There are many benefits to working as a contractor — it can pay better than doing a similar salaried job and be more flexible. But there are some tax implications to think about, too.
Thank you for reading this post, don't forget to subscribe!Withholding tax rules are aimed to ensure tax is withheld from payments to companies and individuals who are primarily only supplying labour on a job, it can be a bit tricky to work out what rate to use and how it all works so we wrote a little explainer to help.
What is Withholding Tax?
Withholding Tax (WT) also known as tax on schedular payments, applies to freelancers or contractors for income earned from labour only contract work rather than salary or wages.
WT is deducted and paid by the company paying the contract, but the contractor still needs to file an income tax return declaring the income and any tax that has been paid or residual amount that is due. Some expenses can be claimed for against this income.
What industries does WT apply to?
Common industries where WT is compulsory includes labour only construction, IT and entertainment, there is a full schedule of industries available on the IRD website. If you contact via a labour hire company then WT is compulsory also.
How does it work?
Contractors need to elect and notify a tax rate for their WT – The standard rate is 20%. At the start of your employment, you will need to fill out an Inland Revenue’s IR330C form for contractors and work out how much tax to pay.
Note: a non-notified rate is 45%, so it pays to elect and notify a rate and have the use of your cash.
You can apply for an exemption to paying tax via WT, but this can be hard to get approved unless you have a good history of making tax payments (which doesn’t include PAYE).
What traps should you watch out for?
1. Electing a rate that is too low – Contractors need to be careful not to elect a rate that is too low (e.g., 10% minimum instead of 20%) if they are in fact a higher earner (Earning over $55K) as they will likely face a large tax bill at the end of the year. If their residual tax outcome for the year exceeds $5,000, they will fall into provisional tax.
2. GST calculations and accounting software – Care needs to be taken when applying GST to income that is subject to WT and generally requires a manual journal adjustment to be accurate.
3. Filing returns and other taxes – It is important to ensure you file a tax return at the end of the financial year.
Also be aware that as you are not paying PAYE as a contractor, you will need to factor in other costs such as your ACC earner’s levy. You will also need to work out and pay any student loan repayments or non-compulsory KiwiSaver contributions.
The bottom line is that you are responsible to ensure the correct rate is used and forms completed and returned.
– Eshan Gupta