GST on Legal Settlements & Awards in NZ
Won a court case or settled a business dispute? This guide explains exactly when 15% GST applies to your payout, how to draft settlement agreements correctly, and the costly mistakes businesses make at the negotiation table.
In New Zealand, the GST treatment of legal settlements and court awards is one of the most misunderstood areas of tax law. Whether you receive a payout from a breach of contract claim, a Disputes Tribunal decision, or a private mediation, the tax treatment depends entirely on the underlying nature of the payment — not the label the parties put on it.
The core question the IRD asks is: does this payment replace something that would have been subject to GST in the normal course of business? If the answer is yes, the settlement payment is taxable. If the payment compensates for a purely personal or private loss (such as pain and suffering, defamation, or emotional distress), no GST applies.
This guide walks you through the key legislative provisions under the Goods and Services Tax Act 1985, real-world scenarios, drafting best practices, and the most common mistakes that cost NZ businesses thousands of dollars.
The “In Lieu of Income” Rule (Section 5(6D))
Under Section 5(6D) of the GST Act, a payment made as compensation, settlement, or damages is treated as consideration for a taxable supply if it replaces money that would have been taxable in the normal course of your business — such as a contract dispute over unpaid goods, compensation for lost trading profits, or reimbursement for damaged business stock. In these cases, the settlement payment is generally subject to 15% GST.
GST Classification of Settlement Types
The table below summarises how the IRD treats common categories of legal settlements and awards. The classification depends on the nature of the underlying dispute, not the wording of the agreement.
Common Settlement Scenarios Explained
Each scenario below mirrors a real NZ business situation. Understanding which category your dispute falls into determines your GST obligations.
Payouts for breach of contract, unpaid invoices, or lost business profits are usually GST-taxable to the receiver. The IRD treats the settlement as stepping into the shoes of the original taxable transaction. You must account for output tax on the full settlement amount (or the GST-exclusive portion if specified in the agreement).
If an insurance payout or legal settlement compensates you for a destroyed or damaged business asset (like a work vehicle, commercial equipment, or stock), you must account for GST under the “deemed supply” rules in Section 5(6D). The payout is treated as if you sold the asset at its pre-damage value.
Payments for personal injury, ACC lump sums, weekly compensation, or general “pain and suffering” damages are purely private in nature and are exempt from GST. This includes both court-ordered damages and negotiated out-of-court settlements for bodily harm.
Real-World Worked Examples
These examples show exactly how GST is calculated on typical NZ legal settlements. Every figure uses the official IRD 3/23 fraction method for extracting the tax component from a GST-inclusive amount.
Sarah’s plumbing company was owed $34,500 for completed work on a commercial fit-out. The client refused to pay, claiming defective workmanship. After mediation, they settled for $28,750, described as “full and final settlement of all claims.” The agreement was silent on GST.
GST portion: $28,750 × 3 ÷ 23 = $3,750.00
Pre-tax base: $28,750 − $3,750 = $25,000.00
Sarah must report $3,750 as output tax on her next GST return.
Mark’s workshop was damaged by a neighbouring tenant’s burst pipe. He received $11,500 in a legal settlement to replace his destroyed table saw and dust extraction system. Both items were business assets used 100% for his taxable activity.
GST portion: $11,500 × 3 ÷ 23 = $1,500.00
Pre-tax base: $11,500 − $1,500 = $10,000.00
Mark reports $1,500 output tax. He can then claim input tax on the replacement equipment he purchases.
Priya slipped on a wet floor in a commercial building and received a $45,000 out-of-court settlement for her broken wrist and six weeks of lost personal wages. The payment was explicitly for “pain and suffering and loss of personal income.”
GST portion: $0.00
The full $45,000 is Priya’s to keep (subject to income tax rules, which are separate).
Ben, a self-employed graphic designer, was rear-ended while driving his work vehicle. He received a $23,000 settlement: $8,050 for the vehicle repairs (business asset) and $14,950 for his whiplash injury and physiotherapy (personal). The agreement itemised both components separately.
GST on vehicle: $8,050 × 3 ÷ 23 = $1,050.00
GST on personal injury: $0.00
Ben reports $1,050 output tax. The remaining $14,950 is GST-free.
Drafting the Settlement Agreement
The biggest and most expensive mistake businesses make occurs at the negotiation table — not on the GST return.
If the agreement is completely silent on GST, the IRD and the courts will usually treat the payment as GST-inclusive. This means 13.04% of your settlement money (calculated as 3/23) instantly belongs to the tax department — money you thought was yours!
Example: You settle for $100,000, thinking it’s all yours. But because the agreement didn’t mention GST, $13,043.48 must be paid to the IRD as output tax. Your actual take-home is only $86,956.52.
Settlement Agreement GST Checklist
Before signing any settlement, ensure your agreement explicitly addresses each of the following points. Missing even one can create thousands of dollars in unexpected tax liability.
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State whether the amount is GST-inclusive or GST-exclusive. Use explicit wording such as “The settlement amount of $50,000 is exclusive of GST” or “The settlement amount of $57,500 is inclusive of GST.”
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Itemise the components. If the settlement covers both business losses and personal claims, break them out separately. This prevents the IRD from treating the entire amount as taxable.
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Confirm the GST registration status of both parties. If neither party is GST-registered, no GST applies to the settlement regardless of its nature.
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Include a tax invoice clause. Specify which party will issue a tax invoice showing the GST component, and within what timeframe. This ensures the paying party can claim their input tax credit.
