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My brief overseas experience in Great Britain has taught me that British people tend to pronounce Ibiza as Ibitha. My questions are as follows:
Why is this the case?
How did this develop?
What are the circumstances that determine if a z is pronounced like a z or a th?
Because Spanish people pronounce 'Z' as 'th' and the British are famous throughout Europe for their insistence on punctilious observation of foreign language and customs.
ts dz sounds, just as they were populating south America. So south American Spanish ended up with a slightly different 'c' and 'z' than Spanish-Spanish
/θ/. Also, both Catalan and northern and central Spanish (and from the Andes) realizes /s/ apically as [s̺] not laminarly as [s̻], which confuses the untrained anglophone’s ear into making the wrong phonemic assignments.
I understood the question to be about British usage, not general Spanish pronunciation... so here's my crack at it.
1) and 2) As @mgb pointed out, the British are rather notorious for pronouncing foreign words in their own way, and the rest of the world be damned. Even on the BBC World Service, which is produced for foreign consumption, you will regularly hear heinous offenses committed against the Spanish, French, Italian, German, and Russian languages. (Probably most others, too, but those are the only ones where I can tell the difference.)
Ibiza is a singular exception. I believe that the reason is that it's a very popular British holiday destination; Britons on holiday (possibly drunk, and therefore in an unusually receptive condition?) hear the local pronunciation and mimic it. Compare with Zaragoza, which I have never heard a Briton pronounce as "Tharagotha".
3) As far as I'm aware, "Ibiza" is the only example where speakers of (BBC-standard) British English regularly pronounce "Z" as "th". When "z" appears in an English word, it is pronounced as the "z" in "zip"; when it appears in a Spanish word, it's generally pronounced as "s" (occasionally as "th", depending on the region and the reporter); when it appears in a German or Italian word, it's pronounced as "ts" - most of the time. Sometimes they pronounce it as "z" there too, and it makes me want to scream.
This answer obviously contains far too much opinion and should have been posted as a comment, but it ran too long.
It is probably in emulation of Northern/Central Spanish that the British pronunciation is as such (though, tellingly, the initial 'I' is pronounced as the diphthong /aɪ/), as indeed the OED claims in its entry:
In British English, the name is usually pronounced in an approximation of the Spanish.
Ibiza wasn't always known as such in English. In the 18th and 19th centuries the island was known to the British, and especially to the Royal Navy, as Ivica (from the older Spanish orthography Iviça):
Looking at Google Ngrams for the three toponyms, we see that Iviza became the more popular name during the end of the 19th century, and Ibiza overtaking the older words in the 1930s-40s:
This adoption of the current Spanish orthography was possibly accompanied by the 'Spanish' pronunciation, the word only relatively recently gaining popularity.
The toponym has gone through a number of modifications both before (as different peoples had control or influence on the island) and after entering the English and Spanish lexicons:
Note, the native language of Ibiza is Catalan, not Spanish, and in Catalan the island is called Eivissa.
With the diphthonged initial 'I' and the distinción pronunciation of 'z', the British pronunciation of the word ends up sounding like a hybrid of the Catalan and Spanish words:
[əjˈvisə] [əjˈβi.sə][iˈβiθa] (Northern/Central Spain)/aɪˈbiːθə//ɪˈbiːzə/ /iːˈbiːsə/'Z' is, to my knowledge, not pronounced as /θ/ in any other word in English.
However, the attempt to evoke the native pronunciation of a loanword happens occasionally in other toponyms. The word Weimar, for example, entered the English lexicon around the same time as Iviza/Ibiza, and it is commonly pronounced in British English as /ˈvaɪmɑːɹ/, emulating the German pronunciation of 'w'.
