Issue
Is the entity, a commodity trader, making a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) , when it makes a cash settlement payment in relation to a deliverable commodity forward contract where there is a formal default?
Decision
No, the entity is not making a taxable supply under section 9-5 of the GST Act when it makes a cash settlement payment in relation to a deliverable commodity forward contract where there is a formal default.
The cash settlement payment is made in respect of damages and accordingly the payment is not a supply.
Facts
The entity is a commodity trader. The entity enters into commodity forward contracts to buy and sell commodities. The physical delivery of the commodity would be a taxable supply under section 9-5 of the GST Act.
The relevant contracts conform to an industry association's trade rules. The rules state that a formal default occurs when one party defaults by either the buyer not paying for the goods, or the seller not delivering the goods. These rules for a formal default will only apply if the defaulter is provided with written notice that they are in default under the relevant trade rule. Once written notice is provided the rule operates as follows: • The non defaulting party will have the right to repurchase or resale of the commodity as the case may be. The defaulter must make good the loss from any repurchase or resale, by payment of a cash settlement amount. • The party in default must pay, by way of liquidated damages, an amount equal to the difference between the contract price and the fair market value for the commodity at the date of termination of the contract.
The trade rules also specify that the same calculation of the default payment will apply when one of the parties becomes insolvent.
The entity defaults in relation to the deliverable commodity forward contract it makes with another entity. This is a formal default under the industry association's trade rules. The entity makes a cash settlement payment in relation to a deliverable commodity forward contract.
The entity is registered for goods and services tax (GST). The transaction is made in the course of an enterprise carried on by the entity and is connected with Australia.
Reasons for Decision
Section 9-5 of the GST Act sets out the requirements that must be met for an entity to make a taxable supply. A transaction is only a taxable supply under section 9-5 of the GST Act if it also comes within the word 'supply' as discussed in section 9-10 of the GST Act.
Goods and Services Tax Ruling GSTR 2001/4 (paragraphs 71 to 73) discusses some circumstances where a payment may not relate to a supply: Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of...termination or breach of contract. ...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.'
Where the default provisions in the trade rules are triggered, the payment is for damages, as one party has not met their obligations under the contract. Therefore, as the payment made by the entity is in respect of damages, the payment is not a supply under section 9-10 of the GST Act.
As such, the entity is not making a taxable supply under section 9-5 of the GST Act when it makes a cash settlement payment in relation to a deliverable commodity forward contract where there is a formal default. Note: When a party is in default due to insolvency, the payment is not for damages due to a breach of contract, it is a payment to compensate one party for the loss of the bargain of the contract. The payment does not result in a supply for consideration from one party to the other party, it is essentially paying compensation for losses and will be treated in the same manner as damages.