GST implications for negotiated commercial settlements

10 March 2020

In light of the recent release of an Inland Revenue Issues Paper on a variety of GST matters, Directors and company executives should seek tax advice on the GST implications for any negotiated commercial settlements.

The “Issues Paper”, which is seeking feedback on certain proposed law changes, highlighted insurance payments received by a GST registered person and the requirement to return GST on those payments. Importantly, this can apply even where the person receiving the insurance payment is not party to the insurance contract.

For example, if two commercial parties are involved in litigation or a dispute, a negotiated settlement payment to be made by the defendant may in fact be made directly by that party’s insurer. As a result, the recipient may have a requirement to return GST on that payment even where the involvement of the insurer is not obvious.

A failure to contemplate the GST consequences of a settlement payment can have a material detrimental financial impact and should form part of the commercial negotiation. Particularly given that, in the absence of an insurer, settlement payments are generally not subject to GST on the basis they are merely compensatory and do not relate to a supply. The problem is that it may not be clear from the documentation and correspondence with a defending party that an insurer is even involved. It can therefore be a surprise if a party has successfully negotiated a settlement only later to discover that a significant amount needed to be paid to Inland Revenue.

This issue is often overlooked in practice and the “Issues Paper” notes that Inland Revenue has dealt with an increasing number of disputes in this area. It has proposed three possible options for addressing this issue.

  1. Shift the burden of paying the GST to the insurer. It is acknowledged this would increase compliance costs for insurers and necessitate the implementation of new systems.
  2. Require insurers to disclose to the recipient of the payment that it is being made by an insurer and that GST may apply.
  3. Leave the law as it stands but provide greater education and guidance in this area.

It is unlikely that any law change for this issue will apply before 2021. In the meantime, for any negotiated commercial settlements, it is prudent to ensure that tax advice has been sought on the GST implications. It may be appropriate to include a representation that a payment is being made by the defending party in their own capacity and not directly from an insurer. It may also be possible to direct the payment to a related non-GST registered party that is also a claimant in the dispute.

If you would like to know more about GST and the relevant tax considerations for your organisation, the Tax advisory team at Findex can tailor an approach based on your business needs.

The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex NZ Limited.