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GST: Compensation vs Consideration Guide

Updated · Standard formula, shown below

This guide explains how to tell whether a payment you receive is compensation (not subject to GST) or consideration for a supply (subject to GST) under Australian GST law. You will learn the key tests, work through examples, and avoid common misclassifications. Before you start, you should have the relevant contract, invoice, or payment details on hand.

What You’ll Need

  • The contract or agreement under which the payment is made
  • Any invoices, tax invoices, or payment receipts
  • Details of what you provided in exchange (goods, services, or nothing)
  • Your ABN and GST registration status (if you are registered or required to be)

Step-by-Step

  1. Identify the payment’s purpose. Read the contract or correspondence to determine why the payment is being made. Is it for something you did, gave, or promised to do? Or is it to compensate you for a loss, damage, or injury?
  2. Check if there is a supply. Under GST law, a supply is any form of supply whatsoever, including goods, services, real property, or the creation, grant, or transfer of rights. If you are not providing anything in return for the payment, there is likely no supply.
  3. Look for a direct connection between payment and supply. The payment must be ‘consideration’ for the supply. This means there must be a sufficient link: the payment is made in return for the supply, and the supply is made in return for the payment. If the payment is not linked to any supply you make (or will make), it is not consideration.
  4. Test for compensation. A payment is compensation when it is recompense for loss, damage, or injury suffered, and it is not made in exchange for a supply. Common examples: insurance payouts, damages for breach of contract, compensation for personal injury, or payments for early termination of a contract (if no supply is made in return).
  5. Consider ‘acts’ that are not supplies. Some things are specifically excluded from being supplies, such as a payment of damages, a payment of a fine or penalty, or a payment of interest. If the payment falls into one of these categories, it is not consideration for a supply.
  6. Review the ATO’s guidance. The ATO has published detailed guidance (GST Ruling GSTR 2006/9) on the distinction between compensation and consideration. It provides examples and a framework. Use it to test your situation.
  7. Apply the ‘but for’ test. Ask: Would the payment have been made if the supply had not occurred? If the payment would still be made regardless of any supply, it is likely compensation. If the payment is conditional on the supply, it is likely consideration.
  8. Check for mixed payments. A single payment may have both compensation and consideration components. If so, you must apportion the payment between the two. For example, a settlement may include $10,000 for lost profits (consideration for a supply) and $5,000 for emotional distress (compensation).
  9. Determine GST treatment. If the payment is consideration for a taxable supply (and you are registered for GST), you must include it in your GST turnover and remit GST on it (unless it is GST-free or input-taxed). If it is compensation, it is outside the GST system and you do not remit GST.
  10. Document your decision. Record the reasoning and the basis for your classification. This is crucial if the ATO later reviews your treatment.

Common Mistakes

  • Assuming all payments are for supplies. Just because you receive money does not mean you made a supply. A payment for damages is not a supply.
  • Ignoring the ‘direct connection’ test. A payment that is only incidental to a supply (e.g., a late payment fee) is not consideration for the supply itself.
  • Treating early termination payments as compensation. If the termination payment is in exchange for the supplier releasing the customer from a contractual obligation, that release can be a supply (a supply of a right). The payment may be consideration for that supply.
  • Failing to apportion mixed payments. If a payment has both compensation and consideration elements, you cannot simply treat the whole amount as one or the other.
  • Not considering GST-free or input-taxed supplies. Even if the payment is consideration, it may not be taxable if the supply is GST-free (e.g., basic food) or input-taxed (e.g., residential rent).

Tips

  • Always document the commercial substance of the arrangement. A written agreement that clearly states the payment is ‘compensation for loss’ will help your case.
  • If you are unsure, seek professional advice from a tax advisor or the ATO’s GST ruling system.
  • Keep records of all correspondence and calculations used to determine the GST treatment.
  • For settlements, consider getting a clause that specifies the GST treatment to avoid disputes.
  • Remember that GST is a tax on supplies, not on receipts. Focus on what you are providing in return.

Troubleshooting

  • If you cannot determine whether a supply exists: Break down the payment into its components. What did the payer receive? If they received nothing, it is likely compensation.
  • If the ATO disagrees with your classification: You can object to the ATO’s decision within a specified time frame. Seek professional advice to prepare a strong objection.
  • If you have already remitted GST on a payment that turns out to be compensation: You can claim a credit for the GST you overpaid, but you must act promptly and correct your BAS.
  • If you did not remit GST on a payment that is actually consideration: You may be liable for GST, penalties, and interest. Correct your BAS as soon as possible to reduce penalties.

Frequently Asked Questions

Is an insurance payout subject to GST?

No. Insurance payouts are compensation for loss and are not consideration for a supply. They are outside the GST system.

Is a payment for cancelling a contract subject to GST?

It depends. If the payment is compensation for loss suffered due to the cancellation, it is not subject to GST. However, if the payment is in exchange for the supplier releasing the customer from a contractual obligation, that release is a supply and the payment is consideration, subject to GST.

Do I need to charge GST on a settlement payment?

Only if the settlement payment is consideration for a supply you make. If the settlement is compensation for damages, no GST applies. If it includes payment for goods or services provided, GST applies to that part.

What is the difference between compensation and consideration?

Compensation is recompense for loss or damage, with no supply made in return. Consideration is payment made in exchange for a supply. The key is whether there is a direct link between the payment and a supply.

Can a single payment be both compensation and consideration?

Yes. A settlement may include amounts for lost profits (consideration) and for emotional distress (compensation). You must apportion the payment and treat each part accordingly.

Does it matter if I am registered for GST?

Yes. If you are not registered for GST, you do not remit GST on any payments, but you also cannot claim GST credits. The classification still matters for determining whether the payment is part of your GST turnover, which affects your registration threshold.

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