Plaintiff v First Defendant

2 The written objections filed on behalf of the plaintiff in respect to the bill of the first defendant raised no issue in relation to the Goods and Services Tax ("GST").

3 The Notice of Objections filed on behalf of the plaintiff in relation to the bill filed by the second defendant has the following general objection:

On the basis that the First (sic) Defendant is registered for the purposes of the A New (sic) System (Goods and Services Tax) Act 1999 and is in consequence thereof an entity entitled to claim an input tax credit in respect of the tax payable on the goods and services supplied to it by its legal advisors ("the said incidence of taxation"), the plaintiff objects to reimbursement of that portion of the professional costs and non-exempt disbursements claimed in the First (sic) Defendant's said bill of costs that represents an allowance for the incidence of taxation"

4 The bill of the second defendant was taxed first and oral submissions were made by the plaintiff in support of this general objection. The ruling in relation to this GST point was reserved by me and the taxation of individual items in the bill proceeded to conclusion. The final figure was quantified but was expressed to be subject to the impact (if any) of the reserved decision in relation to GST. An interim taxation figure was then agreed between the parties with the quarantined part being referable to the impact of any adverse decision concerning the GST issue upon the second defendant's position.

5 Although the Notice of Objections filed by the plaintiff in relation to the bill of the first defendant omitted the general objection in relation to GST, oral submissions were made on behalf of the plaintiff about the GST issue relevant to the bill of the first defendant. Similar to the approach taken in the taxation of the bill of the second defendant, the taxation figure was subject to the ultimate ruling on the GST issue and an interim taxation amount was agreed between the parties.

6 I gave directions that any written submissions on the GST issue were to be filed and served by 6 June 2006, and that the defendants had the option of filing joint or separate submissions.

7 The plaintiff's written submissions were filed on 6 June 2006 in compliance with the direction and they can be summarised as follows:

• The costs paid by the defendants to their respective lawyers are a "taxable supply" which attracts GST.
• Both defendants are registered for the purposes of A New Tax System (Goods and Services Tax) Act 1999 ("the Act").
• Appendix A to Chapter I - Supreme Court (General Civil Procedure Rules 2005 contains the relevant scale of costs ("Scale"). The sums in the Scale were increased immediately after the introduction of the Act to include GST and counsel fees claimed also include a GST component.
• The defendants have already been indemnified for the GST component in circumstances where they can claim an input credit in relation costs and disbursements. That is, they are not 'out of pocket' for the GST component.
• Reliance is placed on a number of sources in support of these submissions, including Australian Tax Office Goods and Services Public Ruling (GSTR 2001/4) ("Public Ruling"), the practice in South Australia in the Federal Court of Australia and a South African case (Price Waterhouse Meyernel v The Thoroughbred Breeders' Association of South Africa (2003) (3) SA 54 - discussed at paragraphs 24 to 26 below). The plaintiff also relies on Thornton v Apollo Nominees Pty Ltd ( 2005) TASSC 38 (discussed at paragraphs 27 to 29 below) to the extent that it can be distinguished.

8 The second defendant also filed written submissions on 6 June 2006 in compliance with the direction. In summary it relies upon the following:

• On a party/party taxation all costs are allowed as are necessary or proper for the attainment of justice or for defending rights and 'costs' include disbursements.
• The Taxing Master has a discretion to allow more than the scale, but unless specified in the rules, no discretion to decrease the allowable Scale payments. The Rules do not permit a reduction for GST.
• To maintain consistency disbursements ought to be assessed on the same basis as professional fees listed in the bill of costs.
• The Public Ruling provides that payment of court ordered costs will not be considered as a supply for consideration for the purpose of determining whether GST is payable on the amount and the ruling applies irrespective of whether or not a party is registered for the purposes of GST.
• The Public Ruling is often misinterpreted to mean that since costs will not be a consideration for a supply, the liability to pay party/party costs does not attract a liability to indemnify for GST.
• Reliance is placed on Thornton v Apollo Nominees Pty Ltd in support of the assertion that such an interpretation is incorrect. The case is relied upon as an authority that the GST payable in the hands of a successful party are costs and expenses that are necessary for the proper attainment of justice.
• The question of whether a party has received a benefit as a result of being awarded costs for an input tax credit amount is a private matter to be regulated by the Commissioner, and in the absence of a Ruling there is no legal basis for a taxation of costs to be exclusive of GST for disbursements but not for other items.

