act are satisfied.
Furthermore, entity A's supply is neither GST-free under Division 38 of the GST Act nor input taxed under Division 40 of the GST Act. Therefore, entity A is making a taxable supply under section 9-5 of the GST Act.