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.
Failure to contemplate the GST consequences of a settlement payment can have a 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 actually needed to be paid to Inland Revenue.
Inland Revenue has proposed three possible options for addressing this issue.
The first is to shift the burden of paying the GST to the insurer. It is acknowledged that this would increase compliance costs for insurers and necessitate the implementation of new systems.
The second option is to require insurers to disclose to the recipient of the payment that it is being made by an insurer and that GST may apply. The third suggestion is to simply leave the law as it stands but provide greater education and guidance in this area.
It is unlikely that any law change for this 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.
Greg Neill is a tax partner at Findex - Hawke's Bay and can be contacted at greg.neill@findex.co.nz
This information is general in nature and readers should seek specialist advice before making financial decisions.