GST on Legal Settlements and Awards in NZ

In New Zealand, the GST treatment of legal settlements and court awards turns on substance, not the label on the deed. Inland Revenue asks whether the payment is consideration for a taxable supply under the Goods and Services Tax Act 1985, as explained in Interpretation Statement IS 23/07 (issued 10 July 2023).

Compensation for loss is generally not subject to GST. A payment that replaces or varies consideration for an earlier taxable supply, or that buys contractual rights, forbearance, or an agreed early exit, usually is. Purely private payments for personal injury, pain and suffering, or personal defamation sit outside GST.

This guide walks through IS 23/07, section 5(13) insurance payouts, employment settlements, drafting traps, and the maths on typical NZ payouts. Relationship property sits in the separate family court settlements guide. The Act itself is on legislation.govt.nz.

The Inland Revenue Test: Is It Consideration for a Supply?

Under IS 23/07, a court award or out of court settlement attracts GST only where it is consideration for a taxable supply. That can be a new supply (for example transfer of property, an agreed termination of rights, or priced forbearance) or a change to an earlier taxable supply (for example settling unpaid invoices for taxable work). Pure compensation for loss is generally GST free. Insurance payouts are a special case under section 5(13) of the GST Act 1985: where they apply, you return 15% GST even though no supply actually happened.

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.

Insurance Payouts: The Section 5(13) Rule That Overrides the Normal Test

If your insurer pays you for a business loss, section 5(13) of the GST Act deems that payment to be consideration for a taxable supply. You must return GST on it even though no supply actually happened and even though pure compensation for loss would normally be GST free.

The rule applies where a GST registered person receives a payment under a contract of insurance and the payment relates to a loss suffered in the course of their taxable activity. No actual supply is needed and no connection between the payment and a supply has to be shown. This is the one place where Inland Revenue's normal position that compensation for loss is not consideration does not protect you. The Commissioner's full position is set out in Interpretation Statement IS 23/07, issued 10 July 2023.

It also catches payments the insurer makes directly to a third party. If someone else's insurer pays you for damage they caused, you are the recipient and you return the GST, whether or not you are a party to their insurance contract. Where the money passes through a solicitor's trust account, the client is treated as receiving it, so the GST obligation sits with the client, not the solicitor.

There are carve outs. Section 5(13) does not apply where the insurance contract itself was not subject to New Zealand GST (for example, the insurer is not resident in New Zealand and has not elected New Zealand treatment), nor to payments for loss of earnings as defined in the accident compensation legislation.

Restitution, Compulsory Acquisition, and Continuing Wrongs

A court award based on restitution, which strips a defendant of a gain taken without justification, is not consideration for a supply and carries no GST. A compulsory acquisition of land is the opposite: ownership legally transfers, so there is a supply and GST can apply.

In restitution the payment is made because it is not practicable to return the thing taken and it would be unconscionable to let the defendant keep the benefit. No reciprocity exists between the payment and any supply, so Inland Revenue treats the award as GST free. In Case S77, a GST registered farming couple paid an out of court settlement after a fire they lit spread to a neighbouring farm. The Taxation Review Authority held the payment was made on account of the neighbour's loss, involved no supply to the couple, and so gave them no input tax credit.

Compulsory acquisition is different because the land is legally transferred to the acquiring authority. That transfer is a supply, and the compensation can be consideration for it. Damages awarded for a continuing wrong sit with restitution: where the High Court awards damages instead of an injunction under section 13 of the Senior Courts Act 2016 (for example, for a sewer pipe laid across private land without permission), the property rights are not supplied merely because the court refused to stop the infringement, so the damages are not consideration.

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.

Set Off: Netting the Payments Does Not Change the GST

When a court award is set off against an amount you owe the other party, the set off is only a payment mechanism. The GST on each underlying obligation stays exactly as it was.

Inland Revenue's example makes the point cleanly. An ice cream seller buys a $100,000 truck, pays $75,000 up front, and wins a $30,000 court award when the faulty freezer ruins an order. The parties set the $30,000 award off against the $25,000 balance still owed on the truck, so only $5,000 cash changes hands. For GST purposes nothing netted out: the seller's output tax and the buyer's input tax credit are still calculated on the full $100,000 consideration for the truck, and the $30,000 award, being compensation for loss, has no GST consequences of its own.

Drafting the Settlement Agreement

The biggest and most expensive mistake businesses make occurs at the negotiation table, not on the GST return.

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.

Forbearance to Sue: When Promising Not to Sue Becomes a Taxable Supply

Inland Revenue accepts that the standard not to sue clause in a settlement is usually just finality paperwork with no GST consequences. But the moment the agreement puts a separate price on the promise not to sue, that portion becomes a taxable supply of services.

A forbearance to sue is capable of being a supply because the definition of services is wide enough to cover giving up a legal right. In the usual case the settlement sum is paid for the underlying loss, not for the forbearance, so none of it is attributed to the promise and no GST arises. Inland Revenue will look harder where the agreement itself attributes part of the payment to the forbearance, where the payment cannot be explained by the underlying loss, or where the payer is plainly buying silence because of reputational risk or the strength of the claim.

Example drawn from Inland Revenue's own guidance: an adviser settles a negligence claim for $15,000, with $10,000 described as compensation for the client's loss and $5,000 described as consideration for agreeing not to take the claim to court. The $10,000 has no GST consequences. The $5,000 is consideration for a taxable supply of forbearance (this assumes the client is GST registered and the forbearance is supplied in the course of their taxable activity), so the client returns output tax of $5,000 minus ($5,000 ÷ 1.15) = $652.17, and the adviser claims a matching input tax credit.