9 The GST came into effect on 1 July 2000. In summary, it is a broad based consumption tax introduced to tax private consumption expenditure. This is achieved by taxing all taxable supplies wherever they occur in the consumption chain and allowing input tax credits to registered entities which themselves produce or provide taxable and other supplies to ensure that the GST is ultimately paid by the end user.

10 Generally, an input tax credit is available to a registered business for any GST included in the price paid for goods and services used as part of their business. Many businesses will therefore be entitled to input tax credits for GST included in the fees of barristers and solicitors and process servers for work performed on their behalf in relation to the business. Effectively, in those circumstances, these businesses will not bear the GST component of the acquisition costs. Exceptions can arise, for example where the purchasing entity is not registered for GST, or in the case of an individual who is not in business. It was conceded on behalf of the defendants that they are registered and have the capacity to obtain input tax credits for GST paid.

11 The Commissioner for Taxation has outlined his interpretation in relation to court ordered costs in the Public Ruling. This is contained in paragraphs 145-155 of "Goods and Services Tax: G.S.T. consequences of Court orders and out-of-Court settlements" (GSTR 2001/4):

1. When a dispute is finalised, either by a court giving judgment or through negotiation of a settlement, the unsuccessful party in the action may be required to pay the costs or part of the costs that have been incurred by the successful party in bringing or defending the claim.

These costs, referred to as party party costs, could include, barrister's fees, solicitor's costs, fees for various expert reports and court costs.

1. In any legal action the parties concerned are required to pay their legal advisers the solicitor client costs incurred and the supply of these legal services will attract GST and be GST inclusive sums to the extent that they are not GST-free. Both parties to a dispute, as recipients of a supply of legal representation respectively, may be entitled to an input tax credit for a creditable or partly creditable acquisition of these services.
2. For the purposes of this Ruling, we are concerned with the subsequent stage when the successful party is able to recover costs wholly or partly through a court order for costs or by negotiation of an amount in a settlement.
3. As we have seen for a supply to be a taxable supply the conditions under section 9-5 of the GST Act must be met. In the instance of the payment of costs under the court order or settlement there is no supply for consideration from the successful party to the unsuccessful party. This is essentially paying compensation for costs or losses incurred in the dispute and will be treated in the same manner as damages under paragraphs 110 and 111.
4. Accordingly, the payment of court ordered costs or costs negotiated in a settlement in the circumstances described will not be consideration for an earlier or current supply. It does not matter that the payment of the costs order or settled amount is made by an entity other than the unsuccessful party. The costs order or settled amount should take account of any entitlement to an input tax credit of the parties to the original supply."

12 In summary, the view of the Commissioner is that where one party is required to pay the costs of another party, there is no supply to the first party and the amount paid is not consideration for the supply of legal services to that first party. In other words GST is not payable on the sum paid by one party to the other. This much seems clear. This interpretation is in line with the treatment of damages and with the fact that party/party costs are an extension of the damages principle. There has not been a supply for consideration.

13 The next (more difficult) issue is what happens to the GST component included in the fees charged to the winning party by its own lawyers; how is the input tax credit status of the party favoured by a party/party costs order to be regarded within the bill of costs served on the unsuccessful party; and how is that bill to be ultimately quantified by the Taxing Master. The last line of paragraph 149 of the Public Ruling is of some significance. It states "The costs order or settled amount should take account of any entitlement to an input tax credit of the parties to the original supply." What follows then at paragraphs 150 to 152 is an example of an unregistered entity (recited in Thornton v Apollo Nominees Pty Ltd and discussed below at paragraphs 27 to 29). At paragraphs 153 to 155 of the Public Ruling an example of a registered entity is recited. This example is particularly relevant to the facts at hand (recited below at paragraph 31).

14 The issue for determination is what treatment is given to any GST component by the Taxing Master in a taxation of costs in relation to a bill drawn on a party/party basis. Such a bill of costs is drawn on Scale in relation to work performed by the solicitor, and usually includes disbursements paid in the running of the litigation, for example counsel and process server fees.