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Add a “Plus GST (if any)” catch-all clause. This protects the paying party in case the IRD later reclassifies the payment as taxable. It allows recovery of the GST from the other party.
Liquidated Damages: The Important Exception
Liquidated damages are pre-agreed penalty clauses written into a contract — for example, a construction contract that specifies “$500 per day of delay beyond the completion date.” The IRD generally treats these payments as penalties, not as consideration for a supply of goods or services.
Because no supply is being made in exchange for the payment, liquidated damages are typically not subject to GST. However, there is an important exception that catches many businesses off guard.
If the “liquidated damages” payment is actually disguised consideration for early termination of a contract (i.e., a cancellation fee that releases the other party from their obligation), the IRD may reclassify it as consideration for a supply of “forbearance” — and levy 15% GST. The substance of the payment matters more than the label.
Ask: “Is one party receiving something of value in exchange for this payment?” If the answer is yes (e.g., release from a contractual obligation, consent to terminate early), GST likely applies. If the payment is simply a penalty for poor performance with no corresponding benefit to the payer, it is likely GST-free.
How to Account for GST on a Settlement
If you’ve determined that your settlement is subject to GST, here is the step-by-step process for correctly reporting it to the IRD.
If the settlement is GST-inclusive, extract the tax using the 3/23 fraction: multiply the total by 3, then divide by 23. For example, a $57,500 inclusive settlement contains $7,500 GST and a $50,000 pre-tax base.
The party receiving the settlement (if GST-registered) should issue a tax invoice to the payer showing the GST component. This allows the payer to claim an input tax credit. If no invoice is practicable, document the GST calculation in your records.
Invoice basis: Report the GST in the period when the settlement agreement is signed (i.e., when the legal obligation to pay arises). Payments basis: Report the GST in the period when you actually receive the settlement funds.
Your lawyer’s fees for handling the dispute are a business expense. You can claim the GST on those fees as an input tax credit — regardless of whether you won, lost, or settled. Ensure you have a valid tax invoice from your solicitor.
Claiming Input Tax Credits on Legal Fees
One frequently overlooked benefit is that you can claim the GST component of your legal costs as an input tax credit, even if you lose the case entirely. The key test is whether the legal fees were incurred in connection with your taxable activity.
- Enforcing payment of a business debt
- Defending a breach of contract claim
- Employment disputes (employer side)
- Commercial property disputes
- Intellectual property enforcement
- GST or tax dispute with the IRD
- Personal injury claims (your own injury)
- Family Court proceedings
- Criminal defence (personal charges)
- Private property disputes (non-business)
- Wills and estate planning
- Personal immigration matters
Mixed Settlements: When One Payout Covers Both Business and Personal
Many legal disputes involve claims that are partly business and partly personal. When a single settlement covers both, the GST treatment must be apportioned based on the nature of each component.
This is why itemising your settlement agreement is critical. If you receive a lump sum with no breakdown, the IRD may argue that the entire amount relates to the taxable activity — particularly if the dispute originated from a business relationship.
Always negotiate separate line items in the settlement deed. For example: “$25,000 for lost business revenue (plus GST if any)” and “$15,000 for personal injury (no GST).” This clear delineation protects both parties and prevents the IRD from applying GST to the personal component.
Frequently Asked Questions
If the award is related to your business activity and replaces lost taxable income (e.g., lost revenue, unpaid invoices, or destroyed business assets), yes, you must account for 15% GST under Section 5(6D) of the GST Act. If it is compensation for a purely private matter like personal injury, pain and suffering, or defamation of personal character, no GST applies.
Yes, if the legal fees are incurred for your business or taxable activity, you can claim the GST portion as an input tax credit on your return. This applies regardless of whether you win, lose, or settle the case out of court. You need a valid tax invoice from your lawyer. The outcome of the dispute does not affect your right to claim the input credit.
Generally, no. Payments made strictly as “liquidated damages” (pre-agreed penalty clauses in a contract for things like construction delays) are typically not subject to GST because they do not constitute consideration for a supply of goods or services. However, if the payment is actually a disguised “cancellation fee” that releases a party from their contractual obligations, the IRD may reclassify it as taxable.
If the agreement does not specify whether the settlement amount is GST-inclusive or GST-exclusive, the IRD and the courts will generally treat the entire payment as GST-inclusive. This means the receiver must extract and remit the GST component (3/23 of the total ≈ 13.04%) from their settlement. For a $100,000 settlement, that’s $13,043 going straight to the IRD.
Yes, if the loss of goodwill relates to a taxable activity. Goodwill is an intangible asset directly connected to business operations, so a payment compensating for its destruction or diminishment replaces what would have been a taxable supply. The full settlement amount (or its business-related portion) is subject to 15% GST.
Yes, if you are the GST-registered party receiving a taxable settlement, you should issue a tax invoice to the paying party showing the GST component. This allows them to claim an input tax credit. Include the settlement deed reference number, the GST amount, both parties’ GST numbers, and the date. If issuing an invoice is impractical, keep detailed records of the GST calculation.
Your GST accounting basis determines the timing. On the payments basis, account for GST on each instalment as it is received. On the invoice basis, account for the full GST liability in the return period when the settlement agreement is executed, regardless of when instalments are actually paid. If you’re unsure which basis you’re on, check your GST registration in myIR.
No. ACC (Accident Compensation Corporation) payouts — including lump sum independence allowances, weekly compensation, and rehabilitation payments — are not subject to GST. These are statutory entitlements under the Accident Compensation Act 2001 and are not consideration for a supply of goods or services.
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