When entities suffer damage or loss, it is likely that the resulting GST implications are not necessarily top of mind. However, there are some very specific rules that apply that entities need to be aware of.
To provide context, take a simple example where one party causes damage to another entity’s assets, and where we assume both parties are GST-registered and the damages occur while both parties are carrying on activities that relate to carrying on their enterprise. To be specific, take the example where the truck driver employed by the Supplier accidentally breaks a window at the Customer’s premises while delivering goods. The GST-inclusive cost to repair/replace the window is $2,200.
The GST implications arising for this scenario depends on a number of factors including whether the Customer claims compensation directly from the Supplier (i.e. claims damages), or makes an insurance claim.
Let’s assume the parties resolve this between themselves (that is, no insurance claim is made), with the Customer seeking compensation directly from the Supplier, and the Supplier making a payment directly to the Customer.
Generally for GST purposes, an entity makes a taxable supply where:
- there is a supply made for consideration;
- the supply is made in the course or furtherance of carrying on an enterprise;
- the supply is connected with the indirect tax zone (i.e. Australia); and
- the supplier is GST-registered or required to be GST-registered.
For this reason (and assuming the supply is in connection with Australia and done in the course of carrying on an enterprise), where an amount of money is paid from one GST-registered entity to another, and this is for a supply being made, the transaction will ordinary be subject to GST. However, the question of the nexus between consideration and supply is the critical issue when considering damages.
The ATO has issued a public ruling setting out its view of the GST implications for out-of-court settlements (GSTR 2001/4), with the question of nexus considered in paragraphs 100 to 114 of that ruling. In particular, paragraphs 110 and 111 state the following in relation to damages for loss:
110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply made by the aggrieved party. If a payment made under a court order is wholly in respect of such a claim, the payment will not be consideration for a supply.
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.
Considering the example provided above, notwithstanding that the Supplier pays an amount of money to the Customer (to cover the loss caused), based on the comments in paragraph 111 that amount will not be treated as consideration for any supply made by the Customer. As such, there is no supply made for consideration, and as one of the conditions for a taxable supply has not been satisfied the amount paid will not be subject to GST.
Where this is the case, the Supplier would only need to compensate the Customer for an amount equal to the Customer’s out-of-pocket expense – in this case, $2,000. Even though the Customer would engage a glazier to repair/replace the window and pay $2,200 (including GST) for such repairs, after claiming a GST credit of $200 the net (after GST) cost to the Customer is $2,000.
Let’s now assume the parties were unable to resolve this between themselves, and the matter was dealt with via an insurance claim. Let’s further assume that, as it was the Supplier who caused the damage, the Supplier paid the Glazier directly for the repairs, and the Supplier then made a claim to its Insurer to cover the costs of the damage.
The GST implications of insurance matters are dealt with via special rules contained in Division 78 of the GST law. Division 78 refers to the following entities:
- insurers – the insurance company;
- insured entities – in this case the Supplier;
- third parties – for example, the entity that has suffered the loss (in this case, the Customer); and
- repairers – in this case the glazier who fixed the broken window for a GST-inclusive amount of $2,200.
Ultimately, the GST treatment of the transaction will be dependent on:
- the facts of the case (including the nature of any arrangements between the insurer and the repairers);
- the number and type of parties involved;
- the method by which the insurers and insured entities settle the claim;
- whether the insurer is entitled to GST credits for the insurance policy (or not); and
- whether the insured party was entitled to claim a GST credit for the insurance premium, and whether they notified the insurer of this.
Considering the example provided, and assuming the Supplier was entitled to a full GST credit and notified its insurer of this entitlement, the GST implications (based on the above) are as follows:
- the Insurer makes a taxable supply when supplying the insurance, and therefore the premium paid is subject to GST;
- assuming the insurance premium charged is $550, the Insurer is liable for GST of $50 and the Supplier would claim a GST credit for $50;
- the Insured (the Supplier) made a payment to the repairer for $2,200 and claimed a GST credit for $200 – the net cost to the Supplier is $2,000;
- when the Supplier makes its claim with the Insurer it informs the Insurer of the repair costs;
- the Insurer only pays the Supplier $2,000:
- this is because a payment made by an Insurer is ‘not treated as consideration for an acquisition made by the insurer’ [refer to s 78-20(1) of the GST law]; and
- the amount received is not treated as consideration for a supply made by the entity that was entitled to an input tax credit for the premium paid for the insurance policy’
If, instead of the Supplier agreeing to pay the repairer, the Customer paid the repairer directly and the made a claim against the Supplier, the net cost to the Customer would still be $2,000 (for the reasons outlined above). The Supplier would then refer the Customer’s claim to its Insurer as part of the insurance claim. If the Insurer then paid the Customer directly, such a payment would also not be treated as consideration for a supply between these parties [refer to s 78-65(1)].
The explanation above is not intended to be a detailed account of how GST and insurance interacts, but a summary in the context of the above example.
As can be seen, the GST implications of damages or loss are complex and, as has been highlighted, the facts and actions of the parties are critical. This is of particular relevance when Division 78 (regarding GST and insurance) needs to be considered as there are many extra layers of complexity, and having a clear understanding of the facts is absolutely essential.
This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.