Taxing issues with insurance claims
Tax Alert - March 2023
By Alex Robinson & Hana Straight
In the aftermath of a disaster, tax is the last thing anyone wants to be dealing with. Inland Revenue recognises this and has a range of tax relief measures for emergency events to ease the burden of filing and payments. This is great in the immediate aftermath of a disaster while everyone is transitioning from response to recovery. However, this only touches on the tip of the tax iceberg for businesses affected by significant adverse events, especially once an insurance claim is in the mix.
At a broad level, the tax principles for insurance receipts (or similar compensation) are relatively straightforward and should generally follow matching principles:
- Insurance for Business Interruption (aka lost profits) should be taxable in the period of interruption it relates to.
- Insurance for Material Damage or Increased Costs of Operations is taxable to the extent deductible costs/losses are incurred, or offset capital costs. If the insured asset has been destroyed, then the insurance becomes the disposal proceeds and may give rise to taxable depreciation recovery income (i.e. offsetting historic depreciation deductions) or capital gains.
- Insurance for Trading Stock is taxable on the assumption a deduction is taken for the damaged stock.
However, as we saw in the aftermath of the Canterbury Earthquakes when claims are broad-ranging and significant in size, and both the claim and recovery processes stretch over years, a number of issues can arise including:
- Which year(s) should insurance be allocated to if settlement takes time?
- What happens if I receive an advance or interim payment?
- What happens if I don’t spend all of the insurance?
- Can I still depreciate an affected asset, what about if access is restricted, and when do I record disposal of an insured asset?
- How do I handle allocations of insurance, historical cost, and book values when my tax fixed asset register of old properties was condensed or didn’t record separate buildings/PPE?
- How does this impact my deferred tax?
Insurers often prefer their settlement agreements to be “global” and generally only document against the two main types of policies: Business Interruption and Material Damage (the broader the settlement scope, the less likely additional claims can be made). Often a material damage settlement will only state “for loss and damages at XYZ Street”. However, as highlighted above, for tax purposes we need to consider more discrete matters – often down to individual assets and activities – and where insurers and claimants have negotiated settlement values, excluded certain items, or applied claim excess deductions, the tax process becomes even more complicated.
To get to the correct tax answers, ultimately, we have to look into claim documents and correspondence, including reports from loss adjustors, assessors and engineers.
Ok, so insurance claims may complicate my income tax, but what about GST?
If you’re a GST registered business, don’t spend your full insurance payment without thinking about the GST impact!
Most insurance payments, made to GST registered businesses/individuals for business risks that have been insured against are made on a GST inclusive basis. This means that 3/23rds of the insurance payment needs to be included in your GST return and paid to Inland Revenue. There are some exceptions to the rules so please confirm the relevant treatment for you with your tax advisor. Normally it does all work itself out in the end, as when the business uses the insurance payout to fund the purchase of replacement goods, the business will get to claim back the GST on those costs.
Various organisations, including central and local government, as well as private/public companies can make funding available in times of crisis to assist impacted businesses and individuals.
Often these are distributed following applications. You need to be aware that different applications may have different GST requirements. There are two aspects to this, the first is determining whether the grant will be treated as “GSTable” income with 3/23rds being included as income in your GST return and paid to Inland Revenue, and the second is what the application's requirements are regarding the application being made on a GST inclusive basis.
This is an area of confusion, even with larger taxpayers. Before April 2022, when the Government made grants to local councils, some councils failed to consider the GST impact and would commit support of the GST inclusive figure to the community. For example, if the Government announced that it was giving $100,000 to a mayoral relief fund it was in fact only giving $86,957 and expecting the council to pay GST of $13,043 to Inland Revenue. Post-April 2022, these grants are now made exclusive of GST and GST is added to the announced amount when the payment is made. Using the same example of $100,000 grant funding being announced, now $115,000 is given to the mayoral relief fund, with $15,000 being returned to Inland Revenue.
In order to determine the GST treatment you need to know:
- Who is distributing the funds?
- What they are being distributed for?
- Whether there are any special legislation/regulations that allow the payment to be exempt from GST.
Specific tax relief measures
All these tax issues are before even considering any specific tax relief measures that may be introduced for major disasters. We understand that Inland Revenue is currently considering whether the concessions introduced for the Canterbury Earthquakes may be appropriate for Cyclone Gabrielle. These measures included:
- Depreciation recovery income rollover relief – effectively allowing a taxable outcome for asset disposal to be deferred and applied against a replacement asset’s value instead, which helps taxpayers have more of their insurance funds available for recovery efforts and quality replacements, rather than paying tax.
- Uneconomic-to-repair situations – engineers are famous for saying anything can be achieved or repaired with sufficient time and money, which doesn’t help when trying to determine whether an asset has been “irreparably damaged” or a building “rendered useless” for disposal purposes. This concession created deemed disposals to trigger the asset disposal rules (with instant reacquisition of the dilapidated asset for $0).
- Optional timing rules – allowing insurance income and any related deductions for repairs or disposals to be deferred in their entirety until there is full clarity for costs and receipts.
These concessions were invaluable for taking monetary and tax compliance pressure off taxpayers. However, as you can imagine, each concession had its own requirements and potential fishhooks to be aware of (e.g. an uneconomic to repair building may become revenue account property going forward if there’s a purpose or intention to dispose of it at the time of the deemed disposal and reacquisition), not to mention deferred tax implications. The earthquake concessions were also drafted under urgency, so they were not necessarily as tidy as other parts of tax law, but with only a limited life to the concessions, there was little interest in revising for clarity. We’ll have to wait and see what happens in this space for Cyclone Gabrielle tax relief.
Inland Revenue concessions and assistance announced to date
The Inland Revenue have announced some initial tax relief and assistance for taxpayers impacted by both the flooding and Cyclone Gabrielle. They have an information pages for concessions and assistance which includes:
- Donated trading stock concession extended
- Removing penalties and interest charged on late filing or late payment
- Extension to the filing deadline for R&D Tax Credits
- Paying by instalments
- Financial hardship support
- Estimating provisional tax
- Income equalisation scheme
- Child support assistance
- Updating estimated income for Working for Families
- Tailored tax codes
March 2023 - Tax Alerts