If you're expecting to receive money from an insurer as part of a settlement, there's a magic trick Inland Revenue can pull on you without you ever seeing it coming. It does not matter if you're the one suing, the one negotiating, or the one expecting to bank the full settlement: If an insurer pays out money instead of the counterparty to the settlement, Inland Revenue can reach in and take a slice of it before it ever reaches your account. That's not because of anything anyone did wrong, but simply because of who wrote the cheque.
That's exactly what happened in the long-running Mainzeal litigation. Following the Supreme Court's 2023 ruling that four Mainzeal directors breached their duties, the directors' insurer paid the liquidators just under $20m. Inland Revenue said GST of $2.6m was payable on that sum. Mainzeal disagreed and went to the High Court to get its money back. It lost and ended up keeping only around $17.4m of the payment.
GST and settlements
Ordinary damages are not subject to GST. If you sue someone for breaching a contract, negligence, or breach of duty, and they pay you compensation, there is no taxable supply happening and no GST to worry about. However, where a genuine supply or additional supply is bundled into the settlement, GST can still apply to that part regardless of who pays it.
The twist: Who pays matters
Section 5(13) of the GST Act creates a separate, special rule that overrides the ordinary position, but only where an insurer is footing the bill. In Mainzeal's case, the liquidators had asserted a statutory charge over the insurance money, so the insurer paid Mainzeal directly, instead of paying the directors, who were the ones insured under the Policy.
Mainzeal argued this should not matter for GST purposes, on the basis that it had no contract with the insurer, and its claim for breach of director duties had nothing to do with the insurance policy at all. The High Court disagreed. What matters under section 5(13) is that the insurer paid pursuant to its obligations under the insurance policy, not whether the recipient has any contractual relationship with, or entitlement under, that policy. A payment made under a contract of insurance is caught even where the recipient is a third party with no connection to the contract whatsoever.
The moral of the story
This case does not change whether GST applies to insurance funded payments generally. Inland Revenue has held that position for years, though tellingly, the Court got to the same place under its own steam, having expressly put Inland Revenue's own guidance to one side and worked the answer out from the wording and history of the section itself.
What it nails down is the narrower (and in our view, sneakier) question of whether GST depends on who signs the cheque. It does. Pay the same damages award via an insurer's cheque rather than a cheque from the counterparty, and up to 15% of those damages can disappear into thin air, or rather, into the Crown Account. In addition, if you're the third party expecting the insurer's tax gross up clause to save you, do not count on it. Those clauses generally protect only the insured, not an outside claimant collecting under a statutory charge.
If you're negotiating a settlement backed by someone else's insurance, the mechanics of payment are not boilerplate. They can be worth real money. We recommend engaging tax advisors before you sign any settlement, not after. Reach out to our tax team if you have any settlements you would like to discuss.