Paying provisional tax – do you want it to be easier?
Kiwi business owners are all too familiar with the concept of provisional tax, and for many, paying it can be a bit of a chore.
One of the biggest issues people face is the IR’s inflexibility. Inland Revenue (IR) sets the dates you have to pay, and you’ve got no choice but to follow their lead.
No consideration is given to the time of year, business cashflow, or seasonal circumstances. After all, no one wants to pay a big lump sum when cashflow is tight.
The IR model doesn’t consider whether businesses are light on cash, have an urgent need for money, or a better use for their funds. You simply have to pay up or face the penalties — with IR interest on top of late payment fees.
But there’s one thing you should know about paying provisional tax. There is a better, easier way: tax pooling.
Tax pooling gives you more choice over your tax and lets you make payments on your terms without incurring the IR’s wrath.
The option has been available to New Zealand provisional taxpayers for more than two decades.
Since 2003, thousands of businesses have been paying provisional tax through tax pooling providers like TMNZ. We let you pay what you owe at a time that suits you.
The best part? Tax pools are IR-approved.
So, how does a tax pool work for paying provisional tax?
A tax pool is all about balance. Some businesses in our pool may end up overpaying their liability. These overpayments help other businesses in the pool that need more time to pay. A collective approach.
Users of our tax pool do have to pay some interest, but it’s charged at a much lower rate than the IR’s interest or the rates you’d pay for taking out an overdraft with the bank. There are also no late payment penalties to think about.
All you have to do is tell us the tax amount due and when and how you’d like to pay. We’ll take care of the rest and notify the IR.
Why haven’t I heard about this before?
While tax pooling isn’t common knowledge among small businesses, it is considered best practice among many accountants and tax advisers.
How can I start paying provisional tax with tax pooling?
Discuss tax pooling with your accountant (or with one of our Premium TMNZ Accounting Partners) ahead of your next provisional tax instalment or if you’ve struggled to match business cashflow with your past payments.
Ask your adviser to download this free guide that provides simple information on how tax pooling works.
Want to learn more about tax pooling?
Get in touch, or book a tax pooling overview with one of our experts.
Provisional tax 101 — making things easy
Provisional tax breaks up the income tax you pay Inland Revenue (IR). It is paid in multiple instalments instead of one large sum at the end of the year.
You may have to pay provisional tax if you earn income where tax hasn't been deducted before you receive it. When your residual income tax (RIT) for the previous year was more than $5000, you will have provisional tax to pay. Residual income tax is the amount of unpaid income tax for the year minus any tax credits such as PAYE that you are entitled to.
Generally, you will pay provisional tax three times a year. For example, if you have a 31 March balance date (your end of financial year). In that case, your three provisional tax instalments are usually due on 28 August, 15 January, and 7 May.
These dates can change by a few days to avoid public holidays and weekends. They can also differ according to how you have calculated your RIT, so it's best to check in with your accountant or myIR to confirm your payment dates.
What if you miss your provisional tax payment?
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 owe, you will receive a refund from IR.
However, suppose you have underpaid your income tax for the year. In that case, you must pay the remaining balance or risk late payment penalties (LPP) and interest accruing on what you owe. IR interest is calculated daily on any outstanding amount that you owe. You can check the current interest rate here.
Don’t worry though, TMNZ can help. Read about our flexible ways of paying tax below.
Late payment penalties and interest
Penalties and interest on missed or underpaid tax may be charged as follows:
- one percent the day after the payment was due.
- an additional four percent if the tax amount (including LPP and accrued UOMI) remains unpaid after seven days.
- UOMI may be charged from the day after the payment was due - UOMI will be charged daily until you have paid your total tax amount, including late payment penalties and any accrued interest.
Special IR interest rules under the Safe Harbour Provision
If you have used the standard uplift method to calculate your provisional tax:
- and your RIT for the year is less than $60,000
- and you pay all required provisional tax instalments on time and in full
Then you don't have to worry about incurring IR interest if the tax you have paid during the year is less than your actual RIT total. This is because you fall under what's known as the Safe Harbour Provision. Any final balance to settle your tax bill will be due by your terminal tax date. IR interest will only apply from your terminal tax date if you don't pay your balance by then.
The rules work slightly differently if the actual RIT is $60,000 or more.
In that situation, if you have paid all your instalments on time and in full, you will incur IR interest on the remaining balance until you have paid in full. IR interest is calculated from your final instalment date for that year.
Flexible ways to pay your provisional tax
With an IR-approved tax pooling provider, like TMNZ, you can smooth out your tax payments up to 75 days after your terminal tax date, so you have up to 22 months longer to pay your tax bill.