Termination and Cancellation Fees: Agreed Exits Attract GST, Walkouts Do Not

A payment to end a contract by mutual agreement is consideration for the supply of contractual rights and carries 15% GST. A payment extracted after the other party simply walked out is compensation for loss and carries none.

Where one party terminates without any right to do so and without the other's agreement, there is no supply of rights because the innocent party never agreed to give anything up. The settlement compensates their loss, so no GST applies. Where instead the parties agree to vary or end the contract in exchange for a payment, the party giving up its contractual rights makes a supply of those rights, and the payment is consideration for it.

Worked example: an Auckland software company pays $23,000 to exit a three year support contract two years early, with the supplier's written agreement. Because the supplier agreed to release its rights under the contract in exchange for the payment, this is a taxable supply. GST: $23,000 × 3 ÷ 23 = $3,000.00 output tax for the supplier, and a $3,000 input tax credit for the software company on a valid tax invoice.

This is the same boundary the liquidated damages section above draws. A genuine penalty agreed in advance for delay or poor performance is not consideration. A “cancellation fee” that buys your release from the contract is.

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.

Already Returned GST on the Original Invoice? Do Not Pay It Twice

If you account for GST on the invoice basis and already returned output tax when you issued the invoice, receiving the settlement later creates no new GST liability.

This is the point most businesses miss in the worked examples above. Sarah the plumber invoiced $34,500 including GST and, on the invoice basis, returned $4,500 of output tax ($34,500 × 3 ÷ 23) in the period she issued the invoice. When the $28,750 settlement arrives, she returns nothing further on receipt. The GST was already accounted for; the settlement is just the disputed debt finally being paid.

The mirror image applies on the payments basis. If Sarah had accounted on the payments basis, the GST liability would arise only when the settlement money actually landed in her account.

For the payer, the same timing logic decides when the input tax credit can be claimed. A payments basis payer claims it in the period the settlement is actually paid. An invoice basis payer who held off claiming because the amount was genuinely in dispute is not stuck: the law allows the deduction in a later period, within two years of the earlier of the invoice issue date and the payment date, and with no time limit at all where the failure to claim was caused by the dispute itself, by missing invoice information, by a mistaken belief the supply was not taxable, or by a clear oversight.

When a Court Award Changes the Price: GST Adjustments Under Section 25

When a court order reduces the price you already charged, section 25 of the GST Act treats the original invoice as inaccurate and requires both sides to adjust their GST returns in the period the order is made.

The classic case is an order under section 43(3)(c) of the Fair Trading Act 1986 varying a contract by reducing the price, for example where goods were misrepresented. The supplier claims an input tax deduction for the GST now overpaid, and the recipient returns output tax for the input credit now excessive. The supplier should issue supply correction information (the document formerly called a credit note), but the recipient must not wait for it: the adjustment belongs in the return for the period in which the parties learned of the court order.

Example from Inland Revenue guidance: a restaurant owner buys a pizza oven for $3,000 including GST ($391.30 GST). The court finds the oven was misrepresented and orders a $2,000 partial refund of the price. The GST on the supply is now only $130.43, so each side adjusts $260.87: the retailer claims a $260.87 input tax deduction and the restaurant owner returns $260.87 of output tax, both in the period the order was made.

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.

Do not confuse that input credit with GST on a costs award. Under IS 26/11 (issued 22 May 2026, finalising PUB00516), court awarded costs and disbursements are usually not consideration for a supply, so the successful party does not return GST on the award and the unsuccessful party cannot claim input tax on paying it.

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.

Employment Settlements: Why GST Usually Does Not Apply

Most employment settlements carry no GST. Wages and salaries sit outside the GST system, so when a settlement pays back wages, holiday pay or redundancy, the tax question is PAYE, not GST.

IRD factsheet IR1047 treats lump sum payments to employees as extra pay. Back pay, back paid holiday pay and redundancy payments all go through PAYE, with the employer deducting tax before the money reaches the employee. Because the payment is employment income and not consideration for a supply, no GST applies, even if the employer is GST registered.

Compensation for hurt and humiliation is different again. Under section 123(1)(c)(i) of the Employment Relations Act 2000, payments that are genuinely and entirely for hurt and humiliation are capital receipts, not taxable income (IRD public ruling BR Pub 06/05). With no income and no supply, there is no GST either. In TDS 23/01 (issued 22 February 2023), the taxpayer argued with medical evidence and a genuine personal grievance that payments labelled salary and wages in the record of settlement were really hurt and humiliation compensation. Inland Revenue disagreed: it held the record of settlement was the correct starting point and treated the payments as taxable employment income. The lesson for drafting is to describe each component for what it truly is, because Inland Revenue starts from the settlement document.

One part of an employment settlement can attract GST: the employee's legal or advocacy costs. Where the employer agrees, as a separate settlement term, to pay the employee's advocate directly on a proper GST invoice, one practitioner's advised position is that this is a separate taxable supply of legal services, with the employer claiming the GST as an input tax credit for a real saving compared with rolling the costs into the employee's lump sum. That position is not settled law: it is contested, and in one 2023 Employment Relations Authority decision, Armstrong v MTS Energy, the Authority went the other way. The input tax credit position has not been confirmed by Inland Revenue. The arrangement must sit lawfully alongside section 150A of the Employment Relations Act 2000: the costs payment is a distinct term of the settlement, the employee agrees to it, and the advocate's GST invoice is addressed to the employer (Anderson Law on section 150A settlements).

Practical note: employees are rarely GST registered. If the person receiving the settlement is not registered for GST, no GST can apply to the payment in any case, and the PAYE and hurt and humiliation analysis above is what matters. For wage side maths, use the PAYE tax calculator.

Frequently Asked Questions