When On, the adapter passes through the coordinates from the in-car GPS antenna. When Off, only the GPS of the phone is used. It can easily be tested by putting the phone in a place without satellite visibility.
GPS data may have an impact in cases where the wireless connection isn't stable. The additional data being sent over Wi-Fi can increase the lagging in GPS navigation apps I suppose. In such cases you can either disable GPS passthrough or try to reduce the video data rate.