15 The purpose of taxing a bill of costs on a party/party basis is to determine and allow "all costs necessary or proper for the attainment of justice or for enforcing or defending the rights of the party whose costs are being taxed" [see Order 63.29, Supreme Court (General Civil Procedure) Rules 2005 ("Supreme Court Rules")]. The taxed sum is a partial indemnity in relation to costs actually incurred by the successful party (see Russo v Russo (1953) VR 57). The order for costs indemnifies in respect of liability for professional fees necessarily and reasonably incurred (see Latoudis v Casey [1990] HCA 59; (1901) 170 CLR 534).

1. While it could be said that the GST component in any costs and disbursements may have been properly incurred, the issue for determination is whether the client who receives an input tax credit for the GST amount ought to receive a sum representing the GST component from a taxation of costs. In other words, has that party been effectively reimbursed via an input tax credit, and is adding the sum into a bill of costs in those circumstances open to challenge on the basis that it is no longer a "liability". Clearly, party/party costs are not intended to over-compensate a successful party or put them in a more favourable position than they would have otherwise been.

16 It is convenient to deal with costs and disbursements separately.

17 It is apparent that at the time of the introduction of the GST on 1 July 2000, a number of Court costs scales were increased to make allowance for the impact of the tax. It is stated in Quick "The Law of Costs" (see Volume 2 at paragraph [4.11]) "....all the State Supreme Court Scales have made provision for the GST as part of the scale claim." The same occurred with Federal Scales. The Supreme Court of Victoria Scale is usually adjusted annually on 1 January. In 2000 the scale was adjusted twice, first on 1 January 2000, and then again on 1 July 2000 when it was increased by around 9.5% to take into account the introduction of the GST.

18 It has long been accepted that the Taxing Master has a wide discretion to allow more than the Scale charge, however, there is no general discretion to allow less than the Scale items except in instances where there is an express power to do so (See Re: Fat-Sel Pty Limited and Brambles Holdings Limited [1985] FCA 176; (1985) 2 FCR 440 , Russo v Russo (1953) VLR at 63 and Re: Ermen (1903) 2 Ch. 156).

19 There are only a few exceptions in the Scale where the Taxing Master has a discretion to reduce the Scale item, however they are specifically described in the Scale and they are in limited circumstances. Two such examples are item 24 in relation to photocopying where ten or more copies of the same document are required or item 26 in relation to perusals in circumstances where the solicitor is or ought to be familiar with the contents. The Scale and Supreme Court Rules do not appear to provide anywhere for a discretion to reduce the Scale having regard to the impact of GST.

20 Other jurisdictions appear to offer greater latitude to the Taxing Master or their equivalent in relation to the treatment of GST in taxation of costs.

21 In England, where a similar tax regime applies under the Value Added Tax Act 1983, it is apparent that provisions have been made for the treatment of this tax in bills of costs. Paragraph 5.3 of the 'Practice Direction about Costs', which supplements parts 43-48 of the Civil Procedure Rules 1998, states that:-

V.A.T. should not be included in a claim for costs if the receiving party is able to recover the V.A.T. as input tax.

[Note: pro forma bills of costs displayed on the Department of Constitutional Affairs website in England provide for a third column under the heading "V.A.T." (in addition to the columns for costs and disbursements)].

22 In Ireland a similar provision is to be found in the Rules of the Superior Courts 1986. Order 99 Rule 1(6) headed 'Right to Costs' states:

An award of costs.......shall include any sum payable by the party in favour of whom such an award is made by way of value added tax on such costs, where and only where such party establishes that such sum is not otherwise recoverable.

23 The South African Supreme Court of Appeal case of Price Waterhouse Meyernel v. The Thoroughbred Breeders Association of South Africa (2003) (3) SA 54 is illustrative in relation to the treatment of V.A.T. in that country. In the judgment of Howie JA (a judgment with which Hefer AP, Vivier ADP, Harms & Conradie JJA concurred) at 61 (paragraph 18), it is stated:-

A costs order - it is trite to say - is intended to indemnify the winner (subject to the limitations of the party and party costs scale) to the extent that it is out of pocket as a result of pursuing the litigation to a successful conclusion. It follows that what the winner has to show - and the Taxing Master has to be satisfied about - is that the items in the bill are costs in the true sense, that is to say, expenses which actually leave the winner out of pocket.

