GST payable on insurance proceeds received by third party claimants
Inland Revenue has confirmed that a third party claimant who is GST-registered can be liable for GST where they receive a payment from an insurer in settlement of an insured person’s liability.1 This applies irrespective of the third party claimant not being party to the insurance contract, and can apply where the settlement payment is for damages or loss incurred that would otherwise not ordinarily attract GST.
Ordinarily there is no GST payable on a damages award, being compensatory in nature and with no reciprocity of supply. This is unless the damages are paid in respect of something that was itself a taxable supply, e.g. if a dispute is about non-payment for goods or services purchased. The act of settling a dispute is not, in and of itself, a taxable supply.
However, there has been some confusion about the GST treatment of a settlement payment that is funded by an insurance policy and paid directly by the insurer to the third party claimant. In its recent statement, Inland Revenue expressed its concern that some taxpayers are adopting the view that such settlement payments made directly to a third party claimant are not subject to GST.
Inland Revenue cites section 5(13) of the Goods and Services Tax Act 1985, which provides that “if a registered person receives a payment under a contract of insurance, whether or not the person is a party to the contract, the payment is, to the extent that it relates to a loss incurred in the course or furtherance of the registered person’s taxable activity, deemed to be consideration received for a supply of services performed by the registered person.”
This means that, even where a settlement is for compensatory damages, a third party claimant receiving an insurer-funded settlement payment is deemed to have made a taxable supply under section 5(13) and is liable for GST on the insurance proceeds. This is provided that the claimant is GST-registered and receives the payment in relation to a loss incurred in the course of its taxable activity, and the premiums under insurance contract were subject to GST (i.e. which is not usually the case where a non-resident is the insurer).
The following example illustrates how section 5(13) operates in practice:
- an insured person and an insurer have entered into a contract of insurance;
- a third party has agreed to settle a claim brought against the insured person in consideration for $1,000,000;
- the insurer pays the $1,000,000 agreed settlement amount directly to the third party claimant;
- the third party must pay GST of $130,435 on the sum received, and retains a net sum of only $869,565; and
- the insurer will be entitled to an input tax credit of $130,435.
Inland Revenue has advised taxpayers that, because there has been no change in the Commissioner’s practice, it will continue to apply this treatment in all cases, including retrospectively.
We agree that Inland Revenue’s position correctly states the intended effect of clause 5(13), and is consistent with the view that has broadly been adopted by GST experts. However, while Inland Revenue stresses that this reflects its long-standing position, in our experience the GST obligation imposed on third party claimants comes as a surprise to some and is difficult to apply.
In practice, a third party claimant will often not appreciate that it will be liable for GST on the insurance proceeds, or even be aware that the settlement payment will be funded by an insurer (thereby triggering a GST liability) and can risk leaving it undercompensated in settlement of its claim. This is especially harsh given that the claimant would also need to know whether GST was charged on the premiums under a contact of insurance to which it was not a party.
Inland Revenue’s statement reinforces that failing to address GST during settlement negotiations can mean that a claimant will be out of pocket, receiving less than what was expected.
Future impact of Inland Revenue’s GST issues paper
On 24 February, Inland Revenue released an issues paper seeking feedback on a wide range of GST-related policy matters, which included discussion on potential options for mitigating this GST issue.2
The first (and most disruptive) option proposed by Inland Revenue is to make insurers responsible for the GST obligations. This could be achieved through a reverse charge mechanism, or by denying the insurer’s input tax deductions for insurance payments to a GST-registered person (the latter would mean that section 5(13) of the GST Act would consequentially be repealed).
Two alternative options being considered are:
- requiring insurers to disclose in writing to the third party that the amount of their settlement payment is covered by insurance and may be subject to GST; and
- retaining the current rules but providing education and guidance for advisors and GST-registered businesses.
Inland Revenue is inviting submissions on the potential compliance costs and system impacts of these three policy options.
If you would like assistance in making a submission to Inland Revenue, please contact a MinterEllisonRuddWatts tax advisor.
- Commissioner’s Statement CS 20/01: GST liability for insurance and settlement payments to third party claimants (CS 20/01) (https://www.classic.ird.govt.nz/resources/b/d/bde20259-0272-4c5d-86ef-bc9d84bc1996/cs-20-01.pdf)
- 2. https://taxpolicy.ird.govt.nz/publications/2020-ip-gst-issues/overview