Understanding Contracts and the GST Clause

Contract mistakes can be costly, and administering them often needs an understanding of both what is trying to be achieved and the legal aspects. It is important, as part of the overall contract, to have an understanding of the Goods and Services Tax (GST) issues that may arise as a result of the transaction.

Contracts rely more on common law (administered by the courts) than written legislation and therefore understanding the Australian contract law principles is essential in managing the risks of unenforceable, or voidable contracts. Frustratingly, litigation resulting from GST disputes, which arise from poorly worded or vague GST clauses, continue to come before the courts.

Why gst on contracts is so litigated

Under the GST Act, the supplier incurs the liability to pay GST, but the supplier has no statutory right to pass on that GST liability to the purchaser – this needs to be done as part of the contractual relationship. How this contractual relationship is recorded is critical and many of the commercial disputes involve a contest about the terms of the contractual relationship.

In the first part of this series, we will consider the GST aspects of the GST clause and the GST consequences when things go pear-shaped.

The GST clause

When considering GST and contracts, the GST clause itself is the starting point. Does it make sense (for example, supply of going concern clauses) and deliver the GST outcome both the buyer and seller want?
All these years after the introduction of GST, the GST clauses are generally well (but still not perfectly) understood. It is important the clause says what you want it to say and does what you want it to do.
An example of a poorly worded GST clause was in Booth v Cityrose Trading Pty Ltd (ACN 077 934 671) and anor (Civil Claims) [2011] VCAT 278. 

This could not have come at worse time as the two parties were involved in ongoing and bitter litigation.
The GST clause included a common clause, being the terms used have the meaning as set out in the GST Act. The problem was another clause said:

"Where a taxable supply is made under this contract for consideration which represents its value, then the party liable to pay for the taxable supply must also pay at the same time and in the same manner as the value is otherwise payable the amount of any GST payable in respect of the taxable supply.”
 

The above clause says that “consideration” and “value” mean the same thing. However, if expressions used in this clause had the meaning given to them in the GST Act, “consideration” and “value” would mean very different and opposite things.

The contract was a nonsense and the parties had to argue whether or not the price included GST. Clearly, the vendor wanted to add GST but the buyer did not, treating the amount as GST inclusive.
A messy and expensive exercise for both parties for what was seemingly a straight forward item.

GST on settlement of a contractual dispute

Contractual disputes may be resolved either by the judgment of a court, or (at a time prior to the court delivering its judgment) by agreement between the parties. An agreement between the parties is often referred to as an out-of-court settlement. Out-of-court settlements will include any form of dispute resolution in which the terms of the resolution are agreed between the parties, rather than imposed by the court. Some examples of this are:

1. the parties obtain a consent order, the draft of which has been agreed to in a settlement deed;

2. they agree to have the action struck out without a consent order;

3. they enter into an agreement settling their differences before court action commences.

The GST consequences of a court order or out-of-court settlement will depend on a number of matters, including whether a payment made under the order or settlement constitutes consideration for a supply and, if so, whether the supply is in the nature of a taxable, input taxed, or GST-free supply.

As an example of the complexity in determining the GST position, the Commissioner considers conditions of settlement can create supplies for GST purposes. The supplies may be characterised as:

1. surrendering a right to pursue further legal action; or

2. entering into an obligation to refrain from further legal action; or

3. releasing another party from further obligations in relation to the dispute.

The Commissioner refers to supplies of these kinds as “discontinuance supplies”. However, whether a discontinuance supply would be a taxable supply would then depend on the requirements of section 9-5 being met in relation to that supply.

Conclusion

As you can appreciate, this is a very high-level look at the issues. The GST treatment will always depend on the exact nature of the facts and circumstances.

This article highlights some of the GST issues which can arise with contracts. It is important they be considered properly noting every contract, as well as the facts are different. When it comes to getting a 10% advantage because of a poorly worded contract, people will jump at the opportunity.