Goods and Services Tax
by Technical Assessing | October 21, 2014
By Andrew Buchanan
The treatment of GST on claims is often a source of confusion for Insureds and Claimants. Whilst it is not the responsibility of claims practitioners to provide “tax advice”, it is often necessary to point out where GST has been incorrectly applied in claims presentation and to provide guidance on the approach to be adopted. It is therefore important that any such instruction is in accordance with the GST rules in order to ensure not only that the Insured is property indemnified but also to potentially avoid exposing any parties to the future application of penalties and interest for incorrect treatment arising from misguidance.
Goods and Services Tax (GST) is “Value Added Tax”, meaning that it the tax is collected on the value that is added by GST-registered entities at each stage of the production/supply chain. By way of simplified example: if a wholesaler purchases a good from distributer for $30, then sells it to a retailer for $50, the “added value” is $20, and the business’s GST liability (at 10% of this added value) is therefore $2.
The mechanism by which the tax is collected involves a two-stage process. Firstly, GST-registered businesses must include 10% GST on all taxable supplies of good and/or services they provide. Secondly, GST-registered businesses are entitled to claim Input Tax Credits (ITCs) on the GST component of all those goods/supplies it has purchased for use in the business.
To return to the earlier example, the business is required to charge $5 GST when selling their product (10% of $50) but entitled to claim a $3 ITC (corresponding to the GST paid on the $30 purchase price). The net result is that the business (which, in this simplified example, has no other costs on which they can claim ITCs) would be required to pay $2 GST; which, of course, corresponds to the GST liability on the “added value”.
GST is levied on each separate (GST-registered) business entity at every stage in the production/supply chain until the good or service is obtained by the final consumer. GST is therefore technically a tax on each of the businesses supplying the goods/services and not the entity purchasing them (though it may not seem that way to the paying consumer at the end of the chain!)
When determining the liability of an Insured or Claimant (or Third Party) to pay GST as part of a settlement it is necessary to determine whether a taxable supply has been provided. Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides the requirements for a supply to be a taxable supply: a business makes a taxable supply if it makes a supply for consideration, the supply is made in the course or furtherance of the enterprise, the supply is connected with Australia, and the supplying business is (or is required to be) registered.
The Commissioner of Taxation has previously ruled that an award of damages by a court and its payment is not a taxable supply. Goods and Services Tax Ruling GSTR 2001/4 (GSTR 2001/4) provides the Commissioner's view on GST consequences of court orders and out-of-court settlements. Significantly the Commissioner confirms that damage, loss, or injury, in itself does not constitute a supply under section 9-10 of the GST Act.
Accordingly, payment of damages does not represent a taxable supply.
It is common for Claimants to present their claim by “invoicing” the Insured for the damages sought plus GST (or having their contractor address any repair invoices to the Insured; the thinking being that as the Insured is legally liable for the damage the repair service is provided to the Insured. This approach is flawed: the Insured (as tortfeasor) is only liable to pay compensatory (financial) damages, not to repair the physical damage caused. The Claimant is the recipient/beneficiary of any repair service provided and the party to whom any invoices should be addressed.
In such instances, the Insured’s liability to pay GST should generally be contested. Exceptions include where the Insured does benefit and has actually contracted with the Claimant for provision of the supply (see example below), or where the Claimant is statutorily entitled to undertake repairs and charge the responsible party.
In a recent claim the Insured caused damage to a hired-in forklift. Often in such cases the hire agreement will require the Insured to indemnify the hirer for the cost of repairs, the hire company then undertakes the repairs to their ownequipment (no external taxable supply, so nil GST) and the Insured compensates them for the cost of doing so. However, in this particular case the hire agreement instead made the Insured responsible for repairing damage to the hired forklift. The Insured chose to contract the Claimant (the hire company) to undertake the necessary repairs on the Insured’s behalf; this repair service was a taxable supply to the Insured: the Claimant was therefore required to add 10% GST to their invoice and the Insured needed to pay such.
