Date: 12th January 2016
As the saying goes, death and taxes are the only certainties in life. We’re not qualified to talk about the former, but we do have do have a thing or two to say about taxes, namely provisional tax. This is timely because many of you will have provisional tax to pay shortly on the 15th of January. So here are some basics.
Provisional tax is income tax paid in instalments throughout the year, instead of a lump sum at the end of the year or through PAYE. If you pay it, it’s typically because you had more than $2,500 of income tax to pay Inland Revenue at the end of the previous tax year.
Once you’ve filed your annual tax return, the IRD compares what you’ve paid with the amount you are required to pay, based on your actual profit for the year. You will either get a refund or be required to pay any difference.
Let’s take a look at some other important facts about provisional tax that you should know:
It’s hard to estimate your annual earnings when you’re starting out, but that doesn’t mean it’s tax-free. You’ll need to file an income tax return at the end of your first year and pay any residual income tax (RIT).
If your RIT is more than $2,500, you may have to pay provisional tax for your second year in business as well as any tax due for your first year. Your first provisional tax instalment is often due before the tax bill for your first year of business – so it’s a good idea to start budgeting for these payments and put some money aside.
The amount of provisional tax you pay is based on your expected profit for the year. It’s calculated from one of these methods:
Standard — the default option. Your last year’s tax to pay + 5% (or your tax to pay from two years ago plus 10%).
Estimation — you estimate what you think your tax bill will be for the year. This can be a good option if you expect your income to be lower than last year.
Ratio — worked out as a percentage ratio of your GST return. This can be a good option if your income fluctuates a lot.
The different methods suit different businesses, so it’s worth figuring out which is right for you. If you don’t specify a choice, you’ll be charged using the standard method. Speak to us about which method is right for you.
When and how often you pay provisional tax each year depends on the method you use to calculate your provisional tax, and if you’re registered for GST. Once you know when your payments are due, map these out for the year so you’re always prepared for the instalment due dates.
Note that if we do your annual returns, we’ll let you know when your payments are due.
An over or underpayment of income tax will attract interest, known as the use of money interest (UOMI) rate. UOMI aims to encourage you to pay the right amount of tax at the right time while also providing compensation to you if you pay too much tax, and to the Government if you pay too little.
Currently UOMI is 9.21% on underpayments of tax, and 2.63% per annum on overpayments.
Tax pooling allows approved tax intermediaries to match due tax refunds with taxpayers who have tax to pay. The tax intermediaries offer this service at better interest rates than the Government’s UOMI rates, offering significant savings.
Tax pooling also saves taxpayers who have underpaid from late payment penalties as the transfer to their IR account is at the original date of payment by the transferor.
More about managing cashflow with tax pooling.
If you need help with provisional tax, please contact us and we can discuss your options.
Read more about provisional tax at business.govt.nz