What is provisional tax? How’s it calculated? When is it paid? What happens if you don’t pay?
If these questions are currently occupying space in your head, don’t worry – we’re about to provide some answers.
A brief overview
Provisional tax breaks up the income tax you pay Inland Revenue (IRD) 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.
Options to calculate provisional tax
Four options are available to calculate your provisional tax.
The first, and default choice, is the standard uplift method. Under this method, the amount of provisional tax payable is your previous year’s RIT uplifted by 105 percent.
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 IRD interest on any difference between their actual RIT and what they estimated for the year.
The GST ratio method – available for monthly or two-monthly GST registered taxpayers whose prior year RIT was less than $150,000 – bases your provisional tax on a percentage of your taxable supplies.
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.
You can find out more about each method by downloading our free guide on provisional tax.
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.
After paying provisional tax
When you file your income tax return and calculate your RIT for the year, you deduct the provisional tax you paid earlier.
If you have paid more provisional tax than you actually owe, you will receive a refund from IRD.
However, if you have not paid enough provisional tax to cover the RIT for the year, you will have to pay terminal tax.
For most, this will be due on either 7 February (or 7 April if you have an accountant with an extension of time arrangement) the following year.
This shortfall may also incur IRD interest (currently seven percent).
Special IRD interest rules for standard uplift taxpayers
If your RIT for the year is less than $60,000 and you pay all required provisional tax instalments on time and in full using the standard uplift method , then you don’t have to worry about incurring IRD interest if the tax paid during the year isn’t enough to satisfy your actual RIT.
This is because you fall under what’s known as the safe harbour provision.
Any final balance to settle the actual liability will be due by your terminal tax date. IRD interest will only apply from your terminal tax date if you don’t pay this amount by then.
The rules work slightly differently if the actual RIT is $60,000 or more.
In that situation, providing you paid all other instalments on time and in full using the standard uplift method, you will incur IRD 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 my provisional tax on time?
In short, bad things.
As well as incurring IRD interest from the date payment was due, late payment penalties may 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 IRD-approved tax pooling provider such as Tax Management NZ (TMNZ) can provide payment flexibility if you wish to manage your cashflow.
It lets you pay provisional tax when it suits you – without facing IRD 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. However, it’s considerably cheaper than what IRD charges if you do not pay your tax on time.
You can also use TMNZ 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.