Understanding provisional tax

What is provisional tax? How is it calculated? When is it paid? What happens if I don’t pay?

Here we provide you with answers to commonly asked questions about provisional tax. We also discuss the opportunities for getting more flexibility, as well as avoiding penalties and interest.

A brief overview

Provisional tax breaks up the income tax you pay Inland Revenue (IR) so that it is paid throughout the year as opposed to one giant sum at the end of the year. If you earn income where tax hasn’t been deducted before you receive it, you may have to pay provisional tax.

You’ll become a provisional taxpayer if your residual income tax (RIT) for the previous year was more than $5000. RIT is the amount of tax on the income for that year, minus any tax credits such as PAYE to which you are entitled.

Four options to calculate provisional tax:

1 The first, and default choice, is the standard uplift method. Under this method, the amount of provisional tax payable is based on your previous year’s RIT. 2 If you are expecting a significant drop in income, the estimation method allows you to pay provisional tax based on an estimate of your profitability for the year. A taxpayer using this option will be liable to pay or receive

IR interest on any difference between their actual RIT and what they estimated for the year. 3 The GST ratio method – available for monthly or twomonthly GST registered taxpayers whose prior year RIT was less than $150,000 – bases your provisional tax on a percentage of your taxable supplies. 4 Finally, the accounting income method (AIM) is available to those using approved accounting software with turnover of less than $5 million. Under this method, you pay provisional tax based on your accounting profit. No accounting profit for the period, no provisional tax payable for that period. Each option suits different businesses, so it pays to do your homework first. Special IR interest rules for standard uplift taxpayers

If your RIT for the year is less than $60,000 you will not be subject to UOMI until after your Terminal Tax date. However, if you have not paid on time and in full you may be subject to Late Payment Penalties (LPP) of 1% after one day, and a further 4% after five days. The penalties are cumulative, so the total penalty after five days is 5.04%.

Any final balance to settle the actual liability will be due by your terminal tax date. This will be either 7 February (or 7 April if you’re linked to an accountant with an extension of time arrangement) the following year. Interest will apply from your terminal tax date if this amount isn’t paid by then. The rules work slightly differently if the actual RIT is $60,000 or more.

In that situation, you will incur IR interest from the date of your final provisional tax instalment for that year if any remaining balance to satisfy your RIT is not paid by then.

What happens if I don’t pay on time?

As well as incurring IR interest from the date payment was due, late payment penalties will be charged as follows: • One percent the day after the payment was due. • An additional four percent if the tax amount (including late payment penalties) is not paid after seven days.

Pay provisional tax when it suits you

An IR-approved tax pooling provider such as Tax Management New Zealand (TMNZ) can provide payment flexibility if you wish to manage your cashflow. It lets you pay provisional tax when it suits you – without facing IR interest and late payment penalties. You can defer the entire payment to a future date of your choosing or pay what you owe in instalments.

There’s some interest payable, but it’s considerably cheaper than what IR charges if tax is not paid.

Tax pooling can also be used to wipe late payment penalties and reduce your interest cost if you have underpaid your provisional tax.

As always, we recommend you speak to your accountant if you have any questions.

Number of payments

Apart from the GST ratio method (six payments) and AIM (up to six or 12 payments depending on your GST filing frequency), provisional tax is generally paid three times a year. You will only make two payments if you pay GST every six months.

For example, if you have a 31 March balance date, your three provisional tax instalments are due on 28 August, 15 January, and 7 May. The payment dates will be 28 October and 7 May if you’re only liable for two instalments.

TMNZ is an NZCB National Partner and New Zealand’s leading tax pooling pioneer. Get in touch with TMNZ on 0800 829 888 or support@tmnz.co.nz if you have any questions about tax pooling.