A recent AAT decision highlights the importance of carefully drafting terms of settlement
Failure to consider GST when documenting settlement terms of a dispute can result in unintended and unfavourable GST consequences.
In Lighthouse Financial Advisers (Townsville) Pty Ltd v Commissioner of Taxation, the director of Lighthouse was formerly employed as a financial planner. He signed an employment agreement with his former employer that included a restraint of trade.
The director left his employer and established Lighthouse. A large number of clients followed the director to Lighthouse.
The former employer sued Lighthouse and the director claiming damages and an account of profits for breach of the restraint.
The parties negotiated a settlement where Lighthouse acquired the clients from the former employer and agreed to pay an amount that reflected the value of trail fees and commissions generated by the clients. The settlement deed was drafted on the basis that the amount paid was to settle ‘all claims’. The deed did not indicate that the settlement amount was paid in consideration for a parcel of fees.
Lighthouse applied for a private ruling that it could claim input tax credits for the GST component in the settlement sum on the basis that the settlement involved a creditable acquisition, being the supply of rights to trail fees and commissions associated with the clients, or in the alternative the release of Lighthouse from its restraint.
The ATO determined that Lighthouse could not claim input credits. They read the terms of settlement strictly and did not have regard to extrinsic evidence from Lighthouse that indicated the consideration reflected the value of the fees acquired. Lighthouse appealed to the AAT.
The AAT also read the terms of the settlement deed in isolation. As there was no mention in the deed that the settlement amount was paid in consideration for fees or a release, the Tribunal agreed that the payment was not consideration for a taxable supply. Lighthouse was not entitled to any input tax credits.
TAKE AWAY MESSAGE
Before agreeing to settlement terms, parties and their advisers need to carefully consider the tax, GST and duty implications of the proposed settlement.
This should be done before a draft settlement deed is submitted as changes made to a draft deed to achieve a more favourable tax outcome may be caught by the anti-avoidance provisions in the relevant legislation.