24 Further, at 62 (paragraph 21), it is stated that:-

In short, any payment of input tax credit will inevitably be matched by a credit or refund. Consequently, if plaintiff is entitled to claim from the Revenue, as an input tax, the V.A.T. which it is required to pay to its attorney, it does not in respect of such input tax incur an out of pocket expense.

....It is not without interest and significance that in England V.A.T. may be included in a claim for costs but a specific Practice Direction decrees that it must not be included if the party entitled to costs is able to recover V.A.T. as input tax :see Halsbury's Laws of England 4th edition Reissue, vol 10, para 24.

26 The most pertinent Australian authority appears to be the decision of the Tasmanian Supreme Court in the case of Thornton v. Apollo Nominees Pty. Ltd. (2005) TASSC 38 ("Thornton"). Evans J touched upon the issue when he dealt with a review of the taxing officer. When dealing with two bills of costs made in favour of one party (appellant) against the other (respondent), each bill contained items in respect of GST payable in respect to both professional services provided and also disbursements incurred on behalf of the client. Upon the hearing of the taxation, the taxing officer refused to consider the GST component as he considered that as a matter of principle it was not allowable. In doing so, he relied upon the Public Ruling referred to at paragraph 11 above.

27 In his judgment Evans J quoted paragraphs 145 to 149 inclusive from the Public Ruling. The judgment also includes paragraphs 150 to 152 which outline an example in relation to an unregistered entity. This was no doubt apposite to the facts before him and presumably the appellant who was favoured by the order for costs was not registered for GST purposes. Significantly, Evans J did not quote paragraphs 153 and 154 which relate to a registered entity (quoted below in paragraph 31).

28 The Judge ultimately came to the view that the ruling was not of significance as the issue could be resolved by reference to the Act itself. He concluded that any liability for GST payable in respect of the provision of services by the solicitor to the client is also a cost or expense which was necessary or proper for the attainment of justice for maintaining or defending the rights of the party. Reference was made to Tasmanian Supreme Court Rules 2000, Rule 837(A) - mentioned at paragraph 38 below. His Honour then made reference to the terms of the Public Ruling and concludes that:-

The ruling is consistent with my conclusion that the G.S.T. liability of the appellant's solicitors that was passed on to the appellant and is the subject of the G.S.T. items in his Bill of Costs for taxation were properly claimed.

29 This passage appears to be relied upon by the defendants as justification for the position that the Taxing Master is not required or able to assess the impact (or option) of input tax credits upon the party favoured by the costs order. This issue does not appear to have been referred to or argued before Evans J and the case is distinguishable from the present matter for consideration before me.

30 Paragraphs 153 and 154 of the Public Ruling go on to provide an example of a registered entity:

153 "ABC Co, a registered transport company, sues for compensation for damages arising out of a breach of contract it has with a major retailer. Prior to any proceedings being issued a settlement is reached whereby the retailer agrees to pay the estimate of damages and a percentage of the costs incurred by ABC Co in bringing the action, for example, for the recovery of dishonoured cheque fees, costs of issuing a letter of demand, or court filing fees etc.

154 ABC Co is able to claim an input tax credit for the GST included in the fees charged by its legal representatives. The actual cost to ABC is a GST exclusive amount. Consequently the parties should take this into account when negotiating the amount that will be paid in respect of costs. "

31 The approach in this example appears to be consistent with the approach to costs outlined in Practice Direction 5.3 in England in relation to registered entities (see paragraph 22 above). The example in the Ruling is consistent with the view that cognizance must be taken of the impact of the capacity of the recipient to claim an input tax credit.

32 I regard the case of Thornton to be an authority for the proposition that as a matter of course GST can be included in a bill of costs and claimed on a party/party basis in a scenario where there is no capacity for the party favoured by the costs order to claim an input tax credit. The blanket exclusion of the GST component by the taxing officer was held to be inappropriate. The case however does not address how the individual circumstances of the recipient are viewed by the Taxing Master in circumstances where the recipient to the entitlement to costs has the option of an input tax credit.

33 In my view, the question of the impact of GST in relation to the costs items in the Scale is clear cut. Put simply, the Scale is the Scale and although it was adjusted at the relevant time to include a component for GST, it does not take into account the impact upon the individual in the sense that Scale items are not capable of reduction due to any entitlement that the recipient may have in relation to input tax credit unless the Scale or Rules outline a discretion or power to do so (see paragraph 19 above).

