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 own
equipment (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 made
by 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.
