If you own a business or are self-employed, you’ll likely pay tax in several instalments. This way of paying income tax is called provisional tax.
Thank you for reading this post, don't forget to subscribe!Provisional taxpayers often earn the following types of income:
• self-employed income
• rental income
• income earned as a contractor
• income from a partnership
• overseas income.
Provisional Tax is not a separate tax but a way of paying your income tax (in advance) as income is received through the year. You pay instalments of income tax during the year, based on what you expect your tax bill to be. The amount of provisional tax you pay is then deducted from your tax bill at the end of the year. Provisional tax helps you to “spread the load” to avoid a large end of year tax bill.
You must pay provisional tax if, at the end of the previous year, there is tax to pay of more than $2,500. We call this amount your “residual income tax” (RIT). Specifically, RIT is the amount of tax to pay on your taxable income, less any tax credits such as PAYE deducted or Resident Withholding Tax etc. Residual income tax is clearly labelled in the tax calculation in your tax return.
In the first year of business, no provisional tax is required to be paid because the RIT in the prior year is zero. However, what this does mean is that in the second year of business, effectively two years tax will be required to be paid. One year for the year you are currently in, and one year for the year just passed.
When Are Provisional Tax Payments Due?
All taxpayers usually pay provisional tax in three instalments, in August, January and May by using the standard or estimation option methods.
But taxpayers who file GST Returns on a six-monthly basis must pay in two instalments of provisional tax, due in October and May.
If you choose the ratio option method for provisional tax, you’ll pay in six instalments.
Recent Changes
The New Zealand Government has recently passed legislation to increase the provisional tax threshold from $2,500 to $5,000. This means any current provisional taxpayers with provisional tax payments of less than $5,000 will have until 7 February following the year to pay their tax bill. This is intended to lower compliance costs for small taxpayers and allow them to retain cash for longer. The Inland Revenue department expects that this will reduce the number of taxpayers paying provisional tax by around 95,000. This is a permanent change that will take effect from the 2020-2021 income year. For most taxpayers, this will mean from 1 April 2020.
Penalties and Interest
If the correct provisional tax payments are not made by the due date, an instant 1% late payment will apply and a further 4% will apply 7 days later. The levy of interest is known as ‘use of money interest” (UOMI). The interest is calculated on the difference between the actual RIT for the year and provisional tax paid for the year. You don’t have to pay any UOMI if you satisfy safe harbour provisions.
Provisional Tax Payment Management via Tax Intermediaries
UOMI and certain penalties can be reduced by the use of tax payment intermediaries authorised by the IRD. Such as Tax Management NZ (TMNZ) and Tax Traders. These intermediaries effectively sell overpayments of provisional tax to taxpayers who have underpaid, giving taxpayers the ability to deter tax payments for up to eleven months. There is a cost of this service, however the cost is usually less than the use of money interest that otherwise would be payable.
-Eshan Gupta, For more advice on the taxation of your investment property and other accounting and business services, please contact the expert team at Tax Professionals. First consultation is FREE. Contact the Tax Professionals team at: 09 213 7315 or online at www.taxprofessionals.co.nz