1 Are you entitled to an input tax credit in relation to the payment you made to A pursuant to the Settlement Deed?
1 No.
You are registered for GST. You account for GST on a non-cash (accruals) basis. You and related parties (including B and other related parties) entered into franchise agreements with A who are the franchisors. A permitted you and your related parties to operate as franchisees. A is registered for GST. There is a history of litigation between A and you and your related parties with some matters previously settled. You and related parties were in dispute with A in relation to the franchise relationships and have been for some time. The main dispute was over ownership of XX contracts. There were also other issues of dispute between the parties, including alleged XXX XXX breaches by you and B that had allegedly caused damage to the reputation of the A trademarks and diluted the value of those trademarks. The dispute came to an end through an out of court settlement. The dispute led to a separation as detailed in the Settlement Deed (SD). You provided a copy of the SD to the Australian Taxation Office. You paid a very large amount of money as compensation to A, which was required under the terms of the SD. You paid all of the compensation that was payable under the SD.
The SD provides that: • you and certain related parties to you were liable to pay the relevant amount to A as 'compensation' • the franchise agreements are terminated by mutual consent and each party is released from their obligations under those franchise agreements • A releases you and your related parties from any obligations or claims (except for any obligations that may arise on execution of the SD). The definitions clause defines 'claim' to mean any claim that is 'past present future or contingent'. The parties agree to walk away and carry out the existing agreements until the date of separation and then issue their invoices which is business as usual. The SD indicates that the parties are settling on a no admission basis to avoid litigation. Pursuant to the SD, the parties to the dispute entered into obligations to not pursue further legal action or make further claims. A clause in the SD provides that this document represents the entire agreement between the parties to resolve the dispute.
The language of the SD avoids specifying specific supplies for specific consideration. The SD does not specify that the compensation payment is a remedy for particular heads of claim.
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 A New Tax System (Goods and Services Tax) Act 1999 section 11-5 A New Tax System (Goods and Services Tax) Act 1999 section 11-10
In these reasons for decision an asterisk indicates a term defined in section 195-1 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). Question Are you entitled to an input tax credit in relation to the compensation payment you made to A pursuant to the Settlement Deed? Summary You are not entitled to an input tax credit in relation to the compensation payment as is it not consideration for a supply. Detailed reasoning You are entitled to input tax credits on your creditable acquisitions. You make a creditable acquisition if you meet the requirements of section 11-5 of the GST Act, which states: You make a creditable acquisition if (a) you make an acquisition for a *creditable purpose; and (b) the supply of the thing to you is a * taxable supply; and (c) you provide, or are liable to provide, *consideration for the supply; and (d) you are *registered, or *required to be registered. Acquisition must be made for a creditable purpose Subsection 11-15(1) of the GST Act states: You acquire a thing for a creditable purpose to the extent that you acquire it in *carrying on your *enterprise.
Subsection 11-15(2) of the GST Act states: However, you do not acquire the thing for a creditable purpose to the extent that: (a) the acquisition relates to making supplies that would be *input taxed; or (b) the acquisition is of a private or domestic nature. Whether taxable supplies were made to you Under paragraph 11-5(b) of the GST Act, to make a creditable acquisition, a taxable supply must have been made to you. To be a taxable supply, the requirements of section 9-5 of the GST Act must be met, which 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. You have agreed to an out-of-court settlement with A. The GST consequences of an out-of-court settlement will depend on a number of matters, specifically:
• whether the payment or any part of the payment under the settlement constitutes consideration for a supply made to you (and corresponding acquisition by you), and • if so whether the supply is a taxable, GST-free, input taxed or an out-of-scope supply. These concepts are discussed and analysed in Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court order and out-of-court settlements (GSTR 2001/4). That ruling focuses on the first requirement of a taxable supply in paragraph 9-5(a) of the GST Act that there is a 'supply for consideration' in relation to out-of-court settlements. Section 9-15 of the GST Act defines consideration. It states at subsection 9-15(1): Consideration includes; (a) any payment, or any act or forbearance, in connection with a supply of anything; and (b) any payment, or any act or forbearance, in response to or for the inducement of a supply of anything. GSTR 2001/4 explains at paragraph 21 that for there to be a 'supply for consideration' three fundamental criteria must be met: • there must be a supply
• there must be a payment • there must be a sufficient nexus between the supply and the payment for it to be a supply for consideration. GSTR 2001/4 outlines three categories of supplies that may relate to out-of-court settlements: • an earlier supply, where the subject of the dispute is an earlier transaction in which a supply was made involving the parties • a current supply, which involves a new supply that may be created by the terms of the settlement, (paragraph 141, GSTR 2001/4) and • a discontinuance supply: created by the conditions for settlement i.e., surrendering a right to pursue further legal action, entering into an obligation to refrain from further legal action or releasing another party from further obligations in relation to the dispute. Paragraph 109 of GSTR 2001/4 states the following in relation to discontinuance supplies:
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. There may be more than one supply that relates to a settlement. In addition, the subject of the dispute may not be a supply at all. For example, 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 do not constitute a supply under section 9-10 of the GST Act (paragraphs 71 to 73 of GSTR 2001/4). This damage, loss or injury, being the substance of the dispute, cannot itself be characterised as a supply made by the aggrieved party. See also paragraph 111 of GSTR 2001/4:
111. 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. Following paragraph 111 of GSTR 2001/4, we need to determine whether A made earlier, current, or discontinuance supplies in return for the settlement payment. The entirety of the arrangement between the parties should be evaluated. Where the parties have reduced their understanding of the transaction to writing, that documentation is the logical starting point in determining the supplies (if any) that have been made. An examination of any relevant documentation and the surrounding circumstances, which together form the total fact situation, is also important in determining whether the documentation captures the nature of a transaction for GST purposes: paragraph 222 of Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: Supplies (GSTR 2006/9).