With TMNZ Flexitax, you can smooth out your payments to match your business cashflow. There is no up-front payment, and as long as you settle your arrangement by the date TMNZ provides, your IR account will show as paid on time. Meaning you'll never have to worry about LPP or high interest rates again (ours are extremely competitive). And of course, it's all tax deductable.
If you know when you'll have the funds to pay your tax, you can also delay your payment and move to a date in the future using Tax Finance. With Tax Finance, you can look ahead and match your tax payments to seasonal highs. Meaning you can avoid things that have the power to set you and your business back – like bank overdrafts and loans.
With Tax Finance, you choose a date or dates in the future when you know you can pay your tax. You'll lock in a competitive interest rate that you pay upfront. You can rest easy knowing that as long as you settle the arrangement by the date TMNZ provides, your tax will show as paid on time with IR. No late payment penalties, and you will have saved considerably on interest.
Better for your cashflow, better for your business.
What if I've missed my provisional tax payment?
TMNZ can help to wipe late payment penalties and reduce your interest cost if you have underpaid or missed your provisional tax. Contact your accountant or tax agent and let them know you want to pay your missed or underpaid provisional tax using TMNZ tax pooling. Or get in touch to see how we can help.
As always, we recommend you speak to your accountant with any questions.
Information correct as at 15/07/2024
Syncing provisional tax to cashflow
As a self-employed painter and decorator, Bart Taylor knows full well how business owners can get themselves into strife if they don’t plan for their tax obligations.
He speaks from his own personal experience.
That’s why Bart is happy to talk about how TMNZ enables him as a self-employed tradesperson to take the stress out of having to pay provisional tax on dates dictated by Inland Revenue (IR).
TMNZ offers Bart the flexibility to make the payments when it suits his cashflow.
As someone who doesn’t always get paid every week, that’s important because it offers his business some breathing space while he waits for the money he’s earned from completed jobs to land in his bank account and ensures that other important invoices can be paid in the meantime.
A bit about Bart
Bart owns and operates his own business in Christchurch.
He’s a one-man band and that’s the way he likes it. Plus, most of his work means he does not require a crew, although he will occasionally use contractors when required or on larger jobs.
Bart has been his own boss since 2013, when, at the age of 24, he decided to make a go of this painting lark on his own. The market in the Garden City was awash with painting gigs during the rebuild and becoming self-employed seemed like a low-risk move.
Fast-forward nearly eight years and his gamble has paid off. He is enjoying the benefits that come with self-employment and, as a husband and father in a young family, the better work-life balance he has achieved.
Tough tax lessons
Yet that’s not to say that everything has been a bed of roses during that time.
“Becoming self-employed has been a bit of a rollercoaster. Lots of learnings, lots of difficult times, hard times,” says Bart.
“First and foremost, I’m a tradesman, so I am a worker. The back office, the organisation, the financial side of things is not my strong point. With the tax side of self-employment, I managed it very poorly for years because I was so young.”
Like other business owners, Bart wasn’t as prepared as he should have been and was “stung” in his second year of trading. That was when two years’ worth of tax was due. Ouch.
He admits having to pay provisional tax was “rough for a little while”.
“In the trade industry, you don’t always get paid every week and you need cashflow to run your business,” explains Bart.
“My accountant saw there was a risk of if we paid that tax bill in full, that I might fall short in other areas and he wanted to make sure that my relationship with my trade suppliers stay good and that the invoices I need to pay get paid on time, not just the IR ones.
“He recommended Tax Management NZ and that freed up cashflow.”
Breathing space from IR to manage cashflow
That’s because TMNZ gives Bart the flexibility to pay his provisional tax when it suits his business, without the consequences of steep IR interest and late payment penalties.
It operates with the blessing of the taxman, too.
TMNZ makes a date-stamped payment to IR on Bart’s behalf on the date his provisional tax is due. Bart pays TMNZ at a time when it suits his cashflow.
TMNZ transfers the date-stamped payment to Bart’s IR account and IR treats it as if Bart himself has paid on time. This eliminates any IR interest and late payment penalties showing on his account.
“Sometimes the option of TMNZ, to be able to borrow some money for a short period of time, to make sure you hit that IR deadline, frees you up with your cashflow until that payment [you are waiting on] comes through,” says Bart.
“The fee of using Tax Management NZ is so low and affordable in comparison to the failings of if you ran out of money in that time, or the scramble and the stress, so it’s definitely worth it.
“It’s changed my perception around making these tax payments. It takes the stress off of it.”
And how does dealing with TMNZ compare to dealing with IR?
“You get a bit more of a personal touch with Tax Management NZ because you get a prompt response and it’s not a cookie-cutter [reply].”