34 The issue of disbursements in relation to GST is different from costs, illogical as that may seem at first. Unlike Scale costs, disbursements are entirely discretionary. The written submission of the second defendant suggests that consistency ought to be maintained and that there is no legal basis to treat professional fees and disbursements differently in relation to GST. However there is no legal basis to treat them the same, as attractive as the consistency argument may seem. If the recipient is registered for GST purposes and is able to recover the GST component of any disbursement by way of an input tax credit, then to allow the GST component to remain as part of the disbursement would be to allow "double dipping". To ignore the practical effect of the costs order and the impact on the recipient in these circumstances, leaving it as a private matter between the entity and the Commissioner is too simplistic.

35 For example, a party favoured by a costs order pays counsel's fees of $11,000 inclusive of a GST component of say $1,000. An input tax credit will mean that the actual cost to the party is $10,000. This represents the 'out of pocket' figure and should be the starting point for the taxation. By claiming $11,000 in a party/party bill this party would be recovering more than they have incurred if the bill is taxed at any figure between $10,001 and $11,000. If, for example, the figure is taxed at $11,000, then the GST component of $1,000 is received in addition to an input tax credit for that sum. The party would then recover the equivalent of $12,000. A party/party taxation is to provide an indemnity or partial indemnity not a profit.

36 There is no doubt that if the party favoured by a costs order does not have the ability to claim an input tax credit, then the GST component in the disbursement should remain. For example, in an action for personal injuries, there ought to be no reduction of the amount referrable to GST from the disbursement. If however the litigation arises out of commercial dealings and the recipient is able to claim an input tax credit for the component then it ought to be deducted from the disbursement.

37 Tasmanian Supreme Court Rule 837(A) entitled "Goods and Services Tax" addresses the issue of disbursements as follows:-

The Bill of Costs for taxation may include as a disbursement an amount referrable to tax paid or to be paid under A New Tax System (Good and Services Tax) Act 1999 of the Commonwealth and the Taxing Officer is to make such allowance as is appropriate for the impact of the G.S.T. within the meaning of that Act on the Bill of Costs.

The main purpose of a rule such as this appears to be to enable the taxing officer to then take the next step and assess the impact of the Act on the entity favoured by a costs order.

38 The absence of an equivalent rule in Victoria is not significant. A disbursement has to represent an 'out of pocket' expense. The approach in that rule merely embodies the principle that a party ought not to obtain more on a party/party taxation than they are ultimately required to pay. Irrespective of the basis upon which it occurs, when dealing with a recovery or partial recovery of disbursements, it cannot be proper or reasonable for a successful party to claim an amount for disbursements that they will not ultimately have to bear.

39 Again, a simplistic view would be to say that a disbursement is "money which [the party] actually had to pay out to other people" (see Buckland v Watts ( 1970) 1 QB 27 at 37 cited in CGU Workers Compensation (Vic) Ltd v Rees 2003) VSCA 18 at par 14), the money paid to counsel therefore meets a liability and the impact of GST in the hands of the payee is a private matter. However, the Taxing Master has a responsibility, and a wide discretion in the assessment of disbursements, to determine what is 'necessary or proper' on a party/party taxation (see Order 63.29 of the Supreme Court Rules) or 'reasonable' in amount on solicitor and client basis (see Order 63.30 of the Supreme Court Rules).

40 Is it 'proper' to include and allow the GST component in a disbursement in a scenario where an input tax credit is claimable by the party concerned? In my view to allow the portion that represents the GST is not proper in those circumstances and it should not form part of the disbursement when such disbursement is being considered in a taxation of a party/party bill.

41 Accordingly, where the recipient of costs has an ability to claim an input tax credit, the GST component of non exempt disbursements ought to be deducted by the Taxing Master where the item includes GST, before consideration is given to the appropriateness or otherwise of the disbursement.

42 In a party/party taxation the costs items drawn on Scale cannot be adjusted having regard to the impact of GST on the recipient of the costs. However, in relation to disbursements claimed, it is appropriate to deduct any GST before assessing the quantum in circumstances where the recipient has the ability to claim an input tax credit in respect of the service provided.