Application of Goods and Services Tax to costs awarded by courts or settled by agreement

When the Tax Office is: • making a legal costs payment, or • formulating a schedule of legal expenses to receive payment of costs

This Practice Statement deals with the GST implications of the legal costs awarded by courts or settled by agreement between the parties out of court.

A legal dispute is generally finalised either by a court providing a judgment or by a negotiated settlement between the parties. The unsuccessful party is generally required to pay the legal costs that have been incurred by the successful party. These legal costs can be party - party, solicitor - client, indemnity costs or a negotiated amount.

The types of legal costs that are likely to be incurred by a party to a legal dispute include: • solicitor's fees • barrister's fees • expert witness fees • costs of expert witness reports • legal administration fees (copying, courier, postage, etc) • filing fees • court costs • search fees (eg Land Title Office searches & Australian Securities and Investment Commission (ASIC) searches) • advertising fees • service fees, and • other disbursements such as travel and accommodation.

It is important to note that each of these legal costs incurred will have a GST consequence. The GST consequence will depend on whether the resulting payment constitutes consideration for a supply and, if so, whether the supply is in the nature of a taxable, input taxed or GST-free supply. Generally, the GST consequences of the legal services listed in paragraph 4 above are as follows: •  solicitor's fees GST applies •  barrister's fees GST applies •  expert witness fees GST applies •  costs of expert witness reports GST applies •  legal administration fees GST applies •  filing fees No GST •  court costs No GST •  search fees (Land Title Office & ASIC) GST  applies [F2] •  advertising fees GST applies •  service fees GST applies •  travel and accommodation GST applies

Both parties to a legal dispute, in receipt of the supply of these types of legal services to which GST applies, may be entitled to an input tax credit for a creditable acquisition of those services.

Where the Tax Office is a party to a legal dispute and is supplied with a legal service, such as a barrister to perform the counsel function, that barrister is required to provide the Tax Office with a tax invoice where GST is charged. The Tax Office in turn is entitled to claim an input tax credit for the amount of GST charged by the barrister.

The payment of legal costs to the successful party under a court order or negotiated amount is not consideration for a supply. [F3] It is to compensate a party for the legal costs incurred in the dispute and, for GST purposes it is treated in the same way as payment of damages. GST does not apply.

However, the legal costs ordered by a court or the negotiated cost amount must take account of any entitlement to an input tax credit of the parties to the original supply. In this regard, if a taxpayer is registered for GST they will be entitled to claim an input tax credit unless the legal costs do not relate to carrying on their enterprise or relate to making input taxed supplies or are of a private or domestic nature. [F4] It is therefore very important that when the successful party to a legal dispute is recovering its legal costs, the combined GST consequences are clearly understood and applied appropriately.

Taxpayer is registered for GST. • Taxpayer is successful in the litigation (and the exclusions referred to in paragraph 9 above do not apply). • Taxpayer's solicitor renders a bill to the taxpayer for $980 being: • Court fees $100 (no GST) • Search fees $220 (includes $20 GST as searches conducted by the solicitor) • Solicitor's fees $660 (includes $60 GST) • As the taxpayer is entitled to an input tax credit of $80 the correct amount of legal costs payable by the Tax Office is $900. [F5]

Taxpayer is not registered for GST, or the costs are not incurred in the carrying on of their enterprise, or are of a domestic or private nature, or relate to making input taxed supplies. • Taxpayer is successful in the litigation • Taxpayer's solicitor renders a bill to the taxpayer for $980 being: • Court fees $100 (no GST) • Search fees $220 (includes $20 GST as searches conducted by the solicitor) • Solicitor's fees $660 (includes $60 GST) • As the taxpayer is not entitled to an input tax credit of $80 the correct amount of legal costs payable by the Tax Office is $980.

Prior to the Tax Office making a payment of the legal costs, the other party must forward details of the legal expenses it has incurred and is claiming for payment. The invoices must be of sufficient detail to identify how they were determined, whether GST applied, whether the party was entitled to claim an input tax credit and if so, to what extent. If the invoices do not give sufficient details then they should be queried and further details requested in respect of the GST application and payment. Upon satisfaction that the GST component of the invoices has not been included by the party if they are registered and entitled to claim an input tax credit, and that the legal expenses claimed are reasonable given the nature and complexity of the matter, then payment of the legal costs should be made. It is important to note however that when the Tax Office pays the costs of an unregistered taxpayer or a registered taxpayer who is not entitled to claim input tax credits on the legal costs, it is the GST inclusive amount which is to be reimbursed.

Where the Tax Office is to receive a payment of legal costs it must prepare a schedule of legal expenses incurred to enable determination of the amount of legal costs to be paid by the other party. The schedule must contain invoices with sufficient detail to determine whether GST was applied. If so, the GST paid is not a cost to the Tax Office as it is able to claim an input tax credit for that amount, and the expense the Tax Office is seeking to recover must be the GST exclusive amount on the invoice.

There are also less complex legal proceedings where there may be no need for the Tax Office to prepare a schedule of legal expenses, but nevertheless, the same policy applies. Where, for example an Operations officer obtains a default judgment on a summons issued for a tax liability, the only legal expenses likely to be incurred by the Tax Office would be filing fees (no GST applied) and service fees (GST applied). In this situation the Operations officer should seek from the court the costs for the filing fee and the service fee exclusive of the GST amount. As the Tax Office is registered for GST it is entitled to claim an input tax credit for the GST amount on the service fee.

A negotiated settlement of legal costs of a matter generally occurs on settlement of a dispute and can occur prior to, during or after litigation. Irrespective of which point in time the negotiated settlement of the legal costs issue occurs, the Tax officers involved must ensure that a schedule of legal expenses incurred to that point is prepared by the party to receive the payment and must identify whether the GST has been applied correctly in order for the correct determination of the final GST exclusive legal costs amount to be made. In those instances where the other party is not entitled to claim input tax credits in relation to the legal costs the amount of the payment would need to be GST inclusive.

Where the AGS has acted on the Tax Office's behalf in respect of a matter, AGS will deal with the legal costs. AGS will discuss any issues that may arise with the Legal Services Branch case officer. It is important in this arrangement that instructions to AGS must clearly specify the correct position of GST law and the policy of the Tax Office in respect of the GST implications on legal costs orders and payments.

The Tax Office as the administrator of the Commonwealth taxation laws must act as the 'model taxpayer' and must be seen to be fully compliant with all aspects of taxation law related legislation. The Tax Office must also act as a Model Litigant in accordance with the Legal Services Directions of the Attorney-General. To over claim or overpay legal costs through the misapplication of the GST law would adversely affect the integrity and public confidence of the Tax Office's administration of taxation laws. It is therefore imperative that the Tax Office correctly applies the GST laws to legal costs calculations for payment and recovery, either by court order or negotiated settlement.

There are various areas in the Tax Office that may have direct involvement in dealing with legal costs orders, including: • Legal Services Branch • Business Line litigation liaison officers • Business Line officers involved in negotiating settlement of disputes • Operations, and • In House Prosecutions.

Where the Tax Office is awarded legal costs against another party it has a duty under the Financial Management and Accountability Act 1997 to seek to recover the legal costs. Where AGS and external counsel are engaged and acting in a matter, they should be clearly instructed in respect of this obligation to seek to recover the legal costs.