Special arrangements
Payment of damages
Damages are compensation for loss or harm. They are generally not payment for a supply, so no GST applies, but some payments labelled damages can be consideration for a supply.
Damages are money paid to compensate someone for harm, loss or breach of a contract, often as a result of a court order or settlement. For GST, the key question is whether the payment is consideration for a supply. A supply is something the recipient of the money does in return, such as providing goods or services. Compensation for a wrong done to someone is usually not a payment for any supply, so GST generally does not apply.
For example, if a business receives money because a supplier damaged its stock, the payment is compensation for the loss, not for goods or services provided by the business. In that case, no GST is payable on receipt, and the payer cannot claim a credit for it either. The same is typically true of settlements of personal injury claims and many other types of legal claims.
However, labels can be misleading. If a payment is described as damages but is really a payment for something the receiver does, it may be consideration for a supply. A cancellation fee, a payment for releasing someone from a contract, or an amount for agreeing to give up a right can all involve a supply, in which case GST can apply. The substance of what the payer receives in return is what matters, and each situation needs to be assessed on its facts.
Where damages compensate for the loss of a taxable sale, the position needs careful attention. If a customer cancels an order and pays an amount for losses, that amount might be damages for breach, or it might be a fee for the cancellation, and the GST result differs. The wording of the contract, the nature of the right and the surrounding circumstances all play a part.
Another aspect is what the compensation replaces. If the damages are for lost goods and the business had previously claimed credits on them, the business may need to consider whether an adjustment is needed because the goods are no longer applied to a creditable purpose. Similar questions arise with insurance settlements. The receipt of money and the earlier credits are separate matters, and both should be looked at.
Interest on a court award and legal costs paid to a party can raise their own GST questions. Legal services themselves are generally taxable supplies, so a registered business that pays or receives legal costs should check how they are treated. Where litigation is likely, getting advice about GST at the settlement stage is wise.
Because the line between compensation and consideration depends on the facts, this page is general information only. Confirm your position with the ATO or a registered tax professional.
Worked example
A registered café's freezer is damaged by a contractor and a court orders the contractor to pay $5,500 for spoiled stock and lost trading. The payment is compensation for the harm, not payment for a supply by the café, so no GST is reported on the $5,500. By contrast, if the café charged a $550 fee for cancelling a catering order, that fee may include GST of $50.
Practical tips
- Look at what the payer receives in return, because a payment called damages may still be consideration for a supply.
- Review whether earlier credits need adjusting if damaged or lost goods were not used as planned.
- Seek advice on GST before finalising a settlement, because the wording of the agreement can affect the outcome.