Small provisional tax changes have big consequences

Small provisional tax changes have big consequences

Small provisional tax changes have big consequences 1200 630 Lee Stace
Image: Taxation (Kiwisaver, Student Loans, and Remedial Matters) Bill

A standard uplift taxpayer who files an estimate at any time will now be treated as using the estimation method for that entire tax year – meaning IRD interest will accrue from date of their first instalment if the provisional tax they have paid is not enough to satisfy their residual income tax (RIT) liability.

And IRD removing a taxpayer’s ability to choose the instalment date to which they apply a provisional tax payment will see taxpayers worse off as they will face compounding interest and late payment penalties.

Indeed, these are among the changes to provisional tax legislation after the Taxation (Kiwisaver, Student Loans, and Remedial Matters) Bill was enacted on 23 March.

Other key amendments include:

  • Clarifying the ‘lesser of’ calculation of interest for standard uplift taxpayers.
  • Clarifying the application of late payment penalties applicable from the final provisional tax instalment date.
  • Clarifying the way in which IRD truncates provisional tax to whole dollars.
  • Inclusion of a tolerance for provisional tax instalments.

General overview

The changes in the Bill simply align the legislation with what IRD is doing operationally. For the most part, they are taxpayer friendly.

For instance, the tolerance threshold will be welcome after some smaller taxpayers were losing the ability to use the safe harbour interest concession when underpaying an instalment by $1 (or, in some cases, less).

So too will the clarification around IRD applying the lesser of 105 and 110 percent uplift when determining the instalment amount due. Again, we covered this in an earlier blog post.

However, with the situation regarding COVID-19 dominating the world, there are two seemingly minor changes that were part of the Bill that may have gone unnoticed.

Although small, these will have big consequences for those who are not aware of them.

1. Eliminating the requirement to estimate provisional tax at the final instalment date

This amendment allows taxpayers to pay an amount lower than uplift at their final instalment (P3), without having to file an estimate.

It applies in situations where RIT for the year is going to be less than what was calculated using the standard method.

A new formula in sRC10 Income Tax Act 2007, which deals specifically with P3 for uplift taxpayers, removes the requirement of having to file an estimate.

On the face of it, this is a sensible move.

After all, very few taxpayers are filing estimates in cases where they are reducing their P3 payment.

Moreover, this requirement was only included after it was pointed out there was no legal way for anyone to pay less than standard uplift at P3 if RIT for the year was going to be lower.

The ramifications

However, anyone who was following the letter of the law and filing an estimate ahead of P3 needs to take notice of the implications of doing so from now on.

IRD says a taxpayer who switches to this method at any time during the year will no longer be able to use the interest concession rules in s120KBB Tax Administration Act 1994.

As such, they will fall under s120KB of the Act and be subject to IRD interest from the date of their first instalment if they have not paid enough provisional tax to satisfy their RIT for the year. 

The reason s120KBB of the Act no longer applies is because the definition of ‘interest concession provisional taxpayer’ found in subsection (4)(a) has been amended. In simplistic terms, an interest concession provisional taxpayer was previously defined as a person who:

(i) Uses the standard uplift method to calculate all their instalments; or

(ii) Uses the standard uplift method to calculate all their instalments except P3, which they estimate.

Subsection (4)(a)(ii) has been repealed as a result of the final instalment formula added to sRC10 Income Tax Act 2007.

This amendment applies from the 2020 tax year onward.

Key takeaway

Don’t switch from standard uplift to estimate. There’s no need to whatsoever.

2. Removing the ability for taxpayers to choose the provisional tax instalment to which they apply a payment

This amends s120L of the Act to prevent a taxpayer from allocating a provisional tax payment to an instalment of their choosing. IRD will now apply their payment(s) to the oldest overdue provisional tax first.

Prior to the interest concession rules for standard uplift taxpayers and the removal of the incremental one percent monthly late payment penalty, it was beneficial for taxpayers to apply payment to the oldest debt first.

However, since introducing these changes, IRD believes a taxpayer might now inappropriately apply the payment to more recent debt to avoid late payment penalties. In addition, their system configuration prevents them from allocating payments to a provisional tax instalment of a taxpayer’s choosing.

The ramifications

As a result, taxpayers who pay late may now be punished multiple times as they will be subject to further interest and late payment penalties at future instalment dates – rather than just facing interest and late payment penalties for the initial instalment they missed.

The example below illustrates this.

Example

A taxpayer forgets to pay their uplift instalment of $54,755 on 28 Aug 2018 (P1). They instead pay $109,510 (this being two-thirds of their uplifted RIT from the previous year) on 15 Jan 2019 (P2).  

On 7 May 2019 (P3), the taxpayer pays the uplift amount of $54,755 because they feel this will be the final balance to settle their liability for the year. They file their return on 31 March 2020, confirming the RIT for the year is $164,265.

Previously, if they asked IRD to apply the entire P2 payment to this date, the taxpayer would only be liable for the LPP for the missed P1 payment, plus 140 days of IRD interest*.

This works out to be:

LPP: $2759.65
Interest*: $1809.26

What happens now
However, with this amendment, IRD would allocate a portion of the $109,510 paid at P2 to the LPP and core tax owing at P1.

This means at P2 the taxpayer will have a shortfall of $2759.65. This equates to further LPP and interest at P2 of:

LPP: $139.08
Interest*: $72.93

As the $54,755 payment made at P3 is required to cover the LPP and core tax owing for P2, they will have a shortfall of $2898.72 at this date. Therefore, they will have further LPP and interest for P3 of:

LPP: $146.08
Interest*: $225.38 (as at 31 March 2020)

So, rather than only having LPP and interest at P1, the taxpayer is also now liable for this at P2 and P3.  

*IRD interest in this example is 8.22 percent for tax underpaid prior to 28 August 2019. The rate which applies from 29 August onward is 8.35 percent.

It’s important to note this amendment will apply retrospectively from the 2019 tax year onward.

However, for taxpayers who previously requested and obtained a payment direction, IRD says a savings provision will preserve this treatment so they are not retrospectively penalised.

Key takeaway

For those who miss or forget to pay an instalment, we recommend you use an IRD-approved tax pooling provider such as TMNZ to purchase the backdated tax you require at this date.

As the tax you are purchasing was paid on the date it was originally due, the taxman will treat it as if you paid on time once it processes this transaction, eliminating any interest and late payment penalties you are being charged.

TMNZ can reduce the interest cost by up to 30 percent.

Further information

We appreciate this was a lengthy read with a lot of information to absorb. Well done if you made it this far. Seriously.

Please don’t hesitate to contact us if you have any questions about the provisional tax changes in the Taxation (Kiwisaver, Student Loans, and Remedial Matters) Bill.

Lee Stace

Lee Stace is the PR and Content Manager at Tax Management NZ.

All posts by: Lee Stace

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