When the unexpected happens — a fire, flood, or major equipment failure — insurance proceeds can provide some welcome relief. However, from a tax perspective, how that payment is treated isn’t always as simple as it first appears.
While many businesses instinctively classify insurance proceeds as taxable income, this is not always necessary. Applying the correct tax treatment can potentially reduce your tax liability.
If the insurance proceeds relate to a depreciable asset that’s been lost or destroyed, the key comparison is between the proceeds and the asset’s adjusted tax value (ATV). The ATV of an asset is calculated by subtracting any depreciation claimed from the asset’s original purchase price. It reflects the remaining value of an asset for tax purposes, which may differ from its market value. This value will affect if all or part of the insurance payment is taxable.
For damaged assets, where the insurer covers repairs, the proceeds should not be taxable, and no deduction is allowed for the repairs. However, if the proceeds received exceed the actual repair costs, the excess reduces the asset’s ATV. If this reduction results in a negative ATV, that negative amount becomes taxable income, to the extent of depreciation claimed.
As we know from natural disasters and significant events across New Zealand in the last few decades, the insurance process can stretch over a number of years. Consideration should be given to whether Inland Revenue has made any specific concessions (as observed with the Canterbury Earthquakes and Cyclone Gabrielle), timing of asset disposals, allocation of insurance proceeds and treatment of split payments.
Remember, not all insurance proceeds are taxable. Assess what the payment was for and how it aligns with the ATV to ensure the correct tax treatment.