The first step is to identify any relevant supplies made on settlement of the claims made against you. Is there a supply? 'Supply' is defined in section 9-10 of the GST Act. Subsection 9-10(1) of the GST Act provides that a supply is any form of supply whatsoever. Subsection 9-10(2) of the GST Act provides a non-exhaustive list of things that are included as supplies and states: (2) Without limiting subsection (1), supply includes any of these: (a) a supply of goods; (b) a supply of services; (c) a provision of advice or information; (d) a grant, assignment or surrender of *real property; (e) a creation, grant, transfer, assignment or surrender of any right; (f) a *financial supply; (g) an entry into, or release from, an obligation: (i) to do anything; (ii) (ii) to refrain from an act; (iii) to tolerate an act or situation; (h) any combination of any 2 or more of the matters referred to in paragraphs (a) to (g).
However, a supply does not include a supply of money unless the money is provided as consideration for a supply that is a supply of money (subsection 9-10(4) of the GST Act). The fundamental question to be answered in an Australian GST context is whether the amounts paid under clause XXXX of the SD are consideration for supplies. You contend that many supplies were made in connection with settlement of the dispute and that the compensation payment is consideration for these supplies. For example, you contend that: • A has released each sub-franchisee in the territories from their obligations under their respective franchise agreements, including but not limited to, all restrictive covenants and non-compete obligations. • A has released you and B from claims and demands that it had made in the course of the dispute. We consider that the SD sets out supplies, and these include a discontinuance supply made by A to you and that it also sets out various payments and acts and omissions that can amount to consideration.
The connection between a supply and a payment must be 'direct and immediate'. A clause in the SD indicates that the parties are settling on a no admission basis to avoid litigation. The SD provides that: • you and certain related parties to you were liable to pay the relevant amount to A as 'compensation' • the franchise agreements are terminated by mutual consent and each party is released from their obligations under those franchise agreements • A releases you and your related parties from any obligations or claims (except for any obligations that may arise on execution of the SD). The definitions clause defines 'claim' to mean any claim that is 'past present future or contingent'. The language of the agreement avoids specifying specific supplies for specific consideration. The agreements are at an end and all rights and claims end with it. The payment is 'by way of compensation'. The agreement does not anywhere in its language make a connection between a supply and consideration that could be said to be quantifiable.
An absence of a nexus between a supply and a payment is more likely where the payment is described as compensation and the settlement deed does not dissect the payment into separate amounts for separate heads of claim. The agreements are at an end so there are no earlier supplies. The parties agree to walk away and carry out the existing agreements until the date of separation and then issue their invoices which is business as usual. In our view, the case has to be decided by interpreting the SD. AP Group Limited v FCT [2013] FCAFC 105 was a case about analysing whether there was a supply for consideration in the context of incentive payments in the automotive industry. One of the issues was determining to what level it is necessary to particularise numerous identifiable supplies and consideration in a given agreement. Ultimately, selection of the appropriate level of generality or particularity at which the assessment is to be carried out is fact-dependant. The critical facts include the nature of the supply said to be involved. This flows from s 9-5 which is concerned with each supply.
The facts of your case taken from the language of the SD suggests that there is no particular supply that is made for consideration. Although the SD sets out particular supplies, there is not a sufficient nexus between those supplies and the payments made under the settlement. There are no admissions of liability in this case, and no related payment. The agreement operates to include 'future claims' under the definition. A payment for a potential future claim is not quantifiable and has no connection to a visible supply. As the payment is not consideration for a supply, the requirement of paragraph 9-5(a) of the GST Act is not met. Therefore, you do not meet the requirement of paragraph 11-5(b) of the GST Act as no taxable supply has been made to you in return for the payment. As you do not meet all of the requirements of section 11-5 of the GST Act, you are not entitled to an input tax credit in relation to the payment.