Of course, on the occasions where the Insured is liable for GST (on repair costs etc) they are normally able to claim an Input Tax Credit (ITC) on this cost and therefore suffer no loss in this regard. Accordingly, even though the Insured will have to pay the GST element on the Claimant’s invoice, Insurer’s indemnity to the Insured will still be net of GST (it is, however, necessary for the full amount, inclusive of GST, to be recorded in any Deed of Release and for the Insured to pay the GST component to the Claimant).
Complications arise with the following situation: the Insured (a builder) causes damage to the property of a non-GST registered Claimant, the Insured then agrees to undertake the required repairs to the Claimant’s property in full satisfaction of the claim. The Insured does not invoice the Claimant but seeks an indemnity for the repair cost under his Public Liability Insurance.
Whilst no money was exchanged between the Insured and Claimant, the Insured’s repair service was provided for a “consideration”: that being the extinguishment of the Claimant’s right to seek compensatory damages from the Insured. The Insured’s repair works therefore meet all the requirements to be a taxable supply to the Claimant and the Insured must therefore charge 10% GST. Insurer’s settlement should therefore indemnify the Insured for the cost of undertaking the repairs, inclusive of GST.
As an aside, it is worth remarking that the above scenario also has implications for activation of the Operative Clause of typical Public Liability policy wordings. It is not unknown for Insurers to seek to argue that, due to the Insured having undertaken works to avoid legal liability attaching, the Operative Clause (which requires legal liability on the part of the Insured) has not triggered. In practice, however, the Insured has generally not “avoided” legal liability but, instead, settled the claim through provision of service.
Where the goods or services are provided by the Insured purely on a gratuitous basis (for example a business giving an injured customer flowers or vouchers in the hope that they will not pursue a claim) then there is no “consideration” provided by the Claimant (who has agreed to nothing!) and the supply does not attract GST.
In addition, replacement goods or repair services will not attract GST where they are provided by under a warranty or guarantee. This is because the consideration was paid by the Claimant/customer at the time of purchasing the original goods/service (inclusive of guarantee/warranty service). This, however, only applies to the element of the service(s) which are within the scope of the guarantee/warranty: if the Insured’s provided services post-incident go beyond this (to include, most obviously, repair of resultant damage) then such additional services will incur GST.
The earlier example of an Insured causing damage to the property of a (non-GST registered) Claimant is further complicated where the Insured (rather than undertaking repairs themselves) instead arranges for a third-party contractor to undertake repairs to the Claimant’s property; with the contractor then direct-billing the Insured.
The above situation gives rise to two possible scenarios: either a “payment arrangement” or a “tripartite transaction” exists. This depends on whether the Third Party contractor’s contract is deemed to be with the Insured or with the Claimant.
Where the contract is deemed to exist between the contractor and the Claimant, then this is a “payment arrangement”. All the Insured is doing is short-cutting the funding chain by paying the contractor directly on the Claimant’s behalf (rather than the Claimant paying the contractor, then the Insured reimbursing the Claimant). The taxable supply is provided by the contractor to the Claimant (as sole recipient) and the Claimant (if not-GST registered) cannot claim an ITC on the transaction, nor can the Insured.
Conversely, where the Insured directly contracts directly with the contractor, for the contractor to provide a supply to the Claimant, then this is a “tripartite transaction”. In this instance the contractual supply is madeby the contractor to the Insured, but the actual/physical supply is provided to the Claimant.
In genuine tripartite transactions, the (GST-registered) Insured will be entitled to claim an ITC on the supply received. The rules surrounding tripartite arrangements are complex but may, for example, include the situation where the Insured engages a third party to provide a warranty repair service to a customer on the Insured’s behalf.
However, if the Insured’s entering into the arrangement with the contractor was done on the basis of receiving “consideration” from the Claimant (i.e. the Claimant’s agreement to extinguish/reduce their claim in exchange for the Insured arranging repairs) then this is not a genuine tripartite agreement and the Insured will not be entitled to claim an ITC.
Whilst all the forgoing may seem overly complicated, this reflects the nature of the GST rules (and the rulings determining the correct interpretation thereof). Unfortunately there is no one simple “rule of thumb” that covers all possible situations and it is important that the fundamental nature of any supplies between an Insured and Claimant are investigated and understood in order that GST is correctly addressed in any agreed settlement.