Bart is one of many small business owners throughout New Zealand who benefits from the provisional tax flexibility TMNZ offers. Get in touch for more information about our service or if you have any questions. We're happy to help. Alternatively, register with TMNZ to explore tax pooling for yourself.
Easy money for business not always the best option
Not long ago, one financial adviser was heard to lament the Kiwi habit of using the mortgage to fund the business. Others turn to bank overdrafts or their personal savings – all of which some might argue are easy choices to make but not necessarily the best.
Research by YouGov, commissioned by small business lending specialist Prospa, found that 69 percent of SMEs use personal finances for business purposes – including credit cards – and one in four borrows from family or friends.
Approximately 21 percent had drawn down on the mortgage.
The difficulty of securing business finance from banks in New Zealand is well documented, but before you borrow or mix personal and business finance, consider the options below.
Self-finance
Consider reducing your costs as a way to self-finance your business.
Businesses incur costs, such as small but regular payments that slip beneath the radar. Work with your accountant to identify unnecessary expenses and ways to save on costs — review operational details like slow collections, bad debtors, and redundant or excessive inventory.
One consequence of tight cashflow is the failure to pay taxes on time. This leads to expensive Inland Revenue (IR) interest and penalty payments. Tax pooling with TMNZ will help save you money in the long term because you avoid interest and penalties.
Research alternatives
Tax pooling is an alternative and financially cost-effective way to meet your tax payments on time, but there are also many other ways to get business finance.
Government loan schemes, discount invoicing (you administer your sales ledger) or factoring (the factoring company administers your ledger) merit thought.
Other options may include attracting investors or turning to a second or third-tier lender who is more expensive, but you may not be required to put your house on the line.
Review payment terms
Together with your accountant, consider negotiating better terms with your debtors while also reviewing your current payment terms. Simply changing your terms to, for example, seven days with all new customers – or getting the agreement of existing customers – could make a big difference to your finances.
Ultimately, it may be that mortgaging your house is your best option but get expert advice first because easier isn't necessarily better.
What is a cashflow forecast, exactly?
TMNZ has produced a guide called Better Cashflow Management. You can download your free copy here.
Most people nod in agreement when they hear the fable of the ant and the grasshopper – the ant worked all summer while the grasshopper lazed about, only for a starving grasshopper to come begging at the ant's door in winter.
However, it's surprising how few business leaders apply the common-sense lessons the fable teaches.
Many could be forgiven for thinking that the fable is about the value of hard work, and it is to an extent, but it is also a story about prediction and preparation – know what's coming and prepare for it.
Your stock standard cashflow forecast is an essential tool for this purpose.
In its most basic form, a cashflow forecast is a table that 'predicts', over a specific time, a) the money the business expects to receive, and b) the money the company expects to pay out – in essence, how much money you expect to have on hand in any given period.
The benefit of a cashflow forecast is that it allows you to predict the lean times, like winter for the ant, and the good times, like summer for the grasshopper. Summer and winter are pretty straightforward, but real-life business is far more complex and needs to consider, for example, factors like seasonal variables, capital expenditure and increases in expenses like rents.
A cashflow forecast is not a sales forecast, which concerns itself with predicted sales in the coming period and sometimes errs on the side of optimism.
The cashflow forecast should include expected sales but err on the side of conservative – sales aim for the stars, the cashflow forecaster settles for the moon.
1. Determine the period
The ant and the grasshopper concerned themselves with summer and winter. Business leaders will often prepare an annual cashflow forecast, but some argue it's best to take the ant's lead and forecast for a shorter period – even six months, or at least plan to review your cashflow forecast quarterly.
2. Predict your income
Look back over the last couple of years to get a handle on averages as well as the ebb and flow of cash, accounting for seasonal fluctuations and unforeseen variables that have impacted you in the past. Some would argue that basing your cashflow forecast on past performance is looking back, not forward, which is why using your sales forecast is important. Your historical financials may help you temper the optimism of the sale forecast towards realism.
3. Add your costs and outgoings
Don't leave out the small expenses because they quickly add up. Remember that not everybody pays on time. Kiwi SMEs wait on average 24.1 days to get paid, according to Xero's Small Business Insights for December 2020. Consider the risks associated with cost increases, like telephones and other fees. Plan for the best, expect the worst.
4. Put your cashflow forecast to work
A good cashflow forecast will give you an idea of what to expect so that you can prepare now to address any issues. If, like the ant, you note that the winter months of June, July and August will be tight, take steps to prepare better or improve the situation.
In the words of Sir Richard Branson, “Never take your eyes off the cashflow forecast because it's the lifeblood of the business”.